By Sami Mubarak
What comes to mind when you hear the word capital? Buildings? Machinery? Money?
Capital is an essential ingredient for an economy to grow. But along with physical capital, there are other types of capitals, such as natural capital (land, minerals, the atmosphere, fresh waters, oceans, etc.) and human capital. All are crucial for determining a country’s long-term sustainable economic development.
Why is human capital important?
Human capital is the knowledge, skills and attributes within people that allow the creation of personal, economic and social well-being. Measuring its value is arguably the hardest of the capitals but it is essential for understanding the drivers of a country’s economic growth and for determining its long-term sustainable development path.
Imagine that a country imports the most state-of-the-art supercomputer as physical capital to allow genomic sequencing (a technique used to look at an organism’s or a virus’ DNA sequence). The addition of the computer will undoubtedly increase the total amount (or “stock”) of physical capital this country has at its disposal. If used properly, this technology can track viral mutations to help safeguard and improve the health of the country’s citizens.
Now imagine that this country loses its medical researchers – through a combination of retirement, emigration, and death. The loss of these researchers also means loss of the knowledge and skills to use this machine and understand its results. This scenario would therefore result in a loss to the country’s human capital stock as no one is able to utilise this sophisticated piece of technology and harness its benefits. This is why measuring the stock of human capital and understanding why it changes over time is just as important as measuring the physical capital that they use.
How can we calculate the value of human capital?
There are well-established methods for calculating a country’s stock of human capital. These methods include the Income-Based Approach used by the Office for National Statistics (ONS) to produce the UK’s annual estimates of human capital stock. For example, the value of the UK’s human capital stock in 2022 was £25.5 trillion in real terms (the effect of inflation has been removed from this figure). To put this figure in context, the UK’s Gross Domestic Product (GDP) – the most well-known measure of economic progress – was estimated to be £2.27 trillion in real terms in the same year.
ONS’ method of calculating the UK’s human capital stock involves projecting individuals’ discounted lifetime labour earnings into the future based on their sex, age and highest qualification level. This produces an estimate of the present value of potential labour earnings a person can gain in their lifetime. This is then taken as the value of the person’s human capital. All individuals’ human capital values in the working-age population (those aged 16 to 65) are brought together to give the UK’s stock of human capital.
Our research
Alongside the concept of stocks (which are measured at a point in time), there are also economic flows (measured over a period of time) which help to explain the change in the stock from one year to the next. However, until recently, there has been less agreement or research on how to identify and measure the economic flows associated with the human capital stock.
This is a very important topic and is the focus of our new ESCoE Discussion paper. In this paper, we attempt to identify and estimate the causes of the change in the UK’s annual human capital stock from 2005 to 2020 and present their contributions to human capital stock growth. We also propose methods to introduce these changes by categorising them in the economic flows defined in the System of National Accounts 2008 (the framework underpinning the measurement of GDP). These are labelled Gross Capital Formation, Capital Consumption, Revaluations and Other Changes in Volume.
Our research also focuses on population effects on the human capital stock – including shifts in the composition of the working-age population, net changes in economic activity and the effects of death and retirement – as well as changes in people’s earnings from employment.
What did we find?
We found that the largest positive contributors to the growth in the UK’s human capital stock are:
- Growth in average total earnings.
- The change in the highest qualification composition of the working-age population – that is, an increase in the proportion of workers with higher levels of education.
- The inflows of new sixteen-year-olds joining the working-age population each year.
The main negative contributors to the UK’s human capital stock growth are:
- The “ageing effect” (the amount of lifetime earnings lost due to people becoming a year older).
- The change in the age composition of the working-age population (an increase in the proportion of older workers in the working-age population).
Unfortunately, we were unable to estimate the exact effects of net migration on the UK’s human capital stock for this research. This is due to data availability within ONS’ human capital stocks system, which may improve in the future. However, we believe that our paper provides a useful starting point to measure this phenomenon, which others could build on.
Why does it matter?
This research provides a foundation for further work and inspires others to investigate this important area of economic measurement aligned with the ESCoE research project on Beyond GDP and Inclusive Wealth. At ONS, we aim to include some results from this paper in our new measures of sustainable economic progress, Inclusive Income. These build on GDP to incorporate the flows of benefits from produced (physical) capital, human capital and natural capital.
Sami Mubarak is an economist at the Office for National Statistics.
ESCoE blogs are published to further debate. Any views expressed are solely those of the author(s) and so cannot be taken to represent those of the ESCoE, its partner institutions or the Office for National Statistics.