Economic debates often revolve around financial capital — savings rates, investment flows, and the mountain of funds managed in global markets. But a landmark body of research shows that human capital — the skills, knowledge, and capabilities of people — is far more critical for driving productivity and prosperity.
When we measure economic growth through Total Factor Productivity (TFP), human capital doesn’t just contribute directly to output — it amplifies the effect of TFP differences across countries. The implication is clear: both for national governments and individual citizens, building human capital should be the priority. Here’s why.
The Evidence: Human Capital Multiplies TFP Gains
Erosa, Koreshkova, and Restuccia’s quantitative theory of human capital investment finds that:
- Without considering human capital, explaining a 20-fold income gap between rich and poor countries would require an 18-fold difference in TFP in the tradable sector.
- Once human capital accumulation is included, a mere 5-fold difference in TFP is enough to generate the same 20-fold income gap.
- That means human capital almost quadruples the productivity impact — turning modest TFP gains into dramatic output increases.
The mechanism is straightforward: higher TFP raises the returns to education and skills, prompting greater investment in people’s capabilities. This, in turn, increases physical capital returns, driving even more growth.
Sectoral Productivity and Education Costs
Not all productivity gains are created equal. The study also shows that:
- Poorer countries often have relatively higher productivity in services (non-tradables) than in manufacturing (tradables).
- Since education is service-intensive, this can offset some of the damage of low overall productivity — but it’s not enough to close the gap without active human capital investment policies.
- The cost and quality of education — both formal and informal — strongly determine how responsive human capital is to TFP improvements.
Why Governments Should Focus Here
For policymakers, the takeaway is that investing in human capital development yields disproportionate economic returns compared to policies focused only on physical or financial capital. That means:
- High-quality education at all stages of life, not just basic literacy.
- Accessibility — removing financial and geographic barriers to skills training.
- Alignment between skills taught and the needs of the economy, ensuring that education boosts actual productivity.
- Support for non-formal learning — health, nutrition, and home learning environments are significant contributors to human capital.
Why Citizens Should Care
For individuals, the same principle applies. Over a lifetime, your capacity to earn (human capital) is typically ten times greater than the total amount you will save (financial capital).
Focusing on developing marketable skills, adaptability, and problem-solving capacity will do more for your lifetime financial security than chasing higher investment returns on your savings alone.
The Big Shift We Need
We often talk about growing GDP by “mobilising capital.” But the data says: mobilise people first. Every pound, dollar, or euro invested in education, training, and skills not only raises immediate productivity — it amplifies the effect of any future technological or capital investment.
In other words, financial capital without human capital is like a high-tech machine with no skilled operator: the potential is there, but it’s wasted.
If national growth strategies — and household financial plans — put human capital front and centre, the long-term payoff is not just higher incomes, but more resilient, equitable, and innovative economies.
References:
Erosa, A., Koreshkova, T., & Restuccia, D. (2009). How Important Is Human Capital? A Quantitative Theory Assessment of World Income Inequality. IMDEA Working Papers.
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