Human capital formation

Topic: Human Capital: Education, Health and Demographic Dividend · NCERT: Class 11, Ch 4 "Human Capital Formation in India"

Meaning

Human capital formation means adding to the stock of skill, knowledge and health in a country's people over time. It happens through investment in five sources: education, health, on-the-job training, migration and information.

It matters because healthy, skilled people produce more per hour of work. India has a large working-age population. Without enough human capital, that population cannot become a demographic dividend (the growth boost that comes from having many people of working age).

A key measure used here is returns to schooling:

• Return (%) = [(Earnings with the extra year − Earnings without it) ÷ Earnings without it] × 100

Explanation

Stock and flow: what is being "formed"

• Human capital is a stock. It is the skill, knowledge and health that people have at a point in time.
• Human capital formation is a flow. It is the addition made to that stock over a period.
• Human capital lives inside a person. You can sell a machine (physical capital) apart from its owner. You cannot separate a person's skills from the person.
• Class 8 NCERT treats labour as human capital. A worker is more than "hands". The worker's value grows when we invest in their skills and health.

The five sources (NCERT Class 11)

1. Education is the main source. It works like buying a machine.

• A firm buys a machine today to earn more profit later.
• Parents spend on schooling today so that the child earns a higher future income.
• So education spending is an investment, not just consumption.
• Worked example (returns to schooling):
• Worker A: 12 years of schooling, earns ₹2,00,000 a year.
• Worker B: 13 years of schooling, earns ₹2,20,000 a year.
• Return = (2,20,000 − 2,00,000) ÷ 2,00,000 × 100 = 10% for that extra year.
• The extra year is worth it if this return is more than its cost. The cost is the fees plus the wages given up while studying.

2. Health is the second major source.

• Sick worker → stays home → output is lost.
• A healthy worker works more days and works better.

• Health also raises the return on education. An educated worker who is sick cannot use their skills.

• There are four forms of health expenditure:

Form	Meaning	Example
Preventive medicine	Stops disease before it starts	Vaccination
Curative medicine	Treatment during illness	Hospital care
Social medicine	Spreading health literacy (knowing how to stay healthy)	Awareness campaigns
Water and sanitation	Clean water and good toilets	Piped water

3. On-the-job training

• This is training a firm gives its own workers after hiring them. It can be in-house (learning at the workplace under a skilled worker) or off-campus (the firm sends the worker to an outside course).
• It counts as human capital formation because the return (higher labour productivity) is more than the cost.
• Firm pays for training → firm fears the worker will leave → firm asks for a service bond (a promise to stay for a fixed period).
• Worked example:
• Training cost = ₹50,000. Extra output = ₹2,000 a month.
• Bond of 36 months → gain = ₹72,000 → net gain = ₹22,000. The training is worth it.
• If the worker leaves after 12 months → gain = ₹24,000 → the firm loses ₹26,000. This is why the bond exists.

4. Migration

• People move from low-wage places to high-wage places, for example from village to city or from India to another country.
• Travel and a higher cost of living are the costs. Moving is still worth it if the extra earnings are greater.

5. Information

• Labour market information means spending to learn about salaries, about which courses lead to jobs and at what cost, and about where health care is available and at what cost.
• It helps with two decisions:
• (a) whether and where to invest in human capital, e.g. which course to take and at which college;

• (b) how to use the human capital already acquired, e.g. which job fits your skills best.

• Without this information, people pay for courses that do not lead to jobs, and that money is wasted.

Partly social, partly a conscious choice (Box 4.1)

• Much human capital is formed when a person is too young to judge what is good for their future earnings. Parents and society choose the child's schooling and health care.
• Even at college (tertiary) level, peers, teachers and society shape the choice.
• College-level human capital builds on school-level human capital. If schooling is weak, college can add less.
• So human capital formation is partly a social process and partly a conscious decision of the person.
• What this means for policy:
• Children cannot choose for themselves, so the market alone will spend too little.
• The state must step in with free schooling, immunisation and clean water.

In India

• Planning era: from 1951 onwards, the Five-Year Plans treated education and health as social sectors run mainly by the state [1].
• Education spending: spending by the Centre and States together rose from 2.8% of GDP (2014-15) to 3.0% of GDP (2018-19 BE) [4]. BE means Budget Estimates (planned amounts, not final spending).
• NEP 2020 target: public investment in education by the Centre and all States together should reach 6% of GDP [8].
• Social services spending (education, health, housing, welfare and so on) rose from 6.7% of GDP (2017-18) to 7.8% of GDP (2023-24) [3].
• Health spending:
• Total Health Expenditure (THE) is all health spending by the government, households and others. In FY22 it was ₹9,04,461 crore, which is 3.8% of GDP and ₹6,602 per person [2].
• The government's share of THE rose from 29.0% (FY15) to 48.0% (FY22) [2].
• Government health spending rose from 1.4% of GDP (2017-18) to 1.9% of GDP (2023-24) [3].

• Economic Survey 2020-21 recommended raising public health spending from 1% to 2.5–3% of GDP [5].

• Preventive medicine: Mission Indradhanush (2015) aims to raise full immunisation under the Universal Immunisation Programme (UIP) to over 90% [7].

• By 2023, 12 phases had vaccinated 5.46 crore infants and 1.32 crore pregnant women across 765 districts [7].

• Intensified Mission Indradhanush (IMI) focuses more on urban areas and hard-to-reach groups. IMI 5.0 (2023) gave special focus to measles and rubella [7].

• Water and sanitation: Jal Jeevan Mission was launched on 15 August 2019 to give a tap connection to every rural home [6].

• As of 1 February 2025, 12.20 crore additional rural households had been connected under JJM, taking total coverage to 15.44 crore households, or 79.74% of rural households [6].

• Training:

• The National Apprenticeship Promotion Scheme (NAPS) replaced the Apprentice Protsahan Yojana (APY) [10]. An apprenticeship is training by working inside a real firm while learning.
• PMKVY and NAPS are run by the Ministry of Skill Development and Entrepreneurship (MSDE) under the Skill India Mission [11].

• NEP 2020 wants at least 50% of learners to get exposure to vocational education (training for a specific trade or job) by 2025. It also wants vocational education merged into mainstream education [9].

• Information: the National Career Service (NCS) Portal brings jobseekers and employers onto one platform. It offers job matching, career counselling and information on skill courses [11]. It crossed 2 million (20 lakh) active vacancies (2024) [12].

Don't confuse with

• Human capital: this is the stock at a point in time. Human capital formation is the flow, meaning the addition made to the stock over a period.
• Physical capital formation: this means adding machines, buildings and roads. Physical capital can be separated from its owner and sold. Human capital cannot be separated from the person.
• Human development: this treats education and health as ends in themselves, because they are part of human well-being. Human capital formation treats them as means to raise productivity and income.
• Demographic dividend: this is the growth boost from a large working-age population. It is an outcome that is possible only if human capital formation makes those workers skilled and healthy.

Prelims Hooks

• NCERT Class 11 names five sources: education, health, on-the-job training, migration and information. Education and health are the two major ones.
• Returns to schooling = the extra earnings from each additional year of schooling.
• Trap: vaccination = preventive medicine, not curative. Awareness campaigns = social medicine. Water and sanitation is the fourth form of health spending.
• "Human capital formation is purely an individual choice." False. It is partly a social process (Box 4.1).
• On-the-job training counts because return > cost. Firms recover the cost through a fixed service period (bond).
• NAPS replaced the Apprentice Protsahan Yojana [10]. The NCS Portal is the government's job-matching and career-information platform, i.e. the "information" source [11]. The government's share of THE rose from 29.0% (FY15) to 48.0% (FY22) [2].

Mains Points

• India spends too little:
• Education is about 3.0% of GDP (2018-19 BE) against the 6% NEP 2020 target [4][8].
• Public health spending is 1.9% of GDP (2023-24) against the 2.5–3% recommended by Economic Survey 2020-21 [3][5].

• A low stock of human capital means the demographic dividend may be lost.

• Why the state must lead:

• Children cannot choose their own schooling or health care (Box 4.1).
• Education and health also benefit society beyond the individual. These are positive externalities (benefits that spill over to others who did not pay for them).

• So private markets under-supply them. A rising government share of THE (29% → 48%, FY15–FY22) cuts out-of-pocket spending (money families pay from their own pocket), so fewer families fall into debt because of illness [2].

• Prevention, training and information are cheaper than repair:

• Vaccination (Mission Indradhanush) and piped water (JJM, 79.74% rural coverage by 1 February 2025) protect labour supply at a lower cost than hospital care later [6][7].
• Firms train less because they fear trained workers will leave. Apprenticeships (NAPS) help fix this [10].
• Poor job information leads to wrong course choices. The NCS Portal reduces this skill mismatch [11][12].

Related concepts

• Investment in education
• Health expenditure
• On-the-job training
• Training
• Labour market information

Read more

• Sources of human capital formation: education, health, training, information