Introduction to Physical Capital and Human Capital
Capital refers to the wealth, i.e. assets or money that a company owns and which is used to either commence a new business venture or invest in an existing one. Capital is the life force of any corporation; it helps a business to maintain its liquidity while growing in stature. Generally, capital is referred to the physical assets in a company. However, a new concept of human capital has been introduced as well.
The difference between physical capital and human capital is as clear as day. Physical capital refers to a wealth that is tangible like machinery, buildings, money, furniture, etc. On the other hand, the concept of human capital is new. It implies the skill, abilities, and knowledge of individual employees, which is used by companies to meet their future goals. The company does not own this type of capital. Instead, they avail it against adequate remuneration.
While the value of human capital in terms of money is not easy to measure, the influence of investments in it can be calculated and analyzed. Similar ratios used to measure and evaluate the performance of investments in physical capitals are also used in the case of human capital. Investments in both of these capitals lead to fundamental improvements in a business and better chances of achieving long-term goals.
Therefore, before moving on to the difference between physical and human capital, you need to know the definition of these capitals and what they represent.
Physical Capital
In economics, the term ‘physical capital’ represents the inputs, i.e. factors of production or human-made items that are owned by the business like machinery, properties, buildings, furniture, electronic items, and others which are used to convert raw materials into finished goods.
To commence a business, a substantial amount of investments is made to procure the necessary physical capital. It helps a company to start its production of goods and services and helps it to strengthen its position in the market.
After acquiring ample knowledge and calculating the outcome, an investment in physical capital is made. An owner or entrepreneur calculates the expected return from the investments that he/she is making and based on that calculation selects the option, which offers a relatively higher return. Therefore, it can be stated that the ownership of any physical capital is a product of planning and conscious decision-making.
Human Capital
Human capital implies the personal abilities that an employee brings to his/her organization. It is in the form of skills, knowledge, experience, expertise, intelligence, attitude, professionalism, value, and ethics, etc. As a result, employees are considered as assets whose value can be augmented via further training and development.
In simpler words, it portrays the cumulative value of a company’s intellectual capital. This capital is a constant source of innovation and creative solutions. This standard is used to determine the value of an individual’s skill set. However, this concept also makes it clear that every employee is not equal. They are differentiated based on what they bring to the company.
Companies do not own human capital. Instead, they rent it from their employees. Therefore, uncertainty surrounds this capital because when an employee leaves a company, it loses a portion of its human capital.
Physical Capital versus the Human Capital
Physical and Human Capital are different and are both essential for an organization. There is a substantial difference between these two capitals; they are outlined below –
Meaning
Physical capital means an organization’s non-human assets such as buildings, land, plant and machinery, furniture, electronic items, office supplies, etc. In a nutshell, every non-human asset that plays a role in production can be labeled as physical capital.
Contrarily, human capital is classified by the attributes that employees bring to a company. It is a culmination of talent, skill, knowledge, experience, abilities, attitude, etc.
Nature
The nature of physical capital is tangible, which means it can be seen and touched. Whereas human capital is intangible, i.e. it cannot be felt and seen. It can only be visible through the inputs and outputs of individual employees. Human capital can be enhanced through training and skill development.
Formation
The formation process is a significant difference between human capital and physical capital. The formation of human capital is not an industrial process; it is a social one. Additionally, it is also a result of the decision-making of an entrepreneur or manager. Recruitment and training play a big role in building up human capital.
On the other hand, the formation of physical capital is an industrial process along with an economic decision taken by the entrepreneur.
Tradability
Physical capital can be sold in the open market like any other commodity. However, human capital cannot be traded. It is the service that is sold.
Separability
Physical capital can be separated from its owner, but human capital is inseparable. In other words, physical capital is not bound to a person while human capital is an intrinsic part of a person and cannot be separated from the individual.
Financial Statement
Physical capital appears on the financial statement of the company. However, human capital does not appear on any financial statement.
Mobility
Mobility is a significant point that distinguishes between physical and human capital. Physical capital may be mobile, apart from certain government restrictions. Whereas, human capital is not portable. It is primarily restricted by nationality and immigration and relocation laws. Human capital cannot be easily transported like physical capital as the will of an individual also becomes a deciding factor for the move.
Depreciation
Both of these capitals go through depreciation, but the reasons are not the same. Physical capital is deprecated owing to its regular use. However, human capital is depreciated due to aging.
Both physical and human capitals are the building blocks of any successful enterprise. Any company that can seamlessly integrate these two will achieve its targets more efficiently. In terms of economics, the difference between physical capital and human capital is a vital chapter. Apart from this, for other topics related to economics and commerce, students can visit the official website of Vedantu.
FAQs on Physical vs. Human Capital: Key Differences
1. What is the core definition of physical capital in economics?
In economics, physical capital refers to the tangible, human-made assets that a business owns and uses in the production of goods and services. These are non-human assets that facilitate economic activity. Examples include machinery, factory buildings, office equipment, vehicles, and infrastructure. Physical capital is recorded on a company's balance sheet and is a result of investment and conscious economic decision-making.
2. What does human capital represent for an organisation?
Human capital represents the intangible collective value of an organisation's workforce. It is the sum of attributes, knowledge, skills, experience, and health that individuals possess, which contribute to economic productivity. Unlike physical capital, human capital cannot be owned by the company; it is 'rented' from employees in exchange for salaries and benefits. It is enhanced through education, training, and healthcare.
3. What are some clear examples of physical vs. human capital in a software company?
In a typical software company, the distinction is very clear:
- Physical Capital Examples: This includes the office building, employee laptops and computers, servers, office furniture, and company vehicles. These are all tangible assets required for operations.
- Human Capital Examples: This includes the programming skills of the developers, the project management expertise of the managers, the design abilities of the UX/UI team, and the collective problem-solving and innovative capacity of the entire staff.
4. How is physical capital different from human capital based on key attributes?
The primary differences between physical and human capital can be understood across several attributes:
- Nature: Physical capital is tangible (can be touched), while human capital is intangible (resides in people's minds and abilities).
- Separability: Physical capital can be easily separated from its owner and sold. Human capital is inseparable from the individual.
- Formation: Physical capital is formed through an economic and technical process. Human capital formation is a social process involving education and health.
- Mobility: Physical capital is generally mobile, whereas human capital's mobility is restricted by personal choice, nationality, and culture.
- Depreciation: Physical capital depreciates from constant use and technological obsolescence. Human capital can depreciate due to ageing but can also appreciate with experience and training.
5. How is capital formation different for physical and human capital?
The process of capital formation is fundamentally different for both. The formation of physical capital is a conscious economic decision made by an entrepreneur or company to invest money in acquiring tangible assets like machinery or buildings. It is primarily an economic and technical process. In contrast, the formation of human capital is a socio-economic process. It is a result of an individual's conscious decision to invest in their own education, skills, and health, often supported by society and government spending on schools and healthcare.
6. Why is human capital considered inseparable from its owner, unlike physical capital?
Human capital is considered inseparable because it is an intrinsic part of a person. An individual's skills, knowledge, and experience cannot be detached from them and sold as a separate commodity. A company can only access these skills through the individual's labour. In contrast, physical capital, such as a machine or a building, is an external object that can be bought, sold, or transferred between owners without affecting the original owner's existence.
7. Can a company truly 'own' human capital? Explain the concept of 'renting' skills.
No, a company cannot truly 'own' human capital in the way it owns physical assets. The concept of 'renting' skills is used to explain this relationship. A company pays a salary or wage to an employee in exchange for access to their skills, knowledge, and labour for a specific period. The employee is free to leave, taking their human capital with them. This is why employee turnover represents a loss of human capital for a company, a risk not associated with physical capital like machinery.
8. How does investment in human capital (like training) compare to investment in physical capital (like a new machine) for a business?
Both investments aim to increase productivity, but they function differently. Investing in a new machine (physical capital) can lead to immediate and predictable increases in output. The return on investment is often easier to calculate. Investing in employee training (human capital) can lead to improved innovation, efficiency, and problem-solving, but the returns might be less direct and harder to measure. However, a well-trained, motivated workforce can create a more sustainable competitive advantage than physical assets alone, which competitors can also acquire.
9. How does the depreciation of physical capital contrast with that of human capital?
The nature of depreciation is a key point of contrast. Physical capital depreciates due to continuous use (wear and tear) or because it becomes technologically obsolete. For example, an old computer becomes slower and less useful. Human capital, on the other hand, can also depreciate with age or if skills become outdated. However, unlike physical capital, it can also appreciate through continuous learning, experience, and acquiring new skills, potentially making an employee more valuable over time.
10. How does physical capital differ from other economic capitals like financial and natural capital?
Physical capital is distinct from other forms of capital:
- vs. Financial Capital: Financial capital refers to money, stocks, and bonds used to purchase physical capital. It is a facilitator, not a direct factor of production. Physical capital (the machine) is what you buy with financial capital (the loan).
- vs. Natural Capital: Natural capital refers to the world's stock of natural assets, such as forests, water, and minerals. Physical capital is human-made, whereas natural capital is a pre-existing resource from which economic value can be derived.
