Human Resource Economics Research Paper Starter

Human Resource Economics

(Research Starters)

When firms hire workers they are, knowingly or unknowingly, acquiring human capital. The idea is far from new but only recently has it acquired enough stature to be considered a factor of production in its own right. Human Capital Theory and the Resource View of Firm maintain that to prosper, a business must create value in ways that rivals cannot. The wellspring of innovative thinking this requires is the knowledge worker capable of 'learning by doing.' Such at least is the current economic thinking that drives the more traditional human resource function of screening, selection, training and development.

Keywords Core Competency; Cost-Based Valuation; Educational Stock; Factors of Production; Human Capital; Human Capital Theory; Human Resources; Income-Based Valuation; Resource-Based View of the Theory of the Firm; Sustainable Competitive Advantage; Tacit Knowledge; The Resource-Based View of the Firm; Theory of Production

Economics: Human Resource Economics


We live in a 'post-industrial' age where our individual and collective prosperity increasingly depends on how well or ill we acclimate to the 'knowledge' economy. But in order to succeed at this, we will have to see ourselves as more than just hard-working members of the labor force. High wages and steady employment will increasingly go to those of us who think of themselves as an investment in 'human' capital. We must, in a word, build a sophisticated 'skills-set' that adds value to prospective employers' products and services. The alternative is to become a casualty of the onward rush of technology and globalization and eke out an uncertain living at a succession of low-paying jobs. It's a grim choice with a decidedly contemporary edge to it. Actually, though, the idea of people as 'human' capital was discussed in 1776 by the 'father' of classical economics, Adam Smith in An Inquiry into the Nature and Causes of the Wealth of Nations.

Any worker who invests time and effort into mastering a skill, Smith maintained, has a right to a wage over and above a common laborer's. To Smith, this higher wage was just compensation not only for the years of grueling apprenticeship the worker endured to become a tradesman but also for the immediate gratification of other needs that he willingly postponed (Wöβmann, 2003). Over the next two centuries, then, economists considered learning a form of consumption driven by a particular individual's utility function — the sum of goods, services and activities afforded by working that each of us finds uniquely satisfying. To this day, ambitious people forgo income and leisure time to undertake years of demanding academic training to maximize their long term utility. But today, pivotally, this is seen as an investment in 'human capital' rather than a household purchase-decision.

Human Capital

What exactly though is 'human capital'? The formal concept arose in the 1960s out of the work of two American economists, Theodore Schultz and Gary Becker. Schultz had observed how parents in rural households willingly chose to sacrifice their own material comfort in order to finance their children's college educations, so convinced were they that the improved earning powers a degree would bestow on their offspring. Both he and Becker was struck by how their decisions were really no different than a firm's forward-looking decision to re-invest profits in new plant and equipment. The two, in fact, were so similar, they further concluded, that intangible knowledge and concrete physical capital actually mirrored each other in key respects. That very idea was the centerpiece of Becker's ground-breaking 1962 book, Investment in Human Capital: a Theoretical Analysis.

It was a timely introduction, for the traditional factors of production — land, labor and physical capital — added together no longer accounted for all the yearly growth in gross domestic product recorded for the U.S. economy in the 1950s. Initially at a loss to explain the growing discrepancy, economists assigned it the non-descript label, the 'residual' factor. Human capital proved a far more satisfying theoretical explanation (Nafukho, Hairston & Brooks 2004). One that, in hindsight, correctly assessed the pivotal importance technology would assume in production, service-delivery and information processing in the coming decades (Iacob & Andrei, 2011).

Human Capital Theory

Crucially, though, Human Capital Theory as it became known was applied only to the household and the nation as a whole. The firm, the source of all the productive capacity and most of the employment in a national economy, was yet to be incorporated. Still, as originally formulated, it did bridge the labor-capital divide prevalent in previous economic thinking on the subject. Education and training no longer necessarily belonged in the broader definition of labor, which stemmed from the axiom that work could be both mental and/or manual. Knowledge gleaned from a firm's direct experience with production processes, alternatively, no longer had to necessarily be considered a form of physical capital.

Amendment to the Theory of Production

Before the construct could be applied to the firm, though, one of the most basic models in all of microeconomics — the Theory of Production — would first have to be amended. It conceives the firm strictly as a production 'function' where profits are maximized by turning raw materials, labor and fixed capital goods, its 'inputs', into goods and services, it 'outputs'. Whether a business succeeds or fails depends on its ability to simultaneously minimize short-run costs and maximize both short- and long-run profits. To do this, it has to decide the price it will charge and how much to produce. These decisions, in turn, are heavily influenced by the rents, wages and interest it must pay out and the quantities of each productive factor it will require to meet its output quota.

The Resource-Based View

It would take another twenty years for a successor model, the resource-based view of the firm, to come along. Here, a firm is the sum of the strategic resources available to it. And, significantly, many of these are decidedly less tangible forms of assets than the usual plant, equipment, financial capital, etc. Resources like organizational processes, knowledge, technical expertise, in fact, contribute more towards building a sustainable competitive advantage, provided, that is, they are rare, inimitable and non-substitutable. So the morphing of the traditional personnel department into its modern human-resources re-incarnation is more than just cosmetic. For, fundamentally, the processes, knowledge, technical expertise and other strategic resources vital to the survival of today's firm are the product of its human capital (Crook, Combs, Todd, Woehr & Ketchen, 2011). A company has to either make or buy it and retain and encourage it thereafter. And therein lies the reason for the name change.

Further Insights

Compared to Human Capital Theory, marginal analysis, the prevailing neoclassical construct of its day, comes across as mechanistic and one-dimensional. As well it might considering how simple the basic idea behind it is: The amount of output created by one additional unit of input of labor or capital is a very useful measure. And that's because all a firm has to do to maximize its profits is ensure its marginal costs equal its marginal revenues. Formulated at the turn of the twentieth century, it bears all the hallmarks of the era of mass industrialization when most of the labor employed in manufacturing was unskilled and therefore homogeneous. The labor force since then, of course, has grown ever more heterogeneous and the attendant wage differentials among workers more pronounced (Teixeira, 2002). Though not as quantitative perhaps, Human Capital Theory acknowledges this changed reality. Firms that embrace it, moreover, do so because by investing in human capital, a firm is better able to increase its productivity while keeping its wages relatively constant, a sure route to profitability in the twenty-first century.

The Valuation Problem

Still, human capital is an intangible product of the mind and therefore cannot be quantified as easily as rents, wages or investments in plant and equipment. Yet, if it is a full-fledged factor of production as its supporters contend, it must have monetary...

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