Human Capital Formation In India | Class 12 Indian Economic Development Notes
Human Capital Formation is a core chapter in the Class 12 Indian Economic Development syllabus. These notes explain what human capital is, how a country builds it through education, health, training and migration, and why it matters for growth and development. For more chapter notes, see our Class 12 Economics notes.
What is Human Capital?
Just as a country can turn physical resources like land into physical capital like factories, similarly it can also turn human resources like students into human capital like engineers and doctors.
Societies need sufficient human capital in the first place, in the form of competent people who have themselves been educated and trained as professors and other professionals.
In other words, we need good human capital to produce other human capital. This means that we need investment in human capital to produce more human capital out of human resources.
Sources of Human Capital
Investment in education is considered one of the main sources of human capital. There are several other sources as well:
- Investment in health
- On-the-job training
- Migration
- Information
These are the other sources of human capital formation. Individuals invest in education with the objective of increasing their future income.
Investment in Health
Like education, health is also considered an important input for the development of a nation, as much as it is important for the development of an individual. Hence, expenditure on health is an important source of human capital formation.
Preventive medicine (vaccination), curative medicine, social medicine and the provision of clean drinking water and good sanitation are the various forms of health expenditure. Health expenditure directly increases the supply of a healthy labour force and is, thus, a source of human capital formation.
On-the-Job Training
Firms spend on giving on-the-job training to their workers. This may take different forms: one, the workers may be trained inside the firm itself under the supervision of a skilled worker; two, the workers may be sent for off-campus training. In both these cases firms incur some expenses.
Firms will, thus, insist that the workers should work for a specific period of time after their on-the-job training, during which the firm can recover the benefits of the enhanced productivity owing to the training. Expenditure on on-the-job training is a source of human capital formation, as the return on such expenditure in the form of enhanced labour productivity is more than the cost of it.
Why do people migrate?
People migrate in search of jobs that fetch them higher salaries than what they may get in their native places. Unemployment is one reason for the rural-urban migration in India. Technically qualified persons, like engineers and doctors, migrate to other countries because of the higher salaries they may get in such countries.
Migration in both these cases involves the cost of transport, a higher cost of living in the migrated places, and the psychic costs of living in a strange socio-cultural setup. The enhanced earnings in the new place outweigh the costs of migration. Hence, expenditure on migration is also a source of human capital formation.
Physical and Human Capital
Both forms of capital formation are outcomes of conscious investment decisions. The decision regarding investment in physical capital is taken on the basis of one's knowledge in this regard. The entrepreneur possesses the knowledge to calculate the expected rates of return to a range of investments, and then rationally decides which one of the investments should be made.
The ownership of physical capital is the outcome of the conscious decision of the owner, so physical capital formation is mainly an economic and technical process. A substantial part of human capital formation, however, takes place in one's life when he or she is unable to decide whether it would maximise future earnings.
Children are given different types of school education and health care facilities by their parents and by society. Peers, educators and society influence the decisions regarding human capital investments even at the tertiary level, that is, at the college level. Moreover, human capital formation at this stage depends upon the human capital already formed at the school level. Human capital formation is therefore partly a social process and partly a conscious decision of the possessor of the human capital.
Differences between Physical and Human Capital
- Physical capital is tangible and can be easily sold in the market like any other commodity. Human capital is intangible; it is built into the body and mind of its owner and is not sold in the market. Only the services of human capital are sold, and hence the owner of the human capital must be present at the place of production.
- Physical capital is separable from its owner, whereas human capital is inseparable from its owner.
- The two forms of capital differ in terms of mobility across space. Physical capital is completely mobile between countries, except for some artificial trade restrictions. Human capital is not perfectly mobile between countries, as movement is restricted by nationality and culture. Therefore, physical capital formation can be built even through imports, whereas human capital formation has to be done through conscious policy formulation in line with the nature of the society and the economy, and through expenditure by the state and by individuals.
- Both forms of capital depreciate with time, but the nature of depreciation differs. Continuous use of a machine leads to depreciation, and a change of technology makes a machine obsolete. In the case of human capital, depreciation takes place with ageing, but it can be reduced to a large extent through continuous investment in education, health and so on. This investment also helps human capital cope with changes in technology, which is not the case with physical capital.
Human Capital and Economic Growth
Economic growth means the increase in the real national income of a country. Naturally, the contribution of an educated person to economic growth is more than that of an illiterate person. If a healthy person can provide an uninterrupted labour supply for a longer period of time, then health is also an important factor for economic growth.
India as a Knowledge Economy
The Indian software industry has shown an impressive record over the past decades. Entrepreneurs, bureaucrats and politicians now advance views about how India can transform itself into a knowledge-based economy by using information technology (IT). There have been some instances of villagers using e-mail, which are cited as examples of such transformation. Likewise, e-governance is being projected as the way of the future. However, the value of IT depends greatly on the existing level of economic development.
Human Capital and Human Development
The two terms sound similar, but there is a clear distinction between them. Human capital considers education and health as a means to increase labour productivity. Human development is based on the idea that education and health are integral to human well-being, because only when people have the ability to read and write, and the ability to lead a long and healthy life, will they be able to make other choices which they value.
In the human capital view, any investment in education and health is unproductive if it does not enhance the output of goods and services. In the human development perspective, human beings are ends in themselves. Human welfare should be increased through investments in education and health even if such investments do not result in higher labour productivity. Therefore, basic education and basic health are important in themselves, irrespective of their contribution to labour productivity. In such a view, every individual has a right to basic education and basic health care, that is, every individual has a right to be literate and to lead a healthy life.
State of Human Capital Formation in India
The Constitution of India mentions the functions to be carried out by each level of government. Accordingly, expenditure on both education and health is to be carried out simultaneously by all three tiers of the government.
In India, the ministries of education at the union and state level, the departments of education, and various organisations like the National Council of Educational Research and Training (NCERT), the University Grants Commission (UGC) and the All India Council for Technical Education (AICTE) facilitate the institutions that come under the education sector. Similarly, the ministries of health at the union and state level, the departments of health, and various organisations like the Indian Council of Medical Research (ICMR) facilitate the institutions that come under the health sector.
In a developing country like ours, with a large section of the population living below the poverty line, many people cannot afford to access basic education and health care facilities. Moreover, a substantial section of our people cannot afford to reach super-specialty health care and higher education. Furthermore, when basic education and health care are considered a right of citizens, then it is essential that the government should provide education and health services free of cost for the deserving citizens and those from the socially oppressed classes.
Both the union and state governments have been stepping up expenditure in the education sector over the years, in order to fulfil the objective of attaining full literacy and considerably increasing the average educational attainment of Indians.
Education Sector in India
The percentage of education expenditure out of total government expenditure indicates the importance of education in the scheme of things before the government. The percentage of education expenditure out of GDP expresses how much of our income is being committed to the development of education in the country.
During 1952-2002, education expenditure as a percentage of total government expenditure increased from 7.92 to 13.17, and as a percentage of GDP it increased from 0.64 to 4.02. Throughout this period the increase in education expenditure was not uniform, and there was an irregular rise and fall. If we add the private expenditure incurred by individuals and by philanthropic institutions, the total education expenditure would be much higher.
Elementary education takes a major share of total education expenditure, and the share of higher or tertiary education is the least. Although, on average, the government spends less on tertiary education, the expenditure per student in tertiary education is higher than that in elementary education. This does not mean that financial resources should be transferred from tertiary education to elementary education. As we expand school education, we need more teachers who are trained in higher educational institutions; therefore, expenditure on all levels of education should be increased.
The per capita education expenditure differs considerably across states, from as high as Rs 3,440 in Lakshadweep to as low as Rs 386 in Bihar. This leads to differences in educational opportunities and attainments across states.
Future Prospects
Education for All: Still a Distant Dream
Though literacy rates for both adults and youth have increased, the absolute number of illiterates in India is still as large as India's population was at the time of independence. In 1950, when the Constitution of India was passed by the Constituent Assembly, it was noted in the Directive Principles of the Constitution that the government should provide free and compulsory education for all children up to the age of 14 years, within 10 years from the commencement of the Constitution. Had we achieved this, we would have had full literacy by now.
Gender Equity: Better than Before
The differences in literacy rates between males and females are narrowing, which signifies a positive development in gender equity. Still, the need to promote education for women in India is pressing, for various reasons such as improving the economic independence and social status of women, and also because women's education makes a favourable impact on the fertility rate and on the health care of women and children. Therefore, we cannot be complacent about the upward movement in literacy rates, and we still have miles to go in achieving full adult literacy.
Higher Education: A Few Takers
The Indian education pyramid is steep, indicating that fewer and fewer people reach the higher education level. Moreover, the level of unemployment among educated youth is the highest. As per NSSO data, in the year 2000, the rate of unemployment among youth with education up to secondary level and above was 7.1 per cent, whereas the rate of unemployment for youth with education up to primary level was only 1.2 per cent. Therefore, the government should increase the allocation for higher education, and also improve the standard of higher education institutions, so that students are given employable skills in such institutions.
Why it still matters
This chapter is not just old theory. It sits at the centre of one of the biggest questions facing India right now. In 2023, India became the world's most populous country, and it is also one of the youngest. Around two-thirds of Indians are of working age, and the median age is only about 28 years. Economists call this a demographic dividend: a rare window in which a country has many more workers than dependents, which can push up incomes and savings.
Here is the catch, and it is exactly what this chapter is about. A large young population only becomes an advantage if those young people are healthy, educated and skilled. In other words, the demographic dividend pays off only if India invests in human capital formation. If it does not, the same youth bulge can turn into large-scale unemployment instead.
That is why education spending is a live debate today. The National Education Policy (NEP) 2020 set a target of spending 6 per cent of GDP on education. India has still not reached that target, and combined public spending on education has stayed below it for decades. In the Union Budget 2025-26, the central government allocated about Rs 1.28 lakh crore to the education sector, a rise of roughly 6.65 per cent over the previous year, with new money for skilling, more medical seats and IITs. The figures in the older part of these notes, where education expenditure climbs from 0.64 to around 4 per cent of GDP, are the beginning of the very same story that is still argued over in Parliament and in every budget.
So when you read here about investment in education, health and on-the-job training, you are reading about the choices that will decide whether India's youth become its greatest strength. To see how school subjects connect to real careers and the wider economy, explore the Learnacy Hub, and browse more study material in our resources library.
Conclusion
The economic and social benefits of human capital formation and human development are well known. The union and state governments in India have been earmarking substantial financial outlays for the development of the education and health sectors. The spread of education and health services across different sections of society should be ensured, so as to attain economic growth and equity at the same time. India has a rich stock of scientific and technical manpower in the world. The need of the hour is to improve it qualitatively and to provide the conditions in which this manpower is used within our own country.