A loose catch-all term for the practical knowledge, acquired skills and learned abilities of an individual that make him or her potentially productive and thus equip him or her to earn income in exchange for labor. The figurative use of the term capital in connection with what would perhaps better be called the "quality of labor" is somewhat confusing. In the strictest sense of the term, human capital is not really capital at all. The term was coined so as to make a useful illustrative analogy between investing resources to increase the stock of ordinary physical capital (tools, machines, buildings, etc.) in order to increase the productivity of labor and "investing" in the education or training of the labor force as an alternative means of accomplishing the same general objective of higher productivity. In both sorts of "investment," costs are incurred by investors in the present in the expectation of deriving extra benefits over a long period of time in the future. As in the case of ordinary investments in physical capital, investments in human capital make economic sense to the extent that the value of the additional future benefits to be expected (greater productivity and thus more income for the worker and his employer) exceed the extra costs that have to be incurred in the present to obtain them (costs of schooling or training programs, production and income foregone while the individual is in training, the loss of leisure and perhaps the experience of mental anguish undergone by the individual in having to learn new things, etc.). Varying levels of past investment in human capital provides one of the main explanation for the size of wage and salary differentials among individuals: payment for an individual's labor in reality includes not just payment for the employee's leisure time foregone but also a premium that represents the going rate of return on his past investment in human capital.

The analogy between human capital and real capital breaks down in one important respect, however. Property rights over ordinary inanimate capital are normally readily transferable by sale from one owner to another, and consequently markets for capital goods can function easily and smoothly to reallocate such resources from one project to another with minimal complications and transactions costs. The value of resources that have been invested in physical capital by an investor can often be readily recovered later (at least in good part) through resale, with the proceeds being easily redeployed into purchases for consumption or reinvestment in other types of capital goods as the investor may choose. However, human capital is by definition inseparably embedded in the nervous system of a specific individual and it thus cannot be separately owned apart from the individual's living body itself. Except in societies that legalize slavery (or at least enforce very long term transferable indentured labor contracts ), human capital itself cannot be directly bought and sold on the market -- only its temporary services as reflected in the labor productivity of the one individual who alone can own it. If an employee chooses to quit his or her job (perhaps because of an offer of much higher pay by a competing firm in the same industry), then any past investment the employer may have made to upgrade the employee's job skills is lost to the firm from the minute the former employee walks out the door for the last time.

The only person who can invest in human capital with full confidence that he will not be arbitrarily deprived of its fruits in the future without compensation is the individual in whom the investment is made, so other firms or individuals therefore have much less incentive to invest resources in him or her in this way, even if this might be the cheapest way to increase productivity. Even the individual in whom the human capital is to be embedded may be somewhat deterred from investing by the fact that such an investment is necessarily very illiquid -- that he cannot later recoup any part of the value of his own investment in human capital by selling it off if he should desire to go into some other line of endeavor where the skills involved are not useful.

[See also: factors of production, labor, capital]