SMT – ITS/CMM – Spring 2008

Speaker: Yujin Han

Topic: Human Capital

Human Capital
I. Human Capital – Why is Bill Gates so much richer than you are?

A. Why Inequality?
What does 1835 73rd Ave NE, Medina, WA 98039 say to you? Perhaps a neat place to go
visit. Perhaps cutting-edge technology applied to the home. Perhaps simply wealth. This is
the address of the home of Bill Gates. It is presently valued at $200 million. The property
tax alone is $991,000 per year. It’s 50,000 square feet on 5.15 acres of prime waterfront
Washington real estate, purchased in 1988 for $2 million. It has a 27-seat theater, a
reception hall, parking for 28 cars, an indoor trampoline pit, and all kinds of gadgetry, such
as phones that ring only when the person being called is nearby and music that plays in
each room according to a particular person’s preference. Charles Wheelan, in the chapter
on “Productivity and Human Capital” in Naked Economics, observes “The world is a
fascinating playground when you have $50 billion or so…”

One might ponder, “Why do some people have indoor trampolines and private jets while
others sleep in bus station bathrooms?” The latter was the case for Chris Garner in the
movie with Will Smith called “Pursuit of Happyness.” How is it that at the end of the
longest economic boom in American history, many Americans lack the basic necessities?
Nine years of continuous economic growth only dented the poverty rate. Roughly 13
percent of Americans are poor, which is an improvement from a recent peak of 15 percent
in 1993 but not significantly better than it was during any year in the 1970s. However,
Texas still lags the nation with a poverty rate of 17.6%. Meanwhile, one in five American
children – and a staggering 40 percent of black children – live in poverty. And according to
the National Center for Children in Poverty, they indicate that the current standard of
what constitutes poverty is outdated. A better assessment for 2007 is to count a family of 4
making under $41,300 per year, which is twice the federal poverty level amount, as a low-
income household. Using this updated standard, 60% of Black children and 61% of Latino
children would be considered poor (http://www.nccp.org/profiles/US_profile_6.html).
Even so, America is still the rich guy on the block. Vast swathes of the world’s population –
some three billion people – are desperately poor.

Why this inequality? Why is Bill Gates so much richer than the men and women sleeping in
steam tunnels? The answer may be in large part addressed by a concept economists call
“human capital.”

B. What is Human Capital?

Human capital is the sum total of skills embodied within an individual: education,
intelligence, charisma, creativity, work experience, entrepreneurial vigor, even the ability
to throw a baseball fast. It is what you would be left with if someone stripped away all of
your assets – your job, your money, your home, your possessions – and left you on a street
corner with only the clothes on your back.

II. The Benefits of Human Capital

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SMT – ITS/CMM – Spring 2008
Speaker: Yujin Han
Topic: Human Capital

A. The Difference of Education

Who is wealthy in America, or at least comfortable? Software programmers, hand surgeons,
nuclear engineers, writers, accountants, bankers, teachers. Sometimes these individuals
have natural talent; more often they have acquired their skills through specialized training
and education. In other words, they have made significant investments in human capital.
Like any other kind of investment – from building a manufacturing plant to buying a mutual
fund – money invested today in human capital will yield a return in the future. A very good
return. A college education is reckoned to yield about 10 percent, meaning that if you put
down money today for college tuition, you can expect to earn that money back plus about
10 percent a year in higher earnings. Few people on Wall Street make better investments
than that on a regular basis.

B. The Fate of the Unskilled/Uneducated

The opposite is true at the other end of the labor pool. The skills necessary to ask, “Would
you like fries with that?” are not scarce. There are probably 150 million people in this
country capable of selling value meals at McDonald’s. Fast-food restaurants need only pay
a wage high enough to put warm bodies behind all of their cash registers. That may be
$5.85 (2007 Federal/Texas min wage) an hour when the economy is slow or $9 an hour
when the labor market is especially tight; it will never be $400 an hour, which is the kind
of fee that a top trial lawyer can command. The most insightful way to think about
poverty, in this country or anywhere else in the world, is as a dearth of human capital.
True, people are poor in America because they cannot find good jobs. But that is the
symptom, not the illness. The underlying problem is a lack of skills, or human capital. The
poverty rate for high school dropouts in America is twelve times the poverty rate for
college graduates. Why is India one of the poorest countries in the world? Primarily because
35 percent of the population is illiterate (down from almost 50 percent a decade ago). Or
individuals may suffer from conditions that render their human capital less useful. A high
proportion of America’s homeless population suffers from substance abuse, disability, or
mental illness.

C. The Greatness of America

This assessment is strongly affirmed in one of the most influential and best-selling studies
on why companies are successful and remain successful. They argue for the all-importance
of high human capital. These studies have been published by Jim Collins as two books:
Built to Last and Good to Great.

In fact it is the rise of human capital that has made America as great as it is. Rising levels
of human capital enabled an agrarian economy to evolve into places as rich and complex as
Manhattan and Silicon Valley. Not all is rosy along the way, of course. Educated workers
who design machines and processes that produce better yields may displace obsolete skills
and put many out of jobs – this is called creative destruction in Economics. However,
technological breakthroughs may eliminate one job in the short run; the country is better
off in the long run. The society becomes richer; the unemployed may be hired into new
fields in the new economy. Of course, educated workers fare much better than uneducated
workers in this process. They are more versatile in a fast-changing economy, making them
more likely to be left standing after a bout of creative destruction.

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Speaker: Yujin Han
Topic: Human Capital

D. Human Capital Improves Our Whole Way of Life

Human capital is about much more than earning more money. It makes us better parents,
more informed voters, more appreciative of art and culture, more able to enjoy the fruits
of life. It can make us healthier because we eat better and exercise more. Educated
parents are more likely to put their children in car seats and teach them about colors and
letters before they begin school. In the developing world, the impact of human capital can
be even more profound. Economists have found that a year of additional schooling for a
woman in a low-income country is associated with 5 to 10 percent reduction in her child’s
likelihood of dying in the first five years of life.

E. Human Capital is the Major Factor in Social Prosperity

Similarly, our total stock of human capital – everything we know as a people – defines how
well off we are as a society. We benefit from the fact that we know how to prevent polio
or make stainless steel – even if no one here would be able to do either of those things if
left stranded on a deserted island. Economist Gary Becker, who was awarded the Nobel
Prize for his work in the field of human capital, reckons that the stock of education,
training, skills, and even the health of people constitutes about 75 percent of the
wealth of a modern economy. Not diamonds, buildings, oil, or fancy purses – but things that
we carry around in our heads. “We should really call our economy a ‘human capitalist
economy,’ for that is what it mainly is… While all forms of capital – physical capital, such
as machinery and plants, financial capital, and human capital – are important, human
capital is the most important. Indeed, in a modern economy, human capital is by far the
most important form of capital in creating wealthy and growth.”

There is a striking correlation between a country’s level of human capital and its economic
well-being. At the same time, there is a striking lack of correlation between
natural resources and standard of living. Countries like Japan and Switzerland
are among the richest in the world despite having relatively poor endowments of natural
resources. Countries like Nigeria are just the opposite; enormous oil wealth has done
relatively little for the nation’s standard of living. In some cases, the mineral wealth of
Africa has financed bloody civil wars that would have otherwise died out. You may have
seen this dramatized in some recent movies – Hotel Rwanda (2004) and Blood Diamond
(2006). In the Middle East, Saudi Arabia has most of the oil while Israel, with no natural
resources to speak of, has the highest per capita income.

F. Human Capital Improves Generational Development

well-educated parents invest

High levels of human capital create a virtuous cycle;
heavily in the human capital of their children. Low levels of human capital have
just the opposite effect. Disadvantaged parents beget disadvantaged children, as any
public school teacher will tell you. Mr. Becker points out, “Even small differences among
children in the preparation provided by their families are frequently multiplied over time
into large differences when they are teenagers. This is why the labor market cannot do
much for school dropouts who can hardly read and never developed good work habits, and
why it is so difficult to devise polices to help these groups.”

Why does human capital matter so much? To begin with, human capital is inextricably

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Speaker: Yujin Han
Topic: Human Capital

linked to one of the most important ideas in economics: productivity.

III. What Makes Human Capital So Significant? Productivity

A. What is Productivity?

Productivity is the efficiency with which we convert inputs into outputs.

In other words, how good are we at making things? Does it take 2,000 hours for a Detroit
autoworker to make a car or 210 hours? Can an Iowa corn farmer grow thirty bushels of
corn on an acre of land or 210 bushels? The more productive we are, the richer we are. The
reason is simple: The day will always be twenty-four hours long; the more we produce in
those twenty-four hours, the more we consume. America is rich because Americans are
productive. We are better off today than at any other point in the history of civilization
because we are better at producing goods and services than we have ever been.

B. Productivity Historically Improving in America

The bottom line is that we work less and produce more. In 1870, the typical household
required 1,800 hours of labor just to acquire its annual food supply; today, it takes about
260 hours of work. Over the course of the twentieth century, the average work year has
fallen from 3,100 hours to about 1,730 hours. All the while, real gross domestic product
(GDP) per capita – an inflation adjusted measure of how much each of us produces, on
average – has increased from $4.800 to $31,500. Even the poor are living extremely well by
historical standards. The poverty line is now at a level of real income that was attained
only by those in the top 10 percent of the income distribution a century ago.

C. Productivity is directly related to Competitiveness

Ross Perot heralded a concept called the “giant sucking sound” in his 1992 Presidential
Campaign. In it he argued against the North American Free Trade Agreement (NAFTA),
saying that opening our borders to free trade with Mexico would cause millions of jobs to
flee south of the border. Why wouldn’t a firm relocate to Mexico when the average
Mexican factory worker earns a fraction of the wages paid to American workers? The
answer is productivity. Can American workers compete against foreign workers who earn
half as much or less? Yes, most of us can. We produce more than Mexican workers –
much more in many cases – because we are better-educated, because we are healthier,
because we have better access to capital and technology, and because we have more
efficient government institutions and better public infrastructure. Can a Vietnamese
peasant with two years of education do your job? Probably not.

Of course, there are industries in which American workers are not productive enough to
justify their relatively high wages, such as manufacturing textiles and shoes. These are
industries that require relatively unskilled labor, which is more expensive in this country
than in the developing world. Can a Vietnamese peasant sew basketball shoes together?
Yes – and for a lot less than the American minimum wage.

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Speaker: Yujin Han
Topic: Human Capital

D. Productivity Rate is directly related to a Country’s Wealth Growth Rate

Will our children be better off than we are? Yes, if they are more productive than we are,
which has been the pattern throughout American history. Productivity growth is what
improves our standard of living. If productivity grows at 2 percent a year, then we will
become 2 percent richer every year. Why? Because we can take the same inputs and make
2 percent more stuff. (Or we could make the same amount of stuff with 2 percent fewer
inputs.)

From 1947 to 1975, productivity grew at an annual rate of 2.7 percent a year. From 1975
until the mid-1990s, for reasons that are still not fully understood, productivity growth
slowed to 1.4 percent a year. That may seem like a trivial difference; in fact, it has a
profound effect on our standard of living. When we apply the rule of 72 [which basically
says that when you divide 72 by a rate of growth (or interest rate), the answer will tell you
roughly how long it will take for a growing quantity to double], productivity growing at 2.7
percent year means that our standard of living doubles every twenty-seven years while at
1.4 percent, it doubles every fifty-one years.

10-Year Productivity Report from http://data.bls.gov/PDQ/servlet/SurveyOutputServlet?

data_tool=latest_numbers&series_id=PRS85006092

Year Qtr1 Qtr2 Qtr3 Qtr4 Annual

1997 -1.4 4.9 3.5 1.6 1.6
1998 3.2 1.2 4.6 2.1 2.8
1999 3.6 0.9 2.8 7.0 2.9
2000 -1.8 7.5 -0.9 3.9 2.8
2001 -0.5 5.7 1.8 6.0 2.5
2002 7.2 0.7 4.3 -0.3 4.1
2003 3.4 5.9 10.2 -0.4 3.7
2004 0.8 4.8 0.9 0.5 2.8
2005 3.4 0.7 4.3 -1.4 1.9
2006 2.1 1.3 -1.5 1.6 1.0
2007 1.0 2.6 6.3 1.9 1.8

E. International Growth in Productivity Good for All Countries

Productivity growth makes us richer, regardless of what is going on in the rest of the world.
If productivity grows at 4 percent in Japan and 2 percent in the U.S., then both countries
are getting richer. In other words, productivity growth is not a zero-sum game, someone
does not always benefit at the expense of another. What would be the effect on America if
500 million people in India became more productive and gradually moved from poverty to
the middle class? We would become richer, too. Poor villagers currently subsisting on $1 a
day cannot afford to buy our software, our cars, our music, our books, our agricultural
exports. If they were wealthier, they could. Meanwhile, some of those 500 million people,

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Speaker: Yujin Han
Topic: Human Capital

whose potential is currently wasted for lack of education, would produce goods and
services that are superior to what we have now, making us better off. One of those newly
educated peasants might be the person who discovers an AIDS vaccine or a process for
reversing global warming.

F. What Impacts Productivity Growth?

1. Productivity Linked to Idea of Delayed Gratification

Productivity growth depends on investment – in physical capital, in human capital,

in research and development, and even in things like more effective government
institutions. These investments require that we give up consumption in the present
in order to be able to consume more in the future. If you skip buying a BMW and
invest in a college education instead, your future income will be higher. Similarly,
a software company may forego paying its shareholders a dividend and plow its
profits back into the development of a new, better product. The government may
collect taxes (depriving us of some current consumption) to fund research in
genetics that improves our health in the future. In each case, we spend resources
now so that we will become more productive later.

Our legal, regulatory, and tax structures also affect productivity growth. High
taxes, bad government, poorly defined property rights, or excessive regulation can
diminish or eliminate the incentive to make productive investments.

2. Productivity Linked to Human Resourcefulness

The study of human capital has profound implications for public policy. Most
important, it can tell us why we haven’t all starved to death. The earth’s
population has grown to six billion; how have we been able to feed so many
mouths? In the 18th century, Thomas Malthus famously predicted a dim future for
mankind because he believed that as society grew richer, it would continuously
squander those gains through population growth – having more children. These
additional mouths would gobble up the surplus. In his view, mankind was destined
to live on the brink of subsistence, recklessly procreating during the good times
and then starving during the bad. As Paul Krugman has pointed out, for fifty-five of
the last fifty-seven centuries, Malthus was right. The world population grew, but
the human condition did not change significantly.

Only with the advent of the Industrial Revolution did humans begin to grow steadily
richer. The large productivity gains made parents’ time more expensive. As the
advantages of having more children declined, modern humans began investing their
rising incomes in the quality or their children, not merely the quantity.

One of the fallacies of poverty is that developing countries are poor because they
have rapid population growth. In fact, the causal relationship is best understood
going the other direction: Poor people have many children because the cost of
bearing and raising children is low. Birth control, no matter how dependable, works
only to the extent that families prefer fewer children. As a result, one of the most
potent weapons for fighting population growth is creating better economic
opportunities for women, which starts by educating girls. Taiwan doubled the
number of girls graduating from high school between 1966 and 1975. Meanwhile,

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Topic: Human Capital

the fertility rate dropped by half. In the developing world, where women have
enjoyed extraordinary range of new opportunities over the last half century,
fertility rates have fallen near or below replacement level, which is 2.1 births per
woman. In fact, as many of you may be aware, South Korea has experienced an
economic boom of recent years and this may be a factor in their low birth rate such
that they have to now give financial incentives for women to have children out of
concern for the future growth of the population.

IV. Human Capital and Inequality

A. Inequality Growing in America

Is America growing more unequal? Yes! Between 1979 and 1997, the average income of the
richest fifth of the population jumped from nine times the income of the poorest fifth to
around fifteen times. As American’s longest economic boom in history unfolded, the rich
got richer while the poor ran in place, or even got poorer. Average income (adjusted for
inflation) for the poorest fifth of American actually fell 3 percent between 1979 and 1997
before turning up sharply at the end of the 1990s. Why the inequality?

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Topic: Human Capital

B. Inequality linked to Disparities in Human Capital

1. Competitiveness in the American Economy

Human capital offers the most insight into this social phenomenon. Skilled workers
in America have always earned higher wages than unskilled workers; that
difference has started to grow at a remarkable rate. In short, human capital has
become more important, and therefore better rewarded, than ever before. One
simple measure of the importance of human capital is the gap between the wages
paid to high school graduates and the wages paid to college graduates. College
graduates earned an average of 40 percent more than high school graduates at
the beginning of the 1980s; now they earn 80 percent more. Individuals with
graduate degrees do even better than that.

Our economy is evolving in ways that favor skilled workers. For example, the
shift toward computers in nearly every industry favors workers who either have
computer skills or are smart enough to learn them on the job. Technology makes
smart workers more productive while making low-skilled workers redundant. ATMs
replaced bank tellers; self-serve pumps replaced gas station attendants; automated
assembly lines replaced workers doing mindless, repetitive tasks. Indeed, the
assembly line at General Motors encapsulates the major trend in the American
economy. Computers and sophisticated robots now assemble the major components
of a car – which creates high-paying jobs for people who write software and design
robots while reducing the demand for workers with no specialized skills other than
a willingness to do an honest day’s work.

2. Competitiveness in the Global Economy

international trade puts low-skilled workers in greater

Meanwhile,
competition with other low-skilled workers around the globe. In the long run,
international trade is a powerful force for good; in the short run, it has victims.
Trade, like technology, makes high-skilled workers better off because it provides
new markets for our high-tech exports. Boeing sells aircraft to Singapore, Microsoft
sells software and Apple sells iPhones to Europe, McKinsey & Company sells
consulting services to Latin America. Again, this is more good news for people who
know how to design a fuel-efficient jet engine or explain total quality management
in Spanish. On the other hand, it puts our low-tech workers in competition with
low-priced laborers in Vietnam. Nike can pay workers $1 a day to make shoes in a
Vietnamese sweat shop. You can’t make Boeing airplanes this way.

V. Practical Steps to Improving Your Human Capital

Self-management: Building Effectiveness

A. Effectiveness Can be Learned

1. To be effective means “to get the right things done”

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Speaker: Yujin Han
Topic: Human Capital

2. Effectiveness not related to brilliance but to hard systematic work.

3. Manual work needs only efficiency – ability to do things right; But knowledge
work requires doing the right things

4. Knowledge work is not defined by quantity but RESULTS.

5. Conventional view of the manager development: Universal Genius; But the

reality is most fit the Universal Incompetent

6. Effectiveness is independent of personality

7. Effectiveness is a Habit, a Complex of Practices that can be learned.

B. Basic Principles of Effectiveness

1. The Effective Person Knows Where His/Her Time Goes

Time is a limited resource, totally inelastic, totally irreplaceable, and

everything requires it. Failure of British business because executives thought
they could rest on their laurels

a. Recording Time

b. Managing Time

i. Identify and eliminate the things that need not be done at all, that
are purely a waste of time – Ask, “What would happen if this were
not done at all?”

ii. Which of the activities on my time log could be done by somebody

else just as well, if not better?

iii. A common cause of time-waste is the time of others that you waste
– Ask, “What do I do that wastes your time without contributing to
your effectiveness?” (Harry Hopkins, Pre. Roosevelt’s confidential
advisor in WWII)

c. Consolidating (Discretionary)Time

2. The Effective Person focuses on Outward Contribution

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Topic: Human Capital

a. Must ask, “What can I contribute?”

b. Must regard the usability of his/her contribution – Results Orientation

c. Requires the right Human Relations (Creates Team)

3. The Effective Person Builds on Strengths (ex. Of General Grant)

a. “What can he do” rather than “What can’t he do”

b. Human excellence can only be achieved in one area, or at the most in

very few (Drucker/Gianini)

c. Placement Implications

i. Right job

ii. Provide challenge (bring out strength) and scope (significant results)

iii. Start with what a man can do rather than what a job requires

iv. To get strength, must put up with weakness – Does this person have
strength in one major area? (ex. Grant/Robert E Lee)

d. Consider Temperament

4. The Effective Person Concentrates on the Few Major Areas where Superior
Performance will produce Outstanding Results

a. Systematic sloughing off

b. Priorities and Posteriorities – What to do and what not to do? – Requires

courage!

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