The Difference between Human Capital and Physical Capital

Introduction

Today, more and more business entities are automating their operations in a bid to lower as well as streamline production costs and processes. For businesses, staying relevant in the market is integral to their survival, and is enabled by adapting and keeping up with the ever changing and improving technology in all key business processes; i.e. right from production, to distribution and sale to the customers.

The question of how best to combine physical and human capital is becoming a dilemma for many enterprises. The consensus however remains that both forms of capital are essential in the successful running of business operations. When suitable human capital is matched with the proper physical capital, values of both forms of capital are enhanced, resulting in the production of high-quality goods and services.

It is therefore paramount for businesses to form and have a contextual understanding of the differences between human and physical capital sources available to them. This requires an initial understanding of these two terms. The section below gives a brief explanation of the terms.

Definition of terms

Human capital refers to the capabilities, experience, and skill-sets that employees bring to a business organization. These capabilities, skill-sets, and experience contribute to the productivity of the employee. Simply put, the human capital of any given venture is the economic value that its employees add to it (1).

Physical capital, on the other hand, refers to all tangible, non-human, and man-made resources utilized in the production processes of goods and services. Examples of physical capital include business buildings and plants, vehicles and machines. Past educational background, ongoing professional related training, certifications, and employees’ networks make up human capital.

In people-driven business contexts, particularly the service industry, such as food and hospitality firms, the significance of human capital as a factor of production cannot be overemphasized. Hiring the right chef, for example, is crucial to the success of a restaurant. However, for manufacturing firms, there might need to invest more in physical capital such as advanced equipment and machinery for production of high quality and quantities of goods.

Therefore, it is important to consider your business context and operating environment, for informed decision making when it comes to the combination of physical and human capital. This will, in turn, enhance productivity, effectiveness, market relevance, and efficiency in business operations, and lead to profitability.

Distinction between Human and Physical Capital

The differences between human and physical capital can be looked at from various angles. In this article, the following factors are used to distinguish between the two forms of capital:-

Composition

As defined previously, human capital refers to the combined value of an entity’s human component, in particular, the work force; whereas physical capital is comprised of all non-human resources utilized in the production of other goods and services. The former comprises all the employees’ academic and professional credentials, experience, abilities, skills, and circle of networks relevant to the business (2). The latter on its part includes all material assets belonging to a business entity such as buildings, vehicles, and equipment.

Management

Whereas management of physical capital is mostly non-personal and generic, that of human capital is personal and customized in nature. For example, equipment and tools undergo routine checks and repairs to ensure they are in the right form and shape for their intended use. Employees on their part require well thought out and tailor made management initiatives such as team building activities and trainings to ensure morale and productivity at the work place. When managing your staff creativity and spontaneity is essential, on the other hand managing working tools is relatively standard and follows a set out protocol.

Utility and Depreciation

Generally, the use of human and physical capital is complementary. Ideally, the combination of technically superior machines and qualified staff results in the production of high-quality goods and services leading to profit making by the business. However, the utility value of employees is noted to improve as time progresses, while most physical assets depreciate with time, due to wear and tear even with regular maintenance. This is because human capital has the potential to evolve and self-augment, while physical capital lacks a similar capability (2).An organization’s human capital improves when more opportunities for training are availed to staff.

However, it is important to note that the ability of human capital to self-augment is dependent on the health of the employees, training opportunities, and migration opportunities (2). Thus, it is essential to invest heavily in improving health facilities in order to increase the strength and vitality of the employees, as well as their life expectancies. In addition, firms need to provide training opportunities for both their aged and youthful employees.

There should also be a provision of primary, secondary, and tertiary education to the entire population to guarantee a highly skilled and educated populace (3). The government of the day should also put in place literacy programs for adults in order to cater to those adults who might have missed any formal education.

The migration policy within the country should also be flexible in order to give the human capital room to self-augment. Individuals and their families should be able to migrate without any excessive restrictions so that they can be able to adapt to changes in job opportunities (2).

Nature

Physical capital is tangible and concrete, i.e. it is possible to physically touch, feel, taste, and see, and on the other hand, human capital is intangible. The tools, equipment, plant, and machines comprise the physical capital of the company, and one can easily see and feel these components (3). On the other hand, human capital is the health, the talents and skills, as well as the expertise of the employees, and these attributes cannot be touched or felt. Human capital is the only exceptional active factor of production, whereas physical capital like all the other factors is passive in nature.

Measurement of value

Capital in general means two things for businesses. Firstly, capital in a business is supposed to guarantee the sustenance of liquidity. Secondly, accumulation of capital by a firm is aimed at ensuring constant productivity levels, while allowing room for expansion of operations.

The value of physical capital is easy and straight forward to calculate and is usually expressly indicated on a company’s balance sheet, whereas that of human capital is a bit more complex to calculate and is in most cases assumed.

The multifaceted nature of human capital complicates the calculation of value. For instance, an employee’s value to the company goes beyond their competencies to also include the value of their networks and the corresponding goodwill those networks come with. In this scenario, the standard ROA ratio (Returns on Assets), would not be sufficient in calculating the human capital value.

Furthermore, when it comes to calculating the value of human capital, the market sets wages and salaries, and the individual employee cannot be bought or sold (4). On the other hand, the market sets buying and selling prices of the physical capital, and these assets can be bought and sold as commodities.

Combination of physical and human capital for maximum returns

Given the complementary nature of utility for physical and human capital, it goes without saying that finding a way to mutually enhance their values, results in the production of top quality products and profitability for the business.

Arriving at the best combination of human and physical capital for your business involves an initial and deep look at the types of business operations and processes involved. For example, businesses utilizing automation in most of their operations will in turn require lesser human capital levels. In contrast, ventures that are predominantly people-oriented might spend more on human capital.

Conclusion

Physical and human capital both require significant investment to acquire and develop. In addition, firms need to spend considerable amounts of money in repairing both of these types of capital. It is, therefore, crucial for business owners and managers to identify and utilize sources of both types of capital available to them, in order to add value to the business operations. A clear distinction between the two types of capital will enable their proper combination, resulting in maximum productivity and returns for business entities.

Summary; Comparison table

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