Chapter 4 — Human Capital Formation in India

Chapter 4 is titled 'Human Capital Formation in India.' It explains the concept of human capital, identifies five sources of human capital formation (education, health, on-the-job training, migration, and information), examines the link between human capital and economic growth, distinguishes human capital from human development, and analyses India's progress and challenges in the education sector.

Human capital formation is the process by which a country converts human resources into human capital through deliberate investment. Just as physical resources like land are turned into physical capital like factories, human resources such as nurses, farmers, and students are turned into human capital such as engineers and doctors. This enhanced productivity results from investments in education, health, training, migration, and information.

The five sources are: (1) investment in education, which increases future earning capacity; (2) investment in health, which raises the supply of healthy labour force; (3) on-the-job training, where firms train workers to enhance productivity; (4) migration, where people move to places offering higher salaries, making expenditure on migration a source of human capital; and (5) acquiring information relating to the labour market, education, and health, which enables efficient utilisation of human capital.

Human capital is inseparable from its owner (unlike a bus, the bus driver must be physically present), whereas physical capital is separable. Human capital is intangible and cannot be sold — only its services are sold. Physical capital is completely mobile between countries; human capital is not perfectly mobile due to restrictions of nationality and culture. Importantly, human capital creates both private and social (external) benefits, while physical capital creates only private benefits.

Human capital treats education and health as a means to increase labour productivity, so any investment that does not enhance output is considered unproductive. Human development, in contrast, is based on the idea that education and health are integral to human well-being in themselves — every individual has a right to be literate and lead a healthy life, irrespective of whether it raises productivity. Human capital treats human beings as a means to an end; human development treats them as ends in themselves.

Education and health services create both private and social benefits, which is why both private and public institutions exist in these markets. Government intervention is essential because expenditures in these sectors have substantial long-term impacts that cannot be easily reversed, and individual consumers often lack complete information about quality and costs, giving providers monopoly power. In a developing country like India, many people living below the poverty line cannot afford basic education and health care, making government provision necessary.

India's literacy rate has risen significantly from 16.67% in 1951 to 43.57% in 1981, 52.21% in 1991, 65.20% in 2001, and approximately 78% by 2018-22 (Table 4.1). However, the chapter notes that despite higher literacy rates, the absolute number of illiterates in India remains as large as India's total population at the time of independence, so universal literacy remains a distant goal.

During 1952–2020, education expenditure as a percentage of total government expenditure increased from 7.92% to 16.54%, and as a percentage of GDP increased from 0.64% to 4.47%. This is still below the 6% of GDP recommended by the Education Commission (1964–66) as necessary for a noticeable rate of growth in educational achievements. The chapter notes the expenditure increase has not been uniform, with irregular rises and falls throughout the period.

The Right of Children to Free and Compulsory Education Act was enacted by the Government of India in 2009. It made free education a fundamental right of all children in the age group of 6–14 years. This Act was aimed at fulfilling an objective stated in the Directive Principles of the Constitution passed in 1950, which required the government to provide free and compulsory education for all children up to the age of 14 years.

The Government of India levies a 2 per cent 'education cess' on all Union taxes. The revenues from this education cess are earmarked specifically for spending on elementary education. In addition to the cess, the government also sanctions a large outlay for promotion of higher education and new loan schemes for students pursuing higher education.

The chapter highlights that unemployment is highest among more highly educated youth. As per NSSO data (2011-12), the unemployment rate among rural male youth who had graduated and above was 19%, while their urban counterparts faced 16% unemployment. The most severely affected were young rural female graduates, with nearly 30% unemployed. In contrast, only about 3–6% of primary-level educated youth in rural and urban areas were unemployed. The Periodic Labour Force Survey 2023-24 indicates the situation has improved moderately.

The Seventh Five Year Plan explicitly acknowledged the importance of human capital by stating: 'Human resources development has necessarily to be assigned a key role in any development strategy, particularly in a country with a large population. Trained and educated on sound lines, a large population can itself become an asset in accelerating economic growth and in ensuring social change in desired directions.' This showed that India recognised the importance of human capital in economic growth at the planning level.

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