Understanding Capital

What is capital and why does everything require capital of some type?

Depending on the economist consulted, the forms of capital are:

• Human Capital
• Social Capital
• Natural Capital
• Financial Capital
• Manufactured Capital

To these five, some economists offer internal and external distinctions; some add time as a unique capital; others add constructed as distinct from physically adding value. The consensus, however, is that everything we do consumes and/or creates capital. That’s true of all living creatures, not only humans.

I begin with human capital because things have value based on our abilities to use those resources. In early economics (which isn’t that long ago), human physical labor was the most important form of capital. Physical labor was demanding and often dangerous. In time, economists recognized that skills and knowledge were human capital. These made some people more valuable in particular circumstances. Your mechanic is worth a lot when your car won’t start, for example. Motivation also adds to someone’s value: a motivated, enthusiastic worker adds more value.

Human capital increases with education and experience. Education is the investment of human capital (a teacher) into another person or group of people. This reveals one of the problems with original economic theories. A teacher can help one person or two dozen. The teacher’s value and value product are not fixed, unlike that of a mechanic who cannot fix a dozen cars at once. Labor isn’t so simple as one person is equal to another because the type of work changes the value dispersion. Technology leads to dispersion (the delivery of human capital) on a massive scale. A movie star’s product reaches millions of people, each paying a small amount individually. The movie star earns a lot because of this dispersion. Even a doctor, clearly an important and skilled expert, can only deliver services to one person at a time — at a much higher per service cost.

Philosophically, debates on the value of human capital are unlikely to be resolved. Emotionally, some struggle to rationalize that many people paying a small price for a service results in massive wealth transfers. But, if you ask if a movie or song delivered two cents of pleasure, people tend to answer “Yes.” The same is true of software products that have value to millions of users.

Combining individual human capital into groups results in social capital, the value of teams, communities, businesses, organizations, and government agencies. Generally, people combine their skills and multiply the value delivered. When the right people are assembled as a group, they can produce not only more of something, but often produce things they could not create alone.

Social capital allows us to specialize. The baker doesn’t need to know how to grow grain or make flour. Our society depends on specialization, with experts delivering technical breakthroughs and innovations. Without specialization and social capital, we’d all still be living (barely) on small family farms.

All creatures use natural capital to survive. We also use natural capital (or natural resources) to make other things. We rely on much we did not and cannot create. Another debate in economics is if individuals or groups should have the ability to own natural resources. There also questions of how to compensate society for any damage done during the consumption of natural resources — or damage done while producing manufactured good.

Manufactured capital is the value added when natural resources, existing products, and ideas are employed to create something new. Land has value, but actively farmed land might have yet more value. That’s manufactured capital in its earliest and most simple form: a natural resource put to work via human capital. The equation natural capital + human capital = manufactured capital represents much of human history. Today, much of what is manufactured is combined into yet more manufactured capital, with human innovation adding value.

I’ll end this post with financial capital because it is how we understand modern economic transactions. Financial capital is conceptual, not an actual thing. In the United States, the dollar was a specific amount of gold, but today it is a measure of a standard work hour for unskilled labor. The minimum wage indirectly suggests the value of today’s dollar. Currency, physical or virtual, exists only to enable barter between people not necessarily needing or wanting each other’s services at a specific moment. Currency exists because barter is unreasonable. For example, I might be a mechanic who needs to see my doctor. Unless my doctor has a car with engine trouble, the doctor does not need my services. Instead of a scrip (promise) for future car repairs, I pay my doctor. With that payment, the doctor can purchase a good or service.

People argue against capitalism, but the reality is that currently (capital) enables transactions beyond basic barter. Why doesn’t this work within communism or socialism? Because, in the end, people start to create markets outside the regulated market. In most controlled economies, black markets emerge that represent the real economy as determined by voluntary transactions. (We should not confuse welfare states with social safety nets with classical Marxism. Social democracies still rely on capitalism — and most systems end up hybrids of various economic models.)

Economists study all forms of capital and allocations of those capitals. Financial capital is simply the one most often associated with the discipline of economics.