Human in the Machine
Most people think of capital as something tangible, like cash in the bank or shares traded on the stock market. But it’s much more than that. Capital is something that generates future income, growth & profits. So in that sense people are capital too.
This is known as human capital, and it is the economic value of a person’s knowledge, skills and labor.
Natural resources are important, but they are inherently limited. Human capital on the other hand is what defines a country in the long term.
As we've already outlined with our Asian Capital Development model, growth in human capital is essential if a country is going to transition from agriculture to manufacturing to services.
As an investor, you need to know what level a country’s human capital stands at. This knowledge will go quite far in figuring out which sectors will grow, shrink or explode.
The Government Knows What’s Best (For You)
A ruling body utilizes its human capital in order to grow the nation, and subsequently, benefit their own personal power and wealth. Those in government will have policy goals, and will funnel the country’s resources to make their vision a reality.
For those at the bottom of the ladder, this may entrap them in an endless cycle of absolute poverty. The lower-middle class on the other hand - and the bulk of people in Asia - essentially enter a system in which the government has laid out their entire future.
Taiwan’s policy-makers, for example, envisioned an economy where the majority of people worked in manufacturing, specializing in low skilled labor (initially). Special Economic Zones (SEZs) were built, people were trained, and that’s what the population did – slowly moving up the value chain.
Today, as the country moves into higher-skilled manufacturing jobs and services, so does the bulk of the population move into middle and upper income status.
Automated production lines: A mark of development or a threat to incomes?
Who benefits? Workers do enjoy stability of course. Some even gain a competitive edge and move themselves into high positions as CEOs, business owners and shareholders – but in the end, at the top of the ladder, factory investors and government reap the rewards.
Those in power simply have to figure out what works best from what they ‘inherit’ once their power is established.
Emerging markets can’t go from growing rice to making microchips overnight. So how do countries unlock the potential of human capital and move up the “value chain” - from farming to manufacturing to services?
Productive people make productive economies. Countries with higher levels of human capital produce and earn more. Now, just like other forms of capital, human capital needs investment in order to grow.
Unlocking Human Capital
Developing countries start out with two things: natural capital and human capital. Reforms in agriculture, land policies and banking move people towards manufacturing. Wages rise because factories are more profitable than fields.
Human capital increases as manufacturing becomes more developed and education levels rise. Over time, economies continue to develop and the service sector starts to supplant manufacturing.
Now more people are working in banks, hospitals and offices instead of factories.
Let’s look at this in action: in 1960s China most people worked in agriculture: it made up around 40% of China’s GDP, as the graph below shows. Services made up just over 20%.
Fast-forward to 2000 and that ratio has been turned upside down. In 2015, agriculture accounted for just 10% of GDP, but services went up to 50%!
What happened to China’s GDP over this time?
Well, as the model goes, China got richer as it unlocked the potential of its human capital and moved up the “value chain.”
This did not happen overnight - human capital and economic development have to grow together.
If this process is rushed, people will be unequipped with the knowledge or skills to use new technologies. Countries who have tried to make the leap from agriculture to services too soon discover that their workers are less productive and the service sector is inefficient and uncompetitive.
The mutual link between a country’s economic development and its people is strong. If a workforce has been educated or developed to a certain point, when a switch within the economy occurs, then the proverbial ‘bump in the road’ is either small or non-existent. The transition is smooth.
Let’s compare human capital to gross national income, the total value of goods and services produced in a nation.
As this graph shows, countries with more human capital tend to be richer. Of course, we have to take population into account. China has over a billion people, so higher human capital in cities like Beijing and Shanghai are balanced out with lower levels in rural areas.
Singapore, with just 5 million people, who all have high levels of human capital, produces almost the same gross national income as Malaysia (with 30 million people) and does more than Vietnam (with 93 million people).
What Does All This Mean For You?
Knowing where different countries are in the “value chain”, their current levels of development and human capital, can help in picking stocks in markets that are about to grow and sell shares in the sectors that are in decline.
In countries with a highly skilled workforce, like Japan and South Korea, the focus should be in advanced manufacturing and services. In Indonesia, Vietnam and other countries with a less developed workforce, one must instead look to agriculture and low skilled manufacturing for investment opportunities, though this is changing fast.
Our next article further explores how Asian governments utilize their people and natural resources in an attempt to move up the value chain, often at a great initial cost. Reform, and unlocking a land’s wealth, is often a brutal business.