The RSA



Valuing human capital

The old corporate cliché that ‘our people are our greatest asset’ is based on a fundamental truth. Michael Echols FRSA argues that the way we evaluate economic success and the impact of investment in people needs to reflect this.

In a knowledge-driven economy, organisations depend on the intelligence, talents, skills and expertise of their employees to create value.

The problem is that our macroeconomic theories, standard accounting protocols, evaluation tools and decision-making structures do not allow us to properly recognise, value and invest in these seemingly intangible, yet vital, assets.

As we search for new sources of innovation and growth in the context of a weak and fragile economic recovery, attention has turned towards investment in infrastructure as an important source of economic stimulus in the short term, and growth in the longer term. However this has tended to focus on physical infrastructure rather than the human resources upon which our economic prospects depend. In the US, as in the UK, the service sector dominates the economy.  It is the acquired expertise, knowledge and skill – the human capital – that drives productivity, innovation and competitiveness. The fruits of this human capital can be seen in new and effective products and services, patents, designs and breakthrough technologies.

It is through a combination of informal learning and formal education that professionals acquire these capabilities, and as a result, provide value for their employers, customers and society at large. Yet many employers encounter significant obstacles to investing in the innovative and productive capabilities of the workforce. Given the clear link between human capital and value creation, why should this be the case?

Some barriers are obvious: for example, the standard protocols of accounting practice class investment in workforce development, training and education not as ‘capital’ but as a period expense or cost. This makes the company appear less profitable. It also makes it seemingly rational for senior executives to limit their spending on developing their employees. The result is a short-term focus on improving quarterly returns and profitability at the expense of the long-term prospects of the company.

The result is a distortion in the apparent value of firms, at least from an investment perspective. In knowledge-intensive, high-value companies such as Apple and Google, less than 5 percent of assets reside in the physical infrastructure recorded on their balance sheets. Even in these innovation-driven enterprises expenditure on developing people is not recognised as value-creating investment even though it is integral to the company’s success. And this problem is replicated at national level, all underpinned by a macroeconomic theory that discounts the value of intangibles.

Another obvious barrier is the difficulty of measuring impact and the limitations of current value evaluation tools. While US firms spent approximately $171.5 billion on learning and development in 2010 many corporate leaders currently lack the ability to truly ascertain the return on this investment. This is not to say that measurement is easy; it is difficult to disentangle causal relationships between investment and outcomes. More importantly effective evaluation involves methodology not familiar to the accounting and finance professions.

But the challenge is to make such intangible value more tangible, and therefore suitable for investment-based approaches to human capital development. This will require specific, executable actions that policy makers and executive decision-makers can take to create value for individuals, organisations and nations.

Some positive change is happening. First, in both policy and analytic circles, there is heightened interest in recognising and measuring the value of intangible assets (including human capital) as drivers of innovation and value creation. For example, in a 2011 paper Gang Lui estimated that the value of human capital could be up to 10 times larger than that of traditional physical capital.

This progress is welcome. But the times we live in require much more attention to be given to this still neglected aspect of our economic recovery. Only then can we tackle the more specific barriers to the much needed and valuable investment in human capital. We at Bellevue University in the USA are pleased to be working with the RSA over the coming year to do precisely that.

The joint project will look at different ways in which human capital can be developed and measured, and look for ways to overcome obstacles to greater corporate investment in human capital development. If you are interested in getting involved please email Julian Thompson, RSA director of enterprise.


Footnotes

Liu, G. (2011), ”Measuring the Stock of Human Capital for Comparative Analysis: An Application of the Lifetime Income Approach to Selected Countries”, OECD Statistics Working Papers, No. 2011/06, OECD Publishing.
doi:
10.1787/5kg3h0jnn9r5-en

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  • focusedlearning

    It amazes me why more smart people have not rallied around the notion that Echols is talking about here. What is really holding this back?