The capital question

Print edition : June 26, 2015

Outside the AMR Tech Park II in Bangalore. The contribution of the services sector to India's GDP is currently close to 60 per cent. Photo: G.P. Sampath Kumar

The book adopts the three capitals approach for an understanding of economic evolution but does not explain what growth indicates and what development means in the Indian context.

The subtitle of the book under review provides a descriptive account of what the book is about—an attempt to make the analysis of economic evolution more robust by bringing in explanatory factors that had been left out until recently and whose significance is still not adequately recognised.

The foreword to the volume notes: “Since the 1950s, thinking about ‘development’ has been dominated by the dismal science of economics, aided and abetted by the two Bretton Woods institutions, the World Bank (WB) and the International Monetary Fund (IMF). Unsurprisingly, it has been blinkered by a rigid academic-cum-bureaucratic approach to inquiry. …It excluded [for] too long concepts from other disciplines that might have fostered better understanding sooner.”

It is claimed, too, that the economic approach assumed capital scarcity to be the critical issue in development. The attempt, therefore, is to bring in the neglected factors in the understanding of development. The author’s preface takes the theme further: “[T]he book analyses three intangible forms of capital —human capital, social capital and institutional capital—to identify the dynamic between them as the crucial determinant of economic growth and development and to understand the process of economic evolution.” Any attempt to provide a better understanding of a complex phenomenon like development (which, of late, has moved from the jargon of economists to the manifestos of politicians) must certainly be welcomed.

Let us place on record, though, that although initially economists had oversimplified the factors responsible for development, their own calculations had shown that over time there was a substantial residual of economic growth that could not be attributed entirely to capital and its productivity. Many explanations had been put forward, but one of the leading scholars was honest enough to admit that the residual was an indication of “our ignorance”. The search continued, with some attributing the residual to technological change, thereby also bringing in the human factor (until then seen simply as an input called labour) as an explanatory factor in development. Indeed, economist-philosophers like Amartya Sen would go to the extent of claiming that development is freedom or capabilities expansion.

Human capital

Be that as it may, let us see how the author deals with human capital, social capital and institutional capital and their interaction as the determinants of development. The human element in production and growth was not neglected by the limited economic approach; it was there as homogeneous “labour” along with capital as one of the two “factors of production”. But human beings differ in their intrinsic as well as acquired capabilities.

The concept of human capital, therefore, recognises the diversity of human beings enhanced by the differences in education, training and interactions they come to have during their lifespan. Viewed differently, the concept of human capital puts the emphasis on the knowledge that individuals gain through life, which brings about a major difference to the contribution they can make to the production process. Or, human capital results from the transformation that an individual experiences through the acquisition of knowledge.

That transformation is not an isolated phenomenon. It takes place in the social context through interactions and through different kinds of “networking” that naturally develops to some extent, but is also deliberately cultivated, and so, social capital is necessary for a proper appreciation of human capital. “Social capital is a broad term encompassing reciprocity, sanctions, trust and networks facilitating collective action for mutual benefit,” says the author. She also endorses a broader definition of social capital as “the aggregate of the actual potential resources which are linked to possession of a durable network of more or less institutionalised relationships of mutual acquaintance and recognition—or in other words, to membership of a group—which provides each of its members with the backing of the collectively owned capital, a credential which entitles them to credit, in the various sense of the word.”

In turn, the understanding of social capital leads to the specification of institutional capital because social norms soon get institutionalised. After all, society consists of not isolated individuals but those who, from the very beginning, interact with others through a variety of institutions, the family, the village community, and a variety of production organisations, all of which provide the individual with a sense of belonging. The individual acquires knowledge through these institutions; all decisions are taken in an institutional context; the values that an individual possesses directly or indirectly originate in and are preserved by institutions.

While analytically, human capital, social capital and institutional capital can be viewed separately, they are invariably intertwined. Thus, human capital formation is facilitated by social processes; individual productivity depends on the knowledge and effort of co-workers; multiple institutions nurture the habits and values that give rise to social capital; institutions and their legacies structure preferences, interests and values. The thesis that the author presents is that different societal and economic outcomes depend on different possible combinations of these three factors—human capital, social capital and institutional capital —in different interlinked contexts. This thesis has some intuitive appeal. The problem is that the permutations and combinations of the three broad “capitals”, each with its own many and heterogeneous strands, can be used to rationalise any past and present “development” experience. The second part of the book consists of five case studies, the Industrial Revolution in Britain, the early industrial revolution in the United States, Japan’s post-Second World War growth, the manufacturing sector in China and India’s service sector growth since the 1980s. The conclusion that is arrived at from the case studies is that in spite of the variety in experience, all these cases can be shown to be interactions of human, social and institutional capital.

That technical change was a major factor in Britain’s Industrial Revolution is well known. A major reason for it, according to the author, is the shift from asking the question “which technique worked” to “why technique worked”, indicating a qualitative shift in the approach to knowledge that “mentally imbued engineers and inventors with a faith in the orderliness, rationality and predictability of natural phenomena”.

This scientific culture placed applied science at the service of commercial and manufacturing interests. The institution of apprenticeship played an important role, too, as many of the innovations were largely produced by workers who had little formal education, but who had benefited from the apprenticeship. The church, trade unions and temperate associations set up libraries, which enabled members, many of them workers, to educate themselves. “What helped the British economy grow and sustain its growth was having… the kind of agility that allowed institutions to change when the environment changed.” A wide range of social norms also evolved during the period, which included what was commonly described as “gentlemanly behaviour” and “gentlemanly capitalism”, making opportunistic behaviour sufficiently taboo so that only in a few cases was it necessary to use the formal institutions to punish deviants.

The early industrial revolution in the U.S. was also the result of the interaction among human capital, social capital and institutional capital, but of a different kind. The early migrants went to partially settled areas where survival depended on learning different ways of doing things, which produced a new pool of knowledge. Because of the differences in the background of the migrants, new norms of community living had to be evolved.

Churches and other voluntary organisations helped shape the moral standards and social capital of a heterogeneous population. Institutions of higher learning and professional societies were also instrumental in emphasising the importance of knowledge in public life. Continual migration produced a large group of consumers and encouraged occupational mobility.

China and beyond

Shift now from the West to the East and from early developing economies to more recent times and to a radically different pattern of development, that of China of the 1980s and later.

The author argues that the interaction among human, social and institutional capital is key to the understanding of China’s record-breaking growth and entry into economic interactions with other countries. After the Cultural Revolution, China moved to a policy to provide universal education up to Grade IX. Higher education, too, received attention. Both these, especially the latter with an emphasis on learning from the West, were indicative of the role of knowledge in economic development and social progress.

The traditional “guanxi”—literally passing the gate and getting connected—was put to use to encourage the formation of different kinds of networks. These informal arrangements were put to use to provide a sense of stability in the context of the breakdown of past norms. Experiments through the Township and Village Enterprises and Household Responsibility System prepared the ground for market relationships that rural Chinese were not used to and to generate the spirit of entrepreneurship that was necessary for sustained growth.

These brief summaries of old and new experiences of economic development and evolution show how easy it is to use the “interaction of human, social and institutional capital” formula to provide post-facto rationalisations of any experience of the past or the present. If professional economists are guilty of over-quantification, the approach presented by the author is not tainted by any quantitative assessment at all. Some of the factors that economists consider crucial, such as the availability of vast expanses of land and of labour via slavery in the U.S., are totally ignored as well. There is not even an attempt to show why some countries succeeded by adhering to the formula and why some others failed because they did not do so. Surely, there are cases of countries that in the past and even in the present did not pay enough attention to the new capital trinity.

India’s services sector

The case study of India presented in the book raises another issue. The services sector of the Indian economy is included in the book to show how even the performance of a sector of an economy can be explained in terms of the three capitals and their interactions.

The author draws attention to the phenomenal growth of the services sector from the 1980s but more so since the last decade of the past century. It is pointed out that in 1970-71, the sector’s contribution to the gross domestic product was just 39 per cent, which by 1990-91 had moved up to 48 per cent. Currently, it is close to 60 per cent. The author quotes with approval from a study that claimed that “deregulation, liberalisation of foreign investment, greater private participation since 1991 increased industry outsourcing, and high-income elasticity of demand for services have been the key factors driving the high growth in India’s services sector.” To this the author adds others such as India’s large pool of qualified professionals, its widespread use of English, its rapidly increasing stable of world-class companies, and cost advantage over other locations.

As a matter of fact, that assessment can also be accepted. As for social capital, the author’s view is that the multiple identities of Indians, among them religion and caste specially noted, have become impediments to forging solidarity between different groups, though they have been countered by the government, non-governmental organisations and the private sector through their attempts to create and sustain inter-group relationships. The British had established a kind of institutional capital which was “based on private property rights and an English style judicial system”.

The crucial question that the author does not raise is whether the soaring growth of the services sector is a healthy sign while the goods-producing sectors lag far behind. In particular, the agricultural sector, on which some 60 per cent of the population depends for sustenance, is in a sorry state. If that is the case, what does growth indicate and what does development mean? It is disappointing that such inquiries, too, would appear to be not part of the comprehensive explanation that is being offered through the three capitals approach for an understanding of economic evolution.

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