Human Capital and Social Capital as Interacting Factors of Economic Development

When studying empirically the differences in levels of income and development between nations and regions, it appears that these enormous and growing differences cannot be fully explained by traditional theories of economic growth, which consider physical capital as the main factor of development. The basic assumption made in classical and neoclassical economic theory states that society consists of a set of independent individuals, each of whom acts to achieve goals that are independently arrived at, implying that the best institution to govern economic exchanges is free market. However, market mechanism based on individually rational behaviour will often not guarantee collectively optimal outcomes because of externalities, whose solving requires cooperative behaviour and attitudes. Acknowledging such duality in economic theory has forced economists to look for new explanations to economic processes. Earlier, the concept of human capital – consisting of good education and health which should yield higher productivity — was added into endogenous growth models, and following empirical work has proved that human capital has strong explanatory power in growth regressions.