The process of production
In the three factors of production labour, land and capital were considered. Textbooks often add a fourth factor of production to this list, called ‘entrepreneurship’. Entrepreneurship is the process of bringing together the other factors in order to produce goods and services. A firm produces goods and services because they are demanded and because a profit can be earned by selling them.
Figure shows a much simplified profit and loss account for a car manufacturer.The items on the expenditure side represent the payments to the factors of production. Wages are payments to labour, raw materials and an element of overheads would be the payments to capital, and the payment for land would be included in overheads. The payment to the entrepreneur is in the form of profit.
What has happened in this process is that the factors of production have been combined to make finished cars and in the process value has been added to the initial value of the raw materials.
The car manufacturer can be thought of as being in the center of a process of production which links together raw materials at one end with the consumers at the other end. The raw materials are extracted and processed and then the finished goods are sold. In economic terminology, the extraction of raw materials is called primary production, the manufacture of cars is called secondary production and the distribution of the finished cars is called tertiary production . Although this simple path from primary production through to tertiary production is the case for many industries, it is likely to be much more complicated in practice.
The discussion at present is confined to a single firm, but it can be moved to the industry level. The industries that deal with natural resources like farming and mining comprise the primary sector. Industries which process these natural resources comprise the secondary sector, which will include manufacturing, construction and energy suppliers. The service industries make up the tertiary sector.There are great difficulties involved in such a classification of industry, as will be seen later, but consideration will now be given to the official classification of industry in the United Kingdom.
The Standard Industrial Classification
The Standard Industrial Classification (SIC) of economic activity is the official classification of industries in the United Kingdom into different sectors. It was introduced in 1948 and has been updated and changed on occasions to take account of the development of new products and industries for producing those products. It was changed in 1980, mainly in order to bring the United Kingdom classification in line with the activity classification used by the Statistical Office of the European Communities (Eurostat), which is called Nomenclature générale desactivités économiques dans les Communautés européennes (NACE).The 1980 SIC is shown in Table.
The 1980 classification had ten divisions(denoted by a single digit). Each of these is divided into classes (two digits), which in turn are divided into groups (three digits) and activity headings (four digits). In total there are ten divisions, 60 classes, 222 groups and 334 activity headings.
The term ‘production industries’ refers to divisions 1 to 4 of the above classification; the term ‘manufacturing industries’ refers to divisions 2 to 4. The SIC does not comply exactly with the broad classification of industry used in the last section.The primary sector of the economy is found in division 0 and parts of divisions 1 and 2; the secondary sector in parts of divisions 1 and 2 and all of divisions3 to 5. The tertiary sector would be divisions 6 to 9.
The SIC is changed periodically to reflect changes taking place in industry, most notably in 1990 and 2003, see below. In 1990 the EC approved a new statistical classification of economic activities in the EU (NACE Rev. 1). This means that the United Kingdom had to introduce a new SIC in 1992. The standardization of industrial classification across Europe will make interstate comparisons easier. The SIC(92) which replaced SIC(80) was based on NACE Rev. 1. It had 17 sections instead of the ten divisions of SIC(80); each of these sections is denoted by a letter from A to Q. The sections are divided into subsections which are denoted by the addition of another letter. The subsections are then broken down into two-digit divisions and again into groups (three digits), into classes (four digits) and into subclasses (five digits).
In January 2003 the EU made a minor revision of NACE Rev 1, which is known asNACE Rev 1.1. As a result, the UK government has had to introduce a new SIC(2003), the broad outline of which is given in Appendix 10.1 at the end of this chapter. The changes were mainly at the 4- and 5-digit level and there has been a slight redistribution of industries between divisions. In SIC(2003) there are 17 sections, 16 subsections, 62 divisions, 225 groups, 517 classes and 285 subclasses. An example is shown in Table. Some sections are subdivided more than others, the obvious example being section D where there are 14 subsections and 22 divisions. The level of detail depends upon the diversity of production included within the section. A major revision of the SIC will take place in 2007 when European classification will be brought in line with North American classification.
Differences between SIC(80) and SIC(2003)
First, there is the obvious change in the numbering system, but there are also some changes in the order in which industries appear. For example, electricity, gas and water have moved further down the list to appear after manufacturing in the SIC(2003). There is also now a much more detailed breakdown of the service sector; the old division 9 has been broken up into eight different sections. This illustrates the increased acceptance of the importance of the service sector in the economy. There have also been changes in the classification within sections. Table gives a comparison of the two Standard Industrial Classifications.
Problems in classifying industries
The classification of industry is problematic. Firms could be grouped together according to similarities in what they produce but some firms produce a range of goods for quite different markets. Firms could be grouped together according to what they ‘do’, so that if their production processes are similar they could be considered as part of the same industry. The service industries are particularly problematic as they have traditionally been defined by the function they perform, but developments in technology have led to these functions overlapping and therefore becoming more difficult to distinguish: for example, publishing and printing. All of this leads to industries that are seemingly very diverse being grouped together in the SIC. Although the SIC does not succeed in overcoming all of these problems, it does provide an accepted classification of industry which can be used for many purposes. The information collected provides a basis for comparing the structure of industry within a country over time and between countries.
Measuring industrial structure
The structure of industry in a country is not static, and it changes over time for a variety of reasons. For example:
Industrial structure is usually measured by the level of employment or output of the various sectors of the economy, and changes in industrial structure over time can be observed by looking at the changes in the employment and output levels in different industries. These will usually (but not always) paint the same picture; a sector in decline will have falling employment and output.
Industrial structure in the EU
Figure shows the industrial structure of the EU as a whole as measured by employment in 1979 and 2004. During the 1980s there was a 20 per cent fall in the level of employment in agriculture, a 14 per cent fall in the level of manufacturing employment and a 15 per cent rise in employment in the service sector. In 2004,5 per cent of the working population of the EU was employed in agriculture, 25 percent in industry and 70 per cent in services. So there has been a gradual trend a way from employment in the primary and industrial sectors in the EU as a whole and a gradual rise in employment in the service sector. Figure indicates the changes in the relative sizes of the three sectors over the period 1980 to 2004.
The trends displayed in the EU are evident in other advanced industrial economies. Table shows that while there are some differences in industrial structure between countries, the tertiary sector in all cases is predominant in employment terms. Within the EU, the United Kingdom has a much smaller agricultural sector than other EU countries and the EU average while Germany has the largest production sector. The new members of the EU will have an effect on these figures as many have industrial structures different from existing members
Poland and Lithuania, for example, both had 18 per cent of their populations employed in the agricultural sector in 2003. Japan has a larger manufacturing sector than the EU average and the USA, and a smaller tertiary sector.
Industrial structure can also be gauged by looking at output figures. For both employment and output the figures tell the same story: the primary and secondary sectors of the main industrial countries have declined in importance, while the tertiary sectors have increased in importance. The reasons for these changes will be considered later in this chapter. The broad averages hide differences between the industries in each sector. Table shows the rankings of major EU sectors by output and employment in 2000. Industries which were forecast by the EU to grow faster than the average between 1995 and 1999 included hotels and restaurants, other market services, air transport, auxiliary transport services and motor vehicles. Industries which were expected to yield negative growth included iron and steel, textiles and clothing and pharmaceuticals.
In the EU there are three main reasons for the restructuring of manufacturing that has taken place over the past 20 years: first, deregulation, which has led to greater internal competition; second, greater competition both internally and externally from third-party countries, especially the less developed, low-wage countries; and third, the creation of the Single European Market and the resulting increases in competition brought about by the elimination of barriers to trade.
There are a great variety of ways in which companies have reacted to these changes but the Panorama of EU Industry identifies several ‘typical’ responses, some of which will have contradictory effects. These include:
Industrial structure in the UK
The United Kingdom does not fare well in international comparisons, as the trend is the same as in the EU but the decline in the manufacturing sector has been more pronounced in the United Kingdom and the jobs lost in manufacturing have not been offset by jobs created in the service sector. It is also true that while there has been a relative decline in the output of manufacturing in all countries, it is only in the case of the United Kingdom that there has been an absolute decline.
Figure shows a graph of employment in manufacturing in four countries over the period 1974 to 2002. It is clear from this graph that the decline in employment in manufacturing has been much greater in the United Kingdom than the others. The United Kingdom started from a much higher base in 1974 and in 2002 had the lowest level of employment in manufacturing except for Japan, which has experienced a sharp economic slump.
Table gives an indication of the change in industrial structure in Great Britain between 1969 and 2004. It shows the total numbers employed in various industries for 1969, 1995 and 2004. It is important to realize that when different years are compared the figures will be affected by the state of the economy in each of those years, but nevertheless the comparison will give an indication of changes in the relative importance of the three sectors of the economy. The change in the Standard Industrial Classification that occurred during this period would have had a minimal effect on the figures and has been corrected as far as possible.
There has been a slight increase in the level of total employment during this period but a substantial change in the pattern of employment between the different industries. The level of employment has fallen in the primary sector from 929 000 in 1969 to 267 000 in 2004. There has been a similar change in the level of employment in the secondary sector, which fell from 10.2 million to 4.5 million during the period. These falls were partly offset by the increase in the level of employment in the tertiary sector. The trend is clearly seen in Table, which shows the percentage share of total employment in the United Kingdom in the three broad sectors of the economy over a period of time.
It is clear from Table and Figure that there has been a shift in the pattern of employment which indicates a change in the structure of industry in the United Kingdom. The relative importance of the primary sector has declined over the period 1969 to 2004, accounting for 3.6 per cent of employment in 1969 and 1.5 per cent in 2004. The increase experienced at the beginning of the 1980s was due to North Sea oil and the most recent decline was due to the decline of the coal industry. This fall is a continuation of a much longer trend of decline in the primary sector. There has also been a dramatic fall in the relative importance of the secondary sector in providing employment, which fell from 46.8 per cent to 18.5 per cent of employment during the period. Again this table shows that the relative importance of the service sector has increased.
Before consideration is given to the reasons for these changes, the other key indicator of changes in industrial structure will be considered the level of output. These figures show a similar pattern to those on employment. There has been a fall in the relative importance of the secondary sector and an increase in the importance of the tertiary sector. There was an increase in the importance of the oil and natural gas industries in the late 1970s and early 1980s because of the production of North Sea oil and gas; this trend, however, has now been reversed. The broad classification used in Table hides the fact that there are differences within the sectors, where some industries grow while others decline in importance.
The changes in relative sizes of the different sectors of the economy in theUnited Kingdom are the same as in other countries. It is only in the UnitedKingdom that there have been periods of absolute decline in the output of manufacturing industries, as Figure shows. This decline in manufacturing is regarded by many as relatively unimportant; it is seen as a natural process of change which started with the Industrial Revolution and the movement from the land. To some extent this natural growth argument is supported by Table.This change in industrial structure is a trend which is evident in other countries.It might also be the case that some of the growth in the service sector is illusory.
For example, if firms are externalizing services that they once carried out themselves, there is actually not an increase in the amount of work done but a change in where it is done. It is not surprising that employment levels in manufacturing should fall, given the expansion of services and increases in productivity. What is more disturbing is that the absolute value of output in manufacturing has fallen and while similar patterns can be observed in other countries, the United Kingdom does not fare very well in international comparisons.
Causes of changes in industrial structure
There are several explanations put forward for the changes that take place in industrial structure. Broadly speaking these can be classified into demand and supply factors.
Changing patterns of demand will cause changes in the structure of industry.Demand will change as a result of changes in tastes and fashions, changes in the structure of the population, and changes in the levels of income. As income increases there is normally an increase in total spending on goods and services but there will be differences between different types of goods. There will be relatively large increases in expenditure on goods which have high income elasticities of demand2 and relatively small increases or even falls in demand for other goods.
Goods with low income elasticities are necessities like food, fuel, clothing and footwear. Luxury items have high income elasticities of demand; these would include things like durable goods, alcohol and services like tourism and leisure activities. Naturally what constitutes a necessity and luxury would change over the years. Figures and show the trend in expenditure on selected goods and services over a period of time in the United Kingdom.
Figure shows that the expenditure on food and clothing has remained fairly constant over time, as expected. The expenditure on durable goods is much more affected by movements in the trade cycle and the level of income. Expenditure grew over the 1980s but fell back again during the recession of the late 1980s and early 1990s. The expenditure on tobacco fell steadily over the 1980s, probably as a result of increased health awareness but has risen again more recently. Figure reinforces the findings above that services are like durables in that their demand is closely linked to the level of income. The pattern of expenditure is very similar to that for durables. It should also be remembered that suppliers have an impact upon the level of demand for products as they can manipulate demand through advertising and other forms of promotion.
The differential effects of rising income on demand for goods and services would in part explain the growth in the size of the service sector over the years. The change in industrial structure can then be seen as a natural process of change. During theIndustrial Revolution there was a movement from agriculture to industry, in the same way as there is now a movement from manufacturing towards services. Changes in demand, however, cannot explain all of this change. Growth in the service sector does not necessarily mean that there should be a decline in the size of the manufacturing sector when there are high levels of unemployment in the economy. Labour can be drawn from the unemployed rather than from manufacturing industry. During the time period under consideration there have been periods of high unemployment. It is also the case that the import of manufactured goods has not fallen, so it is not that demand has fallen for those goods but that we are buying them from abroad.
Changes in industrial structure can also be triggered by changes in supply conditions. The oil crisis of the 1970s is a good example of this. As a result of the massive increase in oil prices, there was a concerted campaign to reduce the consumption of oil and a search for other forms of energy. Technological change gives rise to new products and/or new processes of production. Different industries will vary in the scope for technological change and for increases in productivity.
Demand and supply forces are interlinked so it is often difficult to separate their effects as new products will generate new demands or could be developed to meet new demands. Added to these internal factors is the fact that the United Kingdom is part of an international economy and competition from abroad will have an impact on the structure of industry through both demand and supply factors.
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