ECONOMIC DEVELOPMENT for Beginners
Concepts & terminology of Micro
Reading time: approx. 20 mints
Economic Activity
Let’s start at the top with the economy and its structure and then proceed to the bottom. What are the different kinds of economic activities that together make up the modern economy? Primitive economies, by distinction, have agriculture as the dominant economic activity. Broadly, economic activities of such type include farming, grazing of animals, small-scale processing and production of commodities derived from the previous two activities. As a primitive economy transforms into an industrialized economy, the contributing share of agriculture, forestry, and fishing (primary industry) within national income declines while the share of mining industry, manufacturing industry, construction industry, and utilities industry—together called secondary industry—rises. Parallel to the rise of secondary industry, the share of services (tertiary industry) within national income becomes considerably larger. The latter also becoming the largest employer. That is pretty much how the early-industrialized countries, as well as the late-industrialized, have had their economic structure transformed, the only difference between those two groups of countries coming down to the much-compressed timespan in the transformation of the economies of the latter.
In Chapters Five and Six, as we develop the microeconomic backdrop of rapid economic development theory, few important concepts and terms such as markets, industries, technology, technological change, product invention, technology diffusion, knowledge, information, etc. become central to the overall framework.
Elsewhere in economic literature, scholars exhibit affinity to some or most of those concepts and incorporate them into economic growth theory building such as the Solow economic growth model centralizing the factor of ‘technical change’, which is residual in the overall growth after accounting for capital and labor. In different ways, those concepts tell us something important and unique in their own right and can readily be turned into a key facet for a new theory construction if so desired. That’s exactly the case of various growth theories that came out of neoclassical economics in the postwar world.
It appears that the mainstream definitions associated with those terms do not indeed convey anything meaningful for an overall policy action point of view for late industrializing countries, but their relevance to industrialization is somewhere to be found.
After a fruitful search for standard economic growth theories for over seventy years during the postwar era, wherein the first few decades until the mid-1970s witnessed a distinct inquiry into economic development theory but thereafter saw a unified attempt to develop an overall standard growth theory, we now have hit a point of serious inspection. It is clear that all of those theories—a few of them covered in the Introduction—explain some of the useful concepts that pertain to economic growth but none of them, whether those are macro or micro in character, particularly retained a wholesome approach to economic growth theory.
Here we shall proceed differently and methodically. In the earlier section, concepts and notations employed in the macro backdrop of the theory have been discussed. Here, we will do the same for the micro backdrop of the theory. Having observed sporadic and half-cut theories of the past, to my mind what they lack is a search for answers to the most definitive questions of microeconomics of late industrialization. If undertaken to resolve such a task here, the micro part of the theory should certainly retain the traits of a macro approach to looking at microeconomics. What I mean by that is, just as macroeconomics deals with the overall economy, any discussion and theoretical development of the micro aspect of the economy—that is, markets, competition, technologies, inventions, knowledge, etc.—should necessarily have a unified theme. That is, without undercutting anything but incorporating just about everything all the nuts and bolts of microeconomics can make way to reaching answers to the questions in consideration. That, in fact, is the approach in Chapters Five and Six.
In particular, we shall probe important questions relating to the micro-economy at the most basic levels. But to do just that we will have to discuss certain critical concepts, their interconnections, and resolve certain terms right here. The approach here is to start from a macro perspective of the micro-economy and gradually cut down to product level to arrive at the discussion of certain concepts. A unified perspective of the micro is essential here, and this section acts a supportive structure to the actual theory building in Chapters Five and Six.
Markets, Industries, and Products
As we move along to the Theory and then to the Mechanism of rapid economic development, it helps to come to square with the definitions of some basic economic terms such as markets, industry, and products to avoid the common practice of using those terms interchangeably, especially here as we deal with the classification of those terms based on a unique factor. Merriam Webster dictionary defines ‘market’ as ‘the area of economic activity in which buyers and sellers come together, and the forces of supply and demand affect prices’; for ‘industry’ as ‘a distinct group of productive or profit-making enterprises’; for ‘product’ as ‘something produced; especially commodity or something that is marketed’; and lastly for services as ‘useful labor that does not produce a tangible commodity—usually used in plural form.’ For ease of discussion, we shall club the two terms—products and services—to refer them together as ‘economic goods.’
The definitions are quite clear. Effectively, markets are the places where industries selling economic goods meet other industries or individuals who make purchases. To have a market, you need to have industries, and to have industries, you need to have a useful product or service discovered or invented. Markets can be formed by profit-seeking businesses manufacturing and servicing economic goods for sale to customers and clients directly or indirectly. However, there arises a need to further characterize the real world markets based on the ownership of industry pertaining to a certain market. When a specific market in a country is made up primarily and not exclusively by domestic industries, we will refer to it as ‘Real Market’, and when a market is made up exclusively by foreign industries selling products in the country, we will call it ‘non-Real Market.’
As an example, domestic automakers such as Ford, GM, and Chrysler (merged with Fiat but listed on NYSE), besides foreign makers Toyota and Hyundai, all manufacturing cars in the US and selling cars in the US mean the US has a Real Car market. Whereas, carmakers (foreign and domestic to Ireland) that sell in Ireland but their autos manufactured elsewhere means Ireland has a ‘non-Real Car Market.’ A country requires a minimum of industries manufacturing products within the boundaries of the country for sale to have a real market for a product. But for a country to have a non-real market, it does not require to have industries making products locally. The country can simply import those products made elsewhere through trading companies, third-party affiliates of companies, manufacturer’s foreign affiliates, etc. Throughout the book, when reference is made to markets, it automatically means real markets. Wherever the reference, if only sparingly, is to ‘non-Real market,’ the qualification is shown. So there should not be any confusion as to the reference to the term ‘market’ throughout the book.
Understanding the intricacies of industrialization requires at times to stress on markets, industries, and products, and in particular, to follow through on the idea of classification of markets and industries. Markets and industries can be classified in a number of ways. That is, classification can be undertaken by nature of economic goods (such as consumer, capital), kind of economic activity (such as mining, construction, manufacturing), intensity of production process (light, heavy), the stage of usage of the product or service (raw, final), etc.
The nomenclature followed here is simple. Group of markets that make a distinct market is classified as XYZ Market, as an example ‘commodity markets’ or ‘consumer goods markets’ each representing distinct goods on some level. Then the group of enterprises that make up a distinct industry can be classified as XYZ industry, as an example ‘services industry’ or ‘light manufacturing industry’ each representing distinct activity on some level.
Classification of Markets by stages of Product Development
Markets of economic goods can be divided into five distinct groups: primary commodity markets, processed commodity markets, consumer goods markets, final goods heavy industry markets, and services markets. All five represent markets of products and services having economic value. Those five together can be to referred as ‘Economic Goods markets’ in that the production of goods represented by all of those markets whether in pre-final form or final are part of the annual gross economic output of a country.
Further, it is important to note that besides the markets of economic goods, there also exist markets of assets—as part of the grand makeup of a Capitalist economy. Asset markets represent together all of those markets organized for selling and purchasing of assets that were already acquired or came into existence prior. They primarily are not economic goods that have been created brand new; they, instead, represent items in one way or another on the balance sheet of the seller, or of the purchaser. They are a stock acquired in the past. In contrast, the goods and services that we call economic goods represent items that correspond to the income statement. Thus, Asset markets and Economic Goods markets together make up a Capitalist economy; the former corresponds to capital or wealth, and the latter to income, even as a portion of income metamorphoses into wealth each year. A person buying few shares of a specific company, or buying a house is transacting within Asset markets, whereas the purchase of food, drinks, clothes, a bulldozer (a brand new purchase) fall under Economic Goods markets.
It may be of interest here that surprisingly many preeminent economists, or the textbooks they write, or even the prominent economic thinkers of the past evident from the economic theories they concocted, had failed to recognize the above feature—simple but central to beginning to understand the complex and dynamic system that is the Capitalist economy. All too often Economic Goods markets enter the frame of analysis, as given; the subject of Assets markets is dealt under a whole different spotlight and often under the sub-discipline of Financial Economics. Lost to them is that many answers lie at the intersection of those two markets. Or to state more precisely, the link between balance sheet (assets and debt) and income statement (economic goods) at the individual level or business level prove crucial to understanding transformative events like the 2008 Financial Crisis, as we will see.
Next, we will discuss the classification of industry by kind of economic activity as opposed to the just-concluded system of market classification, which was by degree of development of the good and on a market level. Following that part is a discussion on the classification of national capital by type.
A Brief Outlook of the Nomenclature of Industry Classification
Several taxonomies for classification of industry into industrial groupings are in vogue. The design of industrial classification is to serve and support the purpose of economic analysis and policy-making and for the general monitoring and evaluation of the performance of an economy over time.
Prominently, Standard Industrial Classification (SIC)—first of such an effort anywhere in the world—was developed by the US government and adopted in 1937; however, in 1997 it has been replaced by North American Industry Classification System (NAICS) that was jointly developed by the governments of the United States, Canada & Mexico. United Nations’ own International Standard Industrial Classification of All Economic Activities (ISIC) is widely adopted across the world. Since the adoption of the original version of ISIC in 1948, a majority of countries around the world have used ISIC for classification of their national economic activity.
The latest version released in 2008—fourth since inception—has been improved on the previous one and was designed to reflect the evolving economy better, recognizing new industries that have emerged in the past two decades. ISIC is a classification according to kind of economic activity and not a classification of goods and services. The UN has a separate classification system called Central Product Classification (CPC) to measure product data at any detailed level. However, for our analysis, besides the industry classification we also require product data, not at national level but international level concerning trade. There exists a different and widely adopted trade classification system called the Harmonized Commodity Description and Coding System (HS) to meet that purpose.
Since we are interested in industry performance measured and analyzed regarding industry exports and imports, the tariff nomenclature, the Harmonized System (HS) is very useful. The HS method of tariff nomenclature is an international standardized system of names and numbers to classify and segregate products based on certain characteristics, developed and maintained by the World Customs Organization. This system allows for flexible analysis at various groupings of products (in the trade of a country) broken down all the way to the level of individual product.
However, in our analysis of product trade of China in Chapter Eight, we require an industry classification structure to partake with product trade classification (under which to dig into trade data). That is we require something that is identical to what we get if we fuse the ISIC system (industry classification) and HS system (product trade classification). That is, when we consider product trade of a country, say, Chinese printing machinery trade, it benefits to have an industry structure under which the product of printing machinery falls. We require not necessarily the ISIC itself but a structure that resembles ISIC because it will be hard to fully reconcile the industry classification of ISIC system with product trade classification of HS system.
Even so, it benefits to have a classification system for industry. Therefore, we shall keep it simple here. We will make recourse to only the top-level classification of industry as per the latest ISIC classification. But in regards to further division down that level, we will develop a structure of classification in the next sub-section based on other characteristics and it is to which we now turn.
Classification of Industry
ISIC has the following sections, from A to U, covering all kinds of economic activities found in a modern economy: Section A is Agriculture, forestry and fishing; B is Mining and quarrying; C is Manufacturing; D is electricity, gas, steam and air conditioning supply; E is water supply; F is Construction. So far, the sections covered Primary industry (section A) and Secondary industry (mining, manufacturing, utilities, construction—sections, B, C, D, E, F). We can club section D and section E under ‘utilities’ for simplification. The rest of the industry sections from G to U cover Tertiary industry—the service industries.
Services activities include: Wholesale and retail trade, repair of motor vehicles and motor cycles (Section G); Transportation and storage (Section H); Accommodation and food service activities (Section I); Information and communication (Section J); Financial and Insurance activities (Section K); Real estate activities (Section L); Profession, scientific and technical activities (Section M); Administrative and support service services (Section N); Public administration and defense, compulsory social security (Section O); Education (Section P); Human health and social work activities (Section Q); Arts, entertainment and recreation (Section R); Other service activities (Section S); Activities of households as employers, undifferentiated goods-and-services-producing activities of households for own use (Section T); Activities of extraterritorial organizations and bodies (Section U).
All sections, from A to U, can be aggregated to the three strata of the economy—primary industry, secondary industry, and tertiary industry. The aggregation into the three strata, however, is not part of ISIC; we shall deploy such aggregation here since it is useful in ways we will see. Consider Fig. 1.2 showing the breakdown of all economic activities—activities that produce economic goods and together make up Economic Goods markets.
What does each strata correspond to? Primary industry comprises economic activities that involve exploitation of resources (except ores) from nature, while secondary industry comprises economic activities that involve extraction of ores from nature (mining) and transformation of raw materials into useful finished products and structures (manufacturing, construction) and lastly tertiary industry comprises economic activities that involve the provision of all kinds of intangible services (education, healthcare, entertainment, etc.)
To reiterate, we have the Secondary Industry divided into these four sections: Mining industry, Manufacturing industry, Construction industry & Utilities industry. Our reliance on ISIC ends right here at that level. All levels deconstructed below this level, especially the many divisions of manufacturing industry—the chief concern to us—are developed right in this Chapter. That is much of the classification under the level of ‘section’ is peculiar outside this book.
The activity of manufacturing, according to ISIC, is defined as the physical or chemical transformation of materials, substances or components to new products. The materials, substances or components transformed are raw materials that are products of agriculture, forestry, fishing (primary industry strata, comprises section A), mining and quarrying (section B) as well as products of other manufacturing activities. In other words, substantial alteration, renovation or reconstruction of goods is generally considered to be manufacturing. Manufacturing activities take place in plants, factories, or mills and characteristically depend on power-driven machines and material-handling equipment for operation.
Classification of Manufacturing Industry
As illustrated in Fig. 1.2, manufacturing industry section is classified into two divisions, Light industry and Heavy industry. Light industry includes the manufacture of consumer goods using machines for final consumption (such as apparel, toys, furniture, footwear, food, paper, etc.). Manufacture of light industry products is less capital intensive in that those industries simply require the installation of product-specific machines to begin production and also access to specific processed raw materials; the activity is also less energy intensive per unit product. For all non-industrial or semi-industrial countries, light industry manufacturing is easy to begin because this industry copes well with non- skilled and semi-skilled labor to create value and also allows the manufacturers to achieve competent product quality quickly since light industry products are technology-free and share the features of a commodity at the core.
Heavy industry is composed of two sub-divisions: Upstream industry and Final goods heavy industry. Mining industry supplies ores and minerals to upstream industry for industrial processing. Upstream industry employs techniques and methods originally developed during the Industrial Revolution to transform ores and minerals that are in the primary form into usable material of forms and types.
Source: Author’s own work
The processed material is then supplied to final goods heavy industry, enabling the manufacture of product machinery and equipment—some of which include gas turbines, internal combustion piston engines, electric motor, electric transformer, etc. In standard literature, the industry that manufactures final machinery and equipment is referred to as ‘Downstream industry’. But let’s dispense with that phrase to employ the much more meaningful term ‘Final Goods Heavy Industry.’
Final Goods Heavy Industry
What characterizes the products that are manufactured under final goods heavy industry? The biggest feature those products share is their existence owing to certain scientific principles, which are embedded in the design and operation of those products. Those products also require large fixed capital investment to begin production; consume massive energy per unit product in the production process; have complex product design and development prior to manufacturing; have advanced production processes at the level of parts; have diverse material inputs that show up in the final form; involve complex supply chain system.
The products manufactured by final goods heavy industry are those generally known as the ‘machines’. They also are usually very heavy, bulk in size, and consume massive energy in their primary operation. Those products are costly in the market as the very intensive nature of their production can attest. Some more examples of Final goods heavy industry products are cars, ships, boats, tankers, airplanes, trucks, bulldozers, excavators, etc.
That is, the products of heavy industry in the final form are chiefly machinery and equipment. Those line of products machine and equip all other industries of the economy, including its division counterpart—light industry, sister sections of secondary industry—that being mining industry (B), construction industry (F), utilities industry (D, E)), and also both primary and tertiary industry—that being agricultural, forestry and fishing sector (A) and service industries (G to U).
It is heavy industry that transformed and upended the entire production skeleton of the economy. Whether farmers deploy age-old shovels or modern agricultural machinery such as tractors, grazers, harvesting machinery to farm and grow crops, or whether patients receive healthcare services wherein treatment is performed with or without making recourse to industrial medical devices, depends on the strength of the final goods industry production and supply.
All heavy industry products in the final form incorporate a workable product-design that has scientific principles at the heart of its operation and allows for mass-production. What are these heavy industry products? What are the scientific principles underlying the product’s purpose of existence? When did they come into existence, or when were they invented?
The product output of final goods heavy industry are those that find a place in power generation and transmission activities and include steam turbines, water turbines, gas turbines, internal combustion piston engines, electric motor, electric transformer, jet engines, etc.—all have Faraday’s Induction law, or Thermodynamic laws, or Law of energy conservation as the scientific principles at the core of their design and operation; those that find a place in construction and mining industry and include excavators, tractors (attached with machine implements), bulldozers, etc.—all have hydraulic principles at the center of heavy duty operation. Most of them were invented sometime between 1870 and 1913, that is, during the Industrial Revolution, in Great Britain, the United States, Germany, Italy, and France, etc. The products up there in practice either operate in conjunction with other products or are enclosed within a larger product, as an example, engines and gas turbines being the prime movers of transportation systems such as automobiles, ships, boats, airplanes, and railways.
Importantly, the questions relevant for the purpose at hand are these. How did those products come about in their creation in all of the early-industrialized countries? What drove further advancement of their design and operation since their invention and all the way up to the present day? How did those products—in improved form after decades of innovation—find new shelters in the late-industrialized countries, all of which have missed the Industrial Revolution but only later have they begun to industrialize? Answers to those questions—the right questions of inquiry—will be taken up in Chapters Five and Six concerning the micro backdrop of the theory of rapid economic development.
So far we have deconstructed industry at these levels: strata, section, division, and subdivision. More deconstructions will follow in the next sub-section.
The Two Sectors of Final Goods Heavy Industry
Previously, we have classified manufacturing industry into two divisions: Light industry & Heavy industry, and heavy industry itself into two subdivisions: Upstream industry & Final goods heavy industry. We now classify final goods heavy industry into two sectors: Capital machinery industry, and Capital equipment industry. The two terms ‘machinery’ and ‘equipment’ have been used interchangeably prior to this, but here onwards distinction between those two serves a primary purpose for classification, and as such their original meanings reflect a singular distinction between the characteristics of products manufactured under those two industries that theoretically bear those names.
Mariam Webster gives the definition for Machine as “an assemblage of parts that transmit forces, motion and energy one to another in a predetermined manner; an instrument such as a lever designed to transmit or modify the application of power, force or motion” and for Equipment as “items needed for the performance of a task or activity.” To understand the latter better, let’s unearth the meaning of the term ‘equip’; ‘equip: to furnish for service or action by appropriate provisioning.’ The singular distinction between the two terms—machinery and equipment—relates to the kind of outcome obtained from the operation of product machine that is the output of each of the two industries. That is, capital machinery industry manufactures final product machinery that in its original operation is designed to power & run things, move & build things, pick & harvest things, make & work things, etc. The word ‘things’ here refers to that which is tangible. In contrast, capital equipment industry manufactures final product equipment that in its original operation is designed to service things, and that, by definition of service, yields an outcome that is intangible.
Whereas product machinery is used to cut and collect (in agriculture, forestry, fishing ‘A’), make (in manufacturing ‘C’), mine and drill (in mining ‘B’), build (in construction ‘F’) and generate power (in utilities ‘D, E’), the latter—product equipment—equips workers in the provisioning of various services (services ‘G’ to ‘U’) including transportation, healthcare, entertainment, broadcasting, etc. Capital machinery industry manufactures product machinery such as agriculture machinery, mining, and construction machinery, power generation and transmission machinery and final goods heavy industry manufacturing machinery, etc. Whereas capital equipment industry manufactures product equipment such as electronics, train sets, airplanes, buses, cars, ships and boats, medical instruments, measuring and testing devices, etc.
The importance of cleaving final goods heavy industry into those two sectors can be surmised by the observation that the product machinery manufactured by capital machinery industry when installed for operation not only helps manufacture (make) the product equipment of capital equipment industry but also in many cases powers them and runs them in their actual operation (of providing service). What’s more, the final goods heavy industry manufacturing machinery when installed in plants not only helps manufacture product machine for all other subsectors of capital machinery industry and capital equipment industry, but also helps manufacture the product machines of themselves.
A note regarding the terminology of capital machinery industry and capital equipment industry—the two sectors of final goods heavy industry—is that the phrase ‘final goods’ has been detached for simplicity. However, that does not mean that capital machinery industry manufactures only final goods in the strict sense of the term ‘final.’ Many mini-machines, which are not truly final, such as engines, generators, electric motors, hydraulic motors, etc. because of their widespread application become an integral part of the product equipment manufactured by capital machinery industry.
For example, gas turbines of capital machinery industry, manufactured by a business under power generation industry (that is, utilities), can give way with few design modifications to turbojets (jet engines) to be utilized by airplane manufacturers—those being businesses belonging to capital equipment industry. That is why the US industrial conglomerate GE manufactures gas turbines under GE Power and jet engines as well under GE Aviation. A secondary reason for such classification of heavy industry is to pave the way for the classification of the national wealth of a country into four types. We will come to that topic shortly.
A General Classification of Industry
To review, we have deconstructed industry into many levels of classification, from the top and all the way to the bottom: economy, strata (example, secondary industry), section (example, manufacturing), division (example, light and heavy industry), subdivision (example, upstream industry & final goods heavy industry), sector (example, capital machinery industry & capital equipment industry) and subsector (example, power generation machinery, agriculture machinery etc.).
The classification of industry has been based on various characteristics at different levels, such as classification by nature of economic activity at the level of strata (ex, Agriculture), by kind of economic production at the level of section (ex, manufacturing), by intensity of manufacturing at the level of division (ex, heavy industry), by stages of value addition at the level of subdivision (ex, final goods heavy industry), by type of operation outcome at the level of sector (ex, capital machinery industry) and finally by name of industry served by the goods at the level of subsector (ex, power generation machinery).
The general classification of industry devised here helps us to portray the intra-economy linkages among industries. The final goods heavy industry supplies all the machinery and equipment to all of the other industries and also to itself to be able to perform economic activities under those industries.
The primary industry strata (that is, agriculture, fishing, forestry) and the mining industry section (under secondary industry) provide all of the raw materials in primary form (that is, not processed or manufactured except for grading, cleaning, sorting) to upstream industry.
The upstream industry processes raw materials supplied to it into usable forms and types by mechanically or industrially processing them and supplies it to the rest of industries, for example, cement to construction industry, coal to utilities industry, iron and steel and their alloy forms, non-ferrous metals to final goods heavy industry and wood, fiber, cotton, raw food to light manufacturing industry.
Overall, whereas the final goods heavy industry supplies product machinery and equipment to every industry including itself to be able to perform economic activity, upstream industry supplies material to other industries for production.
The general classification of industry is properly classified to enable us to study secondary industry. Each industry classified in the above format is related to a specific branch of engineering. Electrical engineering and Mechanical engineering correspond to capital machinery industry and the capital equipment industry, Materials and metallurgical engineering to the metals part of upstream industry, Chemical engineering to the chemicals side of upstream industry, Mining engineering to mining and quarrying section, Civil engineering to construction industry, Electronics and communication engineering to the electronics sub-sector within the capital equipment industry.
The inventors and engineers, by applying scientific knowledge to create solutions to problems, made possible the Industrial Revolution and gave the world the products that we have identified with the final goods heavy industry. We will refer to those products—as they were when invented during the Industrial Revolution from 1867 to 1914, together as Great technologies.
Another significant line of classification of all economic activities, profoundly useful later on, is based on technology. All industries from sections to divisions under the prior classification can be grouped under Traditional economic activities and Heavy industry activities. Traditional activities comprise all economic activities, except ‘heavy industry’ division of manufacturing section, and they are Agriculture, forestry, and fishing (primary industry); mining industry, manufacturing industry (except heavy industry), construction industry & utilities industry (secondary industry); and services (tertiary industry).