February 8, 1993

                       Economic Classification Policy Committee
                                  Issues Paper No. 1

                                  Conceptual Issues

               At the 1991 International Conference on the Classification

          of Economic Activities at Williamsburg, Virginia ([1], hereafter,

          "Williamsburg Conference"), many participants stated that

          economic classification systems, including the U.S. Standard

          Industrial Classification (SIC) system, need to be based on

          economic concepts, or need an improved conceptual foundation. 

          This call for an economic concept was a major departure from

          recent past discussions of economic classifications.

          Classification Systems

               Many economic classification systems exist.  All of them

          group economic data.  

               Some classification systems group individual transactions. 

          The Harmonized Commodity Description and Coding System (HS), for

          example, groups individual international trade transactions into

          product-code groupings for tariff and trade negotiations.  The

          Census Bureau "7-digit" product codes group the value of

          shipments of individual manufacturing products.  In principle,

          such groupings could provide an exhaustive list of the

          commodities and services produced in the economy (though in

          practice, even the most detailed codes must combine commodities

          that differ to an extent).  

               Other classification systems group or aggregate producing

          units into industries.  The U.S. 4-digit SIC codes are an example

          of such an industry system.  The SIC system also aggregates the

          4-digit industries into higher level aggregations, the SIC 3-

          digit and 2-digit industry groups.  The International Standard

          Industrial Classification of all Economic Activities (ISIC), of

          the United Nations, is another industry classification system.  

               Many of the most difficult issues of classification systems

          concern the principles for forming industry aggregations.  For

          this reason, Issues Paper No. 1 focuses its attention on these

          conceptual questions.

               Questions concerning the grouping of "industries" or other

          first-level aggregates into higher-level aggregates are discussed

          in Issues Paper No. 2.  Issues in forming the product- or

          commodity-level detail itself are discussed in Issues Paper No.

          8.  However, the topics discussed in Issues Papers Nos. 2 and 8

          are closely related to these addressed in Issues Paper No. 1, and

          for this reason Paper No. 1 is crucial for the other two. 

          1.1  The Purpose of an Economic Classification System 

               To those most familiar with economic classifications, their

          purpose may seem obvious.  Yet, an explicit statement of purpose

          --the underlying objective of a classification system--is

          essential for many of the topics discussed in the Economic

          Classification Policy Committee (ECPC) issues papers.  

               The literature on economic classifications presents several

          general answers to the question of purpose.  In all of the

                                          2

          following, some listing of detailed commodities and services is

          presumed to exist, and the discussion concerns the formation of

          some first-level aggregation system, that is, an SIC industry, or

          some analogous or similar aggregation. 

          (a)  To facilitate use of the data

               For many analyses, economic data are grouped in order to

          reduce the amount of unmanageable detail.  When detailed

          commodity data are available, some users will prefer to group the

          data for themselves.  Other users, however, prefer that

          statistical agencies group the data into product or industry

          categories, either because of the expense of doing it for

          themselves or because they may lack the expertise to group data

          for their purposes.  A standardized grouping, or classification,

          system is therefore a service to the data user and provides a

          valuable reference point even for those users who decide they

          wish to depart from the standard system in some way.  In

          addition, microdata are not always available, because of

          confidentiality, sampling considerations, or other reasons; in

          these cases, statistical agencies must provide data in grouped

          formats.  

               In past approaches to classification, the objective has been

          to find a general purpose classification system that will meet

          all major user needs, or provide the maximum accommodation to the

          variety of needs for data.  In the earliest U.S. economic

          classifications, different statistical agencies adopted their own

          systems, presumably in part because each agency's system was

                                          3

          tailored to a specific statistical agency purpose or objective. 

          Because many analyses require economic statistics produced by

          different agencies, demand arose for a standard classification

          system that would render all statistical agency outputs

          comparable, yet meet in some manner the specific purposes for

          which individual classification systems had been developed

          previously.  

               What seems new in the Williamsburg Conference is the view 

          that, though standardization across statistical agencies should

          be maintained, different standardized classification systems

          corresponding to different uses of economic data may be needed. 

          These uses, in a kind of short-hand expression, may be divided

          into "supply-side" or "production-oriented" classification

          systems versus "demand-side" or "commodity-oriented

          classification systems (see the development of these terms in

          section 1.2, below). 

          (b)  Structure of the economy

               Frequently encountered in the economic classification

          literature is the statement that the classification system should

          "reflect the structure of the economy."  Joseph Duncan commented

          that "A good classification system...need[s] to reflect the

          current structure of the economy in order to assist in analysis

          of important changes" (Williamsburg Conference [6], pp. 19-20),

          and other participants expressed similar views.  It is often

          remarked that the structure of the economy provides a kind of

                                          4

          snapshot view of the economy at one time, which implies that time

          series will show how the structure changes.  

               Unfortunately, the term "structure of the economy" has not

          been well defined or explained.  In one view, the structure of

          the economy encompasses what industries exist, where they are

          located, what inputs they use, what outputs they produce, and

          what markets they serve.  Yet, the current (1987) U.S. SIC may

          not adequately indicate the industries that exist:  Three-fifths

          (574) of the SIC 4-digit industries are goods producing (of which

          459 are manufacturing), while the remaining two-fifths (430) 4-

          digit SIC's relate to the entire nongoods producing sector.  The

          U.S. nongoods producing sector is larger than the goods producing

          sector by most measures.  It has often been stated that the

          distribution of current SIC 4-digit industries does not seem to

          reflect the structure of the economy.

               Another definition of the structure of the economy refers to

          the organization of production units for marketing goods or

          services, including the degree of vertical integration.  For

          example, two separate meat processing industries are recognized

          in the current SIC (2011, Meat Packing Plants; and 2013, Sausages

          and Other Prepared Meat Products).  The two produce virtually the

          same output, meat products, but meat packing plants slaughter the

          animals that they use in the production of meat products, while

          the sausage and other prepared meats plants produce meat products

          from purchased carcasses and other meats.  As the meat packing

          example illustrates, the degree of vertical integration is

                                          5

          sometimes recognized as an aspect of structure in the current

          SIC.  In other instances, differences in vertical integration are

          ignored, e.g., Poultry Slaughtering and Processing (SIC 2015),

          where slaughtering and processing are combined regardless of

          whether or not the producer actually slaughters the poultry.  

               Moreover, the SIC system has been criticized for reflecting

          changes in vertical integration, when in some sense or for some

          purposes it should not.  Conflicting statements and differences

          in treatment in the present system suggest the need for a more

          coherent statement of how vertical integration is to be treated

          in economic classifications.  

               A third example of structure concerns the combination of

          activities.  The Hotels and Motels (SIC 7011) industry

          encompasses many distinct economic activities.  For example, a

          hotel generally includes a restaurant, bar, the rental of rooms,

          a gift shop, etc., some of which exist separately in other 4-

          digit SIC's.  In the U.S. SIC, the structure that is embedded in

          the SIC hotel industry pertains to the combination of related

          economic activities.  In some other countries, classification

          systems distinguish between hotels that serve food and beverages

          and those that do not.  Structure in the sense of this example

          thus admits to alternative interpretations.  

               Another criticism of the current SIC system structure is

          that new or emerging industries are not recognized very rapidly. 

          Thus, the present system lags in recording these kinds of changes

          in the structure of the economy.

                                          6

          (c)  For use in sampling

               Most statistical programs are based on sample surveys.  The

          requirements of sample surveys provide another reason for

          developing economic classification systems.

               Samples may not be large enough to support estimates at the

          detailed commodity level or even at the 4-digit industry level of

          detail.  Classification systems have traditionally determined how

          commodity detail will be collapsed for sampling purposes into

          more aggregated estimates, such as 4-digit, 3-digit, or 2-digit

          industries.  For some statistical surveys, sampling at the

          commodity-detail level may not make sense:  Because they are

          produced jointly, one cannot collect wage and employment

          information for granulated sugar or for molasses, for example,

          though labor information for sugar products is both collectible

          and useful.  The sampling process often requires stratification

          by relevant economic variables, among which are the variables

          employed in economic classification systems.  Both sample frame

          development and estimates from sample surveys thus depend on

          economic classification systems. 

          (d)  Comparability  

               The expressed purpose of the U.S. SIC system is to ensure

          that industry statistics provided by various agencies are

          comparable and consistent across agencies.  Comparability is

          crucial because the U.S. system is decentralized.  However, even

          if the system were centralized, comparability across surveys

          would be required:  One might want, for example, to use data from

                                          7

          labor market surveys in the same analysis with information on

          product sales or receipts.

               Similarly, if one wants to draw comparisons among different

          countries, it is important that data be collected and reported on

          some standardized basis.  The National Academy of Sciences

          ([14]), emphasizes the importance of comparability between

          international trade data and data on domestic production.  

               One can thus conceive of a classification system as a device

          for organizing in a comparable way data sets produced from

          different surveys, or by different statistical agencies, or by

          statistical agencies in different countries.  Reg Ward

          (Williamsburg Conference [27], pp. 88-9) speaks of a

          classification system promoting "communication" among data sets. 

          The Committee's Position

               This section lists four possible purposes for a

          classification system.  For the reasons set out in the following,

          the Committee believes that the first of the four--facilitating

          the use of economic data--should be the primary purpose of an

          economic classification system.  

               Comparability is clearly necessary for a classification

          system to be useful.  It is also clear, however, that

          comparability is not sufficient, and one must look beyond

          comparability to specify the purposes of a classification system. 

          The SIC system serves to make data produced by different U.S.

          statistical agencies comparable, but comparability has not

          precluded extensive criticism of it.  Criticism of the U.S. SIC

                                          8

          implies that users are concerned with the utility or usefulness

          of an economic classification system, beyond its provision of

          comparability.  Shaila Nijhowne (Williamsburg Conference [15], p.

          560) drew attention to the fact that "We have come a long way

          since the Standard Industrial Classification was used simply to

          achieve data comparability between federal government

          departments, for a limited number of data series.  The SIC's now

          serve a multiplicity of needs."  In the Committee's judgment,

          comparability must be coupled to the requirement that

          classification systems be designed so that they meet user needs. 

          Adopting some existing system merely because it provides

          comparability is not consistent with the Committee's charge to

          conduct a "fresh slate" examination of economic classification

          systems.  

               Survey use--providing a statistical framework for collapsing

          product and industry detail when conducting sample surveys--is an

          important reason that statistical agencies develop and maintain

          economic classification systems.  The sampling use of

          classifications focuses attention on the ultimate purposes for

          which the data are used, because the data programs for which

          samples are selected have themselves differing ultimate uses.  A

          classification system that is used to facilitate drawing samples

          needs to be consistent with the purposes for which samples are

          drawn.  

               The Committee recognizes the long tradition that states that

          classifications systems are intended to portray the structure of

                                          9

          the economy.  There is validity in many complaints that the

          current system does not portray the structure of the economy (its

          failure to record emerging industries soon enough, for example). 

          However, the phrase "structure of the economy" seems to mean

          different things to different users, perhaps because they have

          differing analyses in mind when they discuss structure.  If so,

          the elements of structure that matter for one use of SIC-grouped

          data are not those that matter for another use, and may even

          conflict.  In any event, ambiguity in the use of the term

          suggests the need for a more rigorous definition of "structure,"

          one that could be applied consistently across all the industries

          in the classification system. 

          Request for Comment

               The Committee invites comments on the foregoing discussion,

          particularly its view that data use provides the primary

          rationale for an economic classification system.   

          1.2  The Idea That an Economic Classification System Should be

               Based on a Consistent Conceptual Framework

               At the Williamsburg Conference, there was widespread

          recognition that the present U.S. SIC system does not correspond

          to any single concept for grouping or aggregation.  Critics of

          the present system suggest that the absence of a consistent

          conceptual framework creates anomalies within the system. 

          Particular concern was also voiced at the Williamsburg Conference

          that there is no discernible concept in the services categories: 

          "In general, there seems to be no consistent definition or

                                          10

          classification concept underlying decisions on what to include in

          services or on how to arrange the categories within services. 

          The resulting conglomerate is too diverse to be analytically

          useful" (Courtenay Slater, Williamsburg Conference [20], p. 150).

               On the other side of this issue are those who, while

          recognizing the validity of many of the criticisms of the current

          system, question use of a single concept for constructing a

          classification system.  They believe that classification systems

          must incorporate multiple concepts, both because industries are

          actually organized on varying principles, and because

          classification systems must be the source of data for different

          types of analysis.

               The following section explains the economic concepts that

          have been proposed for economic classifications.  The positions

          taken on the concepts question and the issues that arise under it

          are reviewed in the subsequent sub-section.

          Background:  Economic Concepts for Classification Systems

                 Proponents of adopting a consistent conceptual framework

          for economic classifications have focused on two alternative

          general approaches, which may be referred to as the supply-side

          approach and the demand-side approach.

               A supply-side, or production-oriented, concept aggregates

          according to similarity in the production processes that are used

          to make them.  In the technical language of economists, one would

          group establishments together if each establishment has the same

          or closely similar production function. 

                                          11

               A demand-side, or commodity-oriented, classification

          concept, in contrast, yields a classification system based on use

          of the commodity or service.  Commodities or services that serve

          similar purposes, that are used together, or that are

          functionally related in use, are grouped together.  

               Both general approaches--supply-side or demand-side--are

          derived from economic theory, specifically the economic theory of

          aggregation.  The conceptual approach to economic classifications

          is developed in a paper by Jack Triplett [23] that was published

          prior to the Williamsburg Conference.  That paper contains more

          information on the conceptual approaches described in the

          following paragraphs.   

          The Supply-Side or Production-Oriented Concept

               For the purposes of this paper, the technical term

          production function needs more explanation and needs to be

          related to other terms that have been employed in the

          classification literature.

               Production involves an activity in which inputs are used to

          fabricate some material good or to render a service.  A

          production function describes how the amount of the product (or

          service) depends upon all the inputs used in its production,

          given the state of the art, or "technology."  All of the inputs

          matter, not just the major input (e.g., leather or plastics). 

          The list of inputs includes in principle the types of labor and

          their skills, the types of capital equipment, as well as

          intermediate materials, and, in many cases, intangible inputs may

                                          12

          be important, especially in the production of services.  The

          substitution of one input for another is inherently part of many

          production processes, and that information, too, is incorporated

          into the production function.  The production function should be

          understood as an abstract description of the engineering

          principles for a production process, or as a description of the

          production technology, and not just a list of inputs.  In

          principle, it is engineering information about the production

          process that determines if establishments are sufficiently

          similar to justify grouping them by a supply-side concept.  

               In the international literature on classifications, the term

          "activity" is used to convey ideas that are very similar to the

          terms production function or production process, as these terms

          are used in ECPC issues papers.  Peter Struijs (Williamsburg

          Conference [21], p. 367) remarked:  "...[C]onstructing an SIC is

          to define similarity of businesses.  As the SIC is used for the

          statistical description of the production process as carried out

          by businesses, it is the kind of economic activity of businesses

          that determines their similarity."  Struijs then goes on to note

          several possible "criteria" of classification, one of which is: 

          "The production process criterion refers to the way in which

          inputs are transformed into outputs.  This depends mainly on the

          technology used" [ibid., pp. 368-9].    

               Similarly, the usage of the term "activity" in the

          International Standard Industrial Classification (ISIC), Rev. 3,

          of the U.N. Statistical Office [24] is also consistent with the

                                          13

          meaning of the production function term, as used in the ECPC

          issues papers:  "...[T]he term  activity  is to be understood as

          a process, i.e., the combination of actions that result in a

          certain set of products.  In other words, an activity can be said

          to take place when resources such as equipment, labour,

          manufacturing techniques or products are combined, leading to

          specific goods or services.  Thus, an activity is characterized

          by an input of resources, a production process and an output of

          products" (ibid., p. 9, para. 29).  The following example from

          the same source is illuminating:  "If, for example, pens and

          pencils are produced in the same enterprise, using, however,

          different inputs and different production techniques, the

          enterprise may be considered to carry out two activities..."

          (ibid., para. 32).  Although the ISIC use of term "activity" is

          consistent with the production function concept, this does not

          necessarily imply that the ISIC in practice actually implements a

          supply-side concept.    

          The Demand-Side or Commodity-Oriented Concept

               The demand-side concept is more intuitively understandable

          than is the supply-side concept, but, at the same time, is

          technically more difficult to define.  Under a demand-side

          concept, one would group together commodities or services that

          have similarities in use, that belong together or are used

          together for some purpose, or that define market groupings. 

               A quite old idea is that demand groupings can be formed by

          considering the nature of substitutions.  Very close substitutes

                                          14

          belong together; commodities or services that are not good

          substitutes belong in different categories.  Granulated cane

          sugar and granulated beet sugar, for example, are probably

          indistinguishable in use (they are perfect substitutes) and

          accordingly belong together on the close-substitutes rule.  The

          close substitutes method is sometimes known as the "gaps in

          nature" approach:  To define demand-side categories one looks for

          pronounced gaps in the chain of substitutes.  Empirically,

          finding gaps in the substitute chain has proven difficult. 

               A somewhat related idea is examining the movement of prices. 

          If the prices of two goods move together, then they may be

          combined in a demand-side category.  This is often known as

          "Hicksian aggregation," because it appeared in the work of Nobel

          laureate Sir John Hicks.  The products granulated cane sugar and

          granulated beet sugar probably conform to Hicksian aggregation,

          because it is difficult to comprehend how the prices of such

          close substitutes could differ.  Hicksian aggregation has the

          advantage that it can be examined empirically using available

          government price indexes:  One study by Theodore Jaditz [10], for

          example, employs detailed Producer Price Indexes to determine if

          conditions for Hicksian aggregation are met.  

               Demand relationships extend beyond close substitutes or

          goods whose prices move together.  Cases where commodities are

          used together need to be included in a demand-side concept.  Such

          relationships are sometimes called "Leontief" aggregation (from

          the work of another Nobel prize-winning economist, Wassily

                                          15

          Leontief):  Demand-side groupings can be formed from goods that

          are used in fixed relation to one another.  

               Still more general is the demand-side aggregation known as

          "functional aggregation."  In this case, one aggregates

          commodities if demand patterns among them--whether substitution

          or joint use--are independent of the use of other commodities. 

          The technical condition is that demands for commodities included

          in a group should depend only on the prices of commodities within

          the group, and on consumer income (in the case of consumer

          goods).  This form of demand-side aggregation imposes conditions

          that are highly technical, and that are not easy to explain in

          intuitive language. 

               Another approach to demand-side groupings is to consider

          marketing relationships.  If commodities are commonly sold

          together through similar channels, some users will request that

          information on them be combined.  One example appears to be "Hand

          and Edge Tools" (SIC 3423), which groups together most of the

          tools found in a typical hardware store. 

               From this discussion, it may be understood that one

          technical problem inherent in applying a demand-side concept for

          classifications is that the alternative demand-side rules noted

          above will not necessarily yield the same groupings. 

          Additional Discussion

               The classification of sugar products is an old example that

          illustrates some of the differences between supply-side and

          demand-side conceptual bases for aggregation or grouping.  The

                                          16

          present U.S. SIC distinguishes granulated sugar (as well as

          molasses and other sugar products) made from sugar cane and puts

          these sugar products in a different industry from the same sugar

          products that are produced from sugar beets; sugar products that

          are made from raw cane sugar are yet another separate industry

          (these three industries are, respectively, SIC's 2061, 2063, and

          2062).  

               One could argue that the present SIC grouping makes sense as

          a supply-side or production-oriented concept, on the grounds that

          sugar cane and sugar beets require different production processes

          in the sugar refinery, and that refining of sugar from purchased

          raw sugar also implies a difference in the production process

          (because the first stage of processing will be absent in these

          latter establishments).  If sugar production processes are

          adequately distinguished by the groupings in SIC's 2061, 2062,

          and 2063, then this supply-side grouping of sugar products is

          appropriate for the analysis of production processes for sugar,

          the analysis of productivity in sugar production, and so forth. 

          For production and productivity analyses, an economist wants the

          data grouped so that they represent similar production processes,

          and does not want the data grouped by similarity in use of the

          product.  

               The present SIC grouping of sugar products does not,

          however, conform to a demand-side grouping concept.  Granulated

          sugar produced in SIC 2061 is probably indistinguishable in use

          from the granulated sugar that is produced in SIC's 2062 and

                                          17

          2063, and the same statement undoubtedly holds for powdered

          (icing) sugar, or molasses.  No matter the raw material from

          which they are made or the process used for refining, there is

          little evidence in the marketing or use of sugar that any

          attention needs to be paid to the production processes

          distinguished in the present 4-digit SIC's.

                 The distinction between supply-side and demand-side

          classification concepts is sometimes identified with the

          distinction between an industry classification system and a

          product or commodity classification system.  

               A commodity classification system aggregates only

          commodities--that is, only the outputs of the collection unit are

          aggregated, and not the inputs.  If only the outputs are

          aggregated, one could group molasses, say, wherever produced into

          a single commodity group, and place it, if appropriate, in a

          completely different category from granulated sugar.  A demand-

          side, commodity, classification system is not limited or

          constrained by the necessity for grouping inputs (capital

          equipment, employment, or materials used) along the same lines.

               An industry classification system, on the other hand, must

          be capable of grouping both establishment outputs and inputs by

          the same system.  In a supply-side classification system, putting

          molasses and powdered sugar into different categories would not

          be feasible.  Neither the labor inputs, nor the machinery, nor

          the sugar cane or sugar beet inputs can be allocated uniquely to

          molasses or powdered sugar.    

                                          18

               Another similar distinction is the one between industry and

          market.  James McKie [13], writing nearly 30 years ago, noted

          that economists frequently assume that the limits of the industry

          and the market coincide:  "Marshallian economics envisioned a

          structure of single-stage industries producing single products. 

          For analytical purposes, the boundary of the industry is still

          usually assumed to be the same as the boundary of the market. 

          ...But such a concept is too simple to serve as a framework for

          statistical reporting."  If industry and market boundaries

          coincide, then the conceptual questions in classifications will

          have little practical importance--one will obtain similar

          groupings whether supply-side or demand-side aggregation concepts

          are employed.  Generally, the industry and the market do not

          always coincide, which means that supply-side and demand-side

          groupings may well differ.    

               In some of the discussion at the Williamsburg Conference,

          the distinction between product and industry classification

          systems was not clearly maintained, or the distinction was not

          drawn as it has been in the present paper.  Some of the

          participants envisioned a demand-side aggregation, a market-

          oriented commodity classification system that would also collect

          data on inputs, and so could be used simultaneously both for

          market analysis and for production analysis.  This vision is, of

          course, precisely the historical goal of the current SIC system--

          to construct a classification system that can simultaneously meet

          the demands of all uses of economic data.  

                                          19

          1.3  What Grouped or Classified Data Do Users Need?

               Though statistical programs must always be adapted to user

          needs for data, statistical agencies sometimes find it difficult

          to stay abreast of evolving uses of statistics because data needs

          change, and sometimes they change quite rapidly.  Determining

          actual and potential statistical uses of classified data, and the

          major users of classified data, is particularly difficult.  Data

          classification systems affect the programs of nearly all

          statistical agencies.  Within the decentralized U.S. statistical

          system, there is no single place to which information on the uses

          of classified data flows.  

               One view expressed at the Williamsburg Conference holds that

          uses of classified data can be separated into supply-side

          analyses or uses of data and demand-side analyses or uses of

          data.  Use of grouped data for marketing studies, for example, is

          generally a demand-side use, because marketing studies require

          that data be grouped by use patterns or by patterns of close

          substitutes.  Production analysis or productivity studies are

          supply-side uses, because they require grouping by similarity of

          production processes.

               It is not clear, however, that these distinctions between

          supply-side and demand-side uses were developed out of a

          sophisticated and comprehensive overview of user requirements for

          classified data.  The distinctions seem to have been drawn,

          instead, from the distinctions made in economic theory, combined

          with generalized discussion of how the data might be used.  But

                                          20

          even if the theoretical distinctions are entirely the relevant

          ones, the Committee would still need to compile information about

          major uses to determine which of the groupings that are derived

          from economic theory are the most relevant ones for the major

          uses of the data.  

               A survey of uses of economic data is particularly difficult

          in this case.  Tabulations of inquiries to statistical agencies

          (see the table in Tom Petska, Fritz Scheuren, and Bob Wilson

          [16], p. 57) are generally useful, but are not practical for

          gathering information on classifications.  Files of complaints

          from users about aspects of past classification systems have been

          built up, more or less on an anecdotal basis, but these files

          never have been assembled in a way that relates them

          systematically to major uses of classified data.  Samples drawn

          from statistical agency mailing lists may also fail to reach the

          appropriate audience because many users of statistical agency

          data are not on agency direct mailing lists.

          The Committee's Position

               The Committee believes that more information about user

          needs for classified data must be assembled, regardless of the

          difficulties.

          Request for Comment

               The Committee invites comments from users, especially on the

          uses they make of classified data.  Particularly relevant to the

          Committee's deliberations is information on problems with

          existing (SIC) classified data in serving user needs, especially

                                          21

          analyses that are inhibited by inadequacies in existing

          classifications.  The Committee also invites comment on the view

          that major uses of classified data can themselves be grouped into

          supply-side or demand-side categories for the purpose of the

          Committee's investigation.

          1.4  Should Classification Systems Conform to a Consistent

               Conceptual Framework?

               Whether economic classification systems should conform to a

          consistent conceptual framework brought forth a number of views,

          of which the following are the major contending positions.

          (a)  A single economic concept should be applied consistently

               throughout an economic classification system

               The view that economic classifications require a conceptual

          framework drawn from economic theory was endorsed by a number of

          participants at the Williamsburg Conference, including Joel

          Popkin [17], Frank Gollop [8], Marilyn Manser [11], Ernst Berndt

          [3], Jack Triplett [22], and Cardiff, Kokaski, Smith, and

          Zieschang [4].  

               The case for a single economic concept for economic

          classifications has several interrelated parts. 

               o    Without a consistent economic concept for grouping and

                    classifying data, users will find that the data are not

                    always grouped appropriately for any purpose. 

                    Inconsistencies arise in the system, and users may not

                    know where they are.  The present system contains

                    examples.  Sugar products are grouped by the supply-

                                          22

                    side concept into three separate SIC's because of

                    differences in production processes.  However, some

                    other products (such as Hand and Edge Tools, SIC 3423,

                    or Musical Instruments, SIC 3931) that are produced by

                    different production processes are grouped into a

                    single industry by what appears to be a demand-side

                    concept.  Similarly, presumably a demand-side concept

                    justifies separating timeclocks and time recording

                    devices (which are placed in SIC 3579, Office Machines,

                    Not Elsewhere Classified) from the clocks and watches

                    industry (SIC 3873).

               o    Equally important, without a consistent economic

                    concept, whoever constructs a classification system

                    must inevitably choose from among competing

                    requirements.  Lack of a consistent underlying concept

                    may lead to arbitrary decisions or decisions that seem

                    arbitrary, and may cause unnecessary reclassifications

                    among 4-digit categories (see Edward Denison [5] for

                    the position that SIC reclassifications have made

                    economic data less useful).  

               o    In presenting the system to the public, an economic

                    concept facilitates explaining why data are grouped in

                    one way rather than in another.  Without a consistent

                    concept, the system as a whole cannot be understood by

                    users, which leads not only to inadvertent misuse of

                    the data, but also to controversies and criticisms that

                                          23

                    arise from misunderstandings.  The system needs a

                    consistent concept to provide a coherent framework for

                    criticizing the system in order to improve it. 

               o    If the multiple uses of economic data cannot be

                    accommodated within one conceptually consistent system,

                    then the solution may be to create multiple

                    classification systems, each one conceptually oriented

                    toward a particular use of the data.  At minimum, this

                    would entail an industry classification system based on

                    a supply-side concept and a commodity classification

                    system based on a demand-side concept.  Constructing a

                    single classification system that is intended to

                    accommodate all uses creates, on this view, too many

                    compromises, so that data produced under the system do

                    not meet user needs.   

          (b)  The system needs concepts, but a single concept may not be

               either desirable or feasible

               Others believe that the classification system must provide

          multi-purpose statistical groupings and that there can be no

          single underlying concept.  Accordingly, the system must be a

          balance, and a compromise if necessary, among competing

          requirements for data. 

               This view notes that the multiple concepts embedded in the

          current U.S. SIC are dictated by the fact that in the economy

          some units are organized on the basis of inputs or production

          (e.g., Aluminum Die-Castings, SIC 3363; and Cotton Textile

                                          24

          Finishers, SIC 2261) and others on the basis of marketing

          patterns or uses (e.g., Hand and Edge Tools, Except Machine Tools

          and Handsaws, SIC 3423; and Dolls and Stuffed Toys, SIC 3942). 

          The defenders of the current U.S. classification system suggest

          that requiring the system to conform to a single concept may

          result in data that are less useful, accurate, and comparable

          across time and among agency programs. 

               The current SIC system attempts to implement concepts to the

          extent permitted by establishment input and output patterns. 

          Widespread emphasis is given in the current SIC to products,

          market categories, and stage of processing.  Economic concepts

          may have provided guidelines but they did not define a standard. 

               This system has been criticized because in application it

          results in inconsistencies of concept.  But those who question

          the acceptability of a single concept state that these apparent

          inconsistencies exist because of variations in output patterns in

          the economy which result in groupings that are not conceptually

          consistent.  In this context, inconsistency is a valid criticism

          only if consistency is the major objective of the classification

          system. 

               Many advocates of the current system point out that the

          units of some current SIC industries cannot be grouped according

          to a demand-side concept.  For example, as noted above, the

          aluminum die-castings industry (SIC 3363) is currently

          categorized on the basis of the material used and the production

          process.  Aluminum die-castings establishments produce an

                                          25

          unlimited range of products, the mix of which can change from

          year to year or week to week.  From a practical standpoint, the

          establishments may not even maintain records by product.  If

          these establishments were to be classified on the basis of

          outputs, it would be difficult to obtain accurate data, diminish

          the stability of classification over time, and lessen agreement

          among agencies in their classifications. 

               This view recognizes that both production process and

          outputs are important in a classification system.  A grouping,

          however, should not be based exclusively on the production

          process if that results in grouping outputs that are highly

          dissimilar in use.  There is probably little similarity in the

          production processes for pianos, piccolos, and ocarinas, but that

          does not mean that the musical instruments industry (SIC 3931)

          ought to be separated along production process lines.  

               Under this view, the mixing of concepts in different parts

          of the classification system is inevitable and in some instances

          desirable, because then such a system represents differences in

          industrial production processes and marketing arrangements among

          industries.  It is suggested that these differences should be

          carefully considered when contemplating a commitment to a single

          concept.      

          The Committee's Position

               The Committee believes that the current U.S. approach to

          classifications is problematic, and that an approach or

          approaches that implement an underlying economic concept or

                                          26

          concepts must be considered.  However, the overriding objective

          for a classification is to develop a system that meets user

          needs.  A major part of the disagreement between those who

          advocate the current approach and those who advocate a conceptual

          basis arises out of differing assessments of the usefulness of

          the present SIC system.  Many see the present system as useful,

          though not perfect, in meeting the needs of users, and these

          individuals see criticisms of it as misunderstandings of the

          system's objectives.  Those who advocate conceptual development

          emphasize that the present SIC's objectives are not clearly

          stated and that users have expressed problems with the present

          system.  The Committee's task is to sort out these arguments and

          to form an assessment on the merits and demerits of the present

          system and of proposed alternatives.   

          Request for Comment

               The Committee invites comments on the issue of adopting a

          consistent conceptual framework for the economic classification

          system.  Relevant to the Committee's work are assessments from

          data users about the usefulness of the present SIC system as well

          as indications of problems with it.  The Committee recognizes

          that parallel evaluations of conceptually-based systems cannot be

          rendered at this point, but anticipates public review later in

          the process of developing any proposed revised classification

          system.  Preliminary responses about the suitability of the 

          supply-side concept, the demand-side concept, or the current

          approach to classifications are appropriate and are solicited. 

                                          27

          1.5  If a Conceptually-based Approach is Chosen, Which Specific

               Classification Approach or Approaches Should be Adopted?

               As discussed previously, a substantial body of economic

          theory relates to how economic data should be grouped for various

          purposes.  There is thus considerable basis for implementing any

          of the approaches discussed.  Further research, however, would be

          needed to support actual implementation of either of the two

          conceptual approaches presented above.  The basic question is

          whether either, or both, of the conceptual approaches should be

          adopted, or whether the traditional framework--suitably 

          modified--should be retained.  

          (a)  Should there be a supply-side classification system?

               A supply-side, or production-oriented, structure would group

          together commodities that have similar production processes, or

          as it is frequently stated in economics, similar production

          functions.  A production-based structure would be essential for

          international comparisons similar to the examples listed by Jacob

          Ryten (Williamsburg Conference [18], p. 473):  "...to compare

          across national boundaries the volumes and values of inputs

          required to produce the same outputs; the degree to which the

          relative intensity of labour and capital varies from one country

          to another; the inter-country differences in the scale of

          operations typical of any particular grouping; and perhaps most

          importantly, the different returns to capital employed in the

          same industry but in different countries."    

                                          28

               A production-oriented structure is also essential for

          carrying out productivity studies.  Productivity studies compare

          efficiency relationships between inputs and outputs, and the

          framework for such studies implies that the units that are

          grouped together share identical, or similar, production

          processes.  Improving data for productivity analysis was a major

          priority of the Federal Government's recent Economic Statistics

          Initiative (see Survey of Current Business, February 1990, page

          2).

               In aggregating establishment data, the concept of joint

          production is important.  Joint production occurs when an

          establishment's labor force and/or other inputs cannot uniquely

          be divided among the various products the establishment produces. 

          The case of joint production is different from the situation

          where establishments do not maintain records on inputs into

          producing separate products, although it is likely that joint

          production is often the reason behind the lack of availability of

          such records. 

               Frank Gollop (Williamsburg Conference [8], p. 496) states

          that, in contrast to the demand-side case, statistical agencies

          must form supply-side aggregates because joint production is

          prevalent:  "If all producers of goods and services were single-

          product producers, there would be no need for the Census Bureau

          to provide supply-based aggregates.  ...[However], multiple-

          output producers report the dollar distribution of shipments by

          detailed product code but do not (and most often, cannot)

                                          29

          allocate inputs to the various products or services produced

          under conditions of joint production.  ...If data for multiple-

          output establishments are to be reported at all, the

          Bureau...must aggregate over products within multiple-output

          establishments... ." 

               However, Popkin (Williamsburg Conference [17], pp. 187-8)

          suggests that "...the production-based approach presents

          considerably more hurdles [than the commodity-oriented approach]

          on the road to implementation.  For example, to group

          establishments by similarity of production structure, their

          production structure must first be identified.  In other words,

          to clean the data, the data must first be clean.  ...A

          restaurant, for example, might look more like a food

          manufacturing plant than a retail store, when viewed from the

          production function approach."  

               Others disagreed with Popkin's assessment, or with parts of

          it.  The first part of Popkin's statement implies that only

          formal, data-based technical procedures would be used to

          discriminate among industries, rather than the full range of

          information about industry production that is in fact used in all

          countries for classification decisions.  Triplett (Williamsburg

          Conference [22], p. 28) notes that adopting a consistent

          conceptual approach for economic classification does not mean

          that SIC classification committees must necessarily carry out

          complex statistical or econometric analyses.  Instead, it

          "...means only that the classification committee is instructed to

                                          30

          follow a consistent principle--and only one principle--in

          constructing classifications."

               Nevertheless, implementing a production-oriented

          classification concept does imply gathering information about

          production processes, perhaps beyond the information that is now

          available (see ECPC Issues Paper No. 3).

          (b)  Should there be a demand-side classification system?

               Studies of the demand for various goods and services, of

          market share, and so forth require a demand-side classification

          concept.  A demand-based structure would group together

          commodities that are close substitutes in use, or are

          functionally related in use.  A demand-side system pertains both

          to households buying commodities for consumption and to firms

          buying commodities as inputs into their production process.

               The need for such a demand-based system was addressed by

          Popkin (Williamsburg Conference [17], p. 159), who recommended

          that "...the classification concept be one that classifies items

          by the markets in which they compete and are sold."  He (ibid.,

          pp. 186-7) reasons that "[t]he main advantages of a consumption

          based approach lie in the analysis of the market structure of an

          economy.  Any demand-based analysis would clearly be facilitated

          by the aggregation of outputs." 

               Others do not see the necessity for statistical agencies to

          produce a demand-side system, because, they maintain, the

          detailed commodity data are already provided so that demand-side

          users can aggregate those data for themselves.  Data on

                                          31

          establishment shipments, sales, revenue, and so forth are

          available by Census detailed product classifications.  For

          example, the shipments data required to form a sweetener category

          or a fastener category exist, at least in Economic Census years,

          and can be combined by any users who need them.  Consequently,

          Michael Gort (Williamsburg Conference [9]) and Frank Gollop

          (Williamsburg Conference [8]) contend that there is little need

          for a statistical agency to expend resources on demand-side

          aggregations.  

               Gollop (ibid., p. 497) is also concerned that consensus on

          the methods for demand-side aggregation will not be reached.  He

          notes: "First, there is no single  correct  aggregation scheme.  

          ...There are a number of demand-side aggregation techniques--no

          two of which would necessarily lead to the same set of SIC

          aggregates.  ...The supremacy of each is driven by the particular

          research question being asked.  Second, even if economists were

          to agree on a particular method, there would likely be

          significant disagreement over the process of applying the

          method."  

               Another view emphasizes the distinction between a commodity

          classification system, or a commodity-based aggregation system,

          and an industry classification system.  That is, it emphasizes

          the difference between aggregating detailed product or commodity

          codes and aggregating establishments.  

               If users require data on a sweetener aggregation for market-

          share studies, for example, this need could be met by aggregating

                                          32

          over the relevant commodities from SIC's 2046, 2061, 2062, 2063,

          2099, and 2869.  Such a commodity aggregation system need not

          imply that inputs from these same industries be combined, for

          presumably users do not need aggregated information on inputs for

          demand-side purposes.  A commodity system, if needed, could then

          supplement, not replace, an industry classification system, which

          would continue to be used to group all data, inputs and outputs,

          from the establishments included in the grouping.

          (c)  Is more than one classification system desirable?

               Several participants at the Williamsburg Conference pointed

          out the need for more than one classification system.  William

          Seltzer (Williamsburg Conference [19], p. 487) emphasized that

          multiple classification systems already exist for some purposes

          and endorsed extending this idea:  "In the language that we

          seemed to have adopted at this Conference, while 1,000 flowers

          may be beyond the resources of the Suitland Plantation, certainly

          the Census Bureau and the SIC can produce more than a single

          flower."  Marilyn Manser (Williamsburg Conference [10], p. 522)

          recommended that "...users would be well served if one

          production-based and one demand-based aggregation system were

          developed."  Some other participants expressed similar views. 

               One reason for endorsing two aggregation systems is to

          permit maintaining a clear focus on the purposes of a

          classification system.  Paula Young (Williamsburg Conference

          [28], p. 427) points out that "...data users whose focus is on

          commodity analysis have targeted the SIC as the vehicle for

                                          33

          meeting their needs."   She views this as having weakened the

          SIC's analytical foundation (which is, in her view, for supply-

          side analyses):  "For industry analysis, this foundation must

          reflect the production process and the commonality of input

          structure among establishments, not the end use of the commodity"

          (ibid.).  In support of her production-oriented interpretation of

          the present SIC, Young quotes from the 1987 SIC Manual ([25], p.

          11), which states that the purpose of the SIC is "...for use in

          the classification of establishments by type of activity in which

          they are engaged... ."  Young calls for the establishment of a

          second, commodity-oriented, classification system integrated with

          the SIC.

               The Committee has research underway that examines the

          present 4-digit SIC industries which will identify the number of

          these industries that already fit into either the supply-side or

          the demand-side approaches.  When this research is completed a

          report will be made available.

          The Committee's Position

               The precise concept or concepts to be implemented are not

          yet clear.  The resolution of this issue is perhaps the major

          undertaking of the ECPC project's research phase. 

          Request for Comment

               The Committee invites comments on any aspect of this issue,

          including the importance of providing alternative classification

          systems and on problems that might arise if alternative systems

          were to be adopted.  Proposals for research that would clarify or

                                          34

          resolve the economic issues, or provide new or extended

          methodology that could be applied in developing a system based on

          either supply-side or demand-side approaches, are also

          encouraged.  Also relevant to this topic are assessments on the

          advisability of replacing the current approach to classifications

          with an approach based on economic concepts.  

          1.6  The Classification Unit

               What is the unit of classification?  Does it depend on the

          concept implemented in the classification system?    

               An establishment is defined as a production entity in a

          single location.  Two establishments may occupy the same or

          adjacent space if the data available are separable by activity,

          physical identification, and recordkeeping.  The establishment

          concept has been integral to the U.S. SIC system since its

          beginning.  A key issue in revising the economic classification

          system is whether the establishment should continue to be the

          basic unit that is classified.

               Concern has been expressed that U.S. business operations

          have become less establishment-based (Charles Waite, Williamsburg

          Conference [26], p. 11).  Popkin (Williamsburg Conference [17],

          p. 192) recommends the basic business unit for the new system be

          changed to "the DDS, the division, department, or subsidiary," a

          unit determined by the management structure within each firm that

          reflects its way of doing business.  He believes that

          increasingly firms do not keep records, or report some types of

          data, at the establishment level.  And Popkin also believes that

                                          35

          many of the inputs that have become more important in an advanced

          economy (business services, for example) are increasingly

          provided at the enterprise, rather than the establishment level. 

          If so, even a supply-side classification concept must use the DDS

          as the unit, rather than the traditional establishment.  

               Ernst Berndt (Williamsburg Conference [3], p. 494) notes

          that in many industries, especially in recent decades, the

          extensive activity involving mergers and restructuring of

          companies and divisions implies that the DDS could involve a

          great deal of instability over time.  Robert McGuckin

          (Williamsburg Conference [12], pp. 394-5) recommends against

          moving from the establishment as the basic unit for an industry

          unless absolutely necessary.  Much of the detail on production

          relationships that one gets from establishments would be lost in

          consolidation to the DDS level.  Also, the establishment

          represents a fixed location, independent of ownership status: 

          When establishments are the units, the ability to link microdata

          over time does not depend on the ability to track changes in

          ownership and management structures, as it will if the DDS is the

          unit.  Marilyn Manser (Williamsburg Conference [11], pp. 524-5)

          notes that the need for geographic detail is important, and that

          differing after-tax prices across areas is a reason to refrain

          from aggregating units across geographic lines.  

               Some of the examples cited to show the declining relevance

          of the establishment may simply represent misapplication of the

          concept (Triplett [22], p. 29).  For instance, in banking, ATM's

                                          36

          do not correspond to a production unit and should not be

          considered an establishment.  In other examples as well,

          including pipelines, courier services, and communications,

          providing a network is the essence of the production process;

          defining the production unit in one location (the pipeline's

          pumping station) ignores the most essential aspect of the

          network. 

               The question of the classification unit arises in work on

          classifications outside the United States.  Struijs (Williamsburg

          Conference [21], p. 366) proposes that "The answer to [questions

          about the classification unit] depends on which parts of the

          organization act independently, i.e., where autonomy of action

          resides.  ...For example, a franchising chain, say a chain of

          restaurants, could be seen as an autonomous unit with regard to

          advertising, while the franchises could all be considered

          separate [units] where the selling of food is concerned."  He

          goes on to point out that the unit chosen must be one for which

          records are available, though mere availability does not imply

          that the recordkeeping center is the appropriate unit.  The unit

          must be a decision-making entity, not just one that holds

          information.  

               Some participants at the Williamsburg Conference, while

          generally agreeing that the establishment should remain the

          statistical unit, note some qualifications.  Stanley Feldman

          (Williamsburg Conference [7], pp. 269; 294-6) would retain the

          establishment as the statistical unit, for the most part.  He

                                          37

          discussed particular issues relating to the application of the

          establishment concept in banking and insurance.  It was also

          noted that although there are reasons that we should not drop the

          establishment classification, we may want to supplement it

          (Waite, Williamsburg Conference [26], p. 11).

               A key point for Issues Paper No. 1 is whether the choice of

          unit is determined by the conceptual basis that is adopted for

          the classification system.  Triplett (Williamsburg Conference

          [22], p. 28) suggests that for a supply-side, or production-

          oriented concept, collection of inputs linked with outputs is

          essential.  In this case, the choice of unit is determined by the

          availability of information on the inputs that are important to

          production.  Whether the DDS or the establishment is the correct

          unit depends on whether the growth of nontraditional inputs

          provided by the enterprise has become dominant in modern

          production.  This is an empirical issue, on which there seems no

          current consensus.  

               For a commodity-oriented, or demand-side, classification

          system, on the other hand, the unit is probably not the

          establishment.  A demand-side aggregation system would aggregate

          commodities or services, no matter where produced, and would by

          definition not be concerned with inputs.  Data could therefore be

          collected for any level that is convenient, either below the

          establishment level or at some higher level, such as the DDS.  

                                          38

          The Committee's Position

               In the Committee's judgment, the choice of unit cannot be

          considered in isolation from the concept employed.  Under a

          supply-side concept, the establishment might remain the unit. 

          If, however, the establishment is no longer a decision unit, or

          if business services and other essential inputs cannot be

          allocated uniquely to establishments, then the establishment is

          no longer the relevant unit for production analysis, and some

          other unit is appropriate for classification purposes.  For a

          demand-side system, or other approaches, the choice of the

          classification unit may be less clear.  The ultimate decision on

          this issue also depends on where business records are kept and on

          what information is collectible (see Issues Paper No. 3).  

          Request for Comment

               The Committee invites comments on the choice of

          classification unit, including information on the extent to which

          inputs are shared across physical locations, whether the

          establishment remains a meaningful concept, and on instances

          where the existing establishment concept is inappropriately

          applied.  The Committee also invites comment on the unit that is

          appropriate for a classification system that arranges data for

          market-share analyses or other demand-side purposes.

                                          39

                                      References

          [1]  Bureau of the Census, Proceedings, International Conference
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          [2]  Beekman, Michael, "International and National Standard
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          [3]  Berndt, Ernst R., "Alternative Approaches to Classifying
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          [4]  Cardiff, Patrick; Kokaski, Mary; Smith, Dale; and Zieschang,
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          [5]  Denison, Edward F., "Introductory Statement (Round Table of
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          [6]  Duncan, Joseph W., "A Clean Sheet for Standard Industrial
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          [7]  Feldman, Stanley, "Moving Towards an Improved Micro-Based
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          [8]  Gollop, Frank M., "Panel Discussion on Alternative
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          [9]  Gort, Michael, "Comments on Industrial Classifications
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          [10] Jaditz, Theodore, "Economic Markets and the Standard
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                    Working Paper 205, November 1991.

                                          40

          [11] Manser, Marilyn E., "Alternative Approaches to Classifying
                    Economic Activity," Williamsburg Conference, pp. 520-
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          [12] McGuckin, Robert H., "Multiple Classification Systems for
                    Economic Data:  Can a Thousand Flowers Bloom?  And
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          [13] McKie, James W., "Industry Classification and Sector
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          [14] National Academy of Sciences, Behind the Numbers:  U.S.
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          [15] Nijhowne, Shaila, "Administering and Implementing a Dynamic
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          [16] Petska, Tom; Scheuren, Fritz; and Wilson, Bob, "The
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          [17] Popkin, Joel, "Recommendation and Description of the
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          [18] Ryten, Jacob, "Inter-Country Comparisons of Industry
                    Statistics," Williamsburg Conference, pp. 472-83.

          [19] Seltzer, William, "Alternative Systems for the Year 2000,"
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          [20] Slater, Courtenay, "Services:  The Need for a New Paradigm? 
                    Comment," Williamsburg Conference, pp. 150-2.

          [21] Struijs, Peter, "The Concept of Industry in Transactor-Based
                    Industrial Classifications," Williamsburg Conference,
                    pp. 364-83.

          [22] Triplett, Jack E., "Perspectives on the SIC:  Conceptual
                    Issues in Economic Classification," Williamsburg
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          [23]      , "The Theory of Industrial and Occupational
                    Classifications and Related Phenomena," Proceedings,

                                          41

                    Bureau of the Census 1990 Annual Research Conference,
                    March 18-21, 1990, Arlington, VA:  U.S. Department of
                    Commerce, pp. 9-25.  

          [24] United Nations, "International Standard Industrial
                    Classification of all Economic Activities."  Third
                    Revision, Statistical Papers, Series M, No. 4, Rev. 3,
                    New York:  Statistical Office of the United Nations,
                    1990, 189 pages. 

          [25] U.S., Executive Office of the President, Office of
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                    Classification Manual, 1987, 705 pages. (For sale by: 
                    National Technical Information Service, 5285 Port Royal
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          [26] Waite, Charles A., "Classifying Economic Activity--Problems
                    and Prospects," Williamsburg Conference, pp. 9-16.

          [27] Ward, Reg, "Industrial Classification Systems and the Global
                    Economy," Williamsburg Conference, pp. 81-93.

          [28] Young, Paula C., "Is the Present SIC Adequate?" Williamsburg
                    Conference, pp. 427-35.

                                          42