Statistical Policy

S.I.C. PURSUITS: THE CONSEQUENCES AND PROBLEMS OF CLASSIFYING ESTABLISHMENTS FOR GOVERNMENT STATISTIC

Rolf R. Schmitt and Michael Rossetti

Representatives of the U.S. Department of Transportation to the Technical Committee on Industrial Classification, which was convened by the Office of Management and Budget to revise the SIC system.

(This paper was published in the Proceedings of the Urban and Regional Information Systems Association: 1987, Volume IV, pp. 15-24.)

ABSTRACT. The Standard Industrial Classification (SIC) system provides a uniform method of classifying establishments for the collection of Federal data. SIC codes affect the extent and detail of data collection activities and of tabulations, which in turn have subtle yet pervasive affects on the way in which we perceive the national and regional economies and related public policy issues.

The 1987 revisions to the SIC system are the first major classification changes to be made in 15 years. The revision process involved a delicate balance of Federal, State, local, and industry interests while bringing the system more closely in line with the economy.

This paper provides a brief overview and critique of the SIC system to encourage better provision and use of economic data. The paper illustrates how institutional and statistical considerations can be far more important than data processing to the quality and quantity of information for public decision making.

Introduction

The Standard Industrial Classification (SIC) system provides a detailed, comprehensive approach to classifying economic activity, covering activities from wheat farms and automobile assembly plants to airport runway vacuuming and phrenologists. While the SIC Manual that describes the system in excruciating detail is dry and tedious for all except classification experts and connoisseurs of Trivial Pursuit, it documents one of the most widely used, least understood standards for government statistics. The philosophy and details of SIC system must be thoroughly understood, however, if data on economic establishments are to be collected and used effectively.

This paper provides a brief overview of several issues raised during the recent revision of the SIC system so that providers and users of economic data can better understand the strengths and weaknesses of the information they generate for public decision making. This brief critique assumes that the reader will consult the SIC Manual for a more thorough understanding of SIC concepts and definitions (1).

Basic SIC Concepts

The SIC system is designed to provide a comprehensive, detailed framework for the collection and tabulation of establishment-based statistics by the Federal Government. Establishments can be a one location company or an individual facility of a nationwide corporation. Establishments are classified into Industries by the products made or the services rendered. Industries are identified by a four-digit number, and are aggregated into three-digit Industry Groups, two-digit Major Groups, and Divisions that are identified by a single letter. The definition of each Industry is typically accompanied by one or more examples, called index items, that are used for clarification and illustrative purposes. For example, manufacturers of PCV valves are listed under Industry 3714 (Motor Vehicle Parts and Accessories), which is part of Industry Group 371 (Motor Vehicles and Motor Vehicle Equipment), which is part of Major Group 37 (Transportation Equipment), which is part of Division D (Manufacturing).

Some agencies have an additional level of detail for kinds of business or specific products manufactured by the Industry. The fifth digit is not part of the SIC standard (except in the case of Auxiliaries discussed later), and often misleads data users to think that the SIC system is based on commodities rather than on economic activity. Other governmentwide classification systems exist for commodities.

An additional point of confusion is the distinction between establishments and enterprises. Enterprises are companies and are defined by ownership; establishments are essentially facilities and are defined by economic activity. While most enterprises consist of one establishment, the larger enterprises own many establishments that are classified in several different Industries. As a consequence, enterprise statistics such as those based on tax returns are collected and tabulated under a separate classification system.

Industries are officially recognized in the SIC system when establishments that perform similar economic activity collectively meet size, specialization, and other criteria. Some Industries are defined to include the miscellaneous establishments that do not fit elsewhere in the Industry Group or Major Group, so that every establishment can be assigned to an Industry. These residual Industries often contain a stunning diversity of activities. For example, Industry 4789 (Transportation Services, Not Elsewhere Classified) includes among other activities operators of horse-drawn for-hire carriages and private establishments primarily engaged in the operation of space flights.

Importance of the SIC System

SIC definitions of Industries and establishments are used by agencies throughout the Federal Government to identify the scope of economic censuses and surveys and to tabulate the results. The definitions can affect the data bases that are used to calculate the Consumer Price Index and other measures that are used by all levels of government. Since the statistics based on the SIC system are widely reported by the press and used by public decision makers, this detailed classification system has subtle yet pervasive affects on our perception of the Nation's economic structure and health.

The importance of the SIC has grown in recent years for several reasons:

• SIC-based statistical measures designed for policy research and planning are being used increasingly for other purposes that have direct impacts on the public. An establishment's classification can determine its eligibility for certain Federal benefits, its tax liability, and its liability for health and other regulations.
  
• Many agencies are turning to SIC-based surveys to replace data previously collected by regulatory agencies using other classification schemes.
  
• Agencies at all levels of government responsible for economic, social, transportation, and other programs are performing more frequent and sophisticated economic analyses of their activities, requiring greater amounts of SIC-based economic data. Trade organizations and others in the private sector are also making greater demands on SIC-based data to support the advocacy of their causes before public officials.
  
• The popular press now regularly reports statistics and findings that are based either directly or indirectly on the SIC system.
  

In short, the SIC system is providing a framework for much of the popular perception of economic issues, the ensuing political debate, and the subsequent government actions.

The SIC Revision

Until 1987 SIC revisions were implemented, the growing importance of the SIC system was in stark contrast to the system's declining representativeness of the Nation's economy. The SIC system had not been revised significantly since 1972, when the regulatory environment, technology, domestic and international markets, corporate structure, and other aspects of industry organization were radically different from today. Revisions to the SIC system in 1977 were minor, and an effort to overhaul the system in 1982 collapsed due to budget pressures.

To correct the growing disparity of the SIC system and the economic structure that it was supposed to reflect, the Office of Management and Budget (OMB) convened the Technical Committee on Industrial Classification (TCIC). The TCIC included representatives from the major data collection agencies of the Federal Government, as well as from a healthy cross section of data consuming agencies. The TCIC met on a weekly or more frequent basis from 1984 to 1986 to solicit and review public comments. Over 1,100 changes to the SIC Manual were proposed by government agencies, trade associations, businesses, and individuals in response to a Federal Register notice on February 22, 1984 (49 FR 6982). The TCIC published its recommendations in the Federal Register on February 14, 1986 (51 FR 5640), and final decisions by OMB were published on the following October 1 (51 FR 35170). Innumerable editorial details kept the TCIC busy until the new SIC Manual was printed in Summer, 1987.

Types of revisions to the SIC system include: the creation of several new Industries; the consolidation of old Industries that no longer meet size criteria or that can no longer be distinguished in the current deregulated environment; and, the shifting of some Industry and Industry Group boundaries to reflect shifts in economic activity. Changes are most extensive in high technology areas such as computers and in services where deregulation has resulted in substantial changes in the way business is transacted (particularly in transportation, communications, finance, and banking).

The revised SIC reflects a long series of compromises among TCIC members. Representatives of data collection agencies usually advocated consolidation of existing Industries to resolve classification problems, and resisted other changes to minimize costs of redesigning their data collection programs. Data consumers generally advocated the creation of more Industries to get more detailed information. Agencies that had used the SIC system extensively for years advocated changes that would minimize disruptions to their time series, while major changes to the SIC were occasionally proposed by agencies that were more recent users of SIC-based data or that have experienced substantial changes in their Industries of concern.

The revisions involve a carefully constructed balance among:

• the need for extensive changes to bring the SIC system into closer alignment with the Nation's dynamic economy, especially with respect to the SIC's overemphasis on the declining manufacturing sector and underemphasis on the growing services sector of the economy;
  
• the need for radical changes to several principles of classification that underlie the SIC system and that are woefully inadequate for representing a dynamic and increasingly integrated economy;
  
• the need to minimize changes to maintain comparability of data for time-series analysis; and
  
• the need to minimize changes to minimize costs of converting files of data users and sample frames of data providers.
  

Many of the compromises involved budgetary, data processing, and institutional needs of the TCIC's active participants, which tended to work against the largest changes that were both highly needed and very costly because of the size of the Industries involved. Another force against change was the classic Catch-22 that data were needed to determine whether an emerging activity was big enough to become a new Industry, and the data was not available because the activity had not been previously identified as an Industry. TCIC decisions had to be made from the gut level in some of those cases.

Even though the TCIC's decisions were not always technically pure, the sometimes heuristic and often political process resulted in significant improvements to the SIC system that is now in effect. The general problems that remain require an overhaul that may be beyond institutional, budgetary, and data processing resources of the decentralized Federal statistical community for the foreseeable future. The data user must be aware of these problems for now to make more intelligent uses of economic data collected for 1987 and beyond.

General Problems with the Revised (1987) SIC System

The TCIC deliberations revealed that traditional SIC concepts are being eroded by the growing number and importance of multi-activity establishments, particularly between industries that are converging in the development of new products and services. This is illustrated by explosive growth of intermodal transportation services, such as the growing number establishments that transcend the traditional boundaries between motor carriers and airlines for express letter and parcel delivery service. The emergence of multi-function establishments creates or exacerbates four issues that are not addressed in the 1987 SIC Manual. These issues include: definition of the establishment concept in an increasingly integrated economy; better identification of auxiliary establishments; inconsistencies between the 4-digit Industry, 3-digit Industry Group, and 2-digit Major Group levels of the SIC hierarchy; and overlaps across boundaries of Divisions.

Definition of Establishment

The concept of establishments is easy to implement when individual facilities have distinct and stable locations. Increasingly integrated manufacturing processes, nearly ubiquitous availability of freeways and air transportation, and a revolution in the economics and technology of computers and communications are bringing establishments closer together functionally while allowing them to become geographically dispersed and footloose. Establishments are becoming mobile nodes on a dynamic network.

The SIC Manual recognizes that many establishments in transportation, communications, and public utilities in Division E include geographically dispersed activities. This recognition that establishments may be part of a transportation system rather than just a single facility is used only to delineate the activities to be included with a specific establishment. For example, the maintenance facilities, control towers, and other parts of a railroad are lumped together with the home base of those railroad employees since they are traveling frequently between the individual facilities.

This recognition that a facility is really part of a more distant establishment needs to be extended to classifying the establishment's Industry. This is done to some extent in transportation, where local pick up and delivery service that is part of an intercity carrier is classified in the Industry for intercity or long-distance service by that mode of transportation, and local service that is not an integral part of the intercity service is classified in the local Industry for that mode.

Formal recognition that the function of the network defines the function of the establishment on that network is difficult because the SIC system is supposedly based on the activity of the establishment rather than the enterprise (company or network) that it serves. Until a broader definition of establishment is adopted, the basis of classifying establishments will vary between what goes on the the establishment without regard to other units and what the establishment does as part of a network of other units.

Identification of Auxiliaries

The SIC Manual recognizes two kinds of establishments: operating and auxiliary. An operating establishment sells most of its goods or services to establishments owned by other enterprises, and is classified by what it makes or does. An auxiliary establishment sells most of its goods and services to other establishments of the enterprise that also owns it, and is classified by the activities of the establishments that it serves. For example, a local motor carrier that serves a grocery chain is classified as an operating establishment with local trucking in Industry Group 421. A local motor carrier subsidiary of the grocery chain is classified as an auxiliary establishment in Industry 5411 (Grocery Stores).

Under the 1987 SIC Manual, a fifth digit has been added to indicate what the auxiliary establishment does for the Industry that it serves. The trucking example would be classified as a warehousing auxiliary if the trucking arm of the grocery store was based with the warehouse, or as an auxiliary not elsewhere classified. Most auxiliary establishments are either central administrative offices, and a large percentage are in-house research and development laboratories.

The new fifth digit does not provide enough detail in the identification of auxiliary establishments by their function because of policy analysis needs and a potential problem with time-series statistics. The need for a more detailed identification of auxiliary activities is particularly particularly acute in the trucking example. Less than half of all trucking activity in the United States is performed by motor carriers. The majority is performed by private trucking, such as the trucking auxiliary of the grocery chain already mentioned. Many government policies involve establishments that are engaged in trucking, whether private or for hire, and statistics are needed on both segments of the industry. Data on operating establishments engaged in trucking are easily found in Industry Group 421, but trucking auxiliaries are not identified even with the newly ordained fifth digit. Data on the auxiliary establishments are also needed if a major shift in revenues, employment, and other statistics is measured for the trucking industry, since the shift may reflect a change in ownership rather than true change in economic activity. In some States, a grocery chain that spins off its trucking auxiliary to become a motor carrier can cause significant changes in the Industry statistics even though the trucks may be providing the same service to the same stores under independent ownership.

These problems are conceptually easy to resolve by expanding the auxiliary function code to four digits. Rather than use the four categories of auxiliary activity in the new fifth digit, the auxiliary activity could be identified by the code of the Industry into which the establishment would have been classified if it had been an operating establishment. The trucking auxiliary of the grocery chain would thus be classified by the number 5411.4214. The TCIC selected the single digit code over this option for the 1987 revision on the grounds that implementation would be too difficult at this time.

Inconsistent Hierarchical Structure

The continued growth of multifunction and intermodal establishments highlights two fundamental weaknesses of the SIC system's hierarchy of Industries, Industry Groups, and Major Groups: the lack of a rigorously defined, consistent hierarchy across the four-, three-, and two-digit levels; and, the lack of places to classify interindustry activities.

A rigorously defined, consistent hierarchy above the Industry level is important in the SIC system because:

• substantial data are collected or published only at the two- and three-digit level;
  
• the hierarchy specifies relationships among Industries, providing direction to coding and to aggregation of statistics; and
  
• the TCIC is very reluctant to move activities across Industry Group and Major Group boundaries.
  

The importance of this hierarchy is in contrast to the lack of rigor in its definition. Only Industries are defined by rigorous, detailed, explicit rules. Most TCIC recommendations for reorganizing Industry Groups and Major Groups were based on intuitive reasonableness or on the limits of a base 10 numbering system. (Industries were reallocated among Industry Groups when more than nine were together.) This lack of rigor has resulted in inconsistencies and caprice, such as the grouping of public warehousing with trucking in Major Group 42 even though the warehousing industries are more logically placed with transportation services (Major Group 47).

Even if the hierarchy were rigorously defined, there are few places for interindustry activities to be classified. Activities which are the outgrowth of an interaction between Industries, such as piggyback service between trucks in Major Group 42 and railroads in Major Group 40, are typically buried in one of the affected Industries or under "Not Elsewhere Classified." Proposals for new Industries are useful but piecemeal patches to the problem, especially when the affected Industries reside in different Industry Groups.

The inconsistent hierarchy and other problems cannot be resolved completely without a draconian overhaul of the SIC system. The SIC system might have to be restructured from a top-down approach that starts with Divisions, rather than from the TCIC's bottom-up approach that starts with Industries. The requisite magnitude of change may never be possible given the substantial costs of changing data collection programs and converting long-term series of data to a new SIC system.

Boundaries

The problems with the hierarchical structure of the SIC system extends to the Division level, although the issue is primarily one of boundaries rather than of how many and what type of categories should be defined. The boundary problems are most notable between the Divisions for manufacturing and services, and between Public Administration and the other Divisions. Boundary problems also exist between the Divisions for manufacturing, wholesale trade, and retail trade.

Problems with the boundary between Manufacturing (Division D) and Services (Division I) involve a growing number of borderline industries that are packaging services into goods and turning goods into services. The shift from services to goods is illustrated by the new Industry 7372 (Prepackaged Software), the location of which was extensively debated because computer programs were traditionally produced as a service until microcomputers created a mass market for software. When is a computer program a good or service? Is it a question of whether the program is sold in shrink-wrap plastic? The shift goods to services is illustrated by Publishing (Major Group 27), where many printed goods are becoming more popular in electronic form and potentially causing establishments to move from their manufacturing roots in Division D to less readily apparent categories in Division I (such as Industry 7375 for Information Retrieval Services).

The borderline Industries are particularly important given the pervasive references to the manufacturing and service sectors of the economy using a plethora of explicit and implied definitions of those sectors. The often reported shift of the Nation's economy from manufacturing to services is due in part to the changing character of goods and services just noted and to the increasing tendency of manufacturers to contract with other firms for services that were previously performed in-house. Data users must be keenly aware of such definitional rather than functional moves of establishments and activity when analyzing purported shifts among sectors of the economy.

Another dynamic and inconsistent boundary exists between the public and private sectors of the economy. Prior to 1972, all government and government-owned establishments were classified in Division J. The Division was limited in 1972 to public administration and to other government activities that do not have counterparts in the private sector. This principle has not been implemented uniformly. For example, public transit and fire protection are both activities that have private sector counterparts and should therefore not appear in Division J. In the 1987 SIC Manual, public and private transit are properly together in Division E (Transportation), but fire protection shows up in Divisions A (Agriculture), I (Services), and J (Public Administration).

The inconsistent classification of public sector activities with their private sector counterparts is exacerbated in the case of central administrative offices. In concept, activities of the public sector that do not have counterparts in the private sector are classified in Public Administration. In practice, most industries in Public Administration are central administrative offices of establishments that may or may not have private sector counterparts. The SIC system thus classifies most central administrative offices of public agencies as operating establishments, and all central administrative offices in the private sector as mere auxiliaries that are classified with the activity being administered. The inclusion or exclusion of auxiliaries in data must be carefully noted in analyses of public and private sector office growth that has become so important to regional and local economic development.

The boundary problems of the Public Administration Division are symptomatic of an ambivalence toward the way to characterize the public sector in the SIC system that has been made worse by recent efforts to "privatize" many government activities. The 1972 SIC revision changed the Division from Government (which included all public sector activities) to Public Administration (which is a mixed bag of administrative activities and those operational activities that are commonly unique to the government). Other approaches need consideration in future revisions, such as moving all operational activities of government to Divisions A through I and changing Division J to Administration for central administrative office of both public and private sectors.

There are similar boundary problems among Wholesale Trade, Retail Trade, and other Divisions. Part of the problem is the difference between popular perception and the SIC definition of wholesale trade. While the public thinks of wholesale trade in terms of large volume discount outlets, the SIC definition is based on sales to other businesses. Retail trade is sales to households. The distinction between wholesale and retail is getting harder to make as the trade responds to growing purchases by households of products originally designed for business (such as microcomputers).

Conclusion

For its shortcomings, the SIC system remains the most detailed, thorough framework for collecting and analyzing economic data that is in widespread use. The SIC system is based on statistical principles of classification, on both rigorous and anecdotal evidence of change in the economy, on budgetary and institutional constraints, and on the personal interactions of TCIC members through years of debate and decisions. Providers and users of economic data for public decision making must be aware of the SIC's principals, nuances, strengths, and weaknesses when developing and interpreting establishment-based data; and those concerned with quality and quantity of future economic data should be prepared to provide comments when the TCIC reconvenes to consider further changes to the SIC system for 1992.

Bibliography

(1) U.S. Executive Office of the President, Office of Management and Budget, Standard Industrial Classification Manual, 1987. Washington, D.C.: U.S. Government Printing Office, 1987.