Three spheres of economic activity
Economic activity takes place in three major spheres, which we designate here as the core, public purpose, and business spheres. Economists often refer to these groups as household, government, and business spheres. In this article, however, we use the term “core” instead of “households,” in order to emphasize the importance of communities, in addition to households, in the "core" activities described below. (Think of the maxim, "It takes a village to raise a child"). We use the term "public purpose" instead of “government,” to include both government and nongovernmental nonprofit organizations whose activities are of growing importance in modern societies. We will explore the roles of the core, public purpose, and business spheres below.
The Core Sphere
Long before the invention of money, of organized markets, and of systems of government, human societies organized themselves along lines of kinship and community to undertake the economic activities essential to maintaining and improving the conditions for human life. The core sphere is made up of household, family, and community institutions that organize resource management, production, distribution, and consumption, usually on a small scale, and largely without the use of money.
One distinguishing characteristic of the core sphere is how work activities are rewarded: instead of extrinsic monetary rewards, work tends to be rewarded directly by what it produces. For example, work in a home garden is rewarded with tomatoes, and the reward of good child care is a happy and healthy child. People may volunteer their services to their community because they recognize that living in a healthy community is important. People play cards, soccer, or music together because they find these activities intrinsically enjoyable. Another distinguishing characteristic is that core sphere activities tend to be organized to respond to immediately perceived needs—rather than, for example, to the ability to pay.
The core economy is the central location of many important economic activities that sustain human life. These include:
Child bearing and child raising. Parents—even when assisted by family-planning services, child care centers, public schools, extended family, and the like—still carry the primary responsibility for fertility decisions and for caring for and nurturing children. Bearing and rearing a child is the ultimate “human capital” activity—populating the society for the future. Younger children need direct feeding, dressing, bathing, holding, and responsive interaction with caring adults. Older children need less hands-on care but still need supervision and help in learning many physical, mental, and emotional skills. Much of the work of childrearing also involves the building up of “social capital”—helping children function in larger communities. Community supports like playgroups and carpools can also assist in the productive activities of childrearing work.
Decisions regarding investing in skills and education. Other human capital decisions are also often made on a household basis. How long children stay in school, or whether an adult goes for further education or training, are often household decisions.
Care of the sick, elderly, or otherwise needy. In countries like the U.S., hospitals, nursing homes, mental health clinics, and other institutions exist for people who are acutely ill or incapacitated. However, families, friends, and neighbors remain the first source of support for people with dependency needs. People who are temporarily mildly ill, recovering from surgery, or upset over life events are primarily cared for by friends and family. People with chronic mental or physical health problems may require considerable support services from their families and other people in their communities, perhaps for decades.
The final stage of production of many goods and services. Pasta cannot be eaten until it is cooked. A vacuum cleaner provides no services until someone plugs it in and pushes it around. Grass seed does nothing until someone plants it. Household production activities like cooking, cleaning, and house and yard maintenance convert many goods and services (often bought on markets) into forms suitable for final use. These production processes generally involve the use of labor time, materials, and the services of household capital goods (such as stoves and lawn mowers).
The organization of savings and investment. Households decide how much of their cash income to allocate to saving. They also decide how to allocate their financial saving—whether to hold them in retirement funds, real estate, money market funds, etc. While households also save through more structured (and less voluntary) channels like pension plans, the savings decisions of individual households are of much interest to macroeconomists. Family and friends also frequently use savings to make gifts or loans among themselves—for example, to finance food and rent in times of need, or to help a friend or relative to acquire the funds for a house down payment or to start a business.
The allocation of consumption spending. Households are the final decision makers about whether to buy denim pants or DVDs, hybrid cars or SUVs. As we will see, the level and composition of consumption in an economy as a whole plays an important role in determining macroeconomic living standards, stability, and sustainability.
Decisions regarding the supply of labor services. Decisions to work in the labor market, to become self-employed, or to engage in household production are often made not simply by individuals, but by households as part of a joint plan for family support.
The organization of the use of leisure time. Besides putting in work time in core sphere production, people enjoy “play” time with their family, friends, and neighbors as well. Vacations and visits are very often planned on a family basis, and activities of recreation and relaxation are largely organized around core sphere networks of family and community. Having leisure time, and the goods and services to enjoy it with friends and family, is a substantial component of the standard of living.
When the core sphere is working effectively to support the quality of life, important goods and services are provided to many, many people, even if the scale of production in each specific case is quite small. Because most core sphere activities involve face-to-face interaction, the core sphere is the primary location in which the ability to form good social relations is developed.
Of course, core spheres can also work badly or inadequately. For example, responsibilities for children or elderly and ill people may be inequitably assigned between women and men. Such responsibilities may also overwhelm the personal resources of impoverished families and communities. There are limits to what can be accomplished within small-scale, largely informal networks of personal relations. For many economic goals, more formal and larger-scale organizations are also needed.
The Public Purpose Sphere
Kinship and community were the earliest modes of human organization, but larger organizations soon arose. Communities found advantages to banding together in larger groups for mutual protection, increased social contact, etc.
The public purpose sphere includes governments and their agencies, as well as nonprofit organizations such as charities and professional associations, and international institutions like the World Bank and the United Nations.
The distinguishing characteristic of these institutions is that they exist for an explicit purpose related to “the public good”—that is, the common good of some group larger than a household or informal community. Their definitions of "the public good," however, may vary widely and may even contradict one another. They are charged with purposes such as defending a country’s borders, relieving poverty, providing formal health care and education, protecting the natural environment, and stabilizing global financial markets.
Organizations in the public purpose sphere tend to be larger and more formally structured than those in the core sphere, and usually they are more monetized. Work is often motivated by a mixture of pay and volunteerism. Jobs in nonprofit organizations often pay less than jobs of equivalent skill and responsibility in the business sphere. It is sometimes said that government employees are in “public service.”
We can break down the economics functions of public purpose organizations into two general categories: regulation, where the public purpose organization sets rules or standards for the actions of other economic entities, and direct provision, where a public purpose organization itself takes on economic activities.
Regulation. One very basic function of public purpose organizations is to regulate economic activities—that is, to set the standards and “rules of the game” by which other economic actors will “play.” Public purpose organizations that promote, legislate, or enforce property rights, rules about contracts or disclosure of information, laws, or norms of obligation; promulgate standards; and/or perform other coordinating functions create the legal and social infrastructure for economic activity.
Many people think of “regulation” entirely in terms of “government regulation,” and it is true that the government sets many rules and standards with which other economic actors are legally obligated to comply. Government regulation of financial and securities markets, for example, plays an important role in macroeconomics. However, many nonprofit groups participate in regulating economic activity, particularly in the area of standard setting. For example, chances are you have taken a standardized exam like the AP, SAT I or II, GRE, GMAT, or TOEFL. These are all developed and administered by the Educational Testing Service, which is a large private nonprofit organization. While we might not commonly think of such privately provided standards as “regulation,” the standards implicit in these exams do, in fact, influence what is taught by institutions, if they wish their students to be well prepared for taking them. Public purpose organizations often provide the legal, social, and informational infrastructure that both support and constrain other actors in their economic activity.
Direct Provision. Public purpose organizations produce many goods and services, including national defense, physical infrastructure like highways and port facilities, and such services as education and, in many countries, health care. Direct public provision is often used to supply goods that cannot be supplied equitably or efficiently by private provision. Some goods are provided by the public purpose sphere because, as a society, we believe that everyone should have access to them, regardless of the kind of family or community they were born in and regardless of their ability to pay. Public schooling from kindergarten through high school is a primary example. In large U.S. cities, public hospitals provide necessary emergency medical care to the poor and uninsured.
Nonprofit organizations also often offer services related to education, health, and welfare. Both governments and private charities often transfer income to people in need. Other goods and services are provided by public purpose organizations because they are of a type that is called a “public good”. Sometimes it is more efficient for a public purpose organization to provide a good or service because of the presence of significant externalities, transaction costs, market power, or advantages to centralized information.
Although in some instances public purpose organizations offer goods and services for sale, much as businesses do, this is generally not their primary focus. Public purpose organizations usually raise much of the money they need to function by soliciting (or, in the case of governments, requiring) monetary contributions in the form of taxes, donations, or membership fees.
The interplay of governments and nonprofits in providing and regulating services can be quite complex. For example, in the United States the government Securities and Exchange Commission (SEC) regulates the exchange of securities such as stocks and bonds. The SEC accepts what are called Generally Accepted Accounting Principles (GAAP) as the authoritative standard for financial reporting. These principles are actually written, however, by the nonprofit Financial Accounting Standards Board.
The main strength of public purpose institutions is that (like core institutions) they can provide goods and services of high intrinsic value, but (unlike core institutions) they are big enough to take on jobs that require broader social coordination. Unlike the business sphere, the provision of goods and services itself, and not the financial results of these activities, remains the primary intended focus of public purpose organizations.
The public purpose sphere has its weaknesses, of course. Compared to the core sphere, the government, in particular, is often criticized as being cold and impersonal. Compared to the business sphere, institutions in the public purpose sphere are sometimes accused of being rigid, slow to adapt, and made inefficient by an overgrowth of regulations and a bloated bureaucracy. Organizations can lose sight of the intrinsic, common-good goal of providing “public service” and become more interested in increasing their own organizational budget. Because public purpose organizations are commonly supported by taxes or donations that are often not tightly linked to the quality of their services, they may not have financial incentives to improve the quality of what they provide. Many current debates about reforms in governments and nonprofits concern how incentives for efficiency can be improved without eroding the orientation of these organizations towards goods and services of high intrinsic value.
The Business Sphere
The U.S. government defines businesses as “entities that produce goods and services for sale at a price intended at least to approximate the costs of production." The business sphere is made up of such firms. A business firm is expected to look for opportunities to buy and manage resources in such a way that, after the product is sold, the owners of the firm will earn profits.
Whereas the core sphere responds to direct needs, and the public purpose sphere responds to its constituents, business firms are responsive to demands for goods and services, as expressed through markets by people who can afford to buy the firms' products.
Private for-profit enterprises in the United States and many other countries fall into four main legal forms: proprietorships, partnerships, corporations, and cooperatives. Proprietorships are businesses owned by single individuals or families. Partnerships are owned by a group of two or more individuals. Corporations are business firms that, through a process of becoming chartered by a state or federal government, attain a legal existence separate from the individuals or organizations who own it. Individual owners can come and go, but the corporation remains. If the corporation goes bankrupt and is forced to dissolve, the owners of a corporation cannot lose more than their investment. On the other hand, there is no legal limit to the profit they can make if the corporation is successful. This asymmetry, along with its other legal advantages, makes the corporation the preferred structure for major business activities in most countries.
Corporations that issue stock are governed by shareholders according to the principle of one-share, one-vote. In principle, at least, shareholders elect a board of directors, who in turn hire professional managers to run the day-to-day operations of the corporation. Cooperatives, in contrast to corporations, cannot issue stock and are governed by a different ownership principle. Each member of the cooperative, no matter what his or her position, has one and only one vote. In practice, cooperatives are owned by one of three groups: their workers, their suppliers, or their consumers.
A strength of business organization is that, because businesses have at least one clear goal—making profit—they may operate with superior efficiency. A profit orientation is commonly thought to drive firms to choose the most valuable outputs to produce, and to produce them at the least possible cost. The profit motivation is often thought also to encourage innovation: people are more motivated to come up with clever new ideas when they know they may reap financial rewards. We all benefit, in terms of our material standard of living, from business efficiency and innovations that bring us improved products at lower prices.
The relative weakness of the business sphere comes from the fact that business interests may or may not coincide with overall social well-being. Firms may act to enhance social well-being—for example, by making decisions that consider the full needs of their customers and their workers and take into account externalities, including those that affect the natural environment. They may be guided in these directions by the goodwill of their owners and managers, by pressure from their customers or workers, or by government regulation. Production for market exchange, however, has no built-in correction for market externalities. And sometimes “innovation” can take a perverse form. Enron Corporation, for example, in the late 1990s and early 2000s boosted its reported earnings primarily by inventing unusual and “innovative” accounting practices, which served to hide the extreme weakness of its financial situation from investors. In fields such as health care and education, where it can be difficult to define clear goals, businesses may increase profits by “innovatively” cutting corners on the less measurable and less-often-marketed aspects of quality of life.
A Comparative Note: Less Industrialized Economies
Many less industrialized economies have large informal spheres of small market enterprises operating outside of government oversight and regulation. Although this sphere could be classified as “business” because it involves private production for sale, it is also similar to the “core sphere” in that the activities are very small-scale and often depend on family and community connections. Like the core sphere, informal business activities are often ignored in government-compiled accounts.
In the United States, street-level illegal drug trades and housecleaning services provided “off the books” by illegal immigrants would be two examples of the “informal” sphere. In less industrialized counties, however, it is sometimes the case that most people are employed in small-scale agriculture, trade, and services that often go uncounted. If we were focusing mainly on less developed countries, it would be necessary to pay a great deal more attention to the complicating reality of "informal" economic activity and perhaps to discuss it as a fourth sphere. For industrialized economies, however, we can deal with this issue by simply noting, as we have just done, that it could legitimately be classified as occurring within either the business sphere or the core sphere, leaving open the question as to which of these classifications is more appropriate.
- Global Development And Environment Institute, Tufts University
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