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The economics of services: microfoundations, development and policy [Second edition.]
 9781782540847, 9780857932174

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Copyright © 2013. Edward Elgar Publishing Limited. All rights reserved.

The Economics of Services

Jansson, Jan Owen. The Economics of Services : Microfoundations, Development and Policy, Edward Elgar Publishing Limited, 2013. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/centraleurope-ebooks/detail.action?docID=1164200. Created from centraleurope-ebooks on 2021-03-23 08:13:19.

Copyright © 2013. Edward Elgar Publishing Limited. All rights reserved. Jansson, Jan Owen. The Economics of Services : Microfoundations, Development and Policy, Edward Elgar Publishing Limited, 2013. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/centraleurope-ebooks/detail.action?docID=1164200. Created from centraleurope-ebooks on 2021-03-23 08:13:19.

The Economics of Services Microfoundations, Development and Policy, Second Edition

Copyright © 2013. Edward Elgar Publishing Limited. All rights reserved.

Jan Owen Jansson Professor Emeritus, Linköping University, Sweden

Edward Elgar

Cheltenham, UK • Northampton, MA, USA

Jansson, Jan Owen. The Economics of Services : Microfoundations, Development and Policy, Edward Elgar Publishing Limited, 2013. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/centraleurope-ebooks/detail.action?docID=1164200. Created from centraleurope-ebooks on 2021-03-23 08:13:19.

© Jan Owen Jansson 2013 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical or photocopying, recording, or otherwise without the prior permission of the publisher. Published by Edward Elgar Publishing Limited The Lypiatts 15 Lansdown Road Cheltenham Glos GL50 2JA UK

Copyright © 2013. Edward Elgar Publishing Limited. All rights reserved.

Edward Elgar Publishing, Inc. William Pratt House 9 Dewey Court Northampton Massachusetts 01060 USA

A catalogue record for this book is available from the British Library Library of Congress Control Number: 2012953528 This book is available electronically in the ElgarOnline.com Economics Subject Collection, E-ISBN 978 1 78254 824 9

ISBN 978 0 85793 217 4 (cased) Printed by MPG PRINTGROUP, UK

03

Jansson, Jan Owen. The Economics of Services : Microfoundations, Development and Policy, Edward Elgar Publishing Limited, 2013. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/centraleurope-ebooks/detail.action?docID=1164200. Created from centraleurope-ebooks on 2021-03-23 08:13:35.

Contents _____________________________________________________________ Preface

vii

Foreword to the second edition

ix

PART I THE SERVICE ECONOMY IN PERSPECTIVE 1 Two approaches to service sector definition and measurement 2 Merit goods

3 17

PART II MICROECONOMIC FOUNDATIONS

Copyright © 2013. Edward Elgar Publishing Limited. All rights reserved.

3 4 5 6 7 8 9

Production costs of non-storable goods Distribution costs of non-transportable goods The basic trade-off and the resulting market areas Market forms and competition Supply and demand at the system level Welfare economics 1: Towards A-efficiency Welfare economics 2: Towards X-efficiency

31 52 67 79 90 102 119

PART III URBANISATION AND SERVICE SECTOR DEVELOPMENT 10 11 12 13 14

Unprecedented rise in the standard of living Structural change of the economy Urban service industries before the private car Mass motoring, enlargement of service markets and urban sprawl Towards sustainability of the service sector

135 146 162 172 182

PART IV PUBLIC POLICY TOWARDS SERVICES 15 16 17 18 19

Trust in economic growth cannot replace allocation policy Is cost-benefit analysis the answer? Towards social balance in the consumption Increased employment for absolute want satisfaction The financial challenge v

Jansson, Jan Owen. The Economics of Services : Microfoundations, Development and Policy, Edward Elgar Publishing Limited, 2013. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/centraleurope-ebooks/detail.action?docID=1164200. Created from centraleurope-ebooks on 2021-03-23 08:13:46.

208 223 239 253 268

vi

20

Contents

Summary and conclusions

285 306

Index

325

Copyright © 2013. Edward Elgar Publishing Limited. All rights reserved.

References

Jansson, Jan Owen. The Economics of Services : Microfoundations, Development and Policy, Edward Elgar Publishing Limited, 2013. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/centraleurope-ebooks/detail.action?docID=1164200. Created from centraleurope-ebooks on 2021-03-23 08:13:46.

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Preface The roots of this book go back to the 1970s, when I was teaching and doing research as a general microeconomist and was struck by the neglect of services in classical (and neoclassical) economics. In the nineteenth century, when the subject of economics took shape, the Industrial Revolution was taking place and the change of focus from agriculture to the manufacturing industry as the main creator of wealth and welfare was very natural. I wondered why 70 years of the twentieth century had passed without another change of focus in view of the fact that, in terms of employment, the service sector had grown to surpass industry at the beginning of the 1960s?1 However, in the 1960s prominent economists such as William Baumol (1967) and Victor Fuchs (1965; 1968) published work that promised a long overdue change, which was very inspiring. I started to prepare for a PhD project with the aim of exploring how mainstream microeconomics could be adapted in order to better suit the service sector. This project was never launched, as I had become engaged in a couple of research projects concerning transport problems – road pricing in Stockholm, the development of costbenefit analysis for application to road investment, the containerization of international liner shipping and the concomitant seaport adaptation – subjects which proved to be very absorbing. For 30 years transport economics has been my main field of research. This has not only involved applied work. The main lesson as far as the theoretical foundations of the field of transport economics is concerned, is that a separate theory has to be patched together in order to delve deeper into transport problems. Mainstream microeconomics seems either too general to be really helpful or, in some cases, designed too specifically with material goods markets in mind. During all these years, I did not lose contact with the ‘post-industrial service economy’, to a large extent thanks to my colleague Professor Lars Ingelstam, who has been the prime innovator of the institution of the theme of ‘Technology and Social Change’ at Linköping University. Many of the ideas developed in this book are due to him. Resuming work on services in real earnest, my first finding was a negative one: little published follow-up work has been added to the contributions of

1

At that time I did not know about the work by Colin Clark, who in his book, The Conditions of Economic Progress (1940), had pointed at many of the problems discussed in later studies

vii Jansson, Jan Owen. The Economics of Services : Microfoundations, Development and Policy, Edward Elgar Publishing Limited, 2013. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/centraleurope-ebooks/detail.action?docID=1164200. Created from centraleurope-ebooks on 2021-03-23 08:13:57.

viii

Preface

Copyright © 2013. Edward Elgar Publishing Limited. All rights reserved.

the pioneers of the 1960s as far as the necessary adaptation of economic theory to the changing conditions of the service economy is concerned. Several interesting works describing and analysing the development of the service sector have appeared including: Bell (1973), Skolka (1976), Gershuny (1978), Inman (1985), Scharpf (1985; 1991), Petit (1986), Giarini (1987), Ingelstam (1995) and Schön (2000). However, the original task I had set myself appeared doomed to remain uncompleted. The feedback to mainstream economic theory of all the new insight into the dominant part of the modern economy is insignificant. Secondly, another anomaly of mainstream economics now stands out more clearly than 30 years ago: the post-war years have been a period of unprecedented economic growth and yet the question of whether this tremendous addition to the material wealth of already wealthy countries is really worthwhile, is barely asked in the profession. In the course of the work on this book, however, I became aware of an emerging field of research where this is questioned. The survey article by Bruno Frey and Alois Stutzer (2002) and the lectures by Rickard Layard (2003) show that recent results of ‘happiness research’ go straight to the heart of the matter. It also seems that this new research has an important bearing on the economics of services. Finally, it has been interesting to discover a new dimension to my own speciality. Transport plays a double role in the service sector. Transport is itself an important service, and it turns out that a high distribution cost per output unit and kilometre (including transport in a wide sense) relative to the production cost per unit is the outstanding characteristic of services when it comes to economic analysis.

Jansson, Jan Owen. The Economics of Services : Microfoundations, Development and Policy, Edward Elgar Publishing Limited, 2013. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/centraleurope-ebooks/detail.action?docID=1164200. Created from centraleurope-ebooks on 2021-03-23 08:13:57.

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Foreword to the second edition Besides the normal need for an update of the book published in 2006, two aspects of the recent economic policy discourse have motivated a revised, second edition. In the field of service economics, the remarkable inclination in the literature towards intermediate services – that is producer services – at the expense of consumer services has been strengthened. It is true that the producer services have been the most expansive kind in recent decades (due to continuous outsourcing in industry), but the service provision for the final consumers (households) still constitutes 70 per cent of the value added of the total service sector. Therefore the basic outlook of the book remains: economics is in essence the study of consumer want satisfaction by scarce resources. However, to partially comply with the conventional direction, a twofold statistical account of the service sector in line with the National Accounts is presented in this edition. Now the supply-side approach to the GDP compilation, where the value added of all service industries are shown, is supplementing the demand-side approach by which the intermediate service sector is invisible. The other aspect is the strong influence on economic policy discussions of the prolonged financial crises. This tends to block the view of crucial issue for the future of the real economy of the welfare states. The antithesis of austerity versus economic growth is the main issue of the current debate. It has established the medial misuse of the growth concept. All increases in demand and/or production, however casual or temporary, are referred to as ‘growth’. Governments should pursue short-term stabilisation policy, that is short-term demand management with a view to full capacity utilisation: however government cannot command long-term economic growth. In this book it is argued that governments should instead have a consumption policy for the long-term resource allocation adapted to the affluent society, aware of the fact that continuous growth of material goods consumption is unsustainable and would, anyway, satisfy mainly relative wants, which would not raise the general well-being very much. William Baumol, whose development of the idea of unbalanced productivity growth is perhaps the most fruitful achievement in modern economics, shows the way. In 2012 he published The Cost Disease that presents the final proof of the profound relevance of this idea: in the US economy the resource requirement of health and education is approaching fifty percent of GDP, and that is all right in Baumol’s view. It reflects consumers’ willingness to pay, ix Jansson, Jan Owen. The Economics of Services : Microfoundations, Development and Policy, Edward Elgar Publishing Limited, 2013. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/centraleurope-ebooks/detail.action?docID=1164200. Created from centraleurope-ebooks on 2021-03-23 08:14:07.

x

Foreword to the second edition

Copyright © 2013. Edward Elgar Publishing Limited. All rights reserved.

and thanks to continuous productivity growth in sectors untainted by the cost disease, US consumers can afford all what they need for satisfying other wants in spite of the shrinking share of the labour force in manufacturing industry. The present book adds the welfare state perspective to this picture. What then appears is alarming. Contrary to the original aim and expectation, where Health, Education and Care (HEC) are tax-financed the relative resource use in this sector is lagging well behind the US development, and a deteriorating quality of HEC services becomes a major problem. The hope that higher economic growth could solve the problem is in vain, and a social order emerges where people’s efforts are directed to things they do not need while they are told that what they do need, society cannot afford. A way out of this dilemma that many economists recommend could be to abandon the tax-financing of HEC. However, it seems unnatural to give up the whole idea of the welfare state, that of sharing with other people, when the production possibilities are greater than ever. In this edition the natural policy alternative that would preserve the welfare state is developed in depth.

Jansson, Jan Owen. The Economics of Services : Microfoundations, Development and Policy, Edward Elgar Publishing Limited, 2013. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/centraleurope-ebooks/detail.action?docID=1164200. Created from centraleurope-ebooks on 2021-03-23 08:14:07.

PART I THE SERVICE ECONOMY IN PERSPECTIVE

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Chapter 1 Two approaches to service sector definition and measurement Chapter 2 Merit goods The purpose of this book is to present a broad view of the economy that does full justice to the immaterial goods, which after all constitute more than half of all final want-satisfying goods. Immateriality defines the services and makes service markets specifically distinct from material goods markets. This book also challenges the view that mainstream economic theory is equally fit for positive analysis of service markets as for material goods markets. This is not just a claim for theoretical refinement, of mainly academic interest. As the book developed, much to my own surprise it transpires that some crucial problems – perhaps the most important remaining problems of resource allocation in the economy – have been obscured for economists because of the limited applicability of conventional economic theory to services. Therefore, we have to start from the basic level in Chapter 1 by defining and describing the service sector from the two alternative angles applied in the gross domestic product compilation of the National Accounts. Chapter 2 deepens the description by a special account of a service category of outstanding policy relevance, yet which is a veritable Cinderella in mainstream microeconomics: merit goods. Then follows three analytical parts. Part II lays out the appropriate microeconomic foundations. Part III looks at the long-term development and Part IV discusses public policy towards services. In Parts I, II and III, the economic analysis is applicable to most economies, as is economic theory in general. The descriptive material is predominantly based on Swedish data. The data are not meant to point out distinctive features of the Swedish economy, but to illustrate significant issues, which are probably applicable to most other mixed economies. The policy analysis of Part IV focuses on the problems of the modern welfare state. The example of Sweden is frequently referred to in this case too, but I dare say that the problems are general enough to make the discussion widely relevant. 1

Jansson, Jan Owen. The Economics of Services : Microfoundations, Development and Policy, Edward Elgar Publishing Limited, 2013. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/centraleurope-ebooks/detail.action?docID=1164200. Created from centraleurope-ebooks on 2021-03-23 08:14:18.

Copyright © 2013. Edward Elgar Publishing Limited. All rights reserved. Jansson, Jan Owen. The Economics of Services : Microfoundations, Development and Policy, Edward Elgar Publishing Limited, 2013. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/centraleurope-ebooks/detail.action?docID=1164200. Created from centraleurope-ebooks on 2021-03-23 08:14:18.

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1. Two approaches to service sector definition and measurement A pragmatic stand is taken in this book on the question of service sector definition and measurement. We are all inescapably dependent on the National Accounts for grasping the basic structure and development of the economy, so the service sector is what is given in those accounts. That does not mean that the ‘official’ service sector is always a very appropriate aggregate either for descriptive or analytical purposes, but it fulfils the purpose of providing a common, internationally agreed definition facilitating comparative studies. In an appendix to this chapter, a short background to the definitional question is given from the history of economic thought, and some classification problems are briefly discussed. The main point of the present chapter is that two different ways of calculating the gross domestic product (GDP) are applied in the National Accounts, which give the same total result, but quite divergent proportions of the goods and service sectors. One way is to take the point of view of the producers in the economy, and the other way is to take the point of view of the users of the final output of the economy (consumers and real capital investors) when compiling the GDP. 1 THE PRODUCER-SIDE APPROACH By the producer-side approach the value added (VA) of all producers in the economy is recorded. The basic least units of observation are private firms and public enterprises including the tax-financed service providers in the public sector. The VA of private firms and the user-financed public enterprises is made up of the difference between total sales and total purchases of input goods and services. In the absence of market prices, the total factor costs are used as a surrogate total value of the output of tax-financed services. The GDP is obtained by summing up the VA of all producers in trade and industry and the public sector. All producers are sorted into different industries, so for dividing the economy into a goods sector and a service sector the definitions of the different industries are obviously critical. Traditionally, the industry classification follows the goods processing from the primary stage of raw material extraction 3

Jansson, Jan Owen. The Economics of Services : Microfoundations, Development and Policy, Edward Elgar Publishing Limited, 2013. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/centraleurope-ebooks/detail.action?docID=1164200. Created from centraleurope-ebooks on 2021-03-23 08:14:28.

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4

The service economy in perspective

and cultivation, via the secondary stage of manufacturing and finally to the tertiary stage of goods distribution. Industries in the early secondary stage are named after the basic raw material being processed (the wood industry, iron industry, and so on). In the late secondary stage, it is the type of output that names the industries, for example, the car industry, clothing industry and food industry Also, the main type of work being performed, such as engineering, construction, and printing, does name some manufacturing industries and this goes for the service industries, too. The goods industries are of less concern here, and are summarised in Table 1.1 as the primary and secondary stages in the goods processing. With the terminology of the National Account ‘producers of services’ take over in the tertiary stage after the ‘producers of goods’ have done their share. It is the tertiary stage that defines the service sector, so the attendant question is: what does the tertiary stage contain? In Table 1.1 the total of the tertiary stage is made up of the VAs of nine categories of service producers. The relative size of each category is given as the VA as percentage of the GDP. The obvious third stage in the goods supply chain is the wholesale and retail trade. Besides the goods distribution and the public service sector, the tertiary stage contains a good number of different service industries, aggregated to seven main sectors in the table. These sectors are more or less related to the goods supply chain. Some service producers make their contributions to the goods processing in the primary and secondary stages, while others have nothing to do with the goods processing but produce direct consumer want satisfaction. Their output of consumer services cannot reasonably be characterised as a contribution to the tertiary stage in the goods processing, but it is a separate class of ‘goods’ of great importance for our well-being in its own right, including tax-financed services that constitute a major part of the consumer service production in the welfare state. The three largest categories of private service producers in Table 1.1 – the business service firms, goods distribution and the housing sector (in that order of size) – make up two thirds of the private service sector in value added terms. They are very different animals, and two of them seem rather out of place in the service sector. Why should goods distribution be separated from the other links in the goods supply chain? And why should the most durable of all the durable consumer goods – the house one lives in – be treated differently than the rest of the consumer durables? It is true that rented accommodation has the character of services, but that is not the case of owneroccupied houses.

Jansson, Jan Owen. The Economics of Services : Microfoundations, Development and Policy, Edward Elgar Publishing Limited, 2013. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/centraleurope-ebooks/detail.action?docID=1164200. Created from centraleurope-ebooks on 2021-03-23 08:14:28.

Two approaches to service sector definition and measurement

5

Table 1.1 Composition of the gross domestic product compiled (1) from the producer-side and (2) from the final user-side as percentages of GDP. 1. Value added

Primary stage

2.5

1

Secondary stage

25.5

11

Tertiary stage

72

25

12.5

25

Wholesalers and retailers Housing firms and home owners Business service firms

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2. Expenditure on final products

PRODUCERS

Consumer Goods

Consumer Services

7

48

Investment1

12

9

16

Transport firms

5

2

Post and telecom

3

1.5

4

2

1.5

2.5

3

5

20

26

3

48

27

Financial istitutions and insurance companies Hotels and restaurants Pure consumer service sector producers Public sector TOTAL

100

25

Source: Own adaptation of the Swedish National Accounts (2008).

1

Investment includes the difference between export and import; an export surplus can be regarded as an investment in the foreign currency reserve.

Jansson, Jan Owen. The Economics of Services : Microfoundations, Development and Policy, Edward Elgar Publishing Limited, 2013. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/centraleurope-ebooks/detail.action?docID=1164200. Created from centraleurope-ebooks on 2021-03-23 08:14:28.

6

The service economy in perspective

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The value added of houses owned by housing firms or other landlords and the ‘value added’ of home-owners are calculated in a similar way in the National Accounts. The value added of the housing firms is constituted by the actual rents received from tenants minus depreciations, the costs of maintenance and repair, and other costs. The value added that accrues to home-owners living in their own houses consists of imputed ‘shadow rents’2. Nowadays the shadow rents exceed the rents paid by tenants in apartment blocks. Altogether the VA of the private sector service producers makes up 52 per cent of the GDP in Sweden, but the heterogeneity of its main sub-sectors is striking. An immediate, somewhat unruly observation is that a main reason why the ‘service sector’ is dominant in modern economies, is that a number of producers that cannot be assigned to the primary or secondary stage in the goods processing have, for lack of a natural common abode, been bunched up with traditional service producers, instead of referred to an ‘other’ category of left-overs. However, Table 1.1 adheres to the internationally agreed, official definition of the service sector. For practical reasons we have to accept the present situation and make the most of it. It should be noted that the wide-spread notion that we now are in a service economy and will be so even more decidedly in the future has no doubt been helped along by the somewhat inflated size of the service sector defined from the producer side. Calculated in that way the service sector as a share of the GDP in a crosssection of the European member states ranges from less than 60 per cent (Romania) to more than 80 per cent (Luxembourg), where Sweden is close to the European Union average with 72 per cent as is seen in Figure 1.1. 2 THE FINAL USER-SIDE APPROACH The other approach to the GDP compilation is to find out how the total final production is used. It relies to a large extent on questionnaires sent to households concerning their expenditure on consumption and to firms concerning their investments. Adding up total consumer expenditure, government expenditure on public consumption and total private and public investments, also taking into account the trade balance, the value of the GDP is obtained, which in principle should be identical to that obtained by the producer-side approach plus value added taxes.

2 To treat housing investments on par with other investments in buildings and machinery made in industry, where these investments will increase the recorded value added during the whole economic life of the new investments, the returns on owner-occupied house investments that in reality will not appear as a monetary yield are represented by an accounting cost of the accomodation

Jansson, Jan Owen. The Economics of Services : Microfoundations, Development and Policy, Edward Elgar Publishing Limited, 2013. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/centraleurope-ebooks/detail.action?docID=1164200. Created from centraleurope-ebooks on 2021-03-23 08:14:28.

Two approaches to service sector definition and measurement

7

Services

Industry

Luxembourg Cyprus France Great Britain Malta Greece Belgium Latvia The Netherlands Portugal Denmark Italy Sweden Germany Austria Spain Estonia Hungary Ireland Poland Finland Slovakia Lithuania Bulgaria Slovenia Czech Republic Romania

Agriculture

Source: Sandelin 2009

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Figure 1.1 The share of the service sector in a producer-side perspective. Table 1.1 is designed to draw a parallel between the two approaches to the GDP compilation. As seen in the columns for ‘expenditure on final products’, all of the household expenditure on goods consumption pertains to the goods distribution sector. Firms in the manufacturing industry making consumer goods sell all of their final output to domestic consumers via wholesalers and retailers. By the nature of immaterial goods there is no distinct retailing stage of proper services, but production and consumption are typically simultaneous and happen at the same place. Household expenditure on private services is therefore directly divisible between the different service production sectors in the tertiary stage. As seen in Table 1.1 total household expenditure on services amounts to (48-26=) 22 per cent of the GDP. Of this expenditure a third part concerns services that are also used to a large extent by different producers. However, producers’ expenditure on services is not included in the GDP as calculated from the final user-side. In Table 1.1, the VA column does not distinguish customer categories, so to complete the picture, the producers’ expenditure on mixed producer and consumer services such as transport, post and telecom, financial services, and hotels and restaurants have been calculated and put beside the consumers’ expenditure in Table 1.2.

Jansson, Jan Owen. The Economics of Services : Microfoundations, Development and Policy, Edward Elgar Publishing Limited, 2013. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/centraleurope-ebooks/detail.action?docID=1164200. Created from centraleurope-ebooks on 2021-03-23 08:14:28.

8

The service economy in perspective

Table 1.2 Total expenditure on the mixed producer and consumer services by producers (intermediate services) and final consumers. Kind of service Transport Land transport Shipping Air transport Supporting services

Intermediate 9 4 1.5 1 2.5

Final 2 1 0.5 0.5

Post and telecom

2

1.5

Financial services

4

2

Hotels and restaurants

1

2.5

TOTAL

16

8

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Source: Own adaption of the Swedish National Accounts.

It is interesting to note that transport services are particularly important producer services in comparison to the transport services used by consumers, mainly because goods transport by road, rail and sea is prominent. The main consumer transport, that is travel, is made by private car, and is an activity that is only apparent in household time allocation studies. The final user-side approach confines the service sector to private and public consumption of services, as investments in machinery, buildings, roads, and rails are tangible, material goods to the highest degree. Consequently, the service sector in Sweden makes up 48 per cent of the GDP, as is shown in Table 1.1, which is considerably less than 72 per cent obtained by the producer-side approach. This difference is conspicuous. It is not exceptional for Sweden, and the explanation given below is generally applicable. An attendant question also considered is if the two approaches could be reconciled to give the same result? 3 ALTERNATIVE GOODS AND SERVICES SECTOR PROPORTIONS A simplified picture of how the two approaches to the GDP calculation are related is given in Figure 1.2. The relative value added of the main production sectors making up the GDP according to the producer-side approach is represented by the four rectangles drawn to scale.

Jansson, Jan Owen. The Economics of Services : Microfoundations, Development and Policy, Edward Elgar Publishing Limited, 2013. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/centraleurope-ebooks/detail.action?docID=1164200. Created from centraleurope-ebooks on 2021-03-23 08:14:28.

Two approaches to service sector definition and measurement

9

The three vertically linked ones to the left in the diagram give the value added in the three stages of the material goods process. The two darkly shaded ones refer to the goods sector and the lightly shaded, ‘goods distribution,’refer to the service sector in the National Accounts. The large square to the right represents the tertiary stage except for goods distribution. The remaining eight service subsectors of Table 1.1 are merged into four: the housing sector, the pure producer services sector, the mixed producer and consumer service sector, and the pure consumer service sector, where the unshaded area represents the tax-financed public sector.

INVESTMENT 27%

Pure consumer service sector

Goods distribution

Goods 25%

Housing 9%

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Manufacturing industry

Mixed producer and consumer service sector

Housing sector

Building industry

Pure producer service sector

Primary producers

Services 39%

Goods production User-financed service production Tax-financed service production

Figure 1.2 A simple image of the producer-side and final user-side approaches to GDP compilation, and the goods and service sector division

Jansson, Jan Owen. The Economics of Services : Microfoundations, Development and Policy, Edward Elgar Publishing Limited, 2013. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/centraleurope-ebooks/detail.action?docID=1164200. Created from centraleurope-ebooks on 2021-03-23 08:14:28.

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10

The service economy in perspective

The top and bottom ovals in Figure 1.2 represent the total final use of the production in the economy according to the final user-side approach. The use of the total production in the economy is symbolised by the arrows from the squares to the ovals. There is also the kinked arrow indicating the producer service input into the goods processing. The main use of the total production is consumption. Four consumption flows are indicated in the diagram. The dark arrow to the left indicates relatively undisputed goods consumption and the merged light grey and unshaded arrows to the right indicate private and public service consumption respectively3. In-between is the thinner, light grey arrow representing expenditure on housing where it is somewhat tricky to draw the line between goods and services. Unlike all other durable consumer goods that refer to the goods consumption in the year of acquisition by the full purchase price, the housing consumption in the case of owner-occupied houses is valued by an annual shadow rent, as was previously mentioned, and this value refers to the service consumption in the National Accounts. In the bottom oval representing total consumption a housing strip is placed between Goods and Services, indicating that it is a ‘disputed area’. Rented dwellings could be regarded as services just as rented cars and other rented household capital goods. There is, however, a difference between short-term and long-term renting of cars as well as flats, as they meet rather different needs. Car leasing could be regarded as a form of hire-purchase, and could be included in the expenditure on durable goods. The same could go for rented flats. Furthermore, a more reasonable borderline between goods and services in the accommodation sector could be between all housing and hotel services. As mentioned above, in the National Accounts all use of houses to live in, blocks of flats as well as owneroccupied houses, is regarded as services. The goods provided by the supply systems that used to be called public utilities are also part of the housing expenditure but are regarded as goods consumption. They include some difficult borderline cases for a classification based on the materiality criterion. Gas and cold and hot water are material enough just as, for example, fuel used for heating or for driving your car, while electricity could be regarded as immaterial. Refuse collection and sewage disposal are regarded as services, as they are two kinds of goods transport services (or better, ‘bads’ transport); in the former case by road vehicle and in the latter case by sewage pipes. 3 There are also some clearly mixed cases, such as a meal served at a restaurant: the service content is made up of the cooking, the laying and the clearing of the table, and the washing-up. This goes to restaurant services, while the value of the food and drink consumed goes to the readycooked food sub-category of goods consumption. Another familiar case in point is medicine used as part of medical treatments.

Jansson, Jan Owen. The Economics of Services : Microfoundations, Development and Policy, Edward Elgar Publishing Limited, 2013. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/centraleurope-ebooks/detail.action?docID=1164200. Created from centraleurope-ebooks on 2021-03-23 08:14:28.

Two approaches to service sector definition and measurement

11

The top oval in Figure 1.2 represents investments, the second main use of what the economy produces. The three dark arrows represent from left to right: investments in machinery, investments in stocks of raw material, and investments in buildings and the infrastructure. Total investments are in the region of a quarter of the GDP. In Sweden, 2008 showed a large surplus of export over import, so an investment in the currency reserve of 7 per cent of the GDP boosted this use of the total output4. About a tenth of the positive trade balance represented an ‘invisible’ trade surplus. The question now is if it is possible to reconcile the two GDP measurements by some classification amendments such that the goods and services sector proportions are equalised? In Table 1.3 below, a number of conceivable alternative principles for dividing the economy into a goods and a service sector are suggested. Table 1.3 Goods and service sector proportions by different producer-side measurement in the case of Sweden. The present procedure in the National Accounts Switching goods distribution to the goods sector Switching the housing sector to the goods sector

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Adding intermediate services into goods production to the goods sector

28:72 41:59 47:53 58:42

With the producer-side approach three reasonable alternative goods and service sector proportions can be picked out besides the present ‘official’ one applied in the National Accounts, by successively switching (i) the value added of goods distribution, (ii), the value added of the housing sector, and (iii) the value added represented by the kinked arrow in Figure 1.2 from the service sector to the goods sector. The goods and services sector proportion would change from 28:72 (the official one) to 58:42 by making all of the aforementioned switches. With the final user-side approach, only a different treatment of housing seems worthwhile as an alternative to the present procedure. By regarding all housing as durable goods consumption, the proportion of the goods sector and the service sector would be equal to that in the last case shown in Table 1.3, which would imply that the ‘service economy’ is not a very fitting characterisation of our economy. 4

It is also possible to identify some ‘immaterial investments’ in, for example, the purchase of software for it-applications that refer to current business-to-business service inputs which are implicit in the prices of final goods and services.

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12

The service economy in perspective

Does It Matter? The preceding exercise is not meant to unmask the definite truth about the relative size of the service sector, but mainly to show the nebulous character of this sector as given by the GDP compilations in the National Accounts. As stated at the outset of this chapter, there is no point in trying to bring out a particular alternative service sector definition as the only true one. This aggregate is not very useful for analytical work irrespective of exactly how it is defined as it is too heterogeneous. On the one hand, in-depth studies of important service sub-sectors such as Transport, Education and Health have to be clearly-defined, special cases in order to be really useful. On the other hand, there is a need for identifying some common ground of service markets to mark them off from material goods markets that could make some relevant amendments possible to general microeconomic theory. That theory has served us very well for understanding the working of material goods markets, but has been found wanting when it comes to immaterial goods. Part II is an attempt aimed at formulating a reasonably general microeconomic theory for services, which in turn could provide the micro foundations for explaining the service sector development, as well as for analysing some crucial allocation policy issues at the macro level. Before concluding this chapter an answer is ventured to the question of why the conventional service sector aggregate still plays a main part in the economic policy debate.

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The Service Economy Hangup Why has the popular notion of the present service economy had such a firm hold on people’s minds? The answer is probably that it is more natural for politicians and the popular media to think of the structure of the economy in terms of employment (which so far has been left out of the present discussion) rather than in terms of final output, because employment is an entity easily understood and of immediate, overriding importance: where are the new jobs required for full employment to be found?. To be honest, it is far from self-explanatory what exactly service work is, but if service work is defined as all work done in the service sector as measured by the ‘official’ producer-side approach, service employment in Sweden is in the region of 75 per cent.5 5

If service work is put on an approximate equality with white-collar work it can be noted that the share of service work in the total work of the economy would substantially exceed 75 per cent in Sweden because industrial firms now employ an increasing number of this category replacing the traditional blue-collar, or manual workers.

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Two approaches to service sector definition and measurement

13

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The picture of Figure 1.3 below appeared in an article in The Economist where the main feature was that 88 per cent of the total employment in the US is now in the service sector. It did not point out that a substantial part of the service workers mainly contributes to the output of material consumption and investment goods rather than to final services. A more penetrating analysis of the labour market should seek to find out from where the derived demand for labour in the producer service sector originates: either from final goods or from final service consumption demand.

Source: Economist 2005

Figure 1.3: The new worker.

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14

The service economy in perspective

APPENDIX TO CHAPTER 1: DEFINITIONAL ISSUES The definitional questions have been a serial story in the history of economic thought on services. Some interesting problems of terminology and classification have been left out of the preceding discussion but deserve not to be forgotten. Linguistic Problems The word ‘service’ means many different things in different contexts, and the question here is if its meaning is sufficiently clear when making the customary division of what the total economy produces into ‘goods and services’? Both words are far from unambiguous, either in common parlance, or in the language of economics. With regard to ‘goods’ it is used in two oppositional pairs. goods vs. services

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goods vs. ‘bads’ In the former pair, goods are contrasted to services, and in the latter pair goods cover everything which is useful in production, or demanded by consumers, including services. With terms like ‘goods manufacturing’ and ‘goods transport’ it is clearly the former, narrower meaning of material goods that is intended. In more specifically economic terms like ‘private goods’, ‘public goods’, and ‘merit goods’ the wider meaning is intended. In a book on services, the two latter terms are rather confusing in view of the fact that practically all public goods and merit goods, that is all taxfinanced consumption, are services and moreover are the largest consumer service category in the welfare states. Glimpses of Old Controversies A famous discussion of the goods and services dichotomy appeared in an article by Terence Hill in 1977 – ‘On goods and services’ – that also reminds us of some curious ideas about services in the early history of economic thought, where service provision has been regarded by some prominent economists as a less worthy pursuit than material goods production: The distinction between goods and services was emphasized by Adam Smith, and regarded as a matter of great importance by classical economists. It gave rise to the somewhat emotive distinction between productive and unproductive labour ac-

Jansson, Jan Owen. The Economics of Services : Microfoundations, Development and Policy, Edward Elgar Publishing Limited, 2013. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/centraleurope-ebooks/detail.action?docID=1164200. Created from centraleurope-ebooks on 2021-03-23 08:14:28.

Two approaches to service sector definition and measurement

15

cording to whether the labourer was engaged on the production of goods or services, a distinction which through Marx’s influence has survived in the Material Production System of accounting used today in socialist countries. (Hill, 1977, p. 315)

Looking at more recent literature it is found that the main distinguishing characteristic of services has been clear enough for some time; it is just that there is no classification scheme that could accommodate all conceivable special cases without problems.

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Embodied and disembodied production factor services The time-honoured criterion of immateriality does well as the distinguishing characteristic of services versus goods as objects of transactions in markets for the result of the production in the economy (Stigler 1956). In production factor markets, ‘service’ is also a common concept in terms such as labour services and capital services that should not be mixed up with service as a production result. In his first pioneering study of the growing importance of the service industries, Fuchs (1965) makes a reference to Marshall, who made the intriguing remark that in one sense all industries provide services. Man cannot create material things. This goes right to the heart of the matter. The basic production factors of all industries – labour, capital and land – provide services, and in goods industries the production factor services become embodied in the material goods, which are sold on in that form, either as input into a further stage of the production process, or as output to the final consumers. In service industries, where the direct recipients of the services are persons, the production factor services remain disembodied all along. Personal services and services to durable goods Services to persons epitomise the very concept of ‘service’ When labour is the main factor of production and the service is received individually, it is common to speak about ‘personal services’. This is the largest service subcategory, by far, but there are also services to goods. Goods repair and maintenance are referred to as the services industries. The example of shoe-repair as distinct from the production of shoes can be used to illustrate the subtle difference between goods manufacturing firms and service firms, where goods rather than persons are the direct recipient of service. In a boot and shoe factory, the labour and capital services are embodied in the leather and soles to become boots and shoes in the production process, and the factory is obviously assigned to the boot and shoe industry, which belongs to the goods sector. It should be noted that the factory owner has bought the input material, and owns the finished boots and shoes until they are sold. In the cobbler’s workshop the labour and capital services are likewise embodied in boots and shoes. The crucial difference is, however, that the ownership

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16

The service economy in perspective

of the boots and shoes to be repaired stays with the customers who have handed them in. This means cobblers belong to the service sector. Table A1.1 Examples of services to persons and services to goods.

BASIC PRODUCTION FACTORS

Persons

Goods

Labour

Child care

Shoe repair

Capital

Dwelling

Refrigeration

Recreation

Car parking

Land

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Direct recipient of services

The criterion of ownership is not consistently applied in current goods and services industry classification. The outstanding exception is goods distribution, that is, the wholesaling and retailing of material goods. Since the wholesaler and retailer are owners of the goods they have bought in order to resell, their distribution activities could, in my view, be regarded as the last link in the chain from raw material extraction via manufacturing to making the goods ready for sale to the final consumers. From this point of view goods distribution could be included in the goods sector. Only agents who do business on a commission basis, which means that they do not become owners of the goods they are selling, should be counted in the service sector. However, this is not the conventional way of treating goods distribution in official statistics.

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2. Merit goods

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As shown in Table 1.1 in the preceding chapter, the tax-financed services make up 26 per cent of the GDP in Sweden, and 36 per cent of the total consumption. This is not exceptional in Europe and the composition of the taxfinanced consumption seems rather similar, too (Sandelin 2009). The ‘public goods’ typically make up only a fourth thereof. The fundamental characteristic of public goods is that their provision is without limit. Once facilities for providing particular public goods are set up, there is unlimited access to them. Therefore, a good alternative designation is ‘collective services’ to point out that, in addition public goods are all services. Pure public goods cannot be charged for but have to be tax-financed if they are to be produced at all. When this limitation is overcome, which goes for an appreciable minority, the attribute ‘pure’ is dropped. What the remaining three quarters of the public consumption should be called is an open question. They used to be called ‘merit good’, but this designation is not self-explanatory, and has gone out of fashion. In a modern British textbook where the term is used, the definition is: ‘Goods/services that add to the quality of life but are not, strictly, public goods´ (Griffiths and Wall, 2000, p. 705). A more elaborate definition by the same authors reads: Merit goods such as education and health care do not possess the same characteristics as public goods, for instance people can be excluded from consuming them. They could therefore be provided through the market mechanism. However, many are deliberately provided free of charge through public bodies because their consumption arguably confers relatively large social benefits on society that far outweigh their costs of provision. (Griffiths and Wall, 2000, p. 468)

This brings forth further questions: how should the ‘relatively large social benefits’ of medical care, education, child care, and eldercare be estimated, and is it likely that the positive externalities are equal to, or larger than the marginal cost of providing them to justify zero charges? Pure public goods are uncontroversial in mainstream price theory and in the political practice. Pricing policy for impure, ‘quasi’ public goods that are excludable but have zero marginal costs is controversial in many casesand the subject of a growing literature, in particular, in the wide field of ‘information’. These kinds of public goods play an important role in the current discussion of patents and intellectual property rights (see Gilbert 2011 for a 17

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18

The service economy in perspective

good recent example), but are for the sake of coherency left out of consideration in this book. 1 A CINDERELLA IN ECONOMICS Merit goods put three to four times greater demand on the public purse than public goods in the welfare states, and nowadays dominate over the pure public goods even in the US. Nonetheless they are put at a disadvantage in economic literature. A traditional and still common, attitude among economists and non-economists alike is that these goods are not susceptible to economic assessment and should be left for politicians to deal with. To come to grips with this issue, a brief background in the history of economic thought is helpful.

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Musgrave’s Legacy Let us go back to where it all started. The concept of merit goods was introduced by Richard Musgrave, the creator of the modern paradigm of the theory of public finance. Musgrave preferred to take his starting point on the demand-side, and couched his final goods categorisation in terms of ‘wants’, that is, private goods are produced to satisfy private wants, and so on. In his main work, appearing in 1959, Musgrave introduced an additional dichotomy continuing from the, at that time, well-established division of total output into private and public goods, by dividing the public wants into social wants and merit wants. In the introductory section subtitled ‘Situations calling for adjustments in allocation’ in his pioneering book, Musgrave presents the now familiar reasons why a public allocation policy might also be justified so far as private wants are concerned. Then he proceeds to the public wants: Let us now turn to situations where the market mechanism fails altogether and where the divergence between the social and private product becomes allinclusive. This is the case of social wants proper, the first type of public wants to be considered. Social wants are those wants satisfied by services that must be consumed in equal amounts by all. (Musgrave, 1959, p. 8)

In later literature, the goods (that is services) satisfying social wants are seldom called ‘social goods’, but usually simply ‘public goods’, which unfortunately is somewhat confusing:, in some connections public goods can mean social goods as well as merit goods, and in other connections public goods mean merely social goods.

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Merit goods

19

All wants/goods

Private wants/goods

Public wants/goods

Social wants/goods

Merit wants/goods

Figure 2.1 Main demand and supply categories according to Musgrave (1959) The satisfying of social wants aims at making the resource allocation as nearly in line with individual consumer preferences as possible. From Musgrave onwards this is, by definition, not true for merit wants:

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A different type of intervention occurs where public policy aims at an allocation of resources that deviates from that reflected by consumer sovereignty. In other words, wants are satisfied that could be serviced through the market but are not, since consumers choose to spend their money on other things. (Musgrave, 1959, p. 9)

The term ‘merit wants’ indicates that society wants more of the goods than would result from the free interplay of market forces, however, Musgrave like others following in his footsteps also includes unhealthy things such as narcotics, alcohol and tobacco in this category, because the main distinguishing characteristic is that consumer sovereignty is disregarded in the case of merit wants. However, a large majority of the ‘merit wants’ is satisfied by truly meritorious goods. It was an important achievement in the history of economic thought to distinguish and define merit goods. However, one has a feeling that Musgrave was not very happy about his discovery, because he had to conclude that economists should leave the merit wants alone – those are something for politicians to deal with – and focus on the social wants. In his own words: Merit wants presents much greater difficulties. Thus it is proper for the economist to concentrate on the problem of social wants. Moreover, the phenomenon of pure merit wants is not as general as it seems at first sight. What appear to be merit wants are, in many cases, social wants. (Musgrave, 1959, p. 89)

This restrictive and cautious attitude was unrealistic. After Musgrave (1959), two of the three constituents of the health, education and care (HEC) trio have become important sub-areas of microeconomics. Both health economics

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20

The service economy in perspective

and the economics of education (in particular, higher education) are special fields, which like their objects of study are rapidly expanding. Moreover, the last conjecture was wishful thinking, because in the postwar period the merit goods have in general expanded considerably relative to the social goods. It can also be argued that contrary to Musgrave’s claim some of the traditional social goods are in fact merit goods rather than the other way round. In the second largest social goods category of ‘law and order’, an appreciable number of services are private goods by nature, but are nevertheless consumed in ‘equal amounts’, and not from necessity but because of equal rights. The principle of equality in different spheres of life is arguably a main explanation of the increasing importance of merit goods. However, this is not an unchallenged point of view.

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Eternal Controversy In later literature on public economics there is no better summary description of what merit goods really are than services provided free or almost free of charge in spite of being private goods. This definition consequently depends on the public choice actually made in the political process with regard to questions of resource allocation and financing of services, which can have quite different outcomes in different countries with different traditions and institutions. In the welfare states, HEC and merit goods are largely the same. In the US, on the other hand, user charges have always been important and the question of tax-financing versus financing by user charges is constantly discussed, which makes the merit goods designation rather volatile in this case. Musgrave, in the formulation of the basic premises for the theory of public finance, felt obliged to answer potential critics who would deny the justification of merit goods altogether: Does the satisfaction of merit wants have a place in a normative theory of public economy based upon the premise of individual preference in a democratic society? A position of extreme individualism could demand that all merit wants be disallowed, but this is not a sensible view. (Musgrave, 1959, p. 13).

Welfare economists, such as Nicholas Barr and Joseph Stiglitz, and public finance authorities of later generations, cannot offer a firmer definition of merit goods, free of value judgement, than the summary description above. Both economists simply point out that there are two main extreme views on merit goods, opposing one another, and a host of in-between positions. One extreme is the libertarian view, which rejects all infringements on consumer sovereignty and therefore does not recognise merit goods at all. The other extreme is the paternalistic view (Stiglitz, 2000, p. 87), which, as the name sug-

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Merit goods

21

gests, sees many instances where there are good reasons for deviating from consumers’ preferences. Merit Goods in Modern Textbooks From an inventory of textbooks of economics published after 2000, which are mainly American, it seems that the former view prevails: merit goods are not even mentioned in many cases. A possible explanation of this remarkable fact appears in an interview with Assar Lindbeck, the nestor of economics in Sweden, who remembered that when first visiting the US (as a holder of a Rockefeller scholarship) he had the privilege to have James Tobin and Richard Musgrave as mentors:

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I was, however, surprised at the explicit party-political positions that many American academics took on issues of economic policy... At my last visit to US, at the time just before the presidential election in 2004, the party-political devotion to this or that conviction was still stronger among economists... In Sweden, considered to be a very politicized country. I do not even know with what party my colleagues are voting. (Ekonomisk Debatt 2005, p. 53)

A good example of the covert politicising of economics textbooks is the way of dealing with merit goods, or rather the complete neglect of public consumption apart from pure public goods. In the third edition of the best seller Principles of Economics by Gregory Mankiw, who was chairman of President Bush’s Council of Economic Advisors from 2003-05, merit goods is not mentioned, either in the main text or in the seven-pages Glossary. The same is true for a good number of recently published textbooks limited to microeconomics. The welfare state is not an American invention, so in order to explain why many rich countries are tax-financing something like a third of total consumption, it is not American textbooks that should be consulted. 2 THE IDEOLOGICAL BASIS OF THE WELFARE STATES In a generally poor country, the worst off are those who cannot reasonably earn a living by their own efforts, that is, children, the elderly, and the mentally and physically disabled. Two of the most influential Swedish Labour leaders at the beginning of the last century, when the Social Democratic party was gaining its dominating position in Swedish political life, were Gustav Möller (1884–1970) and Per Albin Hansson (1885–1946). They both came from very poor areas in the industrial city of Malmö in the south of Sweden, and each had only four years basic schooling before going out to work. Möller became minister of Health and Social Affairs at the age of 40 and held office for 20 years (1924–26, 1932–38 and 1939–51). Hansson was Prime

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The service economy in perspective

Minister of Sweden from 1932–46. Their idea of the main change to Swedish society, necessary for making living conditions for the weak and penniless fit for human beings, is summarised by the following famous speech by the latter. ‘Folkhemmet’

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On ceremonious occasions, as well as in more ordinary situations, we often speak about society – the state, the town – as the common home for all of us, the ‘people’s home’ [Folkhemmet in Swedish] … The foundation of the home of a family is the community and solidarity. The good home does not know any privileged or slighted, no favourites and no stepchildren. There no one looks down on the other. No one tries to take advantage of the other. The strong one does not oppress and plunder the weak one. In the good home, equality, consideration, cooperation, and helpfulness are ruling. Applied to the great home of all the people – ‘folkhemmet’ – it would mean the breaking down of all social and economic barriers, which are now dividing the citizens into the privileged and the slighted, the ruling and the dependent, rich and poor, propertied and destitute, plunderers and plundered. The Swedish society is not yet the good home for all the people. It is true that formal equality exists – equal political rights – but from a social point of view, the class society still remains, and economically a dictatorship of the few prevails.1

With a general change of mind in the nation in line with this philosophy, it would be possible to carry out the reformation of society in a democratic way. That was the leading principle of the Social Democrats, who are currently out of office but have been in power in Sweden (sometimes in coalition with other parties) for almost 70 years. The main means to the end of reformation of society was tax increases. With the universal right to vote – women did not have the vote in Sweden until 1921 – taxes could be raised to finance new hospitals, comprehensive education for all, and so on. However, the initial stage of building up the welfare state was a long process; it was not until after the Second World War that total taxes were raised above the level of 20 per cent of the GDP, but 1960-1980 the build-up accelerated. The most significant recent fact in the ideological development is that the main right-wing party, that leads the present coalition government, has explicitly accepted the basic idea of the welfare state. From Household to Individual Want Satisfaction In Sweden really poor families hardly exist anymore. So one would think that the public intervention in the allocation of resources should be decreasing.

1

Extract from a speech by Per Albin Hansson in the Swedish Parliament on 18 January 1928.

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Merit goods

23

That this has not happened is to a large extent explained by changing focus from the household to the individual. Unlike traditional microeconomics, which is the study of the behaviour and market interactions of firms and households, the ideas behind the welfare state, as well as the implementation of women’s emancipation, have made the concept of the traditional ‘household’ obsolete as the basic unit in consumption demand analysis,2 and in particular in welfare economics. The family is as important a social construction as ever, but the concept of the household headed by the master/husband with complete authority over all household members belongs to the 19th century, at least in the Western world. Also views on children are profoundly different today. Long ago children were regarded not only as beings with undeveloped faculties, but also with feelings of a more primitive kind, of less value than adults’ feelings. Now full recognition has been established of children as individuals with individual wants in their own right. Individuals should replace households on the demand-side in normative economic analysis. This does not mean that parents are no longer responsible for their children. The point is that in the welfare state the children, and other weak groups, should not be completely dependent on their families or other relatives. Parents’ responsibilities are shared with society at large. Similarly, the responsibility for the elderly and for the disabled is shared by all of society. This is the key to understanding why a large part of total services could continue to be tax-financed rather than user-financed in a country growing richer as a whole. The lasting justification of merit goods is also more understandable in a life-cycle perspective. Everybody belongs to the non-working half of the population at some stage in their life cycle. It can be argued that the distribution of goods and services over the lifetime of an individual is more relevant than the cross-section distribution of household incomes. In Söderström et. al. (1999) it is estimated that as much as 60 per cent of all income redistribution is a circular flow over the life cycle of one and the same individual.

2

For a survey of ‘theories of families’, see Bergstrom (1997). Swedish contributions to this subject field are Daunfeldt (2001; 2002). A concrete example, where an individual rather than a household approach makes a great deal of difference in demand analysis is car ownership forecasting models: see Jansson et al. (1986) and Jansson (1989).

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24

The service economy in perspective

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Absolute and Equal Rights and Duties A further step in the characterisation of merit goods can be taken by referencing the basic values of an enlightened democratic society. Just as there is almost unanimity concerning a core of universal human rights, which is the basis of the United Nations, there are rights and duties of the citizens of a nation that form an integral part of the social contract between the citizens, ultimately binding that nation together. In Musgrave’s terminology, there are private and public wants, which are satisfied by what the economy produces. As individuals we express the private wants by individual willingness to pay (WtP). We express public wants, as voters and taxpayers. Two main kinds of goods are satisfying public wants: goods that are bestowed on everybody in equal amounts by intrinsic necessity, and merit goods that should be provided equally to eligible persons because it is considered equitable, or, to go a step further, those eligible have absolute and equal rights to certain services. The motives behind the second kind should be distinguished from the general striving for a more equal income or welfare distribution. It is not simply a distributional issue but a question of equal rights. Compulsory military service is a corresponding duty, which is a good example of this basic idea: everybody who is fit for duty is obliged to do it. No one can buy the right to be spared from this duty. Similarly, it is not a matter of money when it comes to goods to which eligible persons have equal rights: all who need them will get them, and the quality of service should be the same for everyone. Is this not a blatant case of disregard of the price elasticity of demand, which is a mainstay of microeconomics? Yes and no. It is true that it is implied that the rich should not be able to upgrade, that is get better service than the ordinary majority, by paying extra. In the courts, for example, this restriction is generally accepted as being in line with the principle of ‘equality before the law’. Furthermore, with regard to medical care the notion of equal treatment of patients in the same predicament is part of the code of conduct of nurses, physicians and dentists. The demand of those individuals without the means to pay for certain essential services themselves is a public want. The general clause of the implicit social contract between the members of a society, a nation, county or municipality is that we shall take care of each other in times of distress when anyone of us really need help. Over our life cycle, each of us will be among the needy at some stage. The big problem when it comes to implementing this philosophy in practice is the vested interests following from the widely different situations of a citizen’s life at a particular point of time. As in Rawls's intellectual experiment in his Theory of Justice (1971), the determination of which wants should be declared merit wants should ideally

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Merit goods

25

be made ‘behind the veil of ignorance’, or by unborn souls in full possession of all of their faculties but not knowing their destiny in life. Table 2.1 Underlying values for a tentative definition of merit goods to which all those eligible have ‘absolute and equal rights’

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• Police protection, crime investigation, court procedure and other legal services should be equal for all, given the external circumstances (the severity of intimidation, the type of crime involved, and so on). • Decent care should be taken of physically and mentally disabled persons, and this is a common duty for all of society. • Infants and children are entitled to the same, high-quality health checks, vaccinations and medical care, irrespective of what their parents take the initiative for. • All children have the right (and duty) to receive basic, high-quality schooling, which should be the same for everybody for X years in the name of ‘equal opportunities’ for a future career. • Child care in day nurseries for a nominal fee should be provided for all of the demand to make it possible for both parents to work outside of the home. • High-quality eldercare, which must not compromise the comfort and dignity of the persons receiving care, should be provided for all who need it, and for an affordable fee even for those on a modest pension. The list in Table 2.1 is a first attempt at outlining what a Rawlsian approach to defining merit wants could entail. In the process of working out the list, it became obvious that there is a need for a further distinction: there are absolute and equal rights to goods satisfying undisputed merit wants, and there are a number of relatively meritorious goods – relative merit goods – where it can be disputed exactly how their provision should be financed, and organised. At least the four aforementioned value judgements are suggestive justifications for distinguishing absolute and equal rights typical for a welfare state ruled by law. The most vulnerable members of society are obviously those who have no chance to provide for themselves in their present circumstances, nor have had such a chance earlier in life. In Sweden, as in many other countries, there is national unity in that these undisputed merit goods should be free and provided in equal amounts, or more to the point: the services provided should be of the same quality for everybody who needs them.

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26

The service economy in perspective

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3 SUMMARISING TAXONOMY Fifty years ago, only the first-level division in Figure 2.1 above between private and public goods was applied in microeconomics. Musgrave developed this dichotomy by further dividing public wants into social wants and merit wants. After that it was realised that social wants/goods were rather heterogeneous; only a minority could be characterised as ‘pure’. Moreover, Musgrave’s logical terminology has been violated. His superordinate concept of ‘public goods’ has replaced the term ‘social goods’ and become the established designation for goods satisfying social wants, that is, collective services. In the present analysis, the renamed public goods are divided into pure and impure public goods. The distinguishing characteristic of these two is the non-excludability of pure public goods, while non-rivalry in their consumption is the common characteristic. Since goods satisfying merit wants are private goods in the sense that both limited capacity and excludability apply, it seems that the original dichotomy should be adjusted by assigning the merit goods to the private goods category. In addition, it is suggested here that the large group of merit goods should be further divided into meritorious optional goods and (nearly) compulsory and/or very inelastic goods. These two categories are for short named relative and absolute merit goods in what follows. Unwholesome goods (narcotics, and so on) are usually included in the merit goods category, but this convention seems semantically out of place. The goods category to the far left in the third row of Figure 2.2 includes all material goods as well as ‘normal’ private services. Between this category and the merit goods, a remaining category named ‘utilities’ is placed. It includes local public transport, telecom, district heating, electricity, gas and water supply. The supplying enterprises used to be called ‘public utilities’, but from the Reagan–Thatcher period onwards that attribute has been dropped: they are now privatised, regulated monopolies to a large extent. As is indicated in the drawings in Figure 2.2, all of the categories contain at least some services. The ovals of Figure 2.2 are not drawn to scale. The largest category is naturally the ‘normal goods’ including all material goods. Second in size is the merit goods category that plays a main role in the policy analysis of Part IV.

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Merit goods

27

All goods Private goods

Normal goods

Utilities

Optional, relative merit goods

Public goods

Merit goods

Excludable

Nonexcludable

Very inelastic, and/or compulsory, absolute merit goods

goods services

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Figure 2.2 A development of Musgrave’s goods and service taxonomy

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PART II MICROECONOMIC FOUNDATIONS Chapter 3 Chapter 4 Chapter 5 Chapter 6 Chapter 7 Chapter 8 Chapter 9

Production costs of non-storable goods Distribution costs of non-transportable goods The basic trade-off and the resulting market areas Market forms and competition Supply and demand at the system level Welfare economics 1: towards A-efficiency Welfare economics 2: towards X-efficiency

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The service sector has surpassed manufacturing industry in terms of employment in the post-war period in the ‘industrial countries’. That radical structural change of the economy had relatively little impact on the development of economic theory until the 1960s, when William Baumol and Victor Fuchs made their now classic contributions. In his first pioneering study of ‘the growing importance of the service industries,’ Fuchs observed that: Analytical work requires frequent compromises with reality. The compromises that may be appropriate, or the second-order effects that may be neglected, in an economy dominated by agriculture and manufacturing may turn out to be inappropriate, or too important to be neglected, in an economy dominated by the service industries. (Fuchs, 1965, p. 25)

Fuchs did not exactly identify the neglected effects, and it was left to his contemporary, William Baumol to explore the effects of the unbalanced productivity growth (Baumol and Bowen, 1966; Baumol, 1967; Baumol, Blackman and Wolff, 1985, 1989). These pioneers’ work has been a source of inspiration for a growing body of literature about service sector development.1 The dynamics of the service sector is taken up in the following part of this book. The adaption of basic static microeconomic theory to better describe the service industrial organization and the working of service markets, which Fuchs had in mind, has been conspicuous by its absence.

1

For a survey of the economic literature in this line, see Schettkat and Yocarini (2003). See also Bryson and Daniels (2007), an anthology of papers on the growing service industries: these are mainly written by geographers, who have made substantial contributions to this literature.

29

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30

Microeconomic foundation

In the Papers and Proceedings issue of the American Economic Review, May 2002, a selected topic was ‘Teaching Microeconomic Principles’. In one of the contributions to this topic (Case, 2002) it is pointed out under the sub-heading ‘Space’ that:

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Microeconomics deals with many dimensions of both household and firm behaviour. We spend time thinking about product differentiation, quantity of output in both the short and long run, the technology of production, demand for capital and labour, and so forth. For households we explore product demand, labour supply, and savings behaviour. What is completely left out of most treatments of microeconomics is where firms and households locate. If the ultimate purpose (of a course on the principles of microeconomics) is to teach ‘the way the world works,’ it seems to me difficult to leave out the determinants of the spatial structure of economic activity. For those of us who live in and around urban areas, the environment is the built environment. The core of a large urban area is made up of brick and concrete. Investment in structures is highly durable, and for most practical purposes it is immovable. Locational choices by their nature generate externalities … At least pointing out that the profit-maximizing equation for a firm is made up of variables with location subscripts seems to me to be important. (Case, 2002, p. 457– 8)

These are praiseworthy words, but the gesture of resignation at the end is typical. Adding the spatial dimension to microeconomics is upheld as very commendable, but since it is thought to increase the complexity of the analysis immensely, few attempts are made to translate words into deeds. Ignoring space makes one apt to overlook the distribution costs. That can be passable in many cases for transportable, material goods because the transport cost per ton-kilometre is often very low relative to the value of the transported goods. This is generally not true for non-transportable, immaterial goods. A main symptom of this crucial difference between goods and services as objects of market transactions is that most service markets remain decidedly local.

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3. Production costs of non-storable goods Conventional microeconomic cost theory treats the production and distribution costs as one. In this book these two costs are separately discussed and subsequently combined in a trade-off model which is the key analytical tool of the microeconomics analysis in this part. For the production cost theory the non-storability of immaterial goods is the crucial characteristic. One consequence of non-storability is that the variability of demand cannot be met by a buffer stock. This is well known and has been discussed in the literature for at least half a century. A special branch of price theory concerning peak-load pricing has been developed focusing on the effects of systematic daily, weekly, or seasonal variations in demands. The effects of the random fluctuations of the demand are just as important for the cost theory concerning non-storable goods. The application of queuing theory in this chapter demonstrates this aspect. The consequent non-transportability is the reason why the extent of markets for services is typically very different from that of material goods, and therefore quite different sections of the general production cost functions are relevant. The famous observation by Adam Smith that ‘the division of labour is limited by the extent of the market’ is the main inspiration of the present proposal for cost theory adaptation to services. 1 ELEMENTARY COST THEORY The top diagram in Figure 3.1 gives the general shape of the long-run total production cost (LRTCprod) as a function of the output volume (q) for all kinds of products, goods as well as services, according to elementary production and cost theory (almost as axiomatic as the notion that demand falls when the price rises). Initially, increasing returns to scale prevail, which means that LRTCprod increases digressively with respect to q. After that a relatively wide interval follows, where constant returns to scale apply but, sooner or later, decreasing returns to scale set in, and LRTCprod will increase progressively with respect to q. Needless to say, the detailed path, and relative extent of the three costoutput intervals can vary widely between different types of products. The general feature is that all three intervals exist for all products, which makes for the (often rather drawn-out) U-shape of the long-run average cost (LRACprod) illustrated in the bottom diagram of Figure 3.1. The relatively flat 31

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32

Microeconomic foundations

TOTAL COST

part of LRACprod corresponds to the output interval in the top diagram, where total cost increases in nearly in proportion to output.

LRTC prod

AVERAGE

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COST

q

LRAC prod

1st interval 2nd interval 3rd interval

q

Figure 3.1 The general shape of long-run total and average production costs defines three cost and output intervals. Observations in the third output interval are difficult to make in reality, because a production plant with such a large capacity would normally be a failure; the same output could be produced at a lower cost per unit of output by two plants, each one with half the capacity. Real observations could be expected to also be rare in the first output interval for a similar reason, at least as far as the manufacturing industry is concerned. Small firms, or rather production at low-capacity plants of storable and transportable goods, could not exist if it is possible to produce such goods for substantially lower average costs at plants with a higher capacity. However, in the dynamic reality, where markedly plant-size-biased technical progress has been a salient feature in

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Production costs of non-storable goods

33

many industries, plants of different vintages differ both in size and average production cost. Low-capacity, relatively high-cost plants are kept in operation as long as the price (or marginal revenue) exceeds the current cost. This means that econometric studies of long-run total cost functions, by and large, will give scale-elasticities below and/or close to unity as a result. Engineering cost studies of the corresponding cost and output relationships, which examine technically possible, not necessarily observable production solutions, and consider plants of widely differing capacities representing different technologies, regularly arrive at markedly L-shaped long-run average cost curves.1 There is ample evidence in the engineering cost literature that small-scale production is often very uneconomic compared with largescale production. (See the classic, empirical studies by Haldi and Whitcomb, 1967 and Pratten, 1971, as well as reference works such as Tirole, 1988 and Sherer and Ross, 1990.) Mainstream price theory is focused on the second output interval of the general cost functions of Figure 3.1 because it is assumed that most industrial production takes place in this interval. A long-run efficiency condition, which free market forces are supposed to achieve, is that the average cost minimum should be obtained. Here it will be argued that the general shape of the longrun production cost curve has the same general shape for goods and services, but the crux of the matter is that the extent of markets for services is typically very different from that of material goods, and therefore quite different sections of the general cost functions are relevant.

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The Two Extreme Cases To supplement the preceding outline of the general shape of the production cost function, it can be useful to clearly mark off the limits for the cost and output relationship. In Figure 3.2 the two opposite extremes are depicted: to the left LRTCprod = aq, and to the right LRTCprod = F. The left-hand case, where small-scale operations are natural, is thought to be representative of many simple services such as a manual car wash or a shoeshine in the street. In the egalitarian high-tax society of today these kinds of services are declining, but it should be pointed out that just because existing plant sizes often are small, it cannot be assumed that small-scale disadvantages are generally absent in this kind of service production. This is substantiated in the following section on queuing theory application.

1 The decreasing returns-to-scale in the third output interval, necessary for the commonly assumed U-shape of LRAC, which are caused by organisational diseconomies of size rather than technical limitations, are more difficult to verify by theoretical engineering calculations.

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34

Microeconomic foundations





LRTCprod

LRTCprod

q

q

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Figure 3.2 Two extremes as regards the shape of the long-run total production cost and output relationship. Public goods The right-hand case defines the important category of inexhaustible (nonrival) public goods. Which are the key physical characteristics of inexhaustible goods? First, goods that literally suffice for everybody are never material goods, but services. Secondly, they produce sensations and/or information, that is, light, sound or visual impressions. These are either the final objective, such as lighting, music or the sense of beauty created by a sculpture, and so on, or will result in useful knowledge after being processed in one’s mind. This is no small matter. Now that we have entered ‘the information society’, then the inexhaustible characteristic of information should have profound consequences for future economic development. The fact that the longrun marginal production cost of information is zero does not mean that it is always free for the whole world. First, the producers of information want to be remunerated in order to do their work. Secondly, in many cases there are more or less substantial distribution costs involved for public goods, too. The traditional public goods, national defence and the institutions for maintaining law and order within the nation, had better be named quasipublic goods, because neither of these service-providing institutions has an infinite capacity, especially not the police force and the judiciary. The larger a city is, the more police will be required to uphold law and order at a reasonable level. Even the national defence services do not meet the strict nonrivalry criterion; a more populous country needs more resources for protecting its inhabitants against external enemies than a less populous country, everything else remaining constant.

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Production costs of non-storable goods

35

Expenditures on these quasi-public goods tend to increase both with population and GDP per capita, where the former influence reflects rivalry in consumption just as in private goods consumption, while the latter reflects the demand for a higher quality of service in richer countries.

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Combination cases The two extreme cases illustrated above can be combined, LRTCprod = F + aq, which can be a reasonable approximation of the long-run total production cost function for a number of different goods and services, where the constant F represents a ‘public’ factor of production. This might be the costs of research and development required to come up with a new prototype, which then can be mass produced at a roughly constant unit cost (not counting in F), or the costs of publishing a book including the cost of preparing the final manuscript ready for printing. In the latter case the unit cost, a is particularly low relative to F, because the main additional inputs required for the whole edition are a couple of hours of printing machine time and some bundles of paper. A more general formulation of the long-run total production cost can be: LRTCprod = F + aqα + kq, where 0 < α < 1. In addition to the long-run fixed cost, there are two kinds of variable costs: one is strictly proportional to output and the other increases digressively with the output volume (in the first interval). This formulation is useful for sorting out two main causes of smallscale disadvantages of services, which are less important for goods production: 1.

A relatively high F-value, which is typical of services produced by technically sophisticated, industrial methods, for example, airport services or the services provided by fully-fledged regional hospitals, will be much more telling for immaterial services than for material goods. This is because of the limited extent of the market in the former case, which in turn is due to the relatively high costs of ‘bridging the gap between producer and consumers’.2

2. For services of a relatively low unit cost, so-called ‘low-value’ services, which do not require a very sophisticated production apparatus, and for which a pre-booking system would be too cumbersome, the main cause of small-scale disadvantages of the service facilities concerned is nonstorability. This makes the more or less random arrival of the customers give rise to high queuing costs unless the rate of capacity utilisation is initially kept low. This will be discussed in the next section. 2 In the exceptional case of high-value services requiring very little supporting capital, such as for example psychoanalysis, F is low, and α is close to unity, because it pays to apply strict prebooking. Under these circumstances the small-scale disadvantages are likely to be insignificant.

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36

Microeconomic foundations

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Queuing Theory Application If the first point made in connection with Figure 3.2 above was that the extreme case to the right – the case of public goods – is very important, then the second point is that the left-hand extreme case is unimportant. By reference to elementary queuing theory the common misunderstanding will be disproved that because many, in particular, labour-intensive services are produced by very simple technologies at small plants, they are characterised by constant returns to scale from the beginning. The true case is instead that the long-run total cost is not proportional to output. The crucial aspect which is overlooked is that the rate of capacity utilisation can be very difficult to maintain at a reasonable level in small-scale production of non-storable goods, where a buffer stock is by definition not an option. For storable goods production, the plant size economies are explained by factor indivisibility and/or geometric principles such as that the ratio of the surface area of a container to its holding capacity is two-thirds. In the present case of providing non-storable goods, the possibility of successively raising the rate of capacity utilisation with impunity as regards customer waiting time is the most prominent cause of economies of scale for a wide selection of services. Queuing theory is the appropriate analytical tool for addressing this phenomenon.3 The ideal setting for queuing theory applications is a ‘compartmentalised’ service-providing facility consisting of parallel ‘service stations’. To fit the queuing theory assumptions, the services provided should also be relatively inexpensive so that it is not profitable to introduce an elaborate system of prebookings, implying that the customers have to make reservations well in advance. The basic assumptions of the standard queuing models are as follows. The service-producing plant concerned is assumed to supply services to customers, who arrive largely at random and who have differing time requirements regarding service. Therefore, the short-term demand for services varies – one morning all stations of a particular plant may be occupied and the waiting line is building up, the next morning there may be a number of vacant service stations. The service time of customers can also be highly variable. If it can be assumed that the pattern of arrivals and service times adhere to some well-known probability distribution, the application of queuing theory can be useful. In an appendix to this chapter a more extensive discussion of 3 The predictions of queuing theory have been tested by the present author in the case of port services. In Jansson and Shneerson (1982a) it was found that the simple queuing model predicts a too abruptly upwards-bending function for the mean queuing time with respect to the occupancy rate, but that a multi-stage and multi-channel model seems to give a better fit. For the present purpose, however, it is adequate to be able to establish that the mean queuing time is sharply rising with respect to the rate of capacity utilisation, and falling with the number of berths, given the rate of capacity utilisation.

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Production costs of non-storable goods

37

elementary queuing theory is given based mainly on Saaty (1961). Here the model of a multi-station facility is presented without the lengthy derivation. This model is relevant in pinpointing the importance of plant size economies in service production, where the plant consists of a number of identical service stations. It is demonstrated that even if the investment cost per service station is constant, so that the total capital cost of the whole plant is proportional to the number of service stations, there are very significant economies of scale. This is because the number of service stations can be expanded at a considerably lower rate than the increase in total output without increasing the expected queuing time per customer. Queuing time at a multi-station facility Multi-station queuing models are mathematically much more involved than single-station models. To simplify the exposition, the general formula in the multi-station case is derived from two stages. The symbols used are: w = expected queuing time per customer (hours) A = expected number of arrivals per hour, which equals total output (q) on average s = expected service time per customer (hours) φ = expected occupancy rate (φ = As 0, ∂b

and

∂E qP ∂b