Factors of production

*1. The factors of production and their remuneration*

*a. Land*

Land includes all the _free gifts of nature_, such as the soil, water, plants, fish, game, minerals, weather and atmosphere. Human beings, past and present, survive because of them. Humans can exploit the land (natural resources), but they have very little capability to restore natural resources once depleted.

*Examination tip*

This topic is descriptive in nature. To study it, make use of brain charts.

*Note*

The environment relates to the _natural conditions_ in which people, animals and plants live, for example land, air and water. It is part of natural resources and therefore of land as a factor of production.

*i. Characteristics*

For our ancestors who lived on berries, plants, fish and game, the natural resources that nature provided were _consumption goods_. But for us, living in modern economies, the natural resources have become _factors of production_ and as such have some specific characteristics.

*Their supply is fixed*

If we use, for example, all our soil, extract all our gas (and oil if any) and mine all our minerals, we cannot restore them again. Our forests, wildlife, fish and fresh water, once destroyed, cannot be restored in a lifetime. We cannot import them from elsewhere, for various reasons.

It is, nevertheless, possible to use scientific technology to improve the productivity of some of our resources. For example, farmers can use fertilisers to increase production on a fixed piece of soil, or plant genetically manipulated seeds that are drought and pest resistant and so increase production on land of limited size.

However, to apply technology is expensive and some people have reservations about the health effects that technologically manipulated food may have in the long run. In the final analysis, the supply of resources is fixed or, at the most, limited. We cannot change this. The fact that land is fixed in supply is its most important characteristic.

*They are gifts of nature*

Minerals, gas, timber, fish, game, fresh water and clean air are part of the earth, sea and atmosphere and are provided free by nature. When producers want to use them as inputs in production processes, they must apply capital (machines/technology) and labour to first mine, extract, grow and harvest them.

*They have to be transformed*

Most natural resources on their own and in their natural state cannot satisfy human wants. They have to be transformed and processed. Producers have to transform them into raw materials (intermediate goods) or other useful goods before they can satisfy our wants.

*They are exhaustible and destructible*

For example, mineral resources and fossil fuels are exhausted (used up) when they are mined. Such resources are known as _non-renewable_ resources. If farmers do not use manure and fertilisers, agricultural land will become infertile.

Its ability to produce crops will diminish and ultimately be destroyed. Without controls, commercial fishing, timber felling and hunting will inevitably destroy our fish, forests and wildlife resources. These resources are known as _renewable_ resources.

*ii. Importance*

Being rich in natural resources is a great asset for the economy of any country. Natural resources are important for two (somehow conflicting) reasons.

*Natural resources sustain economic activity*

This is of major importance. The soil and water provide raw materials for the production of economic goods. The land and skies provide minerals and room for buildings and plants. The atmosphere provides a highway for air transport and communications.

Natural resources sustain the operation of primary industries, which harvest plants, animals and fish and extract minerals and gas.

That portion of the output of primary industries that is not consumed is used as raw materials by secondary industries. Such goods are known as _intermediate goods_. Examples are raw fish, cotton and iron ore that are used respectively in the production of canned fish, shirts and steel. _Final goods_ are used in the service industry to store, transport, trade, finance, use, wear and eat.

All human activity involves some element of natural resources, even if it is only for the oxygen needed to breathe and stay alive.

*Natural resources enrich our lives*

Land does not only give us minerals and food. It also provides space for walking and the enjoyment of natural surroundings. Other than providing fish, water is also a source of recreation and relaxation. The atmosphere provides space to fly aeroplanes and to communicate electronically, as well as fresh oxygen-rich air and clean, clear skies.

When we exploit our natural resources for economic reasons, we destroy things that enrich our lives. But, on the other hand, if we do not exploit them we may find it difficult, if not impossible, to survive and improve our standard of living. To find the critical balance is one of the key issues of today, an issue heatedly debated by economists and environmentalists.

*iii. Remuneration*

In everyday speech, rent simply means a _monthly or yearly (or any regular) payment that is made for the use of an asset_.

We pay _rent_ for land, buildings, houses and flats, and for durable consumer goods such as motorcars, television sets, video recorders and play stations. Such rent is known as _commercial rent_ in Economics. _Economic rent_ is something different. It has a special meaning in Economics. It describes the _remuneration, or payment, made for the use of a factor of production which is limited (or fixed) in supply_. When natural resources are used in commercial activities, a minimum price must be paid to use them as input in the production processes. This price is called the _supply price_. However, if a resource receives more than the supply price, the surplus payment is known as _economic rent_.

Ordinarily, rent in economic literature is a broad term, used to describe the remuneration of the factor of production _land_. It is used similarly to _commercial rent_.

The level of rent is influenced by demand and supply for a variety of purposes and changes in productivity.

*b. Labour*

Labour encompasses what people bring to the production process: mental and physical effort that is undertaken for a reward, compensation or remuneration. We regard the effort of a professional soccer player or a paid musician as labour, although soccer and music are often played for leisure and not necessarily for compensation.

*Note*

Labour refers to work by, for example, managers, clerks, technicians and domestics. _Wages_ include salaries and all other kinds of remuneration.

All work involves some mental and physical effort, albeit in different proportions. An artisan passing on bricks uses mainly muscle, but he organises (mentally) the flow of bricks to keep the bricklayer going steadily. The surgeon uses skilled hands, which are coordinated with her knowledge of the human body, to operate.

*i. Characteristics*

As a factor of production, labour has the following characteristics:

*Labour cannot be separated from the worker*

Labour is provided by people and cannot be separated from their humanity. The quality of people’s work is, therefore, affected by their feelings. General job satisfaction, which includes fair remuneration and pleasant working conditions, contributes to the quality and quantity of work done.

*Labour cannot be stored or hoarded*

People cannot lock away their labour, for instance when they are young and healthy, and sell it when they are old and unproductive. Labour ability, whether it is used or not, disappears with time. The labour that is lost during a strike can never be regained. Similarly, the labour effort that you failed to put into your learning when you went to a party the night before an exam is lost forever.

*Labour varies in quality*

The quality of the work done by identically trained people, or even the same person at different times, can (and is likely) to differ. The more comprehensive and complicated a task, the greater the difference in the quality of the work will be. The simpler and shorter a task, the less the difference will be. For this reason, specialisation of labour is imperative. Tasks are made short and simple. This ensures that the quality of work is consistent.

*Note*

The _workforce_ includes employed and unemployed people and is always calculated according to the strict definition, unless stated otherwise. Statistics South Africa (SSA) uses the term _labour force_. Therefore workforce and labourforce can be used interchangeably.

*ii. Importance*

Labour is the most important factor of production because workers receive most of the total income earned in the South African economy. In 2010 it was 51% or R1 198 billion. Labour, as a factor of production, is measured in terms of workforce numbers. The quantity and quality of the workforce are important. The investment in people, such as through education and training, is known as _human capital formation_.

*Quantity*

Another term for the workforce is the _economically active population_ (EAP). Statistics South Africa (SSA) includes people between the ages of 15 and 64 who can work, who want to work and who are actively looking for work in its calculation. This is in line with the definition of the International Labour Office (ILO). The EAP includes the formally and informally employed, as well as the self-employed and unemployed.

The workforce in South Africa increased from 14,2 million in 1994 to 17,5 million in 2011, at a compound rate of 1,24% per year. Growth of the workforce depends on the population growth rate and the labour force participation rate – the proportion of the working age population (15 to 64) that is economically active (employed and unemployed).

Labour is _complementary_ to the other factors of production. This is of major importance. It means that the quantity of labour employed depends on the quantities of the other factors of production available and vice versa. South Africa is well endowed with labour and natural resources but lacks capital. Lack of capital is the main reason for South Africa’s high unemployment levels. The availability of capital depends on savings. In South Africa the level of individual saving is very low.

In South Africa, unemployment numbers are obtained through the _Quarterly Labour Force Surveys_ (QLFS) of SSA in each quarter of each year. The surveys are done by means of interviews.

The _unemployed_ are those within the economically active population who (a) did not work during the seven days prior to the interview, (b) wanted to work and were available to start work within a week of the interview, and (c) had taken active steps to look for work or to start some form of self-employment in the four weeks prior to the interview. This is the strict criteria for calculating the unemployment rate. The expanded unemployment rate excludes criterion (c).

Figure 1.2 shows that the strict unemployment rate increased from 20% in 1994 to 25,2% in 2010. Over the same years, the expanded rate increased from 31,5% to 32,4%. The main reason for the increases in unemployment is the improvement in the efficiency of South African businesses. They had to become more efficient in order to survive in the very competitive global economy.

*Examination tip*

Do exercises with real numbers until you understand the mechanics of graphs.

*Quality*

The quality of the workforce depends on three factors:

_School education_. The first step towards becoming employable is to become literate. In 2009 in South Africa 7,4% of people had no education and 65,8% had completed Grade 9. These people (31% of the EAP) can be regarded as functionally illiterate.

Some 8,2% of the population of working age have completed post-school education at colleges and universities. Globalisation requires a highly skilled workforce, preferably with credits in science, mathematics and information technology (IT).

The total number of candidates who wrote Grade 12 increased from 495 408 in 1994 to 537 543 in 2010. The number of candidates who obtained admission to a bachelor’s degree increased from 88 497 in 1994 to 126 371 in 2010.

_Work-related training_. Training means to be taught a particular job or skill and is usually a post-school experience. Most training, in fact, happens at the workplace. Instruction can also happen at Further Educational and Training (FET) colleges, universities and other accredited training providers’ premises.

The number of trade tests that were written by apprentices (to qualify as artisans) since 1994 has decreased, which is highly undesirable. The number of trade tests written decreased from 10 617 in 1994 to 8 337 in 2009.

The Skills Development Act of 1998 provides for a national skills training strategy. Its aims are to improve the quality of the working life of workers and to encourage employers to make their workplaces available as active learning environments.

In terms of the act, the Department of Labour established the National Skills Authority (NSA). The NSA initially established 25 Sector Education and Training Authorities (SETAs). However, through amalgamations they were reduced to 19 in 2011. SETAs are responsible for developing sector skills plans and targets. They consult with employer, worker and other (professional and civil) organisations. These plans are aligned to the national training plans and priorities.

Skills training is financed by means of levies (1% of the total wage bill in 2011) that employers pay and grants that are awarded to employers for successful training. A learnership agreement is entered into between a learner and an employer.

_Health_. The quality of labour is impaired by poor health. In South Africa, the Occupational Health and Safety Act requires that healthy working conditions prevail. Some occupational diseases such as tuberculosis and asbestosis are notifiable diseases. They are to be reported to the Department of Health. In terms of the Constitution, government must ensure a healthy environment. It is a human right.

Malnutrition damages the health of many workers in developing countries. Lack of clean water and energy (electricity) are also taking their toll.

Workers should not be exposed to diseases carried by animals. Basic healthcare focuses on the prevention of illnesses. The greatest threat to workers’ health in South Africa is HIV and AIDS. It was estimated that 19,2% (10 million) of the South African population were HIV-positive in 2010. The rate is highest in the 15 to 49 years age bracket. Consequences in South Africa are:

- Life expectancy at birth dropped from 65 years in 1994 to 49,3 years in 2011.

- Poverty will increase because of increases in medical and other expenses for households.

- Production will be lost because workers have less energy, are less productive, are less motivated and are often absent from work.

*iii. Remuneration*

Wages are the remuneration earned by labour as a factor of production. Wages describe the reward that workers receive as payment for their labour services and include all incomes from employment, self-employment, consultations, commissions and fees.

Some workers earn, in addition to cash wages, wages in kind. For example, farmers provide their workers with food (produced on the farm), accommodation and firewood for cooking and heating. Other employers may provide their workers with free uniforms (clothing), free transport (to and from work) and free medication. These all form part of wages.

Some workers earn in addition to their basic wages extras like overtime, bonuses and incentive payments. These additional incomes are sometimes significant and responsible for what is called _wage drift_. They are not reflected in wage rates but increase the remuneration of labour.

*c. Capital*

Capital is a people-made resource. It is a factor of production. Capital includes all the goods that are needed to satisfy future wants, including production premises, factory buildings, machinery, transport vehicles, intermediary goods, stocks of raw materials and final goods (not consumed yet). It is embodied in private and public assets.

*i. Characteristics*

Capital is similar to the other kinds of resources, such as labour, because it is used in combination with them.

*Capital is possessed*

It belongs to someone: to enterprises, consumers, producers or the state. The fact that everyone uses bridges, schools and roads does not mean that they belong to everyone. They belong to the state.

*Capital is consumed*

This happens in the production process. Some capital, such as intermediary goods, is consumed in one process. Others, such as buildings, are consumed over many years.

Our national accounts show the amount of fixed capital that is consumed every year. For example, it was R352 billion in 2010. Most capital is consumed by businesses. Fixed capital excludes stocks of raw materials, intermediary goods and final goods.

*Capital formation requires a sacrifice*

The production of capital goods is called capital formation or investment and it is denoted by the letter I in mathematical equations. The finances for producing or buying capital goods are obtained from saving. Savings are current incomes that are sacrificed. Therefore: I = S = Y – C

where S = Savings; Y = Income and C = Consumption

In 2010 domestic savings were provided by enterprises only. Consumers and government contributed negatively. They borrowed more than what they saved, in other words they dissaved. However, foreign savings, in the form of net capital inflows from the rest of the world, contributed 16%. Total gross savings were 17,6% of Gross Domestic Product (GDP).

*Capital increases production efficiency*

*Note*

Technology is sometimes thought of as a fifth factor of production. See the glossary for a definition. In this book it is regarded as part of capital, although in practice it also overlaps with labour, for instance as a method of doing things. However, in most instances technology is tied to the operation of machines and other equipment.

Capital goods, particularly machines, make specialisation possible. Modern production processes consisting of elements of human labour and machine labour are immensely more efficient than the labour of humans alone. Efficiency is the condition of production taking place with the least cost, and with wastage at a minimum. Efficiency results in resources being stretched much further.

*ii. Importance*

The significance of capital lies in its relationship with economic growth. This is of major importance. Economic growth is the increase in the real GDP of a country. In order for growth to happen, the amount of capital that is used in the economy has to grow at a rate which is at least equal to, or higher than, the increase in the workforce. Capital growth is distinguished by capital widening and capital deepening.

*Capital widening*

This occurs when the country’s capital increases at a rate equal to the rate of increase of the workforce. It merely means that the existing labour-capital ratio (the amount of capital per worker) must be maintained as the number of workers increases.

For example, if 10 workers are digging a water trench and have five spades between them, the labour-capital ratio is 2:1. If the number of workers is increased to 20, the labour-capital ratio falls to 4:1. In order to maintain their output, five more spades have to be added. This is capital widening. It requires that the ratio of workers to capital is maintained and ensures that the production levels per worker are maintained.

*Capital deepening*

This occurs when the labour-capital ratio increases. For example, if the 20 workers with 10 spades are given 10 more spades, the ratio increases to 1:1.

Capital deepening is required for real economic growth to happen at a rate that is higher than the growth rate of the population and results in the standard of living of the population being increased. Capital deepening has the result that the real per capita GDP increases.

*iii. Remuneration*

*Note*

The repo rate is the rate at which the South African Reserve Bank (SARB) lends money for very short periods, up to 7 days, to banks.

The income that is earned when money is lent is called _interest_. When enterprises borrow money, they pay interest to the lenders (banks and others) for the use of the money that they borrow.

Most of such borrowings are used to finance capital goods acquisitions. For this reason, money that is borrowed is sometimes also known as _money capital_.

Lenders to enterprises are banks, financial institutions (for example assurance companies) and the owners of the borrowing enterprises (for example shareholders). Banks obtain the funds that they lend from the savings that households and enterprises deposited with them. For low-risk loans they usually charge three to four percentage points more than the rate that they pay on deposits (savings). For high-risk loans, they add about 10 percentage points or even more.

Enterprises must make sure that they can earn more income from their use of borrowed money, than the interest that they have to pay to the lenders. That is: the _marginal productivity_ of their capital must be higher than the rate of interest that they pay.

MPCa > i where: MPCa = the marginal productivity of capital

i = the rate of interest

*d. The entrepreneur*

A true entrepreneur is a _person who takes the initiative to start a business enterprise, to organise its production and to carry the risk_.

Paid managers can, of course, also do all these things, but risk is often carried by shareholders (or the state in the case of public corporations). Such entrepreneurs are known as _entrapreneurs_.

Even if risks in a big enterprise are carried by the shareholders, the chief executives (as paid entrapreneurs) still carry the risk of losing their jobs, their reputation and credibility if the enterprise fails.

*i. Characteristics*

*Note*

Entrepreneurs have a special combination of the right kind of personality, intelligence, drive and energy.

Entrepreneurs are an exceptional kind of gifted people. Although it is possible, to a certain extent, to train entrepreneurs, they are scarce.

- They take the initiative. The ability (gift) to take the initiative is vital, even in an established business.

- They organise production. For production to take place, resources such as capital, labour and land must be found and brought together and set to work. These resources have to be used so that there is minimum wastage.

They carry risks. Buying resources to produce goods that will only be sold in the future to unknown consumers – and when income may not even cover costs – is the essence of _risk-bearing_ in production enterprises.

*ii. Importance*

The role and function of entrepreneurship had been recognised for many decades, but it was only by the 1970s that governments started to appreciate and acknowledge its importance in practice.

*Ensuring competitiveness*

Entrepreneurs create competition. They challenge those that are running profitable businesses. The supply of entrepreneurs to the market is therefore also dependent on the levels of _profitability_. The higher the levels of profitability, the more workers will turn into entrepreneurs.

For instance, if it becomes apparent that organic food shops are making large profits, people will be tempted to risk their (and their relatives’) capital and careers and establish themselves as owners of businesses dealing in organic foodstuffs. Organic foods are foodstuffs produced naturally, without chemical fertilisers and pesticides.

*Creating employment*

Small businesses which, in general, belong to entrepreneurs themselves create far more jobs in the economy than big businesses. In South Africa, small businesses with less than 50 employees generate 68% of the country’s jobs (Anglo American: Enterprise Development). Small businesses employ less than 50 workers each. They are commonly referred to as small, medium and micro-enterprises (SMMEs) and include informal sector enterprises.

*Note*

According to Statistics South Africa (SSA) the informal sector has the following two components:

- employees working in establishments that employ less than five employees, who do not deduct income tax from their salaries and wages

- employees who are not remunerated, own account workers and persons helping unpaid in their household business, which is not registered for either income tax or value-added tax (VAT).

*Improving efficiency*

If new entrepreneurs with new ideas that control costs by using resources prudently and who have a desire to succeed and be profitable are allowed to enter a market, the general efficiency of the market and the overall efficiency of the economy improves. This is of major importance.

Such businesses ensure that factors of production are optimally used. They do not waste resources and are efficient.

*Creating new wealth*

Entrepreneurs entering a market for the first time do so with their and their families’ meagre savings and the money that they borrowed. They create new wealth.

*iii. Remuneration*

The reward for risk-bearing is _profit_. It accrues to the owner who runs the business or to the shareholders in the event of salaried entrapreneurs. Profits differ from the remuneration of the other factors because they are uncertain and they fluctuate.

Profit does not compensate entrepreneurs for their labour – only for their risk bearing. They need to pay themselves wages for their labour. Profit is extra. Profits are mainly influenced by the following:

- Nature of the business. If the enterprise produces everyday household goods such as foodstuffs and groceries, the demand for such goods is not likely to be affected by changes in the economy because they are essential goods. However, enterprises that sell luxury goods such as flowers, watches or perfume will be affected. If consumers in general have less money to spend, the demand for luxury goods decreases first.

- Skillfulness of the entrepreneur. Entrepreneurs who can control costs, produce efficiently and estimate their prices and sales correctly are likely to have higher profits than those who lack similar skills. They are _competent_.

- Competition. Profits normally attract competition. When one business enterprise decreases its prices, other business enterprises have to do the same to keep their customers. When prices decrease, so do profits. It may end in losses.