What Is an Economic Sector and How Do the 4 Main Types Work?

What Is a Sector?

A sector is an area of the economy in which businesses share the same or related business activity, product, or service. Sectors represent a large grouping of companies with similar business activities, such as the extraction of natural resources and agriculture.

Dividing an economy into different sectors helps economists analyze the economic activity within those sectors. As a result, sector analysis provides an indication as to whether an economy is expanding or if areas of an economy are experiencing contraction.

In the financial markets, economic sectors are broken down even further into sub-sectors called investment sectors. Investment sectors represent a grouping of companies with similar business activities. Examples of investment sectors include technology, energy, and financial services.

This article explores the main types of economic sectors and the business activity associated with them, and how investment sectors play a role in determining a nation's economic conditions.

Understanding Sectors

Sectors are used by economists to classify economic activity by grouping companies that are engaged in similar business activities. For example, some sectors are engaged in activities that involve the earliest stages of the production cycle, such as extracting raw materials. Other sectors involve the manufacturing of goods using those raw materials. Still, other companies are engaged in service activities.

Developing and emerging economies tend to have only one or two sectors that define most business activities. For example, some nations rely heavily on the extraction and sale of crude oil, which can be turned into gasoline and sold to consumers within developed economies. On the other hand, developed nations tend to have a more diverse representation of all sectors.

Although there is some debate about the true number of sectors that represent business activity in an economy, typically, sectors are broken out into four main categories. However, please bear in mind that there can also be sub-sectors within each of the four major sectors listed below.

Primary Sector

The primary sector involves companies that participate in the extraction and harvesting of natural products from the Earth. Primary sector companies are typically engaged in economic activity that utilizes the Earth's natural resources, which are sold to consumers or commercial businesses.

Companies involved in the processing and packaging of raw materials are also categorized within the primary sector.

Primary sector business activities include the following:

• Mining and quarrying
• Fishing
• Agriculture
• Forestry
• Hunting

Emerging economies tend to have a higher amount of economic activity and employment concentrated within the primary sector versus more advanced economies. On the other hand, developed nations tend to utilize machinery and technology in their primary sector activities, meaning the primary sector doesn't represent a large portion of the population's employment.

Secondary Sector

The secondary sector consists of processing, manufacturing, and construction companies. The secondary sector produces goods from the natural products within the primary sector. The secondary sector includes the following business activities:

• Automobile production
• Textile
• Chemical engineering
• Aerospace space
• Shipbuilding
• Energy utilities

Tertiary Sector

The tertiary sector is comprised of companies that provide services, such as retailers, entertainment firms, and financial organizations.

The tertiary sector provides services to businesses and consumers by selling the goods that are manufactured by companies in the secondary sector. The types of services provided by the tertiary sector include:

• Retail sales
• Transportation and distribution
• Restaurants
• Tourism
• Insurance and banking
• Healthcare services
• Legal services

Quaternary Sector

The quaternary sector includes companies engaged in intellectual activities and pursuits. The quaternary sector typically includes intellectual services such as technological advancement and innovation. Research and development that leads to improvements to processes, such as manufacturing, would fall under this sector.

The companies and firms within the quaternary sector had been traditionally part of the tertiary sector. However, with the growth of the knowledge-based economy and technological advancements, a separate sector was created.

Firms within the quaternary sector use information and technology to innovate and improve processes and services, leading to enhancements in economic development. Firms within the quaternary sector might be engaged in the following business activities:

• Research and development
• Information technology (IT)
• Education
• Consulting services

Stock and Investment Sectors

In the financial markets, the economic sectors are broken down into sub-sectors to help investors compare companies with similar business activities. While economic sectors represent a broad representation of the economy, investment sectors further define and categorize companies.

Investment sectors are important because they help measure how well an economy is performing based on the financial performance of the corporations within that sector. The list below does not represent an exhaustive list, but here are some examples of investment sectors:

• Technology, such as electronics and software developers
• Financial services, such as banks and insurance companies
• Real Estate, such as residential and commercial real estate
• Industrials, such as manufacturing, machinery, and construction
• Energy, which includes the production and supply of energy
• Utilities, such as water, electric, and gas companies
• Consumer discretionary, which represents non-essential goods
• Consumer staples, which represents essential goods such as food and beverage companies

Sectors and the Economy

Investors use sectors to group stocks and other investments into categories that share unique characteristics. Investment sectors can provide insight as to how an economy is performing and which areas of the economy are performing better than others.

Sectors in an Expanding Economy

If there is a large increase in the purchase of raw materials, such as copper or crude oil, it may be an indication that the economy is expanding. In other words, in an expanding economy, businesses and consumers tend to use more raw materials and energy since consumer and business spending is on the rise.

Industrials would also perform well in an expansionary economy since increased economic growth typically leads to an increase in manufacturing and construction. Similarly, real estate, such as commercial real estate and housing, might also experience an increase in sales and development.

If consumer confidence is high, consumers might increase their purchases of non-essential goods, leading to a rise in consumer discretionary spending. As a result, companies within sectors that benefit from an expanding economy would likely experience increased revenue.

Sectors in a Slowing Economy

Conversely, if an economy is performing poorly or there are expectations that economic growth will slow in the coming months, companies that sell consumer staples often experience an increase in revenue. The reason for this correlation between a slowing economy and consumer staples stocks is that consumers will likely continue to purchase essential products, such as paper towels and toilet paper, even in periods of negative or slowing growth.

Also, investment sectors may represent a specific risk profile that may or may not attract investors. For example, in a slowing economy, investment in the utilities sector tends to increase since those stocks are considered safe-haven investments.

Sector Investing

It is common for investment analysts and other investment professionals to specialize in certain sectors. For example, at large research firms, analysts may cover just one sector, such as technology stocks.

Additionally, investment funds often specialize in a particular economic sector, a practice known as sector investing.

For those who want to invest in a particular sector, there are exchange-traded funds (ETFs) called sector ETFs. These funds contain a basket of stocks or securities within a particular industry or sector. For example, the energy sector, particularly the oil and gas industry, is a large industry that attracts specialized investment funds.

Sector vs. Industry

While a sector represents a large segment of an economy that includes many companies, an industry represents a more narrow focus of the companies within a particular sector. Thus, industries are the result of breaking down a sector into more defined and specific groupings. On the other hand, sectors can represent a large grouping of companies that have similar business activities.

Sectors may have companies that don't necessarily compete with each other, while industries tend to represent corporations that are in direct competition.

For example, companies within the oil and gas industry, such as Exxon and Chevron, are competitors. Those same companies also fall under the primary sector since they both engage in the extraction of natural resources. However, Exxon or Chevron would not likely compete with companies involved in agriculture despite being classified within the primary sector.

The Bottom Line

Sectors are used to categorize the economic activity of consumers and businesses into groupings based on the type of business activity. Each sector represents a different stage of economic activity as it relates to how closely tied or not that activity is to the extraction of natural resources.

For example, primary sector companies are directly engaged in activities utilizing natural resources, such as mining and agriculture. On the other end of the spectrum, the tertiary and quaternary sectors, representing the services and knowledge-based economy, are engaged in activity that is not directly tied to the Earth's resources.

Investors also use sectors to group different types of companies to help gauge whether those companies are performing well or not. Sectors are important since they help investors and economists understand the various levels of economic activity within an economy.