Taxonomy makes the world go round

Taxonomy, like the money supply or the ozone layer, is a stealthy — yet fundamental — concept in our lives that, unfortunately, only a few people know much about.  Taxonomy makes the world go around: all kinds of things would stop moving without it.  But only a small number of people — either inside or outside of the world of the web that manages our lives online — can explain what a taxonomy actually does. It’s generally a vague concept to designers and developers.  Business people often have little idea what it is or why it matters. Even many information architects, and other people with backgrounds in library science, tend to ignore the social and economic significance of taxonomies.

Taxonomy matters because it is the basis of numerous decisions that affect us. But it can be misunderstood when seen as being primarily about making individual decisions: specifically, looking up information.  Taxonomy’s true influence comes from how it supports collective, repeatable decisions and enables the aggregation of data and actions.  Rule-based decisions, whether applied by humans or machines, depend on taxonomies.  

Taxonomies shape many of the most important decisions in our world — those that are made again, and again.  Four taxonomies in particular influence the basic dimensions of our lives:

1. What we eat
2. How money is made and used
3. What goods and services are produced
4. How we evaluate our impact on the environment

All these taxonomies share a common focus on process changes as forming the basis for categorization. Why? When items change state or are susceptible to change, distinctions emerge that are useful to classify.  

Codex Alimentarius: Classifying what we eat

Eating is an elemental need: it supplies nourishment.  Something so basic seems far removed from the abstraction of taxonomy.  And few would expect a taxonomy with a Latin name to be important to the modern world economy.  

The Codex Alimenatrius means “food code.”  It is defined by a United Nations organization based in Rome (a joint effort of the FAO and WHO, in case you care about the acronyms, instead of the Latin).  The “Codex” provides a “classification of foods and feeds.”    

Please don’t get turned off by the jargon — the stakes here are important.

If you have ever wondered how we can safely eat food items produced from around the world, it is thanks to the Codex Alimentarius. It defines in great detail criteria for food commodities, specifying their composition and safety.   The Codex provides a detailed set of guidelines relating to food covering:

• Standards covering processed, semi-processed or unprocessed foods 
• Hygienic and technological codes of practice
• Food additives 
• Maximum levels for pesticide residues 
• Guidelines for contaminants

It promotes the harmonization of national regulations and encourages food producers to adopt common standards.  

The scope of food products is enormous.  To provide useful guidance, the Codex should be able to identify the universe of products needing standards.  The Codex Classification of Foods and Animal Feeds provides this needed classification.   It divides food into classes based on three dimensions:

• How basic or changed, is it? Primary v Processed
• Who is it for? Food for people v Feed for animals
• What’s it made of? Plant-origin v Animal-origin

In all, five classes exist:

1. Primary food commodities of plant-origin 
2. Primary food commodities of animal-origin
3. Primary animal feed commodities
4. Processed food of plant-origin
5. Processed food of animal-origin

Each of the five classes is divided into types that are “based on physical characteristics and traditional use and to a lesser extent on botanical or zoological associations.”  

Types are subdivided into groups and subgroups “whose members show similarities in their behavior with respect to residues and in the nature of the agricultural practices to which they are subjected.”  

Finally, within each group, different commodities are enumerated with a code identifier having a 2-letter preface followed with a 4-number suffix.   

The standards themselves are narrative documents. But what the standards address is determined by the taxonomic classification.  They can be relevant to individual commodities — but also higher-level classifications.  

Let’s explore how the Codex’s classification works by reviewing how it classifies anise, one of my favorite flavorings, an herb that has been used since ancient Roman times. Anise commodities belong to “Class A: Primary Food Commodities of Plant Origin.” 

Anise commodities more specifically belong, within Class A, to Type 05: “Herbs and Spices.”  

Multiple anise-related commodities exist (a few of them flagged in bold below), which get classified in various ways:

• Herbs (group 27), whose commodities have a code prefix of “HH”
  • 027A Herbs (herbaceous plants), broken into commodities with 6 character codes, for example:
    • HH 3191 Anise, leaves
  • 027B Leaves of woody plants (leaves of shrubs and trees)
  • 027C Edible flowers
• Spices (group 28), whose commodities have a code prefix of “HS”
  • 028A Spices, seeds
    • HS 0771 Anise, seed
  • 028B  Spices, fruit or berry
    • HS 3303 Anise pepper
  • 028C Spices, bark
  • 028D Spices, root or rhizome
  • 028E Spices, buds
  • 028F Flower or stigma
  • 028G Spices, aril
  • 028H Citrus peel

The Codex refers to its enumeration as a classification rather than as a taxonomy.  Within the Codex, the term “taxonomy” is reserved for biological descriptions of living plants, animals, and microbes rather than for non-living or man-made food items. Biological taxonomies are also based on identifying distinctions arising from the process of change — distinctions which are increasingly determined through DNA analysis.

Because the Codex is based on science, it is constantly evolving. Experts must account for a growing range of synthetic inputs and outputs that become available, such as lab-grown “meat.”  The classification undergoes revision as needed.

The Codex has been in place for over half a century, achieving something remarkable: it’s made possible the confident trade of food around the world.  We can buy imported food that’s labeled clearly and meets agreed standards. It’s enriched us all, whether we get access to better and less expensive food, or simply have more varied and interesting options.     

The GAAP taxonomy: Is a company profitable and viable?

If you work for a company or have invested your retirement savings in companies, you want to know if a company is profitable.  

And you need to know their statements are reliable. Several high-flying firms, including Wirecard in Germany, Greensill Capital in the UK, and Evergrande in China, have collapsed quite suddenly in recent months.  People need to trust financial data.  

The GAAP (Generally Accepted Accounting Principles) has been the accounting standard for many decades.  But only in 2013 was the GAAP transformed into taxonomy: the US GAAP Financial Reporting Taxonomy (UGT), based on the Extensible Business Reporting Language (XBRL) markup.  

If the GAAP has been around for decades, why is it suddenly a big deal that it’s now a taxonomy?

This development has promoted much greater transparency and global harmonization in financial reporting.    

Accounting, fundamentally, is about the categorization of income and expenses, and of assets and liabilities.  These can be split or lumped according to the granularity sought.  Accounting is taxonomic in its orientation.  Providing precision enables traceability. 

The GAAP taxonomy, when encoded with markup, transforms difficult-to-analyze documents into structured data that can be compared.  

Bob Vause, in his book the Guide to Analyzing Companies, notes the power of the taxonomy to describe individual financial items.  “This involves ‘tags’ — tagging all the individual items of information appearing in financial reports.”

The GAAP taxonomy is being adopted globally, sometimes unofficially, which is promoting a global convergence in approaches.  This is an important development, as different counties sometimes use divergent terminology when describing financial events. Those inconsistencies have hindered the comparison of companies operating in different markets.  

Today, the differences in terminology are less important than in the past because the taxonomy tags provide a standard way to present financial data.  Vause notes: “There will be an international standardised form of presentation; language or terminology will no longer be a barrier to analysis.” He adds: “Moves towards the standardisation of financial report information are leading to significant improvements in the quality, value and accessibility of corporate financial information.”

The GAAP taxonomy helps financial analysts track inputs and outputs, and follow transfers and allocations.  

NAICS taxonomy: what’s the composition of the economy?

It’s difficult to know what’s important in the economy, such as how big a sector is or how fast it is growing.  Some sectors seem to get more media attention than others.  And it’s not always clear what is different about sectors.  For example, is fintech different from banking?  Companies and governments need to understand changes in the economy when making investment decisions.  

Industrial classification taxonomies help analysts dissect the complex composition of an economy.  Since 1997, the United States, Canada, and Mexico have agreed to follow a common system to classify businesses called the NAICS (the North American Industry Classification System). The EU uses a similar classification called the NACE.  Governments define these taxonomies and use them to collect all kinds of data.  By being structured as a  taxonomy, with broader and narrower classifications, it’s possible to aggregate and dissect data about production, orders, hiring, and other activities.  

According to the official NAICS Manual, “NAICS divides the economy into 20 sectors. Industries within these sectors are grouped according to the production criterion.”  But industries could be services as well as manufacturing. For “activities where human capital is the major input… each [is] defined by the expertise and training of the service provider.” 

The NAICS uses hierarchical numeric codes, an approach referred to in the field of taxonomy as “expressive notation.”  These codes don’t look like the more familiar style of taxonomy that uses text labels.  But codes provide many benefits.  They provide a persistent identifier that allows the description to be revised when necessary.  And they enable expansion of the code from 2-6 digits to get the appropriate level of granularity.  They allow the retrieval of either root classes or subordinate classes (subclasses), and the comparison of equally ranked classes.  For example, the taxonomy supports retrieval of data on all performing arts groups, or it can allow the comparison of data for different kinds of performing arts groups (theater companies, dance companies, or music groups). 

When you look at the NAICS, you might disagree with how industries are categorized.  You may think the balance or emphasis is wrong.  But the NAICS isn’t based on any single person’s opinion or even a card sort by a group of people.  It’s a highly governed taxonomy.  Persistence in categories is necessary to allow data to be tracked over time.  Even when a sector is losing importance, it is still useful to understand how it has declined.  And sometimes, obscure sectors can be more important than non-specialists realize.  They aren’t scoring headlines in the news, but they still matter.  

The NAICS is the product of a well-defined methodology. It classifies sectors according to how products or services are created.  “Economic units that have similar production processes are classified in the same industry, and the lines drawn between industries demarcate, to the extent practicable, differences in production processes. This supply-based, or production-oriented, economic concept was adopted for NAICS.”  Much like the GAAP, the NAICS allows analysts to track inputs and outputs.  

The Green taxonomy: classifying climate impacts

Lastly, we turn our attention to another thing humans produce, but one that’s less desirable: greenhouse emissions.  

As I write this, world leaders will soon gather in Glasgow for COP26, the UN Climate Change Conference.  Countries and companies are pledging to be carbon-neutral or even carbon-negative by specific dates.  But what do these commitments really mean?  How will emissions and outsets be calculated?  And how will everyone agree these commitments are measured?  

These important questions will require a slightly longer explanation. 

Over the past year, momentum has been growing for climate change-focused taxonomies. These initiatives classify energy usage according to their emissions. They are discussed using various terms:

• Green taxonomy
• Climate taxonomy 
• Sustainable finance taxonomy   

But how can a taxonomy influence the climate?  In many of the same ways that taxonomies influence other human activities such as food, finance, and the economy.  Taxonomies can help individuals understand processes relating to what we produce and consume. And they can help institutions follow common standards to track and direct energy usage behavior.  

A major motivation for green taxonomies is capital allocation: both the capital used in market debt financing of infrastructure projects and the institutional equity investments into energy-consuming enterprises.  Power plants and grids are expensive.  Converting existing infrastructure to be more green forms is as well. The aspiration is to create new financial products such as green bonds or sustainable index funds to promote such investments.

EU environmental taxonomy

Multiple green taxonomy initiatives are underway globally, which vary in their designs.  At the moment, the bulk of media attention has been focused on the EU’s environmental taxonomy, which is currently in draft.  Some reports suggest it may be finalized by the end of 2021 and that China might join the EU initiative in some capacity.  The ASEAN group of Southeast Asian countries is working on their own taxonomy that is heavily modeled on the EU one.

The EU’s environmental taxonomy is based on the NACE, their industrial classification system. It looks at various economic sectors and  identifies “sustainable” activities within each sector.  

The Commission states: “A common language and a clear definition of what is ‘sustainable’ is needed. This is why the action plan on financing sustainable growth called for the creation of a common classification system for sustainable economic activities, or an ‘EU taxonomy’.”

“The Taxonomy sets performance thresholds (referred to as ‘technical screening criteria’) for economic activities.”

Member states and financial institutions within the EU will be required to report on the sustainability of projects they sponsor.  Those activities deemed sustainable will presumably be more attractive to long-term investors.    

The Commission’s “green list” of those activities it has decided are sustainable has created some controversy.

Notably, the Commission has been unable to decide whether nuclear power and natural gas are environmentally desirable.

In the United States, interest in green taxonomies has also been growing.  Compared with the EU, it is more driven by interest from institutional investors, though US government regulators have also called for better and more consistent standards.

The EU’s approach to a green taxonomy is prescriptive — indicating what activities are sustainable.  The US approach, in contrast, is more descriptive — classifying a range of activities that could support or hinder sustainability and promoting reporting of harms and well as benefits.  

The SASB taxonomy in the United States

In the United States, green taxonomies fall under the broader umbrella of “ESG” (Environment, Social, and Governance) — that is, non-financial information relating to company performance.  US investors increasingly favor ESG-positive firms and funds.  But ESG indicators haven’t been standardized across companies, which has triggered concerns from the US General Accountability Office. The ESG landscape has emerged organically, which partly explains their uneven application.  But some enterprises and investment funds have been faulted by environmentalists and financial regulators for using imprecise standards and metrics to engage in “greenwashing.”  

“Investors are using ESG-related information to make investment decisions and to allocate capital more than ever before. They are increasingly looking for sustainable investments, albeit investors have different thoughts about what ‘sustainability’ means.” 

Securities and Exchange Commissioner Caroline A. Crenshaw

Commissioner Crenshaw adds: “To be useful to investors, disclosures need to be meaningful. That’s particularly true for ESG-related disclosures, as they are too often inconsistent and incomparable. What we should be working toward is a clear disclosure regime that yields consistent, comparable, reliable, and understandable ESG disclosures to investors.”

ESG is broader in scope than sustainability.  But environmental metrics so far have been the major driver of ESG interest.

Following a period of competing initiatives in the US, a unified approach has coalesced under the auspices of the Sustainability Accounting Standards Board (SASB), a nonprofit organization that cooperates with several other like-minded organizations.  

The SASB has chosen a different approach to define a green taxonomy.  They have re-imagined the NAICS to focus it on environmental performance.  It has created what it calls the Sustainable Industry Classification System® (SICS®). “The differences between SICS® and traditional industry classification systems can be categorized in three types: (1) new thematic sectors; (2) new industries with unique sustainability profiles; and (3) industries classified in different sectors.”  The SICS classifies 77 industries are grouped into 11 categories.  

“Unlike other industry classification systems—which use common financial and market characteristics— SICS® uses sustainability profiles to group similar companies within industries and sectors.” 

“SASB Standards identify the subset of environmental, social, and governance issues most relevant to financial performance in each of 77 industries.”

In addition to drawing inspiration from the NAICS, the SASB also modeled its work on the GAAP taxonomy.  

It worked with PwC to convert SASB’s taxonomy into the XBRL format (the “SASB XBRL taxonomy”) to allow data exchange between reporting companies and investors and regulators evaluating the reporting. 

As a recent news report concludes: “SASB Standards Taxonomy in XBRL format…make[s] digital reporting simpler for issuers of environmental, social, and governance (ESG) disclosures and to improve data aggregation and analytics for investors.”

“Having the taxonomy in XBRL, an open standard used in business reporting, will enable reported metrics to be machine-readable via digital tags, and improve usefulness and comparability of ESG reports.”

The next emerging area of focus for green taxonomies is looking at what are called “scope 3” emissions, which consider emissions across the value chain of products.  Instead of looking at individual industries or companies, this work will evaluate the emissions associated with the entire lifecycle of production, consumption, and disposal.  Companies will be more accountable for the actions of their suppliers and customers.  

Taxonomies support exchange

I learned about the value of taxonomies in the late 1980s during my first full-time job after leaving grad school.  I worked as an online researcher at the US Commerce Department.  This was before Tim Berners-Lee launched the World Wide Web — there were no browsers or Google then.  But already online information providers recognized the need to categorize information to make it accessible.  Accessing information at that time was extremely expensive.

Taxonomy is a form of infrastructure, much like the undersea fiber optic cable that transmits internet traffic is.  The scholar Elizabeth Cullen Dunn talks about the role of infrastructure by introducing a Greek word, oikodomi, which she defines as“the infrastructures from which standards emerge and that shape the way they actually effect production.”  Taxonomy is oikodomi, in the sense that it shapes decisions.  

Many people lately are talking about the importance of “systems” (or “systemic” influence) to understand how things work now and how they should in the future.  That’s exactly what taxonomy is doing: defining systems.

Taxonomy standards facilitate global exchange by

• Promoting harmonization between stakeholders in different places
• Connecting descriptions between different fields  

Taxonomy standards connect our diverse world. They can thread together different domains: food, which influences health, companies, the economy, and the environment. They provide the transparency that can reveal the relationships between these dimensions through their precise classifications.

— Michael Andrews