4 May 2018

Why GDP is a hopeless measure of our digital economy


It turns out search engines is worth $17,530 a year to us, email $8,414 and digital maps $3,648. Therefore absolutely everything anyone says about GDP, economic growth, productivity and inequality is wrong. Which is a bit of a problem for those attempting to plan our way into economic growth, productivity rises and a reduction in inequality, isn’t it?

We have it on good authority, from Friedrich Hayek no less, that we can never plan an economy in any detail. We’re simply not able to gather the information centrally so as to be able to do so.

We also know that there are problems with GDP and how we measure it. In fact we know for certain that we’re measuring the effects of new tech and the digital revolution wrongly – the only interesting question is how wrongly.

This is what an illuminating new paper from the National Bureau of Economic Research tells us. There are, of course, problems with it. The numbers are not exactly pinpoint in their accuracy. A reasonable assumption is that we’ve the correct number of digits there and that the first one is right.

We’ve also crossed that line from revealed preferences to expressed. After all, we would much rather judge peoples’ valuations from what they do rather than what they say. But needs must, and so this research asks how much people would need to be paid to give up these new technologies? Not by any means a perfect manner of estimation, but the best we’ve got and usefully indicative if not completely accurate.

These caveats aside, the clear conclusion is that we’re really, really, getting our GDP numbers wrong. Or to be more precise, the numbers might be accurate, but they are a horrible guide to what we’re really trying to measure. What we want to know is ‘how rich are we? How close with popping with the pleasure of it all are we, being alive in this very digital dawn?’.

In economic terms the best we can do here is to estimate the value we get to consume. As a proxy for that – and we really must note that it’s a proxy – we measure GDP, which is value created at market prices. This is a problem when there’s no direct market value for something. As Google’s chief economist Hal Varian has said, GDP has a problem with free.

We know that there’s some value being created by the existence of these free-to-use technologies. Our current measure of the value of that Google engine is, for example, the advertising revenue Google gains from operating it, which is about $25 per year per user.

Clearly this is somewhat different from the $17,530 in the NBER paper. Our usual rule of thumb is that the total value of what is consumed is twice GDP. There’s what we measure directly, those market transactions, then there’s what people would pay but don’t have to, the consumer surplus. It’s a rough guide, no more, but observation tells us that the two are about equal for physical goods and paid-for services. Our question therefore becomes whether the same is true for digital and free ones.

We can, as some have, approach this from the other end. What would have to be the undervaluation of the free and digital in order for us to have those nice historical rates of GDP growth? For years we’ve been told that the Keynesian post-war world gave us higher GDP growth than the neoliberalism that has taken hold since the 1980s. The answer is that, for modern growth numbers to be equal to those earlier ones, we’d have to be estimating digital and free at 10% of their true value creation.

Which is what we do have and more, isn’t it? Search engines are at near one thousandth of their true value, email at something similar, even Facebook is counted at less than that 10% of its real value ($322 a year, instead of the around $20 that arrives in GDP). Again, bear in mind that GDP is merely a proxy to what we’re really interested in, value consumption – and one that’s becoming ever less useful in our modern world.

This failure to take proper account of digital products has profound implications for all GDP-derived numbers. Productivity is GDP divided by the number of hours of labour taken to create it. If value’s higher then so is productivity – telling us that whines about slow productivity growth stemming from the official figures might not be all that usefully correct.

Inequality is also GDP-derived. Given that we’ve all got near equal access to this value of the digital and free, that means the only form of inequality that means anything, that of consumption, is nowhere near what is generally claimed.

Which brings us back rather to Hayek and planning. We’ve the general assertion that we’ll never be able to plan the economy because we’re not capable of gaining the necessary information. And then we’ve got the specific proof here that value creation – what we’re really interested in – is higher than assumed, meaning that productivity is also higher and inequality is lower.

Yet we’ve nearly every politician on the planet trying to plan how to have higher economic growth, greater productivity and less inequality. Exactly the things that are already happening. It’s just that we’re not collecting the correct information telling us this. Meaning that Hayek not only had a general point, but also a specific one about today’s grand political witterings.

Tim Worstall works at the Adam Smith Institute and Continental Telegraph.