12 Conference Report #techonomy12

Why It Matters That GDP Ignores Free Goods

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  • (All photos by Asa Mathat)

Speaker

Erik Brynjolfsson
Schussel Family Professor and Director, MIT Sloan, MIT Center for Digital Business


Kirkpatrick:  Erik Brynjolfsson, who comes up next, is somebody who, last year with his partner Andy McAfee, published a book about what is happening with jobs and kind of concerned me and did some great stuff on stage. Now he’s got some interesting new thoughts about the role of free goods in the digital economy. He’s one of the world’s leading experts on the impact of technology on the economy.

So, Erik, please come out and let us hear what you’ve got to say, man.

Brynjolfsson:  Good to see you.

So we’ve heard from Dave and from the other speakers about all the astonishing technologies that are changing our economy and our society, and like most of you I’m sure, I’m quite convinced that we are in the midst of a major technological revolution. It’s quite astonishing, not what’s already happened, but the next ten years are likely to hold even bigger things in store.

However, if you look at the official government statistics, GDP, for instance, you’d find that the information sector, the part where we think most of this innovation is concentrated, all these digital goods, you’d find that that sector officially hasn’t grown at all. It’s the same as what it was in the 1960s.

Now how can that be? Obviously, there are some major measurement problems in the way we keep our statistics, and that’s a real problem because, as the saying goes, you can’t manage what you don’t measure.

And we are missing more and more of the economy, more and more of what matters in the economy. When the presidential candidates debate and talk about the growth in the economy, or what’s happening to productivity, they are relying on these statistics, they’re referring to these statistics that miss this big revolution that we’re all talking about here. So we need to come up with a better way of measuring things. That’s something we’ve been working on at the MIT Center for Digital Business.

Now if you look at some of the things that have been happening, there’s been an explosion of digital goods. We’ve all used Wikipedia, which of course, is free. And people spend several hundred million hours developing those articles and reading them, of course. And there’s a whole slew of other digital goods, YouTube, people spend more time on that than they do on the major television networks. Facebook, Pandora, Mapquest, search engines, blogs, all these things.

They have several things in common. One is that they are digital goods delivered through the Internet and increasingly mobile devices. And that means that the marginal cost of delivering them is pretty close to zero. Once you’ve developed them, making them available to one more user is very, very close to zero.

And, in turn, not surprisingly, the economic model for most of them is in, in fact, deliver them for free. In some cases, they fund them through advertising. In many other cases, users just contribute the time. They develop them and make them available.

And maybe there’s a little bit of contributions or advertising that pays for the bandwidth, but those costs are relatively minimal.

A third thing they have in common is most of them were just developed in the past ten years, and almost all of them within the past 15 years. There’s just been an explosion of the availability of these goods. And that means we are spending and consuming—spending more and more of our time and consuming more and more of these goods than before. We’ve more than doubled the amount of time we spend on these goods in the past five years.

Now, it’s not just in the United States, of course, it’s a worldwide phenomena. We refer to that prototypical boy in Africa who now has more access to information as Ray Kurzweil would say, than the President of the United States had ten years ago, or a girl in India or, really, men, women and children all over the world.  This is a little map of the information flows, all the free information flowing across the world, across the oceans and all the hotspots on the continents.

And you also could measure—you can count the number of bits produced, you can count the number of articles produced. And those have grown ten-fold since 2004 in the case of Wikipedia.

But what we want to know is not just the number of bits, we want to know the amount of value. What is the actual value? This is where the bug in the GDP occurs. Because GDP measured the total amount spent on goods and services. The total amount spent.

So what happens if the price is free? The price is zero. Well, zero times any quantity is still zero. So you could have an enormous explosion of bits or articles or whatever else. If they’re priced at zero, the statisticians in Washington do the math and, lo and behold, it comes out as a big fat zero contribution for our GDP.

So the traditional metrics are really missing what’s going on in the economy, and missing this information economy because it’s a digital economy and largely a free economy.

So how can we measure it? There are a number of other ways going about measuring it. One is to look at the time that people spent, and that is something that we do. If you just look at the dollars, you’re going to get a sense that actually the economy is stagnant or even shrinking.

You take a look at what has happened to the music industry. The amount of music being downloaded is growing quite rapidly, but the dollars spent on the music industry is shrinking. It’s disappearing from the economic statistics.

Now, that doesn’t mean that all of us are listening to less music or we have less music available. If anything, many of us have more music available than ever before. And people have looked even at the quality and variety of music. Joe Walford, for instance, has found that that has grown as well. But the music industry and GDP statics is shrinking, as are many other information-based industries.

The increased amount of time, however, I think is another way of getting at how we are consuming these goods, because there are different ways you can pay for something. You can pay for something with dollars, but you can pay for something with anything else that has value as well. And when you choose to spend time on consuming a good, you are paying for that. You are paying a piece of your life. You are paying attention, if you will. And that is something that is in finite quantity.

And if you use it for one good, if you use it to consume YouTube or Facebook, that means it’s not available for earning money or for fixing your house or for consuming some other type of measured good.

And this is basically a nub of a way you can go about measuring the value of all these free goods. That’s what we do. We calculate the demand curve for information goods not based on the dollars spent, but based on the time spent.

If you look at the area under that demand curve, it will give you a calculation of a total surplus, the total consumer surplus that you capture. If you’re willing to spend a certain amount but you only have to spend a smaller amount, the difference between those is a surplus measure, the consumer surplus you capture.  Obviously, if the good is free, that surplus potentially could be quite large. Even though the dollars spent on it is quite small.

This is a very different approach than the traditional GDP accounting, but it’s one that we think captures better the real value that goods and services are producing in the economy, especially when you look at not the dollars spent, but the time spent.

So actually implementing this is a little bit complicated. You have to do a few equations. That’s what Yu Hu, my post-doc at MIT, and I went through. I won’t go through all of these. If you want, you can read the paper. I’ll get you to the bottom line.

Basically after you do the math and plug in the numbers, what it turns out is the annual welfare gain from all these free goods is about $300 billion. Now, that’s the average over the past ten years or so. And that works out to about $1,400 per person.

I don’t know whether you think that’s a large number or small number, but it’s certainly bigger than zero. It’s not enough that we can all retire. But it tells you something about what is happening in the economy and how much value is being created.

Another thing you can look at is the change in consumer surplus from one year to the next. This is perhaps a more relevant one that tells you something about the growth of the economy. So even in a recession, people are getting more and more free goods available to them, and even in a slump.

So the actual increase in the value from these free goods is a positive number. It turns out over the past ten years it’s averaged about $34 billion. In the past year or two, it’s been about $40 to $50 billion dollars per year.

To put it in perspective, that works out to be about a quarter of a percent of GDP. Maybe people don’t think that seems like a very large number, but I want to calibrate it for you. Total productivity growth in the economy has been averaging about 1 percent per year.  So this is equal to about a quarter of the total productivity growth in all the industries in the economy put together.  And it’s growing fairly rapidly, so soon it will be close to half of all the productivity growth just from these free goods on the Internet.

Now, you can also calibrate other things. Once we did this study we realized there are other free goods out there. There’s a really big one that actually people spend far more time on. Maybe not in this room, but in the United States, which is television.  There is about 200 billion hours a year spent on television.

So we use the same model to calibrate for television. What we found was, lo and behold, television creates even more value for most Americans than the Internet. That’s simply a function of them choosing to spend time. They have a choice each day. They spend about 30 hours a month on the Internet, but about 30 hours a week on television. So they’re voting with their feet or voting with their hours on that.

Although, if you look towards the end, the value that television is adding has leveled off and has started to fall a bit. The value added by the Internet is growing. So right now in terms of contributions to growth, GDP contribution from his digital goods and the Internet is greater than from television. If we extrapolate, we see those lines crossing within the next decade or so in terms of the total value.

So the bottom line is that the value of these free goods is about $300 billion in 2011. You have to measure it in terms of time, not money. If you look at the dollar value, it turns out to be a much smaller value. But that’s because we’re not counting the real way people are paying for this.

Furthermore, that value is increasing quite rapidly, at an increasing rate. It’s about $40 billion of additional growth every year. That doesn’t show up in our GDP or productivity statistics. That’s because there are more users every year, each user is spending more hours, the value of each hour, according to our model, is growing. All those things, you put them together and they lead to increasing value of these goods.

Finally, you can kind of calibrate it with what’s happening with television. And you find that TV is still a bigger chunk of value, but the Internet is catching up rapidly. So the bottom line I think is, we have definitely had a revolution in technology and the digital goods and the way the economy works. And more and more of it is these free goods.

We’ve been talking about a revolution in management and strategy to take advantage of that. We also need, I think, a revolution in measurement. We need to rethink the way we measure the economy. If we don’t measure the economy to take into account these free goods, we will eventually miss more and more of what is happening in the economy.

If you want to read more about it, it’s available for free on my website.

Thanks very much for giving me a chance to share some of the research.

[APPLAUSE]

Kirkpatrick:  Eric, that was great. Perfect timing. Excellent.

If you combined that with what Vivek Ranadive was saying, which I really like, about doing real data analytics for the Fed—you know, which makes perfect sense. And you mentioned it on stage last year here as well.

There’s clearly a lot being missed by our measurers and other government. I think this is exactly the kind of thing that we at Techonomy, and the Techonomy media, exist to try to highlight.

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