How Should We Measure the Digital Economy?

Erik Brynjolfsson is the Schussel family professor at MIT’s Sloan School of Management, the director of the MIT Initiative on the Digital Economy and a research associate at NBER. He is the co-author of “The Second Machine Age: Work, Progress and Prosperity in a Time of Brilliant Technologies.” Avinash Collis is a doctoral candidate at the MIT Sloan School of Management and a researcher at the MIT Initiative on the Digital Economy.

—–

FOCUS ON THE VALUE CREATED, NOT JUST THE PRICES PAID.

Digital media consumes a large and growing share of our waking lives, but these goods and services go largely uncounted in official measures of economic activity such as gross domestic product and productivity (which is simply GDP per hour worked).

The reason the value of digital offerings is underrepresented is that GDP is based on what people pay for goods and services. With few exceptions, if something has a price of zero, then it contributes zero to GDP. But most of us get more value from free digital goods such as Wikipedia and online maps than we did from their more expensive paper predecessors.

Effective management of the digital economy depends on our ability to accurately assess the value of free digital goods and services. That’s why we developed a new technique to measure not only how much consumers pay for digital products but how much they benefit from them.

WHAT GDP DOESN’T MEASURE

GDP is often used as a proxy for how the economy is doing. However, GDP captures only the monetary value of all final goods produced in the economy. Because it measures only how much we pay for things, not how much we benefit, consumer’s economic well-being may not be correlated with GDP.

The good news is that economics does provide a way, at least in theory, to measure consumer well-being. That measure is called consumer surplus, which is the difference between the maximum a consumer would be willing to pay for a good or service and its price.

To understand why GDP can be a misleading proxy for economic well-being, consider Encyclopaedia Britannica and Wikipedia. Britannica used to cost several thousand dollars, meaning its customers considered it to be worth at least that amount. Wikipedia, a free service, has far more articles, at comparable quality, than Britannica ever did. Measured by consumer spending, the industry is shrinking (the print encyclopedia went out of business in 2012 as consumers abandoned it). But measured by benefits, consumers have never been better off. Our research found that the median value that U.S. consumers place on Wikipedia is about $150 a year — but the cost is $0. That translates into roughly $42 billion in consumer surplus that isn’t reflected in the U.S. GDP.

Consumer spending — the basis for GDP — can be counted at the cash register and shows up on companies’ revenue statements. In contrast, consumer surplus cannot be directly observed, which is one reason it hasn’t been used much for measuring the economy. Fortunately, the digital revolution has created not only tough measurement challenges but also powerful new measurement tools. In our research, we use digital survey techniques to run massive online choice experiments examining the preferences of hundreds of thousands of consumers. The results allow us to estimate the consumer surplus for a great variety of goods, including free ones that are missing from GDP statistics. We start by asking participants to make choices. In some cases, we ask them to choose between various goods. In others, they choose between keeping access to a digital good or giving it up in exchange for monetary compensation. To make sure that people have revealed their true preferences, we follow up with experiments in which participants actually must give up a service before they can receive compensation.

Here’s an example of how this works. To measure the consumer surplus generated by Facebook, we recruited a representative sample of the platform’s U.S.-based users and offered them varying amounts of money to give it up for a month. Bases on the survey and the follow-up experiment, we estimate that U.S. consumers have derived $231 billion in value from Facebook since its inception in 2004.

Facebook operates one of the most advanced advertising platforms, yet its ad revenues represent only a fraction of the total consumer surplus it generates. This reinforces research by NYU Stern School’s Michael Spence and Stanford’s Bruce Owen that shows that advertising revenues and consumer surplus are not always correlated: People can get a lot of value from content that doesn’t generate much advertising, such as Wikipedia or email. So it is a mistake to use advertising revenues as a substitute for consumer surplus.

GETTING THE NUMBERS RIGHT

Working with the Canadian economist Erwin Diewert, University of Groningen’s Felix Eggers and University of British Columbia’s Kevin Fox, we developed a method for measuring the benefits associated with the digital economy. GDP-B is an alternative metric that supplements the traditional GDP framework by quantifying contributions to consumer well-being from free goods. Policymakers, managers and economists can conduct large-scale surveys asking respondents how much they’d need to be paid to give up a given good for a certain amount of time and then validate those results by running smaller-scale studies with real monetary incentives.

Our method has two important limitations. First, our GDP-B estimates are still far from comprehensive and are not as precise as the traditional GDP measure. We will need to include far more goods and conduct more online choice experiments for each to get a more accurate assessment of the full contribution that free goods make to the economy. Second, like traditional GDP, our measure does not capture some of the potential negative externalities associated with goods and services, including online platforms.

On a spectrum ranging from traditional macroeconomic indicators such as GDP and productivity, which tend to be very precise, to well-being indicators such as happiness, which are often coarser, our GDP-B metric lies somewhere in the middle. GDP has a very specific definition and value, but it doesn’t capture the consumer surplus generated by the digital economy; happiness assessments have the opposite problem. GDP-B strikes a balance between those extremes. As such, it represents a useful improvement for policymakers and regulators, who require a full understanding of how technology affects the economy in order to make sound decisions.

THE ANSWERS TO questions concerning how to regulate tech, how much to subsidize digital infrastructure and even what sorts of new digital offerings entrepreneurs ought to create depend on understanding the true benefits derived from the digital economy. Our approach can also help us better quantify the benefits we get from conventional goods. More ambitiously, it could help generate more-accurate estimates of the benefits associated with changes in nonmarket and public goods such as air quality, health care and infrastructure. Ultimately, as governments, managers and researchers around the world adopt this approach, our assessments of how both digital and nondigital goods contribute to our well-being will improve, and with better measurement comes better management.