What the GDP Gets Wrong (Why Managers Should Care)

The irony: We know less about the sources of value in the economy than we did 25 years ago.

Image courtesy of Flickr user Fey Ilyas

Image courtesy of Flickr user Fey Ilyas

We see the influence of the information age everywhere, except in the GDP statistics.1 More people than ever are using Wikipedia, Facebook, Craigslist, Pandora, Hulu and Google. Thousands of new information goods and services are introduced each year. Yet, according to the official GDP statistics, the information sector (software, publishing, motion picture and sound recording, broadcasting, telecom, and information and data processing services) is about the same share of the economy as it was 25 years ago — about 4%. How is this possible? Don’t we have access to more information than ever before?

The answer isn’t about quantity, it’s about price. The bits that comprise today’s information goods are supplanting the atoms that formed yesterday’s encyclopedias, movie theaters, music CDs and newspapers. Online information may be updated every minute of the day and accessible almost anywhere in the world, but its price is usually radically lower than that of its physical counterpart, if there even is a price.

The recording industry embodies this trend. In the past few years, consumers have dramatically shifted their music purchases from physical media such as CDs to online sources such as iTunes. (See “Going Digital.”) Consumers have changed their purchasing habits by buying fewer physical units (CDs, cassettes or vinyl records). Sales declined from more than 800 million units in 2004 to just 400 million units in 2008. Contrast that with the vast increase in paid downloads of digital songs. In 2008, more than 1 billion digital single songs were purchased in the United States, as well as more than 50 million digital albums. An even larger number of songs were downloaded illegally, though that’s not reflected in our charts.

Going Digital
Consumers Are Buying More Music…

View Exhibit

Yet this increase in the number of units has not translated into more revenue — in fact, quite the opposite has occurred. Combined revenue from the sale of songs for the record companies went from more than $12.3 billion in 2004 to $7.4 billion in 2008 — a whopping 40% decline. Even if we add digital sales made on mobile phones (which would include ringtones), subscriptions from services such as Napster Inc. or Real Network Inc.’s Rhapsody, and digital performance royalties paid by Pandora Media Inc. and others, the digital total expands to just $2.7 billion, making the overall total $8.5 billion — still 30% less than it was in 2004. The recording industry is disappearing from the GDP statistics.

But Are Paying Much Less for It

View Exhibit

Have people stopped listening to music? Of course not. But GDP is a measure of current market value of production. So if you listen to a free song, there’s virtually no contribution to GDP (perhaps a few fractions of a cent for the electricity you use). Similar economics apply to reading The New York Times online. Yet if you buy the same newspaper at a newsstand, you add $2 to GDP, whether or not you get around to reading it. The Google Inc. searches you do, the Wikipedia articles you read and the Facebook Inc. photos that make you laugh don’t directly affect GDP for the simple reason that their market prices — what you pay for them — are zero. But this doesn’t mean they have no value.

The irony of the information age is that we know less about the sources of value in the economy than we did 25 years ago. GDP is a more accurate metric of value in industrial-age industries like steel or automobiles than in information industries, and can miss most of the value in information goods. However, there is one measure that economists have thought about for decades that may help us determine the value of these innovations: consumer surplus. Consumer surplus is the aggregate net benefit that consumers receive from using goods or services after subtracting the price they paid. While it can be difficult to measure directly, economists can infer consumer surplus using price experiments from purchase data, lab experiments or surveys. Consumer surplus can be enormous even if — in fact, especially if — the price is low or zero.

Let’s go back to the recording industry. Suppose that for most people, the vast majority of the value of a CD comes from their three favorite songs on it. Those consumers will do much better paying $3 for those three songs on iTunes, rather than paying the $18.99 retail price for the CD. While most of the record company revenues disappear from GDP, consumer surplus increases enormously — but that amount is unmeasured. This is not a bug in the free market system. In fact, it is its essence. As Adam Smith noted more than 200 years ago, the invisible hand of competition drives producers to deliver ever more value to consumers at an ever lower cost. If the cost of producing a good is zero, then over time, the competition should drive the price to zero as well. The invisible hand has been particularly ruthless in information markets. As a result, consumer surplus has soared even if the contribution of information goods to GDP hasn’t.

If we used consumer surplus data to examine the true size of the information economy, we would find trillions of dollars of benefits that are not measured in the Bureau of Economic Analysis’s official GDP statistics. While GDP statistics measure prices and quantities, just as corporate income statements measure costs or profits, neither approach is a particularly accurate way to understand the ultimate value that consumers get from information goods and services. But over time, policymakers and business executives will need to understand not only how innovations affect GDP, but also alternative measures like consumer surplus, which may be more suited to measuring the information economy. The lesson from information economics is that consumers assign value differently than does GDP. What matters most to acquiring and keeping customers is the value that a product delivers — even if that value isn’t directly monetized into revenues.

8 Comments On: What the GDP Gets Wrong (Why Managers Should Care)

  • trev789 | October 5, 2009

    The inability to account for improvements through technology seems to me to be a general weakness of GNP as a measure of prosperity. It isn’t specific to the information sector. E.g. 25 years ago you could buy a video camera for $1200. You can by one now for the same price but it does a hell of a lot more than the ones you could buy back in the mid-80s. This must be the same across other industries – e.g. construction technology must have made it cheaper to get more ‘house’ for your buck.

    Technology increases our prosperity without changing the amount we pay for it. So GDP doesn’t measure the actual increase in prosperity. Which is a shame because growth in GDP is generally taken that way, and is chased by all the major political parties.
    Those are my thoughts. Anyone else?
    Trevor Thomson

  • Stuart Ritchie | January 6, 2011

    The other thing to consider Trevor, is that you can also buy a video camera for $150 that does far more than a $1200 camera used to. So price has come down as well as getting more bang for your buck.

    Stuart

  • Elizabeth Villagómez | April 17, 2011

    Can’t pay to read….I hope you did take the PPP discussion on board in the article as well as the basic economic analysis of product cycles..

  • Vlad | May 3, 2013

    I give away free enterprise software that has about 1 million installations worldwide, mostly as a component in industrial, medical and military equipment monitoring systems. Assuming it provides only $5 of value in its lifetime, it’s a $5,000,000 of off-the-books value that no statistics will ever see, and very little of which I will receive as a compensation ($160 in 2012 :-)). This also puts huge deflationary pressure on the the dollar, as essentially I took a few million dollar pay cut. No wonder that 2 trillion dollars of Feds’ quantitative easing didn’t abate the deflationary trend. We simply are loosing money as a valid measure of humans’ contribution, hence GDP numbers getting less and less useful.

  • Vlad | May 3, 2013

    Also, I would like to attempt to frame the question of how to possibly measure unaccounted added value of free technology: could it be that in the current environment of near-zero inflation and today’s unemployment numbers suggesting employment holding still, that trillions of *dollars emitted by Feds through latest rounds of quantitative easing are roughly equal the value of free goods and services unaccounted for by GDP numbers and other stats*? If not, why?

  • Dear New Yorker: Kuznets Did Not Invent GDP (and that matters) | A (Budding) Sociologist's Commonplace Book | November 19, 2013

    […] which are given away for free. The piece is a nice summary of recent research by economists like Brynjolfsson and Mandel who attempt to augment existing national income accounts with better measurements of the […]

  • Forget GDP -- We Need Numbers That Matter for the Questions We Have - Zachary Karabell - Harvard Business Review | March 4, 2014

    […] have also joined the post-GDP party. Innovative economists such as Erik Brynjolfsson of MIT have drawn attention to how the information technologies and services that now contribute substantially to economic […]

  • Forget GDP – We Need Numbers That Matter for the Questions We Have | Bamboo Innovator | March 8, 2014

    […] have also joined the post-GDP party. Innovative economists such as Erik Brynjolfsson of MIT have drawn attention to how the information technologies and services that now contribute substantially to economic […]

Add a comment