Although GDP is a good measure of what it is supposed to measure, there are always questions about whether it is the right measure when asking a given policy question. This was the driving motivation behind the Living Standard’s Framework and the development of a suite of measures to inform our views on wellbeing, as I’ve previously written (with Anita King and Nairn MacGibbon).
The focus of this post is on digitization. In an era of digitization, economists have become more and more concerned about whether the conventional way of calculating GDP is appropriate for asking questions about changes in consumer welfare (surplus) through time.
GDP associates a dollar value with a product in terms of its market price and aggregates up all the products – we can think of this as a proxy for the way society could trade-off between the products, and also the relative value consumers of the final good have over the products they are buying. In this way, an increase in GDP is associated with an increase in consumer surplus in traditional goods markets .
With the rise of free services provided by digital goods such as free apps on smartphones, Facebook and etc, Erik Brynjolfsson notes that we can end up in a situation where the GDP can stay constant (or even falls), but the technological change increases consumer surplus. Brynjolfsson proposes a new GDP measure called “GDP-B” where he adds contributions from digital platforms into the GDP growth.
Why should we make adjustments to the conventional GDP measure?
Imagine a world where we all had a product that gave us a whole bunch of service value through time. The value of the (durable) product would be measured in GDP as a purchase, but the flow of services would not – so when describing the “flow” of consumption there would be a pretty severe problem. Hence why we put things like “imputed rents” into the GDP data.
Furthermore, we may expect this durable good price to represent the value of the services it provides – but in the face of competition, the price of the durable good may be lower than the price of the services it is replacing.
Now imagine a world where a paid product suddenly becomes “free”. We know there is a “price” somewhere as the price of the cellphone will now in some way reflect this additional value, but how well does that capture the increase in “consumer surplus” that is occurring. If we are trying to use GDP as a reflection of welfare this is an issue.
Tying these points together, the digital economy leads to the provision of a huge number of previously paid services for *free, on the basis of purchasing a cellphone and a cellphone plan. Bundling together all these final services (the things consumer actually value) there has been a massive decrease in the cost of purchasing these services. However, looking at GDP measures we would see a decline in GDP in the industries that previously provided them (eg Kodak cameras) and an increase in purchases of ICT equipment.
If we measured the final consumer service all that has happened is that prices have fallen for market provided services, and so consumer surplus would have risen. But our way of measuring doesn’t capture this reality as it is based on these intermediate product types rather than the final service to the consumer.
Erik Brynjolfsson suggests an adjusted measure, GDP-B, to augment traditional GDP for new and free goods – with the goal of more closely associating changes in the new measure with consumer surplus.
The idea behind these measures is to associate a reservation price with goods that are provided, that is estimated to be the lowest price which would have had zero quantity demanded before the product existed.
- For “new goods” this gives an indication of the reduction in the price associated with the introduction of the good, and a measure of surplus.
- For a “free good” it is necessary to calculate their compensating variation, or how much expenditure would they need in order to be indifferent to losing the good.
To estimate these, Brynjolfsson used a series of large scale, cool, experiments.
For instance, he ran an experiment with cellphone camera usage to identify the importance of quality adjustments for goods with rapid quality change. People would state an amount of money they would be willing to receive in order to avoid using the camera, and then would have their camera taped up – if they took off the tape they would forfeit the money, providing a revealed preference of their valuation!
The experiment gave a strong evidence that consumers obtain a significant amount of surplus from using their smartphone cameras.
So this replaces GDP?
Brynjolfsson, Collis and Eggers suggest that we shouldn’t be replacing GDP, but rather use a different metric to capture consumer wellbeing through consumer surplus, which in sense a new GDP-B metric does.
“We propose a way of directly measuring consumer well-being using massive online choice experiments. We find that digital goods generate a large amount of consumer welfare that is currently not captured in GDP.”
As they note “GDP is a measure of production not wellbeing”. If the question at hand is one regarding domestic production, or the use of factors of production, GDP still has a role. Additional measures are just more appropriate when we have different questions.