Why we’re measuring the digital economy in the wrong way

The economics of sharing

To leave aside companies we might have heard of, consider one that is only rumoured to exist, at least as far as I know. This company noted that many households contain an electric drill. That drill gets used perhaps 20 minutes a year. So, why not set up a “dating service” for electric drills – those who need one to put up an Ikea bookcase wrongly can have one for 20 minutes, paying a fee for the rental.

At which point, here’s a bit of background economics. How much we can consume is obviously determined by how much is produced. How much is produced depends on how many people are producing and for how long and how efficiently. That efficiency depends on the capital added to that labour and the technology we have for organising all these things happening. The “how many people?” question is demographics and not our subject here, but that efficiency can be described in the jargon of the Solow Residual.

The idea is that if we have the same amount of labour, working the same hours, and the same amount of capital being used, what happens if we just get more efficient at combining them? We have an increase in production – and therefore potential consumption – without using more labour or capital. This is called an increase in the Solow Residual. It’s called a residual because we’re really not sure how it works, we just know it’s there.

Our drill rental company manages this. We have no more capital, no more machinery and we’re using the same amount of labour to drill the holes in the wall, but we have an increase in output and more holes in the wall, which means an increase in the Solow Residual. We’ve done this by our smartphone drill-sharing app, which has brought previously underused capital assets into use. We’re all richer as a result – we’re a bookcase up and no one’s had to manufacture a drill to do it.

It can get more complicated when we consider other similar companies, such as Airbnb, Uber and so on. How much of their output is simply displacement from taxis and hotels, what is the depreciation on the cars, what would that labour have been doing otherwise – the great economists’ cry of “opportunity costs” – but the essential condition holds true. We’re sweating assets better than we did before and producing more that can be consumed, thus we’re all richer.

This doesn’t mean GDP goes up, but that’s a problem with GDP as a measure and nothing else. For, as has been noted by others, while we can all see the spectacular productivity and technological changes going on around us, the only place we can’t see them is in the economic numbers such as GDP.

Mis-measuring the value of technology

Netscape founder and tech entrepreneur Marc Andreessen and I tried to puzzle through this once, and the answer is that there’s too much we don’t include in GDP, or mis-measure when we do.

Keynes said that when a person marries their housekeeper, GDP goes down. This is because GDP only measures monetised activity, and the cooking and cleaning (and whatever else) is now being done inside the married household where we don’t count it, rather than being a transaction in the market. So the expensive vacuum cleaner, the microwave and the drip-dry clothes that reduce household labour don’t turn up in GDP.

This is also true of much modern software technology. We don’t measure in GDP the addition of Google or Facebook to the enjoyment of our lives. We measure instead the advertising they sell and call that the addition to GDP, because that’s the monetised part of the transaction. But who actually values either of those two companies at the perhaps $10 a year of advertising they show us each? The rest of that value is in what is called the consumer surplus.

This is the amount that we value a thing, over and above what we’ve had to pay for it. We must value something at more than we pay for it otherwise we wouldn’t buy it. The general assumption is the consumer surplus is double whatever we paid for it. Therefore, the real amount that we get to consume is twice GDP – that is, GDP itself plus the consumer surplus, the value we get to enjoy without having paid for it. But with what are now called, as a result of our conversation, Andreessenian Goods, those Facebooks and Googles where we know we’re mis-measuring the value produced, that consumer surplus might be 20 or 50 times the amount that’s recorded in GDP.

This is where the value of technological change and productivity growth is in GDP, but it’s not there because we’re not measuring the right thing as part of GDP. Equally, we’re not properly capturing the growth in our wealth from the sharing economy because we are getting more output from the same inputs of labour and capital – and that’s the very definition of wealth creation. It’s a rise in that Solow Residual.