06 June 2019
New method to compute GDP
Source: By Sandipan Deb: Mint
The gross domestic product (GDP) of a country is often seen as the one statistic to end them all. Gigantic amounts of mindspace are devoted to this one number. But does the GDP give a fair monetary measure of the market value of all the final goods and services produced in a period of time in a country? This question has become extremely relevant as the world has grown more and more digitized.
The concept of GDP was invented in 1937 by US economist Simon Kuznets, who was awarded the Nobel Prize for Economics in 1971. In 1944, following the Bretton Woods conference that established the World Bank and the International Monetary Fund, GDP became the standard tool for sizing up a country’s economy. However, the world economy has changed spectacularly since then and that change is accelerating. In April last year, British bank Barclays in its annual economic report said that, quantifying the contribution of digital goods and services (which are often consumed for free) poses a challenge of “unprecedented scope and scale". After all, the economic indicators used to measure GDP are still stuck in the manufacturing age.
Basic economic theory sets the price of a good in demand at the marginal cost to produce it. Digital goods have a fixed cost at the start, but often there is zero or near-zero marginal costs. Digital products also don’t suffer from scarcity issues and are cheap or free to transport across large distances. The difficulty of pricing digital goods properly probably leads to an underestimation of GDP, Barclays says. What is the scale of the potential miscalculation?Hard to judge but the gap will keep getting bigger as the digital economy expands.
But there are some ideas being floated about new computational methods for GDP. One of them is “GDP-B", developed by MIT economist Erik Brynjolfsson. It aims to capture the financial value of the things we don’t pay for but still have plenty of value, such as social media, online maps, Wikipedia and so on. In an interview with qz.com, Brynjolfsson explained: “The problem is that, which relationship of more GDP leading to more welfare is not true for digital goods in the way it is for physical goods. And that’s because digital goods have zero price. So if there are twice as many people reading Wikipedia, it doesn’t really change GDP at all… According to the (US) Bureau of Economic Analysis, there’s a category of all information goods that was about 4.6% of the economy back in the early 1980s. Today, it is (still) 4.6%."
In the meantime, with the rise of zero-price online services such as YouTube, Spotify and Wikipedia, priced industries like music, media (CD, DVD) and encyclopedias—and their contribution to GDP—have shrunk dramatically. This is while consumers have access to better quality and much greater choice.
“[GDP is] measuring what we spend," says Brynjolfsson. “[But] production and spending aren’t everything…You need a dashboard with different metrics. What we’re measuring are the benefits you get even when you spend nothing on the good. When you get a smartphone today, most of the value comes from all of the software and the apps that are on it. GDP is measuring [only] the hardware costs…If we don’t measure [the software value]; we’re going to completely misunderstand what we’re dealing with."
The key, obviously, is putting a price to these services—how much a person would be willing to be paid to give up a service. Brynjolfsson started his pricing quest with Facebook with a two-year study in the US. In fact, he has recently posited that welfare gains from Facebook would have added between 0.05 and 0.11 percentage points per year to US GDP since 2004.
Brynjolfsson and his team have now conducted a lab experiment in the Netherlands, mostly using students. They found that WhatsApp, Facebook and digital maps on phones were highly valued, requiring a median compensation for losing one month of access of $602, $109, and $66 respectively. The researchers admitted that the sample size was small and non-representative. However, as the study team put it, “Our overall analyses reveal that digital goods have created large gains in well-being that are not reflected in conventional measures of GDP. By periodically querying a large, representative sample of goods and services, including those which are not priced, changes in consumer surplus and other new measures of well-being derived from these online choice experiments have the potential for providing cost-effective supplements to the existing national income and product accounts." Clearly, lots more work needs to be done.
Brynjolfsson believes that using GDP-B alongside GDP will give a much more realistic idea of what creates value and what doesn’t. If the world finally accepts some form of GDP-B, it may change the ways governments invest. Says Brynjolfsson: “There will be an opportunity to be much more realistic about…how we are allocating our resources to benefit as many people as possible". GDP has been called one of the greatest ideas of the 20th century. For the 21st, we need a GDP 2.0.