We see the influence of the information age everywhere. The number of people using Wikipedia, Facebook, Craigslist, Pandora, Hulu and Google only grows. And each year companies introduce thousands of new information goods and services. And yet we don’t see this influence in gross domestic product statistics. The information sector, which includes such industries as software, publishing, motion picture and sound recording, broadcasting, telecom, and information and data processing services has about the same share of the economy as it did 25 years ago -- about 4%. How is that possible?
The answer isn’t about quantity, it’s about price. Today’s information goods are supplanting those of yesterday’s -- encyclopedias, movie theaters, music CDs and newspapers. Online information may be constantly updated and accessible worldwide, but its price is usually radically lower than that of its physical counterparts.
That trend is embodied in the recording industry. In the past few years, consumers have shifted from purchasing physical media such as CDs to buying from online sources such as iTunes. In fact, when it comes to physical units like CDs, cassettes or vinyl records, sales have declined from more than 800 million units in 2004 to just 400 million units in 2008. Contrast that with how sales in paid downloads of digital songs have increased. In 2008, U.S. consumers purchased more than 1 billion digital single songs, along with more than 50 million digital albums.
Yet this increase in units hasn’t translated into more revenue -- in fact, the opposite has occurred. Record companies’ combined revenues from song sales went from $12.3 billion in 2004 to $7.4 billion in 2008 -- a 40% decline. Even if we add in digital sales made on mobile phones (including ringtones), subscriptions from services such as Napster or Rhapsody, and the digital performance royalties Pandora pays, the digital total expands by 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.
Have people stopped listening to music? Of course not. But GDP measures production’s current market value. So when you listen to a free song, you barely contribute to the GDP (besides the few fractions of a cent you use for the electricity).
Similar economics apply to reading the New York Times online. Yet if you buy the newspaper at a newsstand, you add $2 to GDP, whether or not you get around to reading it. The same goes for the Google searches you do, the Wikipedia articles you read and the Facebook photos you look at: None of them directly affect GDP because their market prices -- what you pay for them -- are zero. But that doesn’t mean they have no value.
The irony of the information age is that we know less about the economy’s value sources than we did 25 years ago. GDP more accurately measures value in industrial-age industries like steel or automobiles than in information industries. It can miss most of the value in information goods.
However, there is one measure economists have thought about for decades that could help determine these innovations’ values: consumer surplus. Consumers receive an aggregate net benefit from using goods and services after subtracting the prices they paid. That’s consumer surplus. Economists can infer consumer surplus, even if it’s difficult to measure directly, by using price experiments from purchase data, lab experiments or surveys. Consumer surplus can be enormous even if the price is low or nonexistent.
To return to the recording industry: Suppose that most people find that most of a CD’s value comes from their three favorite songs on it. Those consumers will do much better paying $3 for those three songs on iTunes than paying $18.99 for the entire CD. While most of the record company revenues disappear from GDP, consumer surplus increases enormously. That isn’t a bug in the free market system. In fact, it’s the essence of the system. As Adam Smith noted some 200 years ago, the invisible hand of competition drives producers to deliver ever more value to consumers at an ever lower cost.
If we used consumer surplus data to examine the true size of the information economy, we’d find trillions of dollars of benefits not measured in GDP statistics. That is something that over time, policy-makers and executives will need to consider when understanding how innovations affect the information economy, because what matters most in acquiring and keeping customers is the value products deliver -- even if it isn’t directly monetized into revenues.
This article is adapted from “What the GDP Gets Wrong (Why Managers Should Care),” by Erik Brynjolfsson and Adam Saunders, which appeared in the Fall 2009 issue of MIT Sloan Management Review. The complete article is available at http://sloanreview.mit.edu/smr/.