Wednesday, August 31, 2016

No, social media is not undervalued in GDP

There's an argument rattling around the Interwebz suggesting that the observed slowdown in productivity growth is, at least in part, a statistical illusion arising from the fact that users don't pay to use Twitter or Facebook.  Or Blogger (to chose a free blogging platform totally at random; I mean, who uses Blogger these days?).

I'm skeptical.

First, let's keep in mind that, when we talk about GDP, we're talking about the market value of goods and services, not their value value.  It's no objection to say that the market value of social media differs from its "real" value -- that's true of literally everything that composes GDP.  It's perfectly valid to argue that GDP is a meaningless construct, at best reifying the current distribution of income and wealth, and at worst merely an exercise in adding apples to oranges because it's easier for our simple brains to think about one number than about two (1).  But it's an entirely different matter to claim that a particular component is being mis-measured.

The usual argument about social media is that, surely, some users would be willing and able to pay to use it.  Ability and willingness to pay for something is, more or less, the definition of market value.  So, to the extent that these users get something they would pay for for free, there is unmeasured economic output being created and consumed.

And that's fine as far as it goes.  However, it's important to keep in mind that a social media property "creates value" for multiple groups of consumers: at minimum, for both users and advertisers.  The total value produced is the sum of the value delivered to all of the consumers.  And that brings us to the question of pricing strategy.

To talk about pricing strategy, I'm going to make up a hypothetical social media property.  My business plan is to combine the decorum and wit of Twitter with Facebook's custom of conducting unauthorized psychological experiments on its users.  Naturally, we will call this transformative platform "TwitBook." (Tagline: "Giving dude-bros and mean girls the social media experience they deserve.")

Now, TwitBook will need to set some prices.  What should we charge users for this unique and innovative experience?  What should we charge advertisers for the opportunity to reach our bizarrely sought-after demographic?  And finally, what should we charge non-participating audience members for the chance to observe the hijinks in real time, much as they might watch a reality TV show or monster truck rally?  OK, I'm kidding about the third one.  Sort of.

To devise this strategy, I'm going to hire the most ruthless greed-heads in sharp suits that I can find.  (Or, as an economist might say, "Assume firms maximize profit, pi, defined as total revenue (TR) less total cost (TC)."  The bit about the sharp suits is, formally, exogenous.)  My greedy minions quickly arrive at two important conclusions.

First, because of the nature of the business, we have unprecedented technical flexibility in price setting.  We can meter literally everything a user does (including interactions with advertisements), and payment processing has never been easier.  This is probably the first industry ever in which implementing a truly optimal price structure is technologically feasible.

Second, there is an inconvenient tension between the prices we charge users and the prices we charge advertisers.  The more we charge our users, the fewer users we will have (because the elasticity of demand is, if not infinite, quite far from zero), and the less we can charge the advertisers.

"Very insightful," I say to my sharp-suited legion of doom, "but I didn't hire you for your penetrating understanding of market mechanisms; I hired you to make me very, very rich.  I don't care whether my money comes from users, advertisers, or space aliens.  Or from spectators, if you can figure out how to make the whole monster truck angle work.  Just find the set of prices that maximizes the total value of the platform."

"You bet, boss," say my compliant lackeys, because that's how my imaginary friends talk.  In my imagination.  Stop looking at me like that.

Soon, they're back with the a pricing structure...and the weird bit is that all of the user-facing prices are zero.  I'm disappointed, because the idea of dude-bros and mean girls literally paying me to run experiments on them made me alarmingly gleeful.  But business is business.

Still, I want an explanation.

"Yes, your highness," say my imaginary business strategists, because now they've started mocking me.  "Our users do value the platform," they explain, as if to a small child, "but not very much, is all."  (If they weren't talking to me as if I were a small child, they'd probably add something clever sounding like, "at the margin."  Jerks.)  "Charging users even the tiniest amount actually reduces the total value of the platform, since the loss of value to the advertisers is measurably higher than the user-revenue we gain."

The upshot of all this is that their advertising revenue is actually a pretty good indicator of the total "value created" by platforms like Facebook and Twitter.  Nobody is leaving "unpriced value" on the table.

But what about consumer surplus?  The fact that the marginal Facebook user places a value of approximately zero on the service doesn't mean that lots of people don't love Facebook.  Surely that must count for something!  But social media is hardly the only industry to yield a large-ish consumer surplus.  Agriculture (a.k.a. "food") comes to mind.  And more generally, the consumer surplus argument is really just another version of the point that "market value is not value value," which is true, but irrelevant to the measurement (or mis-measurement) of GDP.

So I'm inclined to doubt that the growth of social media leads us to systematically underestimate growth, productivity, or the growth of productivity.  In fact, there's a stronger argument for the reverse.

Time is the universally binding budget constraint: there aren't any more hours in the day than there were in 1972 (or in 1066, or in 800 BCE).  Consequently, people's consumption of social media comes at the expense of other activities, notably at the expense of watching broadcast television.

Now, in terms of pricing, TV looks a lot like social media: it's advertising supported and free-to-consume for viewers.  However, there is a major technical difference:  charging users to view broadcast television has been infeasible until very recently.  So, while we know that the observed pricing structure for social media is optimal (or, at least, unconstrained by the feasibility of monitoring and billing for usage), we do not know this for broadcast TV.  That is, the argument that advertiser-supported media is undervalued in the economic statistics applies with much more force to broadcast TV than it does to social media.  And the fact that people turn out to be willing to pay for commercial-supported cable channels suggests that broadcast TV has been undervalued for decades.

So the real story of bias in GDP measurement is the decline of an undervalued product (broadcast TV) in favor of  a properly valued one (social media), which means that economic and productivity growth are both being systematically overstated.

Now, I'm not persuaded that this is, quantitatively, a very important phenomenon.  But it does leave me skeptical of the notion that free stuff on the Internet is somehow concealing a productivity bonanza from the national income and product accounts.

(1) What to make of the fact that I score intellectual laziness as "worse" than disingenuously naturalizing the social status quo is left as an exercise to the reader.