Economists Don't Understand The Information Age, So Their Claims About Today's Economy Are A Joke

from the if-you're-using-gdp,-you're-missing-the-point dept

For years we've pointed out how GDP (Gross Domestic Product) isn't a great way to measure the economy, especially in the digital age. Even if we assume that GDP can be calculated accurately (and, really, it can't), it's an aggregate piece of information, hiding lots of important things underneath. In the extreme, you could have one massively wealthy person who collects all the money, while everyone else has no money, and you could still see a "healthy" economy in GDP terms. Even worse, when it comes to the information age, GDP calculations get... both terrible and terribly misleading. Part of the problem is assuming that value only comes from things that are paid for. There's always been some element of this problem in traditional GDP calculations when dealing with more informal economies (how do you calculate the GDP of a stay-at-home parent who cares for a kid and cooks the meals?). But, when it comes to the information age, this issue has grown exponentially -- especially since so much online is "free to the user."

On top of that, the ongoing march of technology continues to make things cheaper and better (yay, Moore's Law), but getting a computer that's twice as powerful for half the price shows up in GDP calculations as half the economic output, rather than 4x the value. That's why it's great to see economic historian Joel Mokyr take this issue on in a great Wall Street Journal piece pointing out that too many economists focus on GDP and don't understand the information age.

Many new goods and services are expensive to design, but once they work, they can be copied at very low or zero cost. That means they tend to contribute little to measured output even if their impact on consumer welfare is very large. Economic assessment based on aggregates such as gross domestic product will become increasingly misleading, as innovation accelerates. Dealing with altogether new goods and services was not what these numbers were designed for, despite heroic efforts by Bureau of Labor Statistics statisticians.

The aggregate statistics miss most of what is interesting. Here is one example: If telecommuting or driverless cars were to cut the average time Americans spend commuting in half, it would not show up in the national income accounts—but it would make millions of Americans substantially better off. Technology is not our enemy. It is our best hope.

Mokyr is one of the best of the best, and I've often found myself recommending his books (The Lever of Riches: Technological Creativity and Economic Progress is a personal favorite), and this is another great example of his work.

And, yes, economists will argue that they understand the problems of GDP, and yet they still rely on it, because there isn't something better. As we've noted, however, when you have a bad metric, even if you know it's a bad metric, you still tend to optimize for that metric. Because that's what you have. Yet optimizing for GDP could actually limit and hinder innovation, creating results that are actually negative for the well being of the public, just because of the impact on GDP.

And that leads to bad policies, misdirected concerns and dangerous views on innovation itself.

Filed Under: economics, efficiency, gdp, innovation, joel mokyr, marginal cost, technology

Economist: Copyright Is An Antiquated Relic That Has No Place In The Digital Age

from the modern-mercantilism dept

For many years I've been pointing out the basics of economics concerning concepts like "free" and the importance of marginal cost to pricing in an efficient market. After one such recent post, I got an angry email from a college professor who has worked in the entertainment industry for many years, telling me that clearly I had never taken an economics class. That, of course, is not true. I took a great many economics classes, and learned the economics I talk about here on the site from some of the best economists around. Either way, I do wonder what this same individual would say upon reading well known (and greatly respected) economist Dean Baker's latest column about how The Pirate Party has got it right on copyright:

Near the top of the list of the Pirate Party's demons is copyright protection, and rightly so. Copyright protection is an antiquated relic of the late Middle Ages that has no place in the digital era. It is debatable whether such government-granted monopolies were ever the best way to finance the production of creative and artistic work, but now that the internet will allow this material to be instantly transferred at zero cost anywhere in the world, copyrights are clearly a counter-productive restraint on technology.

As every graduate of an introductory economics class knows, the market works best when items sell at their marginal cost. That means we maximize efficiency when recorded music, movies, video games and software are available to users at zero cost. The fees that the government allows copyright holders to impose create economic distortions in the same way that tariffs on imported cars or clothes lead to economic distortions.

The major difference is that the distortions from copyright protection are much larger. While tariffs on cars or clothes would rarely exceed 20-30 per cent, the additional cost imposed by copyright protection is the price of the product. Movies that would be free in a world without copyright protection can cost $20-$30. The same is true of video games, and the price of copyrighted software can run into the thousands of dollars.

Baker goes on to suggest some alternative means to fund such creative works in a world without copyright, including ideas like "artistic freedom vouchers" that would give people a refundable tax credit on supporting creativity, on the condition that any of the creativity funded by such money would not be able to protect it with copyright for a period of time. I find such program interesting, though I do wonder if they'd even be necessary. As we've been seeing over and over again, all sorts of interesting new business models are springing up that have nothing to do with copyright. As there is demand for creativity, I fully expect more and more such models to continue to show up as well. What I fear is that the focus by those who benefit excessively from the monopoly rents and protectionism of copyright, will lead to cutting off innovation or killing off interesting and more efficient business models, before they have a chance to evolve.

Contrary to what some like to say about me, I am not convinced that copyright should be done away with completely. I do think that it needs significant reform. I just want that reform to be based on actual evidence and understanding of basic economics rather than faith and the demands of those who have benefited excessively from it, over those who have been held back because of it.

Filed Under: dean baker, economics, free, marginal cost, pirate party

Android, Economic Moats, And How Zero Marginal Cost Defenses Can Also Be Great Offenses

from the ain't-just-defensive dept

Venture capitalist Bill Gurley has another excellent economic analysis of how powerful Android is and what it really means for Google. I have one (somewhat serious) quibble with it, in that I actually think Gurley misses the key economic point that would have made his argument even more convincing, but I'll get to that later on. The key points he makes are dead on, and should be recognizable to regular readers of this blog on our economic analysis of zero marginal cost products.

He kicks it off with a general business observation from Warren Buffet:

One of Warren Buffet's most famous quotes is that "In business, I look for economic castles protected by unbreachable 'moats'." An "economic castle" is a great business, and the "unbreachable moat" is the strategy or market dynamic that heightens the barriers-to-entry and makes it difficult or ideally impossible to compete with, or gain access to, the economic castle....

For Google, the economic castle is clearly the search business, augmented by its amazing AdWords monetization framework. Because of its clear network effect, and amazing price optimization (though the customer bidding process), this machine is a monster. Also, because of its far-reaching usage both on and off of Google, AdWords has a volume advantage as well. Perhaps the most telling map with regards to the location of the castle can be found in Jonathan Rosenberg's "Meaning of Open" blog post. In this open manifesto, Jonathan opines over and over again that open systems unquestionably result in the very best solutions for end customers. That is with one exception. "In many cases, most notably our search and ads products, opening up the code would not contribute to these goals and would actually hurt users." As Rodney Dangerfield said in Caddyshack, "It looks good on you, though."

From there, Gurley points out that pretty much all of Google's other products are effectively that "moat." They're the things that keep bringing you back to Google's search and ad products. And that's where Android fits in:

So here is the kicker. Android, as well as Chrome and Chrome OS for that matter, are not "products" in the classic business sense. They have no plan to become their own "economic castles." Rather they are very expensive and very aggressive "moats," funded by the height and magnitude of Google's castle. Google's aim is defensive not offensive. They are not trying to make a profit on Android or Chrome. They want to take any layer that lives between themselves and the consumer and make it free (or even less than free). Because these layers are basically software products with no variable costs, this is a very viable defensive strategy. In essence, they are not just building a moat; Google is also scorching the earth for 250 miles around the outside of the castle to ensure no one can approach it. And best I can tell, they are doing a damn good job of it.

From there, he points out, that this makes it difficult for anyone else "trying to extract economic rent for a competitive product in the same market." Indeed. And while that may raise some antitrust alarm bells, Gurley later points out why it should not:

One might yearn to suggest that there is a market unjust here that should be investigated by some government entity, but let us not forget that the consumer is not harmed here -- in fact far from it. The consumer is getting great software at the cheapest price possible. Free. The consumer might be harmed if this activity were prevented. And as we just suggested above, the market is finally driving towards software pricing that represents "perfect competition."

I actually think there's a decent retort to this, which is that someone could say that this moat situation means that others cannot get into the market at all, and thus consumers could be hurt in the decrease of competition, which could mean that certain innovations don't make the market and/or that Google begins to stagnate on innovation as it faces no serious competition in those areas. To date, however, I don't believe there's much evidence that this is happening with Google (though, it is an area worth watching carefully).

But, really, what Gurley is describing is the same stuff that we've been talking about for over a decade: it's the natural economics of digital goods. Over time, someone will figure out a way to price those goods at the marginal cost of zero, and use that to support some other business. So, if you're sitting around hoping to charge for those goods, you're going to be left out in the cold. We know that argument and live that argument, though it's always nice to see it being validated yet again in real life.

But here's the key point that I think Gurley is missing, and which would have made his argument even stronger. Above, I bolded the line in his writeup that said that "Google's aim is defensive not offensive," with these products. I think he's actually underestimating Google here. These moves are both defensive and offensive (the best offense is a good defense, right?), though not in the traditional way of trying to directly monetize those offerings. It's that those "free" or abundant goods don't just act as a defensive shield, but they can also make the scarce "castle" good much more valuable. If we're sticking with the moat analogy, it's a situation where the moat not only acts as a defense, but it also serves to float the castle to even higher levels.

We've described this in other fields many times. For example, in a simplistic example, with music, freeing up the music makes it easier to spread the music, build a bigger fan base, and then increase the value of the scarcities around the musician (so they can make more on tour or through merch or more creative business models).

And I think that's certainly true with Android as well. It doesn't just build a "moat" around Google search/AdWords that protects that business, but it actually enhances those businesses and makes them more valuable directly. It does those things by extending the availability and usage of such businesses (I do searches on the go from my phone all the time these days), but also opens up those businesses to scenarios where they never would have been useful before at all.

So I agree with Gurley's basic premise, that making use of such zero marginal cost infinitely available goods by embracing their free nature acts as a very powerful moat, but I think he underestimates how much of an offensive play it is in not just protecting the castle, but vastly enhancing the castle's offensive power as well.

Filed Under: android, competition, economics, free, marginal cost
Companies: google