Unseen riches.

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The Internet's Hidden Wealth

Noah Smith is a Bloomberg View columnist. He was an assistant professor of finance at Stony Brook University, and he blogs at Noahpinion.
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The question of whether economic growth is stagnating probably hinges on the answer to another question: How much hidden value is being created by the Internet. 

The stagnationists, most prominently Robert Gordon of Northwestern University, claim to have the numbers on their side. People spend a relatively small fraction of their income on online services. Most of what we consume online is free. Facebook is free. Bloomberg View is free. If these goods are so valuable, why aren’t people being charged for them (or for the Internet access that lets you use them, which is typically a tiny share of one’s income)? 

One possible answer is that Internet services generate a large amount of consumer surplus. Consumer surplus is where consumers get a lot more value than what they pay for. If you would be willing to pay $1,000 for the new iPhone, but it only costs $600, you effectively get a $400 bonus. An extreme example is the air you breathe. You pay nothing for air, but you’d be willing to pay almost anything if you had to. The total value of the air is huge, even though the amount we pay is essentially zero. 

So the creation of the Internet, and all of the related services, might be generating a huge consumer surplus. Tyler Cowen, author of the book "The Great Stagnation," is skeptical of this story. He writes:

Might the consumer surplus [from the internet] be especially high?...I did some casual googling, and found a number of estimates suggesting that smart phone demand is relatively price elastic...That implies consumer surplus isn’t especially high, because many people aren’t willing to buy at the higher price...You also could look at the literature on the demand for cable internet services.  The results are mixed, but again I don’t see a strong case for a disproportionately high consumer surplus from these services, if anything the contrary.

In other words, for products such as cable Internet and Samsung Galaxy smartphones, a small rise in price results in a big drop in demand. That’s very different from, say, the air, which you would keep breathing in just about the same amount no matter how expensive it got. If people are willing to abandon products just to save a few bucks, the hidden benefit of those products just can’t be that high. 

But there’s a problem with studies like these. There might be a lot of close substitutes for the goods considered in the studies. If I don’t get cable Internet, I can get DSL, or a fiber-optic Internet connection. If I don’t get a Samsung Galaxy I can get an iPhone. If my home Internet connection gets cut off, I can use my phone for a lot of things. 

When we’re asking about the consumer surplus created by the Internet, we should look at the price elasticity of the entire Internet. How much would people collectively pay to avoid being utterly, totally cut off from the entire Internet -- mobile phones, browsers, e-mail, the works -- for all leisure purposes? That answer is very hard to know, because we can’t actually observe that situation. 

One other wrinkle in the story is that there is one huge important thing that gross domestic product fails to account for: time. It’s obvious that we spend a lot of time online. Think of how much of your day you spend checking your phone, reading e-mail, scanning Facebook or watching streaming videos. It’s a little hard to believe that we would spend an enormous percentage of our lives using something that creates very little value for us. 

Two well-known economists, Austan Goolsbee and Peter Klenow, decided to look at this issue back in 2006. Making some assumptions about how much people value leisure time, they estimated the consumer surplus from Internet services in terms of both time and money. They found that the surplus from the Internet was 10 times higher than previous estimates. 

The number they found was still fairly small -- only 2 percent of people’s annual income. But this was back in 2006, when fewer people were online, and people spent less time online. It was before the explosive growth of social media. It was before the widespread adoption of smartphones. It was also before streaming became big. 

So there are at least two reasons to think that the value of the Internet is higher than the numbers would seem to indicate based on consumer spending. That could be very important, because if it’s true, it means our economy hasn’t stagnated nearly as much in the past decade as the headline numbers seem to suggest. 

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Noah Smith at nsmith150@bloomberg.net

To contact the editor on this story:
James Greiff at jgreiff@bloomberg.net