Rethinking GDP in the Digital Economy

Digital Spillover is an approach that accounts for new services and more comprehensive supply chains

Irving Wladawsky-Berger

Gross domestic product (GDP), the basic measure of a country’s overall economic output, is generally used by governments to inform their policies and decisions. “What we measure affects what we do; and if our measurements are flawed, decisions may be distorted,” noted a 2009 Commission convened to look at the adequacy of GDP as an indicator of economic performance, and led by Nobel-prize winning economists Joseph Stiglitz and Amartya Sen.

GDP is essentially a measure of production. While suitable when economies were dominated by the production of physical goods, GDP doesn’t adequately capture the growing share and variety of services and the development of increasingly complex solutions in our 21st-Century digital economy.

Economists have questioned the validity of GDP in digital economy for several years. Research by MIT IDE Director, Erik Brynjolfsson, and researchers Adam Saunders, and Avi Gannamaneni shows why GDP underestimates the value of digital goods, and proposes methods to account for what’s missing. GDP limitations were also discussed in the 2009 book, Wired for Innovation, and in earlier research reports. It has also been a topic of discussion at the World Economic Forum.

Recently, a new report, Digital Spillover, co-developed by Huawei and Oxford Economics, explores how to better define and measure the true impact of the digital economy. It argues that the scope of the digital economy is expanding and proposes a novel way of measuring its impact.

“A truly digital economy is one in which businesses from across the industrial spectrum are investing in digital and making the most productive use of it,” notes the report. “The mechanisms by which this is happening are complex and evolving. Over and above the direct productivity boost that companies enjoy from digital technologies, a more profound chain of indirect benefits also takes place, as the impact spills over within a firm, to its competitors, and throughout its supply chain. These digital spillover effects materialize through numerous channels, and are integral to understanding the role digital technologies play in the economy.”

Credit: Milken Institute Review

The report argues that digital spillover effects accelerate the transfer of knowledge and innovation throughout the global economy. They amplify the overall impact of direct technology investments beyond their original target and should therefore be included in measurements of the true size of the digital economy.

Digital spillovers come about through three key channels: internal, horizontal, and vertical.

Internal channels — Learning by doing. Companies can significantly amplify the initial gains received from their technology investments by leveraging their knowledge and experience across their different departments. Digital technologies make it possible for people to collaborate, share new ideas and learn from each other across the business, even if they’re scattered around the world.

The report cites the experiences of UPS, which invested in GPS technologies for all its vehicles to improve the tracking and efficiency of their deliveries. Over time, UPS came up with innovative ways of leveraging these vehicle technologies and the data they produced. For example, it discovered that left turns caused the trucks to spend longer periods in standing traffic and increased the chances of an accident. UPS then reconfigured its routing algorithms to decrease the number of left turns, resulting in improved productivity and safety, as well as significant reductions in fuel consumption.

Horizontal channels: Competition effects. Innovations in one company are quickly emulated by other, leading to productivity gains across the whole sector — the hallmark of a competitive marketplace. Examples abound, especially with the rise of the Internet and online applications in the 1990s. As soon as a company put up a website, offering customers the ability to access information and conduct transactions, their competitors quickly followed.

Customer self-service, for example, was the killer-app of the Internet as it was getting a foothold in the general marketplace in the mid-1990s. These kinds of applications were quite simple, yet so useful that they helped convince companies around the world that the Internet was something real. It was quite revolutionary how easy it was to now do-for-yourself so many ordinary activities that previously required a trip to a store or office, or at least a phone call during office hours. All of a sudden you could track the status of your packages, access the latest sports results, check the weather of any city in the world, or buy a book with nothing more than a browser and an Internet connection. And when done well, everybody benefited. Companies could provide superior customer service at lower costs, and their clients were happy that they could easily get whatever information they wanted any time of day or night.

Vertical channels: Supply Chain effects. Innovations in one company are quickly embraced by all the various partners in a supply chain ecosystem.

Cloud computing is a a good example of such a vertical spillover. Advances in the performance, costs, reliability and security of a cloud infrastructure benefit not only the cloud company making the investments but all its users regardless of industry. Similarly, platform advances benefit the whole platform ecosystem, including its developers and operators, as well as the providers and consumers of the products and services offered on the platform.

The report proposes a novel approach for measuring the size of the digital economy that better captures the impact of digital technologies including the various spillover effects. Their approach is based on three fairly elaborate methodologies which are explained in detail in the report. They are:

Measure the value flowing from accumulated digital assets. “Our approach estimates the value generated by businesses each year from their stock of digital assets, rather than the amount of money they spend on it.”

Expand the definition of digital assets beyond traditional national accounting definitions of ICT capital stock. This involves reclassifying certain digital expenditures that are not considered investments in pure accountancy terms.

Include the indirect spillover effects from digital assets. “Our analysis has shown that digital assets stimulate spillover effects across the entire economy. We estimate this effect by contrasting our estimate of the total returns to digital investment… with an estimate of the private returns to the stock of digital assets that companies receive.”

Continue reading the full blog, published October, 30, here.

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