By John Lourenze Poquiz
Physicists propose that the majority of the universe consists of a mysterious material called “dark matter”. These are objects that regular matter, including light, cannot interact with, making them elusive to conventional observation. Nonetheless, their existence is deduced from their gravitational influence on other celestial bodies. Drawing a parallel to the economy, a similar argument can be made regarding the value of free digital products like online maps, personal email services, and social media platforms, among others. While these products undeniably deliver significant value to consumers and industries, quantifying this value through conventional metrics such as Gross Domestic Product and household consumption remains a challenging endeavor.
The significance of free digital services in contemporary life cannot be understated. Yet, economists face a formidable challenge when it comes to quantifying the extent to which these products enhance consumer well-being. In the case of conventional goods and services, a straightforward (albeit simplistic) approach to gauge their contribution to consumer welfare is by assessing their share in GDP or household consumption. However, this approach is not suitable for free digital services due to the fact that National Accounts typically capture goods and services with market prices (with some exceptions). Consequently, this limits the ability of official statistics to accurately provide the contribution of
these free digital products to overall welfare because their prices are zero.
We tackle this challenge in our Discussion Paper by presenting a methodology for quantifying the value of digital products that are provided free of charge to consumers. Specifically, we focus on estimating the value associated with videoconferencing, personal email services, and online news platforms. Our approach ensures alignment with the accounting principles of the National Accounts. The term “value” encompasses various interpretations. In the context of our study, it refers to the value of final consumption, as defined by the System of National Accounts (SNA).
Our concept of “value” doesn’t align precisely with metrics like consumer surplus or other well-being indicators. We’ve chosen our definition to maintain consistency with other important figures in National Accounts. This approach enhances the practicality of our estimates by enabling us to compare them to the value of other goods and services included in household final consumption expenditure that are valued the same way. Think of it as akin to moving towards the idea of full consumption, a welfare- related concept that incorporates not only household final consumption but also the value of household production and leisure[1]. When it comes to productivity, adhering to the SNA standards also ensures that our estimates can be effectively compared with the value of other goods and services produced within the economy.
For our methodology, we employ the prices of “premium” or paid internet goods as a proxy for the value that derives from their free counterparts. For instance, we use the price of paid versions of Zoom as a source of valuation for its free version. This is a common approach for non-market valuation in the National Accounts. Compilers of National Accounts statistics often use market substitutes to impute the value of non-market products, such as services from owner-occupied housing, barter transactions, extraction of groundwater, and agricultural products for own consumption, among others. Compilers of the Household Satellite Accounts also use this strategy to value household services such as childcare. As such, valuation based on this strategy is fully consistent with the SNA’s accounting framework.
We also use hedonic regression to extract the value of the free component from these goods and untangle them from the value of the premium-exclusive component. Hedonic regression is an econometric approach wherein the price of a good is expressed as a function of its characteristics[2], with the goal of estimating the price, or willingness to pay for the set of “characteristics” included in the specification.
Our estimates show that in 2020, the aggregate gross value derived by households from the consumption of the three forms of digital services was between £7 billion to £25.4 billion. This is around 1.1 to 2 percent of UK household final consumption. We also observe that the value derived by households from consuming these goods is growing much faster than aggregate household consumption. For context, the lower limit of our estimates is already 30 percent of total final consumption expenditures for communications, which is at £28.6 billion. Meanwhile, the upper limit almost exceeds the value of the same expenditure item.
We also find that during the initial year of the pandemic, real household final consumption decline would have been 0.07 to 0.13 percentage points less had the value of the three digital goods been incorporated in the estimates. This tells us that the availability of free internet services was partially able to reduce welfare loss during the lockdown.
Is there a risk of double counting with this approach? After all, many of these products rely on advertising and marketing expenditures, which are already factored into GDP estimates. While some elements of these services are indeed included in GDP, a key question arises: to what extent do they benefit households? Typically, advertising costs are embedded within the value of the advertised product itself. For example, the expenses related to advertising a burger are often reflected in the price of that burger. As such, we cannot see the direct link between households and digital products using conventional National Accounts estimates.
One potential solution is to record advertising expenditures, used to finance these free services, as part of final consumption. This approach would align with National Accounting principles as some non-market output, such as government output, are recorded at cost. However, it’s worth noting that since the marginal cost of operating these services is close to zero, the added value from an additional user might have minimal impact on the overall estimate. Consequently, this approach has limitations in accurately reflecting welfare gains. It’s worth recalling that global advertising expenditure decreased during the COVID-19 pandemic, despite our increased usage of these services. Having advertising expenditures represent the value of free digital products to households may provide a counterintuitive story.
Although we acknowledge that our estimates are not perfect in gauging the overall well-being households derive from free digital goods, we believe that they do have their merits. First, when viewed over time, the aggregate resulting from our estimation method can function as an indicator of the rate at which the value offered by free digital goods is increasing. Additionally, we can compare these estimates with other household consumption items in the National Accounts, granting us insights into the role of free digital products in economic activity. As we delve into this economic cosmic puzzle, we are reminded that the invisible doesn’t equate to insignificance.
The Discussion Paper can be downloaded here.
ESCoE blogs are published to further debate. Any views expressed are solely those of the author(s) and so cannot be taken to represent those of the ESCoE, its partner institutions or the Office for National Statistics.
[1] Becker, G. S. (1965). A Theory of the Allocation of Time. The Economic Journal, 75(299), 493-517.
[2] In this context, characteristics are features that describe the good. For cell phones, they can be RAM, storage space, camera quality, etc.