Our techniques for measuring economic performance are obsolete. So we reach improper conclusions about the state of the economy.
The economic recovery is probably more robust than we realize. It is possible that the standard of living for many members of the middle class is improving while their incomes shrink. Many economists, policy makers, and politicians think otherwise, because they are using 20th-century methods to analyze our 21st-century economy.
The problem is caused by the fact that we live in two worlds, physical and virtual.
The physical economy is anemic, struggling, biased toward inflation, and shrinking in many developed countries. Almost everything we do in the physical economy is paid for with money. We use dollars to measure most of the activity. If more dollars are spent or earned, we conclude that the economy is growing.
The virtual economy is robust, biased toward deflation, and growing at staggering rates, everywhere. A lot of the services provided to us in the virtual economy are free. If we paid dollars for those services, they would be counted as part of the GDP and would add to economic growth. But we don’t so they are not counted.
Using the virtual economy in place of the physical economy enables consumers to save lots of money. For example, consumers can substitute Google News for their newspaper. The cost of a USA Today subscription is $275. His earnings will look the same, but he has more money at his disposal and more or less the same consumption. Essentially, he is earning more, but neither his income nor GDP will show it.
For a very long time, economists have realized, understood, and debated this measurement problem. Nobel Prize winner Joseph Stiglitz has advocated an overhaul of our economic statistics. Others have advocated the use of a human development index to compensate for some of the problems associated with the use of GDP.
For numerous reasons, government scorekeepers have chosen to ignore many of the issues associated with free goods and declining costs. They are difficult to measure. Even more importantly, in the past, they did not appear to have an important effect so they could be safely disregarded. This is no longer the case.
The big change is the virtual economy. It has become very large and is having a broad impact. We must take it into account. Failure to do so will cause us to reach wrong conclusions, make policy errors, and feel unduly pessimistic about the state of things.
The current measurement systems ignore our virtual salaries. We earn these salaries by selling our privacy and attention for zero and spending hours deleting targeted emails. Using those salaries, we purchase services that are worth billions—searches on Google, residences on social networks, free email, information storage on Dropbox, phone calls on Skype, free text messages on WhatsApp, free music, reviews on Yelp, and free movies and viewing of TV series.
If advertisers paid us directly for the sale of our privacy and attention and we turned around and spent the money to purchase Google searches, music, and phone calls, the government would count both our pay as income and the sale of the services as part of the GDP.