(Bloomberg View) — 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:
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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.