Measuring the economy of the 21st Century.

• Author: Hulten, Charles R.
• Position: Program Report

The first meeting of the Conference on Research in Income and Wealth (CRIW) occurred in late January of 1936 in the midst of the Great Depression. The general objective of the conferees at this meeting and those that followed was to help fill the void created by the absence of a national statistical system. The CRIW provided conceptual support for the task of developing such a system, and a complex task it was indeed. A national economy is a system of interconnected flows of quantities and payments involving a vast number of goods and services. Fitting all this together into a national accounting framework has justifiably been called one of the "great inventions of the 20th Century." (1)

We are now well into the 21st century, and as with many other great inventions, there are constant challenges in updating the national statistical system to reflect the current technological environment. GDP is an aggregate measure of the flows of goods and services through product and factor markets, one that provides a statistical portrait of the economy as it evolves over time. However, the process of evolution itself has altered these flows in ways that undermine the accuracy or relevance of past concepts and data sources. The rapid transformation of the U.S. economy brought about by the revolution in information technology has introduced a profusion of new products and processes, new market channels, and greater organizational complexity. Parts of the statistical system are struggling to keep up.

The problem is nowhere more evident than in the difficulties associated with the Internet's contribution to GDP. Valuing the 'net and the wide range of applications offered with little or no direct charge is challenging because there is no reliable monetary yardstick to guide measurement, and their omission or undervaluation surely affects GDP.

This is important for the recent debate over future living standards and employment. The two percent growth rate of real U.S. GDP since the end of the Great Recession has lagged the long-term historical rate of three percent, inviting speculation about the emergence of a New Normal. [See Figure 1.] This view is reinforced by Robert Gordon's recent suggestion that the growth effects of the information revolution are not of the same order of importance as those of previous technological revolutions and are, in any event, playing out. (2) The future may look very different if recent GDP growth is significantly understated because of the mismeasurement of new goods and services.

Sorting out the many issues involved in "measuring" the economy of the 21st century has dominated the CRIW agenda since the early stages of the information revolution; it is a large job, and will occupy the CRIW for years to come. Past and current efforts are reviewed in this summary, starting with the importance of accurately accounting for new goods and improvements in the quality of existing ones, and the related problem of measuring the output of the service-producing sectors of the economy. The following sections take a closer look at three of the most important service sectors: health care, education, and finance. Subsequent sections focus on capital and labor in the new economy, the role of entrepreneurship and company formation, and the problem of national income accounting in an increasingly globalized world. A final section sums up.

New Goods and Quality Change

In his discussion of "Effects of the Progress of Improvement upon the Real Price of Manufactures" in The Wealth of Nations, Adam Smith dodged the problem of changing product quality by saying "Quality, however, is so very disputable a matter, that I look upon all information of this kind as somewhat uncertain." (3) He was referring to price trends in the production of cloth, but fast-forward more than two centuries, to William Nordhaus writing on the history of lighting, when he argues that official price indexes may "miss the most important revolutions in economic history" because of the way they are constructed. (4) The quality problem endures and, if anything, has gotten more difficult with the profusion of new and improved goods.

The quality change problem arises when a new version of a good is introduced that embodies characteristics that make it more desirable. The new model may not cost much more than the old, but represents a greater effective amount of output from the user's standpoint. If the price per unit transacted in the market does not change, the substitution of a new unit for an older model will not affect either nominal or apparent real GDP, because the apparent market price has not changed. However, effective real output has increased, and the benefits of the innovation are lost in the official data. Personal computers are an important example, and in the mid-1980s, the Bureau of Economic Analysis began adjusting computer prices to better reflect the technological gains in computing power.

The new goods variant of the product innovation problem is even more challenging because, unlike the quality change problem, there are no prior versions of the good on which to base price comparisons. Current procedures for incorporating new goods into existing price indexes are complicated, but may miss much of the value of these innovations. At the same CRIW meeting at which Nordhaus examined the history of lighting, Jerry Hausman examined the introduction of a new brand of breakfast cereal and found that the treatment (or non-treatment) of new goods in official statistics resulted in a 20 percent upward bias in that component of the Consumer Price Index. (5) He arrived at a similar conclusion in a subsequent paper on mobile cellular telephones, though the magnitude of the bias is larger. (6) By implication, the benefits of important new information technology goods, like the Internet and the many applications it enables, may be subject to significant undervaluation.

Papers on various aspects of price measurement have appeared frequently in other CRIW proceedings, and in 2004 the CRIW hosted a conference on Price Index Concepts and Measurement devoted to the subject. (7) Papers in the resulting volume, published in 2009, ranged over theoretical areas in price measurement, from the reassessment of quality change in computer prices and the issue of outlet substitution bias to measurement problems in specific applications in finance, health, and education. (8) An earlier volume, Hard-to-Measure Goods and Services: Essays in Honor of Zvi Griliches...