We are paying for free entertainment with lower productivity

Łukasz Rachel (©Archiwum prywatne)

Obserwator Finansowy: What is the Solow paradox?

Łukasz Rachel: Robert Solow, the American Nobel laureate in economics, famously said that we “can see the computer age everywhere but in the productivity statistics.” He meant that we are all aware of the fact that in our times technology is developing so rapidly that it is transforming our reality in a fundamental way. It is plain for everyone to see. Yet, at the same time, as economists we are talking about a slowdown in the rate of productivity growth. We look at the data and the technological progress simply isn’t visible there. The Solow paradox therefore expresses the dissonance between what people infer from their own experience and what is indicated by the data.

You’re researching the effects that leisure-enhancing technologies have on productivity. How should we understand this distinction?

The starting point for my research is the assumption that it’s worth separating technologies that are specifically targeted at some sort of leisure and entertainment activities from all other technologies. With this distinction, it is possible to rationalize the aforementioned paradox.

For me the fundamental difference between leisure-enhancing technologies and all the other technologies lies in the way in which they generate profits. In the case of traditional technologies, revenues depend directly on the number of customers buying a given product. Meanwhile, leisure-enhancing technologies are largely available to users for free, and the profits they bring to their owners come from the fact that they capture their users’ time and attention. These, in turn, are the main components of the so-called brand equity.

And what is this brand equity?

It could be described as marketing capital, soft capital. Brand equity is the value of the brand, which is built by increasing the brand recognition and brand awareness among the customers. Traditional companies are heavily involved in the development of this sort of capital. Studies indicate that in today’s economy this sort of intangible capital is increasingly widespread.

In my research, I focus on the consequences generated by the production of this sort of capital. In order to produce brand equity, you first need to attract customers’ attention. And over the past 70 years we have indeed seen more and more technologies capable of attracting this attention. This is becoming increasingly visible in macroeconomic data as well – for example, in the statistics reflecting how we spend our free time.

Is there anything wrong with the fact that we are watching more television? Were our parents right after all?

Not directly, but there can be some negative consequences that are not immediately obvious. The range of entertainment options and their quality is constantly increasing, and this undoubtedly has a direct positive effect. At the beginning, we had radio, then we got black and white television, followed by color television, and now we have smartphones. The quality of these technologies is a whole lot better, and they are extremely attractive. This isn’t even about the smartphones themselves, as these are not available for free, but about the content, the social media platforms, the applications, the games, the television channels. These are the technologies that are fighting for our time.

Because of the competition in this market, these technologies are getting better, and as a result people spend more and more time using them. We see this in the data – the number of hours spent on entertainment has been increasing for decades, and the number of hours spent on work has been falling. It seems that these changes have been taking place at a particularly rapid rate in recent years. All of these trends aren’t necessarily explained by the technologies alone – there are also other factors that are driving these changes. But empirical studies confirm that the technologies are an important factor. What is interesting from the perspective of long-term growth is that these trends could translate into lower innovation rates in the long term as well as a decline in the rate of productivity growth.

There has been a long-standing trend of a decline in the number of hours worked. Are we working less, because we now have new technologies, or do we have new technologies, because we have more free time? After all, the advent of radio broadcasts was not the reason for the introduction of free Saturdays in the United States in the 1930s.

This works both ways. The fact that we have more free time makes it more profitable to invest in technologies on which this free time could be spent. In turn, due to the improved leisure-enhancing technologies people want to spend more time on leisure. Both of these factors are relevant.

The demand for brand equity increases along with the development of the economy. The more companies there are and the greater the demand in the economy, the more companies will be interested in building this marketing capital. This means that the production of entertainment goods that are meant to attract consumer attention and time will become more profitable.

Let’s get back to productivity. How is it measured?

Productivity is usually measured by the average amount of goods produced in the economy per one employee, or – which is more reliable – per one hour worked by that employee. Productivity is shaped by two groups of factors.

On the one hand, the productivity of an employee in the economy will depend on the amounts of fixed capital (e.g., machines, computers), human capital (among others, the education level), and state capital (i.e., infrastructure) available to that employee. These are things that accumulate and that can be calculated. This group of factors has a significant influence, but it is not decisive.

It is the second group, which combines all the remaining factors, that is the most important, especially over long periods of time. The most important item in this group are the “ideas.” Thanks to the experience that we’ve gained as a civilization, as an economy, we currently have a much better understanding of how to produce various goods, how to provide services. These ideas, the technological progress, creativity – these are all factors that are difficult to measure. But we do know from long-term studies that it is precisely these factors that largely account for the differences in income between wealthy, developed countries, and the poorer, developing nations. This is the group of factors, which pushes the economy forward. In the language of macroeconomics, we describe this as TFP (Total Factor Productivity).

And has the TFP growth rate been falling recently?

The TFP growth rate in developed economies declined from roughly 2 percent per year in the post-war years, to about 0.5 percent in the last decade. We observe a decline by 1.5 to 2 percentage points depending on the country. That’s a lot: with a growth rate of 2 percent, it would take less than 40 years for the per capita income to double, whereas with a growth rate of 0.5 percent it would take as many as 140 years.

And what is the impact of leisure-enhancing technologies on this slowdown?

We can build and calibrate a model of traditional economy and leisure economy, based on our understanding of people’s behavior. And such a model could provide an answer as to the size of the impact that these technologies have. We are still far away from definitively proving their impact, but such studies could give us a sense of whether it’s worth investing more in order to gain a greater understanding of this issue. And in my opinion – it’s worth it.

My model, which is calibrated according to our understanding of these parameters, indicates that the development of leisure-enhancing technologies could account for about half of the decline in the rate of TFP growth.

That is a significant impact indeed! How could this happen?

The fact that we spend more time on entertainment mechanically translates into lower gross domestic product, but obviously the lower number of hours worked in and of itself does not affect productivity. The more interesting effect observed here is that the amount of time and attention we devote to work indirectly affects the TFP. The ideas, which are pushing the economy forward, always derive from the efforts of the employees. After all, it’s people who are inventing new business strategies, new solutions, new products. In general, if there are fewer people in the economy who are focused on making work more productive, and if fewer hours are devoted to this task, then economic growth will be lower.

Has this effect been confirmed in the field of economics?

There are studies showing the relationship between the amount of money we spend on innovation and the growth we get in return. Let’s take, for example, computer microchips. There is a famous observation known as Moore’s law, which says that over the past few decades the speed of computer processors doubled every two years. This progress did not come out of nowhere – it was due to the fact that more and more people were working on improving these computer microchips. And this is the case in every sector of the economy.

The effects of the dissemination of leisure-enhancing technologies are clear – it has led to more leisure and entertainment and less work. More attention paid to social media on the smartphone and less attention devoted to the tasks at work. One additional effect are the increased expenditures on innovation in the fields associated with leisure-enhancing and entertainment technologies along with relatively lower expenditures in the traditional sectors of the economy. These are the relationships that drive the decrease in the rate of productivity growth, especially in the other, more traditional sectors of the economy.

Can this explain the Solow paradox?

We are dealing with a phenomenon in which the economy produces something new, something that everyone can feel closely, but this new thing could reduce productivity in traditional sectors. I hope that in the future we will have more data that will allow us to specify the magnitude of this relationship. Previous studies that empirically examined the development of television and the Internet have shown what is the approximate impact of these technologies on the number of hours worked and on people’s attention. And this impact proves to be quite significant. Meanwhile, when it comes to the consequences for long-term productivity, this is a separate issue. This problem is now being explored by economists who study this issue empirically, and not based on models.

You mentioned that the demand for brand equity grows along with the development of the economy. This implies the development of new technologies that produce this new sort of capital. Is there a transfer of investment flows between the traditional economy and the leisure and entertainment economy that would be noticeable on the macroeconomic scale?

It has been said that in the past all the best students from the best universities in the United States would become engineers and go work at NASA. At a later point they were all becoming financiers and working at Goldman Sachs. And now the best students all train to become developers and end up writing algorithms at Facebook that can best determine what people like to see online. This is an illustration of the fact that more and more resources for research and development – that is, the primary sort of effort undertaken by these “smart guys”, by people with very high human capital – are invested in these technologies. The data seem to confirm this.

Looking at individual sectors of the economy in terms of expenditures on R&D we can see that the sectors located in the greatest proximity to the entertainment and leisure-enhancing technologies are increasing their spending on R&D relative to companies operating within the traditional technologies.

But since this only involves a transfer of resources from one sector to another, why would this inhibit overall GDP growth?

The way in which we measure GDP cannot fully capture what these new platforms are producing. The transactions between companies purchasing advertising and the owners of the leisure-enhancing technologies are recorded in the statistics. But these technologies are of little importance when treated as an individual sector of the economy – they only account for approximately 1-2 percent of the GDP. Meanwhile, the value of consumption of the technologies themselves, which in my opinion is an order of magnitude greater, is completely overlooked in the national accounts.

Production and consumption are strongly separated in the leisure and entertainment economy. This is because a product that was produced once can be used by any number of consumers: in the language of economics, these products have a marginal cost – the cost of servicing an additional customer – that is close or equal to zero. To produce one “Facebook” is one thing, but its consumption at the macro level is dependent on the number of people in the economy, the size of the market. If I create a social network, then I can invite any number of people to join. In contrast, the traditional economy has to increase expenditures and incur additional expenses in order to service a greater number of consumers.

So, the free services aren’t included in the GDP?

No, they are not. The current statistical practice isn’t well suited to measure the value of free technologies. Companies operating in the entertainment and leisure economy are treated as advertising agencies, and the value of the free services that they provide directly to the consumers is ignored. As a result of these dilemmas the debate on the validity of GDP and the search for alternative measures of well-being have flared up once again among economists.

So how can we measure the value of consumption of services provided by Facebook or YouTube?

The easiest way is to consider how much time people spend on using these technologies. We can estimate the value of such time by finding alternative ways of using it – that is, using it in a productive manner, at work, for an hourly wage. When multiplying the hourly rate by the time spent, we can roughly estimate the marginal value of these technologies. And it will be a value that is much, much greater than the cost of production of these technologies.

Should we block employees’ access to leisure and entertainment technologies for the sake of the economy?

This is definitely not the right conclusion! After all, it shouldn’t be our goal to produce as many goods and as much GDP as possible, but to achieve the greatest prosperity and well-being, which is a much broader concept. And these entertainment and leisure goods can positively affect our prosperity and well-being.

Therefore, it could be entirely rational to decide as individuals, as consumers, but also collectively, as a society, that we want to produce fewer traditional goods in order to spend more time on entertainment. This could be very positive.

The catch is that the long-term productivity decreases as we shift consumption from the real economy to the consumption of entertainment. We may choose not to take this into consideration when making these decisions. But in the longer term, it may turn out that because we will be less productive in the future, our situation ultimately won’t improve much.

Łukasz Rachel – economist at the Center for Macroeconomics, researcher at the London School of Economics and Political Science (LSE) and at Princeton University, a member of the think tank “Dobrobyt na Pokolenia” (Prosperity for Generations).

Łukasz Rachel (©Archiwum prywatne)

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