A measure of future well-being

  • Nation
  • Monday, 10 Oct 2016

While people’s welfare gains may outpace future GDP growth, the trade-off could be lower incomes and returns on savings.

IN a recently released working paper, five economists used big data to estimate the demand curve for Uber in the United States.

This sounds like the kind of esoteric, elitist, ivory tower exercise that only academics get excited about. But the results brilliantly illustrate one of the key fundamental factors behind lacklustre growth in today’s global economy.

One of the unique things about Uber is its surge pricing algorithm, which tries to match local demand with supply, and adjusts prices accordingly.

When demand is high relative to supply (more users compared to available drivers), the price of a ride goes up – the bigger the difference, the higher the cost.

By tracking customer requests, Uber has information on what customers are prepared to pay at different price points, and how many of them. In other words, a demand curve.

Knowing your demand curve means having the ability to price your goods or services to what the market can bear, thus maximising profits.

But there is another application for this data; knowing the demand curve, the paper’s authors could also measure the extent of consumer surplus, another important principle in economics.

Consumer surplus is the total amount consumers are willing to pay for goods or service but don’t have to, because the market price is below the level they are prepared to pay.

Uber’s consumer surplus came to an astonishing annual total of US$2.9bil (RM12bil) for the four cities from which the data came, and an estimated US$6.8bil (RM28.2bil) for the entire United States.

For every US$1 (RM4.15) spent, US$1.60 (RM6.60) in consumer surplus was generated. Put another way, consumers were prepared to spend US$2.60 (RM10.80) for every US$1 they actually spent. That’s an enormous net benefit to consumers, because the service they receive is worth much more to them than what they paid.

But the flip side might be less obvious – Uber is leaving cash on the table. By pricing to what the market can bear, they could have generated far more revenues than they actually did.

In fact, for 2015, Uber made an EBITDA loss of at least US$2bil (RM8.3bil).

Uber is an outlier, an extreme example of a trend that’s been creeping into the global economy – the divergence between GDP growth and growth in human welfare.

Uber’s contribution to US GDP in 2015 was negative due to their losses, but their consumers actually saw a gain in their well-being because they paid far less than what they had to.

The same argument could be made for Google, Facebook and Twitter. By tracking user behaviour, these companies can tailor advertising precisely to what users might be interested in.

This increases economic efficiency relative to more traditional media but is also very much cheaper.

Consumers benefit through customised advertising, but the companies behind this have seen progressively lower revenues per customer – it’s an increasingly more efficient process, which by definition means for a given service or product, the contribution to GDP is lower.

Problems with GDP and GDP growth reach further than that. GDP and its variants are essentially artificial constructs, invented for an industrial society.

Real output in an industrial economy is easy to track, because most of it come in the form of tangible goods that can be counted. Even then, aggregation problems abound – for example, is one apple the same as one orange or a barrel of oil?

In a post-industrial age when much of GDP is composed of nebulous intangible services, real output is even harder to pin down. In a service-led economy, GDP has both quantitative and qualitative challenges.

Nevertheless, to return to the welfare question, it actually doesn’t sound too bad as the benefit to consumers will likely far outweigh the loss of revenue to corporations.

In fact, if there is one aspect to global population ageing that I don’t worry about, it is whether standards of living will continue to rise.

I firmly believe it will, even if the pace of technological progress eventually slows.

But this divergence between measured growth and welfare is not without its problems.

One is that firms finding it harder to monetise their goods and services will face a reduced incentive to innovate and invest, cutting off one potential source of future growth.

Again, this is something that’s turning up in the official statistics, as companies have been hoarding cash and cutting costs, not investing to increase capacity.

Another factor is that under these circumstances, market power and concentration become a bigger corporate goal than profit maximisation – cue worries about global monopolies that have slowly risen over the past decade.

Uber’s current strategy is to scale up in size and reach, to shoulder competitors out of the market. Google is famously ubiquitous among search engines; Apple and Android control the smartphone market.

Hypermarkets have made corner

shops almost extinct. This trend towards concentration is reducing consumer choice, even if consumer surplus is high.

Just as importantly, a reduced ability to monetise will make it harder to provide a return on investment. GDP is effectively an aggregation of profits across the whole economy.

Though a gross over-simplification, it remains a reasonably accurate description. If profits are harder to come by, stock market returns may become poorer. For a given stock of savings, the reduced universe of investible opportunities also causes yields on debt to drop, as fund managers chase returns. Digging deeper, lower corporate earnings also put pressure on wage growth.

Thus consumer gains in terms of consumer surplus might also be offset by lower incomes and returns on their savings. Economics is fundamentally about trade-offs, and even as people’s welfare gains outpace GDP growth, this is one trade-off we should keep in mind.

Nurhisham Hussein heads the Economics and Capital Markets Department of the Employees Provident Fund. This is the third of a six-part fortnightly series.

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