John Quelch, Professor of Business Administration at Harvard Business School, recently quantified the impact of the Internet on the U.S. economy:

A recent study we prepared with Hamilton Consultants for the Interactive Advertising Bureau uses three methods to value the contribution of the advertising-supported Internet to the U.S. economy:

1. Employment value The Internet employs 1.2 million people directly to conduct advertising and commerce, build and maintain the infrastructure, and facilitate its use. Each Internet job supports approximately 1.54 additional jobs elsewhere in the economy, for a total of 3.05 million, or roughly 2 percent, of employed Americans. The dollar value of their wages is about $300 billion, or around 2 percent of U.S. GDP.

2. Payments value.The direct economic value the Internet provides to the rest of the U.S. economy is estimated at $175 billion. It comprises $20 billion of advertising services, $85 billion of retail transactions (net of cost of goods), and $70 billion of direct payments to Internet service providers. In addition, the Internet indirectly generates economic activity that takes place elsewhere in the economy. Using the same multiplier as for employment, 1.54, then the advertising-supported Internet creates annual value of $444 billion.

3. Time value. At work and at leisure, about 190 million people in the United States spend, on average, 68 hours a month on the Internet. A conservative valuation of this time is an estimated $680 billion.

The Value of the Internet vs. the Value the Internet Creates

Both the title of the article, “Quantifying the Economic Impact of the Internet”, and the description of what the study purports to do, “value the contribution of the advertising-supported Internet to the U.S.” economy”, are inaccurate. There is a subtle, yet critical, distinction between the value associated with the Internet, which is an absolute value, and the economic impact of the Internet, which is a relative value. Yet, this distinction is critical if the purpose of the analysis is to decide how value much the Internet creates.

The distinction becomes clearer, if I revert to the legal way of thinking about the matter, that is, the But-for value of the Internet: But-for the existence of the Internet, how much value would there be? In other words, the economic impact of the Internet is more precisely quantified as the difference between

The value of economic activity in the U.S. as it is today with the Internet

and

The value of economic activity that would exist in the U.S. today had the Internet not been created.

This distinction recognizes the fact that if the Internet did not exist, then a lot of people who are performing economic activities associated with the Internet, say buying books online at Amazon, would, instead, be performing similar activities in the “No-Internet World”, say buying books at their neighborhood bookstore. In other words, you have to account for the fact that the Internet cannibalizes on other parts of the economy. Of course, the extra value to the buyer of being able to buy books online through Amazon, rather than having to schlep down to the local bookstore, should be attributed to the existence of the Internet.

It might seem like I’m nitpicking here by making a distinction between absolute and relative values. However, this distinction is critical when you’re trying to put a value on a new product, project, technology, or whatnot. The relative value of any new product, project, technology, or whatnot over existing alternatives will necessarily be less than its absolute impact. It follows that if you consider the absolute impact of that new project instead of its relative impact, you will end up pursuing projects that really don’t create new value for you. (I emphasize this point in my book Winning the Hardware-Software Game in the context of optimizing the pace of new technology adoption.) As a case in point, the government often claims that its new programs create new jobs. Yet, it doesn’t really count as creating new jobs, if the people who fill the “new” jobs are taken from existing jobs elsewhere. On the other hand, if the total value to society associated with having people do whatever it is they’re now doing for the government is greater than the total value to society of having those same people work in their previous capacities (however unlikely this may be), then the government can, indeed, be credited with creating value for society.

The Value the Internet Creates

So then thinking about it more precisely in relative terms, what value does the Internet create?

The real advantage of the Internet is that it radically decreases the costs to users of transacting or otherwise exchanging information with other users. This means that the value the Internet creates boils down to

1. The Marginal Impact of the Internet over Existing Alternatives: The Internet increases the value associated with any exchange that still would have occurred between users even if the Internet had not existed.

plus

2. The Full Impact of the Internet through New Creation: The Internet creates new value by enabling exchanges that would not have been possible if the Internet had not existed.