Journal of Economic Literature 2019, 57(1), 3–43 https://doi.org/10.1257/jel.20171452

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Digital Economics†

Avi Goldfarb and Catherine Tucker*

Digital technology is the representation of information in bits. This technology has reduced the cost of storage, computation, and transmission of data. Research on digital economics examines whether and how digital technology changes economic activity. In this review, we emphasize the reduction in five distinct economic costs associated with digital economic activity: search costs, replication costs, transportation costs, tracking costs, and verification costs. (JEL D24, D83, L86, O33, R41)

1. What Is Digital Economics? economic models change as certain costs fall substantially and perhaps approach zero. igital technology is the representation We emphasize how this shift in costs can be Dof information in bits. This reduces the divided into five types: cost of storage, computation, and transmis- sion of data. Research on digital economics (i) Lower search costs examines whether and how digital technol- ogy changes economic activity. (ii) Lower replication costs Understanding the effects of digital tech- nology does not require fundamentally new (iii) Lower transportation costs economic theory. However, it requires a dif- ferent emphasis. Studying digital economics (iv) Lower tracking costs starts with the question of “what is differ- ent?” What is easier to do when information (v) Lower verification costs is represented by bits rather than atoms? Digital technology often means that costs Search costs are lower in digital environ- may constrain economic actions. Therefore, ments, enlarging the potential scope and digital economics explores how standard quality of search. Digital goods can be rep- licated at zero cost, meaning they are often ­non-rival. The role of geographic distance * Goldfarb: University of Toronto and NBER. Tucker: changes as the cost of transportation for dig- Massachusetts Institute of Technology Sloan School of ital goods and information is approximately Management and NBER. We thank Andrey Fradkin and Kristina McElheran for helpful comments. We are grate- zero. Digital technologies make it easy to ful to the Sloan Foundation for its support of the NBER track any one individual’s behavior. Last, dig- Digitization Initiative, which built the research community ital verification can make it easier to certify around which this review is based. † Go to https://doi.org/10.1257/jel.20171452 to visit the the reputation and trustworthiness of any article page and view author disclosure statement(s). one individual, firm, or organization in the

3 4 Journal of Economic Literature, Vol. LVII (March 2019) digital economy. Each of these cost changes affect prices and price dispersion. They affect draws on a different set of well-established­ product variety and media availability. They economic models, primarily search, ­non-rival change matches in a variety of settings, from goods, transportation cost, price discrimina- labor markets to dating. They have led to an tion, and reputation models. increase in the prevalence of ­platform-based Early research tested straightforward mod- businesses, and affected the organization of els of lower costs. For example, the search some firms. literature of the late 1990s and early 2000s We next turn to zero replication costs, which built directly on earlier models by Diamond also affect pricing decisions including the (1971) and Varian (1980). As we detail below, decision to provide a good for free. This has empirical work emerged that found some enabled an increase in the provision of public inconsistencies with the simple models, and goods such as Wikipedia, raising a number of so richer models and empirical analysis of the new questions about the motivations for pro- cost reductions developed to take account of viding such goods. Zero replication costs cre- the subtleties of the digital context. ate challenges with respect to excludability. Other authors have also emphasized the Copyright can enforce excludability by using role of lower costs for digital economics the law to overcome the ­non-rival nature of (e.g., Shapiro and Varian 1998; Borenstein the technology. Consequently, copyright has and Saloner 2001; and Smith, Bailey, and become increasingly important to a variety of Brynjolfsson 2001). Ellison and Ellison businesses and a core policy challenge related (2005) discuss the implications of these lower to digitization. search and transportation costs for indus- Because the cost of transporting infor- trial organization with respect to increasing mation stored in bits is near zero, this has returns, distance, and two-sided­ markets. changed the role of place-based­ constraints Since their article, the digital ­economics liter- on economic activity, whether due to costs of ature has grown to contribute to the econom- physical transportation or policy. Digitization ics of crime, the economics of public goods, changes the ways governments can control organizational economics, finance, urban the flow of information, from advertising economics, labor economics, development restrictions to media blackouts. economics, health economics, political econ- We then turn to examine a more recent omy, media economics, public finance, and literature that has identified two other cost international economics. In this sense, we changes: Tracking and verification costs. view digital economics as a way of thinking Tracking costs are the costs associated with that touches many fields of economics. connecting an individual person or firm with In addition to applying across many fields, information about them. Low tracking costs these shifts in costs have transformed many enable novel forms of price discrimination as aspects of the economy. After providing a brief well as new ways to targeting advertising and history of digital technology and the Internet, other information. At the same time, better we discuss each of the cost changes associated tracking has made privacy a key issue, gen- with digitization. In each section, we empha- erating a great deal of research and policy size the key research questions that have discussion. driven the area and how they have evolved, We conclude the discussion of cost and relate them to policy where applicable. changes by detailing changes in verification We begin with a discussion of the effect costs. The rise of online reputation sys- of lower search costs, defined as the costs of tems has facilitated trust and created new looking for information. Lower search costs ­markets. At the same time, such systems are Goldfarb and Tucker: Digital Economics 5

­imperfect, and can serve as platforms for researchers also developed the particu- fraud or discrimination. lar packet-switching standards that define We finish by discussing the consequences Internet communication: the Transmission of digitization for countries, regions, firms, Control Protocol Internet Protocol (TCP / / and individuals. Digitization has affected IP). The National Science Foundation (NSF) productivity, trade, the economic role of cit- began managing a network using that proto- ies, domestic and international outsourcing, col in the 1980s, building a reliable infra- consumer surplus, and how people spend structure that was relatively easy to adopt but their leisure time. also restricted to researchers. Privatization occurred between 1990 and 1995, leading to the modern commercial 2. Digital Technology: A Brief History Internet. The commercial Internet diffused The history of modern computing begins quickly, with universities playing a key role not with the Internet, but in 1945 with the in the diffusion process (Goldfarb 2006). commercialization of technologies developed There was near-universal­ availability and during World War II (Ceruzzi 2003). These widespread adoption in the United States first machines focused on rapid calculation by 2000 (Greenstein 2000).1 Over time, new with little capacity for storing and retrieving technologies have been layered on top of information. By the early 1950s, magnetic the basic TCP/­IP-based Internet, including core memories enabled efficient digital infor- browsers, search engines, online shopping, mation storage and perhaps the first real social networks, mobile communications ­non-arithmetical benefit of representing protocols, security standards, customer rela- information in bits emerged: the lower mar- tionship management systems, and many ginal cost of reproducing information. Over others. These technologies and others have time, storage technology, software, and hard- enabled increased collection and use of data. ware improved so that information processing During this process, there has been an and reproduction became widespread. The open question of who should control vari- software and hardware industries grew rap- ous aspects of commercial Internet activity, idly (Ceruzzi 2003 and Campbell-Kelly 2004). given this historical context of decentral- Limited communication between ization. Standards are often agreed upon computers limited their effect on the through committees with representatives economy. It was with the rise of the from industry and academia. Such standards Internet—and with it, ­low-cost, commer- have an influence on which technologies cial, ­computer-to-computer communica- are widely adopted (Rysman and Simcoe tion—that the representation of information 2008). Therefore, standards setting creates in bits began to have a measurable effect winners and losers. Simcoe (2012) examines on multiple markets. This rise was built on the incentives in standards development for key inventions developed through US mili- one such standard-setting organization, the tary funding in the 1960s and 1970s (Hafner Internet Engineering Task Force, demon- and Lyon 1996 and Greenstein 2015). For strating that the commercialization of the example, the Defense Advanced Research Internet slowed standards development due Projects Agency (DARPA) funded the inven- tion of packet switching, which breaks down a long message into shorter messages that 1 This rapid speed of diffusion proved useful for identi- fication in the empirical papers examining the effect of the can be sent through the network and then Internet on regions, firms, and individuals that we discuss reassembled upon receipt. ­DARPA-funded in the penultimate section. 6 Journal of Economic Literature, Vol. LVII (March 2019) to competing commercial interests. Given Therefore, a key theme in the history of their importance, control of hardware and digital technology is a tension between open- software standards has been controversial. ness and control. As we discuss below, this Echoing this question of control, the tension is at the center of much of the digital earlier literature on the economics of the policy literature with respect to copyright, Internet focused on pricing the sending of privacy, and discrimination. information and how it varies with intercon- nection, competition, and the nature of the 3. Reduction in Search Costs content (MacKie-Mason­ and Varian 1994). In other words, there is a question about Search costs are the costs of looking for the role of Internet service providers in con- information. Every information-gathering trolling access. Laffont et al. (2003) empha- activity therefore involves search costs. The sized how the need for interconnection can basic idea with respect to digital economic affect prices and welfare. This literature activity is that it is easier to find and compare emphasized network effects and the chal- information about potential economic trans- lenges of interconnection (Cremer, Rey, and actions online than offline. Tirole 2000; Besen et al. 2001; Laffont et al. At the beginning of the commercial 2001; and Caillaud and Jullien 2003). Internet, there was much discussion among As data transmission became a key aspect economics researchers around how a dra- of digital technology, the question of net matic reduction in search costs might trans- neutrality has become a central research form the economy by reducing prices, price and policy focus. Net neutrality means that dispersion, unemployment, vacancies, and an Internet service provider should treat all inventories. Alan Greenspan argued that the data in the same way; regardless of the con- information and communications technology tent provider or content, companies cannot (ICT) revolution would reduce the severity pay an Internet service provider to have of business cycles.2 The consequences of low faster speeds. The net neutrality debate asks search costs were discussed in financial mar- whether Internet service providers should kets (Barber and Odean 2001), labor markets exercise control over content. Put differently, (Autor 2001), and retail markets (Borenstein net neutrality is the norm that Netflix pays the and Saloner 2001 and Bakos 2001). The ideas same to send a gigabyte of data to one of their in these papers have their roots in the early customers as a small startup would pay to search literature, which modeled search send data to the same customer. Internet ser- costs as the costs of gathering information vices have had a historic norm of net neutral- (Stigler 1961, Diamond 1971, and Varian ity, though this has been challenged in recent 1980). Reflecting this early focus and solid years by Internet service providers and policy base of economic understanding, the liter- makers in the United States and globally. The ature on the effects of lower digital search net neutrality literature therefore empha- costs is more established than the other parts sizes the role of the connection intermediary of the digital economics literature. (Economides and Hermalin 2012; Bourreau, Kourandi, and Valletti 2015; Choi, Jeon, and Kim 2015; and Goetz 2017). As shown by Lee and Wu (2009) and Greenstein, Peitz, and 2 “Information technology has doubtless enhanced Valletti (2016), the particulars of the model the stability of business operations,” Federal Reserve Chairman Alan Greenspan, February 26, 1997, testimony matter, and the costs and benefits of net neu- before Congress. https://www.federalreserve.gov/board- trality depend on the specific setting. docs/hh/1997/february/testimony.htm. Goldfarb and Tucker: Digital Economics 7

3.1 Are Prices and Price Dispersion Lower and shipping policies. Firms with higher qual- Online? ity may develop stronger brands and there- Low search costs make it easier for con- fore command higher prices (Waldfogel and sumers to compare prices, putting downward Chen 2006). pressure on prices for similar products. This Firms selling products can also shape the should reduce both prices and price disper- search process. When consumers search, they sion. Brynjolfsson and Smith (2000) compare assess multiple dimensions of information: prices of books and CDs at four ­Internet-only price, quality, reputation, shipping fees, time retailers, four offline retailers, and four to delivery, color, etc. Lynch and Ariely (2000) “hybrid” retailers who had both online and demonstrate this for online wine purchasing offline stores. They identified twenty books in a laboratory. If price was available on the and twenty CDs, half of which were best- first page, consumers focused on price. If con- sellers and half of which were randomly sumers needed to click further to learn the selected among titles popular enough to be price, other attributes became more import- sold in most offline stores. They showed that ant for purchase decisions. Fradkin (2017) online prices for these items were substan- shows that the details of the search process tially lower than offline prices. Relatively low matter in the context of short-term accommo- online prices have been shown in a variety of dation platform Airbnb. Structural estimates other settings, including insurance (Brown of the cost of an extra click in the consumer and Goolsbee 2002), automotive products search process suggest they are larger than (Scott Morton, Zettelmeyer, and Silva-Risso­ might be supposed (Honka 2014 and De Los 2001), and airlines (Orlov 2011). Santos, Hortacsu, and Wildenbeest 2012). However, though prices may be lower, This means that consumers stop searching substantial price dispersion remains. sooner than predicted by models that assume Brynjolfsson and Smith (2000) show this search costs close to zero. in their online–offline­ retail study. Baye, In the presence of search costs, and mul- Morgan, and Scholten (2004) use evidence tiple dimensions of information, firms can from thousands of products and prices partly choose which information has the low- to document large and persistent online est search costs. Ellison and Ellison (2009a) price dispersion. Orlov (2011) finds that demonstrate that computer memory chip the Internet increases the intrafirm disper- retailers attract customers with low prices sion of airline prices, but had no effect on at an online price comparison website, and interfirm price dispersion. By contrast, the then show customers other (typically higher development economics literature measur- quality and higher margin) products once ing the effect of mobile phones on commod- they arrive. Using data from eBay, Dinerstein ity prices suggests that lower search costs et al. (2018) emphasizes how the design of reduced price dispersion (Jensen 2007; Aker the search algorithm on eBay affects mark- 2010; and Parker, Ramdas, and Savva 2016). ups charged by eBay sellers. More directly, Given evidence of the persistence of price Hossain and Morgan (2006) show that online dispersion online, research turned to explore sellers often hide shipping fees until the final why price dispersion does not disappear. Of purchase page. Blake et al. (2018) shows a course comparison of online products does similar phenomenon in the information not always compare ­apples to apples. In com- revealed in ticket prices at an online ticket paring book prices, the book may be the same, platform. but the retailer is different. Different retailers Therefore, while prices have fallen, offer different quality, shopping experiences, price dispersion has persisted. The initial 8 Journal of Economic Literature, Vol. LVII (March 2019)

­predictions of low price dispersion missed sold to everyone, while niche products are the point that search costs are endogenous, sold through long-tail retailers. The increase and so firms can manipulate the search pro- in tails at the right and left of the distribution cess in order to sustain higher margins and comes at the cost of products in the middle. prices. The degree to which search costs generate more or less variety depends on the search 3.2 How Do Low Search Costs Affect process endogenously chosen by the firm. Variety? Recommendation engines are a key aspect Low search costs may mean that it is easier of the online search process. Fleder and to find rare and niche products (Yang 2013). Hosanagar (2009) demonstrate this, show- In this case, digital search might lead to an ing that algorithms that emphasize “people increase in the proportion of sales going to who bought this also bought” move the sales products that are relatively rarely purchased, distribution toward superstars. If many peo- a phenomenon dubbed “the long tail” by ple buy Harry Potter, this recommendation Anderson (2006). Using data from a retailer engine will recommend Harry Potter to with both online and offline channels, everyone else. In contrast, if the algorithm Brynjolfsson, Hu, and Simester (2011) doc- emphasizes “people who bought this dis- ument that the variety of products available, proportionately bought,” relatively unusual and purchased, online is higher than offline. items that demonstrate niche tastes will be Low search costs may facilitate discovery of sold. Empirically, Tucker and Zhang (2011) relatively unknown products (Zhang 2018).3 document that popularity information Low search costs could also generate has asymmetrically large effects for niche superstar effects (Rosen 1981). If there are products. vertically differentiated products and the Popularity information affects sales in marginal cost of production is zero, then general. Many online platforms sort items homogeneous consumers will all agree by popularity and feature popularity prom- which product is best and buy it. Consistent inently, reducing search costs for this type with this, Goldmanis et al. (2010) show that of information. Showing such popularity the Internet initially led to a relative increase information affects purchase behavior not in the number of large offline bookstores and only in retail, but also online lending (Zhang travel agencies. and Liu 2012) and online investing (Agrawal, ­Bar-Isaac, Caruana, and Cunat (2012) Catalini, and Goldfarb 2015). explain how superstar and long-tail effects The effect on welfare of this change in may result from a reduction in search costs. variety is not obvious, and so it has been If products are both vertically and horizon- the subject of a rich discussion in the liter- tally differentiated, a reduction in search ature. Lower search costs that lead people costs may lead to an equilibrium where the to buy the products that more closely match most popular and highest-quality products their preferences should increase welfare. are produced in high enough quantity to be Consistent with this, Brynjolfsson, Hu, and Smith (2003) show that increased variety increases consumer surplus. 3 In addition to search costs, variety may increase because digital technologies can make inventory systems At the same time, improvements in wel- more efficient, meaning firms can hold millions of prod- fare may be small. The increase in matching ucts, especially for digital goods that have no physical pres- of products to preferences is, by definition, ence. People may also be less inhibited from purchasing nonstandard items when purchasing on a screen, rather marginal. The new products offered are the than from a human (Goldfarb et al. 2015). products on the margin of being produced. Goldfarb and Tucker: Digital Economics 9

The superstar effects may be marginal rela- polarization of digital content because the tive to the consumers who bought products increase in polarization is largest for demo- in the middle because they were unwilling to graphic groups with the least Internet usage. pay search costs. For example, Ershov (2017) Polarized media may be less concentrated, shows that a reduction in search costs in the generating incentives for niche sources to mobile app market reduced average product intentionally mislead. Allcott and Gentzkow quality. On balance, however, it also shows (2017) show that false news stories about the that the increase in variety led to a substan- 2016 presidential election were shared tens tial increase in overall welfare despite the of millions of times, though they demon- incremental nature of the new products. strate the fake news was unlikely to have Aguiar and Waldfogel (2016) suggest that changed the election outcome. Long before this marginal argument misses the substan- the attention to fake news in the 2016 elec- tial uncertainty about product quality for tion, Antweiler and Frank (2004) examined many information goods. In the context how anonymous, and potentially misleading, of music, they show that several songs and online investing advice affects stock prices. musicians that seem marginal ex ante ended Low search costs—in the absence of a reli- up having substantial sales. Therefore, by able quality filter—meant that this informa- enabling such music to get produced, digital tion could be more easily found and shared. markets led to a large change in the relative Low online search costs have also trans- sales of products. Uncertainty in the process formed the way academic research is con- meant better and more music was created. sumed. McCabe and Snyder (2015) show A great deal of attention has focused on that JSTOR led to an increase in citations the increase in variety in consumption of of included articles at the expense of others. media in particular. The Internet might also Search costs fell, but because they fell more enable people to only read information that for some articles than others, it changed the reflects their narrow viewpoint; despite the nature of attention to specific articles and variety, there is no need to search widely. ideas. More starkly, Ellison (2011) argues The latter idea has been emphasized by Cass that peer review may be in decline because Sunstein as an “echo chamber” (Sunstein of low online search costs. In particular, he 2001). Consistent with the idea of wide vari- shows that ­high-profile researchers do not ety available but consumption in echo cham- need to rely on academic journals to dissem- bers, Greenstein and Zhu (2012) examine inate their ideas. They can post online and the bias of Wikipedia and show that, while, people will find their work. In other words, on aggregate Wikipedia has become less similar to the superstar effect in products, politically biased (toward Democrats) over low search costs combined with thousands time, the bias of articles has not changed of research articles benefit the superstar much. Instead, the political bias has mainly researchers. dropped because of the arrival of new, rela- 3.3 How Do Low Search Costs Affect tively ­right-wing articles. Matching? By contrast, Gentzkow and Shapiro (2011) show that Internet media consumption is Reduced search costs facilitate exchange more varied than offline media consumption. more generally, often enabled by large dig- Therefore, in this context, low search costs ital platforms. Dana and Orlov (2014) show lead to increased variety. Boxell, Gentzkow, that airlines are better able to fill tocapacity. ­ and Shapiro (2017) argues that the Internet Ellison et al. (2014) show that online buy- is unlikely to be responsible for increased ers are better able to find the specific books 10 Journal of Economic Literature, Vol. LVII (March 2019) they want. Kroft and Pope (2014) find online much of the research takes a market design search through Craigslist decreased rental ­perspective. For example, Cullen and apartment and home vacancies (though Farronato (2016) examine an online mar- they measure no effect on unemploy- ketplace that matches buyers and sellers of ment). Anenberg and Kung (2015) show domestic tasks, such as cleaning, moving, that online search enabled the rise of a and simple home repair. They emphasize the market for ­truck-based mobile restaurants challenges in growing both the demand and (“food trucks”). To the extent that the liter- supply sides with respect to variation in the ature emphasizing matching is distinct from quantity of buyers and sellers over time, econ- search, the matching literature emphasizes omies of scale in matching, and geographic that both sides of the market engage in the density. A key result is that demand fluctua- search process. tions in this ­two-sided market lead to changes Related to the above ideas, low search in quantity supplied rather than changes in costs are likely to increase the quality of prices. Similarly, Hall, Kendrick, and Nosko matches between buyers and sellers, firms (2016), Farronato and Fradkin (2018), and and workers, etc. The labor economics lit- Zervas, Proserpio, and Byers (2017) also show erature has emphasized that the Internet that the responsiveness in quantity supplied should reduce unemployment and vacancies. to changes in demand conditions is a key Kuhn and Skuterud (2004) find no effect of aspect of ­peer-to-peer platforms (specifically, Internet job search on employment. Kuhn Uber and Airbnb). Low search costs provide and Mansour (2014) revisit the analysis sev- market demand information that enables sup- eral years later with updated data and find ply to enter the market when needed. that individuals that used the Internet in job 3.4 Why Are Digital ­Platform-based search were indeed more likely to match to Businesses So Prevalent? an employer. The reduced costs of search have led to the Platforms are intermediaries that development of online “peer-to-peer” plat- enable exchange between other players. forms dedicated to facilitating matching. The Digitization has led to an increase in the variety of such online matching markets is prevalence of platform businesses, even extraordinary: workers and firms, buyers and beyond the peer-to-peer­ platforms discussed sellers, investors and entrepreneurs, vacant above. Most of the major technology firms rooms and travelers, charities and donors, can be seen as ­platform-based businesses. dog walkers and dog owners, etc. Several of For example, Apple provides hardware and these markets have been dubbed the “shar- software platforms for others to build appli- ing economy” because people are able to use cations around. Google provides platforms unused objects or skills better. Most “sharing for bringing together advertisers and poten- economy” platforms are not sharing in the tial buyers. sense learned by kindergarteners: custom- As highlighted in Jullien (2012), there are ers typically pay for the “shared” services. two main reasons digital markets give rise to Horton and Zeckhauser (2016) emphasize platforms. First, platforms facilitate match- that many of these markets are driven by ing. In particular, as in the sharing economy an unused capacity for durable goods. Low platforms, they provide a structure that can search costs enable such unused capacity to take advantage of low search costs to create be filled more efficiently. efficient matches. Often platforms serve as In a review of the peer-to-peer­ mar- intermediaries between buyers and sellers, as kets literature, Einav et al. (2018) note that highlighted in Nocke, Peitz, and Stahl (2007) Goldfarb and Tucker: Digital Economics 11 and Jullien (2012). In the context of a central ­distance. On the other hand, Garicano (2000) role of matching, a rich theory literature has also shows that ­low-cost communication arisen that examines competition and pricing could decrease centralization by enabling strategy in such platform businesses, with an ­front-line employees to access information emphasis on the importance of indirect net- previously only available to senior employ- work effects (for example Baye and Morgan ees at headquarters. A variety of papers have 2001, Caillaud and Jullien 2003, Weyl 2010, explored nuances in this trade-off within Hagiu and Jullien 2011, and de Corniere organizations, emphasizing the importance 2016). of the particular technology studied. Second, platforms increase the efficiency Bloom et al. (2014) test this theory directly, of trade. They do this through lower search using data on European and American costs as well as other aspects of digitization manufacturing firms to show that informa- that we discuss below: low reproduction and tion technology is a centralizing force and verification costs. Hagiu (2012) emphasizes communication technology is a decentral- how software platforms enable application izing force. Acemoglu et al. (2007) also dis- providers to serve a large number of cus- cuss the decentralizing role of information tomers quickly, with the only requirement technology. For example, Forman and van that the application serve some particular Zeebroeck (2012) shows that digital commu- customer need, reproduce at zero cost, and nication increases in research collaboration rely on the platform and the other applica- across establishments within an organization. tions to serve other needs. Interoperability Baker and Hubbard (2003) examines the is therefore a key aspect of platforms. There effect of on-board­ computers on asset own- is a large literature on the topic, as reviewed ership in the trucking industry. They empha- in Farrell and Simcoe (2012). A key contri- size tracking costs more than search costs bution of this literature is the emphasis on and find that aspects ofon-board ­ comput- the strategic nature of decisions on interop- ing that improve monitoring pushed truck- erability and standards (Rysman and Simcoe ing firms to more ownership of trucks while 2008 and Simcoe 2012). A related set of aspects of on-board­ computing that improve questions examines whether market partic- ­real-time location information pushed ipants will “multi-home”­ and use multiple trucking firms to less ownership of trucks. platforms (Rochet and Tirole 2003, Rysman Therefore, while adoption of digital tech- 2007, Halaburda and Yehezkel 2013). nology led to improved efficiency, the effect on organization of the firm in equilibrium 3.5 How Do Low Search Costs Affect the depends on the nature of the technology Organization of the Firm? and how its specific features affect trade-offs ­Lucking-Reiley and Spulber (2001) discuss between competing tensions at the bound- several hypotheses with respect to the effect ary of the firm. McElheran (2014) examines of the Internet on firm structure in terms of the decision to centralize or delegate IT the role of online intermediaries and vertical adoption decisions within firms. Firms with integration. This literature emphasizes infor- a greater need for integrated processes (dig- mation flow generally, in which search is one ital or otherwise) delegate less. Forman and key type of information flow. Garicano (2000) McElheran (2013) show that this tendency is shows that low-cost­ digital information flow mitigated by the ease with which IT enables could increase ­centralization by enabling coordination across firms, so that disintegra- headquarters, and organizational leaders, tion of the firm boundary can be seen as an to understand better what is happening at a extreme form of delegation. 12 Journal of Economic Literature, Vol. LVII (March 2019)

In addition to the effect on the domes- be shared without diminishing the original tic boundaries of the firm, the reduction in information. search costs (combined with the reduction In the absence of deliberate legal or tech- in verification costs discussed below) has nological effort to exclude, bits can be repro- also led to an increase in international hiring duced by anyone—not just the producing and outsourcing. While international out- firm—at near zero cost without degrading sourcing is not a new phenomenon (Leamer the quality of the initial good. As Shapiro and 2007), the recent rise of digital international Varian (1998, p. 83) put it, the Internet can labor market platforms suggests a different be seen as a “giant, out of control copying avenue for international hiring. Agrawal, machine.” Lacetera, and Lyons (2016) show that online Nevertheless, the economics of zero mar- platforms with standardized information dis- ginal cost, non-rival­ goods can shift things in proportionately benefit workers from devel- favor of producers, consumers, or both. In a oping countries. The objective information static model, as marginal costs fall the poten- available online, combined with the ability to tial surplus rises, and so the welfare effect send the output of the work (typically infor- depends on the final price and associated mation such as data or software code) for free deadweight loss. The final price and dead- over long distance helps workers who are far weight loss depend on legal and technological from the buyer. Such online labor markets tools for exclusion (Cornes and Sandler 1986), have several important challenges. Using which relate to the ability to track behavior— data from online labor markets, Lyons (2017) the subject of a later section. In this section, shows that cross-cultural­ international teams we emphasize that the underlying technology can be less productive because of commu- enables firms and governments to make a nication challenges. Relatedly, Ghani, Kerr, choice not to exclude. This can allow individ- and Stanton (2014) show that employers in uals to enjoy the full benefits of the­non-rival the Indian diaspora are more likely to hire nature of information-based­ goods. Indians online. 4.1 How Can ­Non-Rival Digital Goods Be Priced Profitably? 4. The Replication Cost of Digital Goods The non-rival­ nature of digital goods has Is Zero led to questions of how to structure pric- The key shift in the production function ing of a large variety of non-rival­ ­zero-cost is not that digital goods have a marginal cost goods, should a producer choose to charge. of zero. Simple microeconomic models with Bundling occurs when two or more products zero marginal cost are not so different from are sold together at a single price (Shapiro models with positive marginal cost. The and Varian 1998, Choi 2012). Bundling demand curve slopes downward and firms models have a long history in economics. price where marginal revenue equals zero. Stigler (1964) and Adams and Yellen (1976) Instead, a key distinction between goods note that a sufficient condition for price dis- made of atoms and goods made of bits is that crimination benefit of bundling arises when bits are non-rival,­ meaning that they can be consumers have negatively correlated pref- consumed by one person without reducing erences. Some people may value an action the amount or quality available to others. A movie at $10 and a romance at $2. Others common analogy for ­non-rival goods is that may value the romance at $10 and the action just as one person can start a fire without movie at $2. Selling the bundle at $12 yields diminishing another’s fire, information can higher profits than selling the action and Goldfarb and Tucker: Digital Economics 13 romance movies separately. The challenge of non-rival­ public digital goods are open- for firms is to identify such negative correla- source software and Wikipedia. Both cases tions in preferences to identify when bun- involve a deliberate decision not to exclude, dling will increase profits. and applying established models is somewhat Bakos and Brynjolfsson (1999, 2000) rec- less straightforward than the bundling models ognize that, under certain assumptions, with highlighted in the preceding subsection. enough goods and independent preferences, Lerner and Tirole (2002) ask why software this challenge is overcome. Furthermore, developers would freely share their code with the non-rival­ nature of information goods no direct payment. They emphasize two core means that large numbers of information benefits from open source that do not appear goods can be bundled without substantially in standard models of public goods. For increasing costs. Therefore, a simple and individual developers, providing high-qual- useful insight on the economics of non-rival­ ity open-source code is a way to signal their information goods is that it will sometimes skills to potential employers. For companies, be optimal to bundle thousands of digital improving the quality of open source software products together. may allow them to sell other services that Chu, Leslie, and Sorensen (2011) use an are complementary to open-source software empirical example to show that the intuition (such as hardware or consulting services) of Bakos (1999) applies to relatively small at a premium. Underlying these core bene- numbers of goods in the bundle. There are fits is the­non-rival nature of the code: digi- also strategic reasons to bundle because it can tal distribution through the Internet means reduce competition (Carbajo, de Meza, and that (high-quality) open-source contributions Seidmann 1990). When bundling has zero can be widely adopted. The literature on the marginal cost, such strategic considerations economics of open source that followed has can become particularly relevant (Carlton, largely supported their hypotheses of career Gans, and Waldman 2010; Choi 2012). concerns and complementarity (Johnson Despite the extensive theory work, it is only 2002; Bitzer and Schroder 2005; Mustonen recently that empirical examples of such mas- 2005; Lerner, Pathak, and Tirole 2006; Henkel sive bundles appeared in the literature, in the 2009; Xu, Nian, and Cabral 2016). form of subscription services such as Netflix Wikipedia represents a different import- for video and Spotify and Apple Music for ant context for the puzzle of why people music. Aguiar and Waldfogel (2018) show that contribute to digital public goods. Zhang and Spotify displaces sales but it also displaces Zhu (2011) emphasize social benefits related “piracy,” or the downloading of music without to breadth of readership. In the context of permission from the copyright holder. They Chinese-language Wikipedia, they show that estimate that the reduction in sales and the users care about audience size, and decrease increase in legal music consumption balance contributions when part of the audience is each other so that Spotify appears to be reve- blocked due to Chinese government policy. nue neutral in the 2013–15­ time period. Consistent with this idea of a social benefit, Aaltonen and Seiler (2016) and Kummer, 4.2 What Are the Motivations for Providing Slivko, and Zhang (2015) together provide Digital Public Goods? evidence for a virtuous circle in which more Information providers can deliberately editing leads to more views and more views decide not to exclude. It is somewhat of a lead to more editing. Contributions are likely puzzle why private actors would choose to related to the interests of the contributors: create public goods. Two prominent examples Wikipedia leaned sharply Democratic early 14 Journal of Economic Literature, Vol. LVII (March 2019) on and has gradually become more neutral (Gordon and Loeb 2002 and Gal-Or­ and (Greenstein and Zhu 2012). Ghose 2005), especially if costly investments Nagaraj (2016) suggests the potential for in data security also are a public good. government sponsorship of digital public While digital technology creates public goods. He finds that open mapping infor- goods, zero marginal cost of production can mation led to a substantial increase in min- also create public bads, such as spam (Rao ing activity, particularly for smaller firms and Reiley 2012) and online crime (Moore, with fewer resources. Therefore, open data Clayton, and Anderson 2009). These have enabled a wider set of participants to succeed. led to policy responses such as the US More generally, the non-rivalrous­ nature Controlling the Assault of Non-Solicited of digital technology could enable consum- Pornography And Marketing Act of 2003 ers and workers in developing countries to (CAN-SPAM). Another example of digital access the same information as people in spam is junk telephone calls, the automation developed countries, conditional on having of which has been enabled by digital technol- access to the Internet. In the context of edu- ogies. Petty (2000) and Varian, Wallenberg, cation, Kremer, Brannen, and Glennerster and Woroch (2005) evaluate the role of the (2013) argue that information technology can federally sponsored “Do Not Call” list in pre- improve pedagogy in the developing world. venting potentially intrusive direct sales calls Underlying their argument is an emphasis and find positive effects. on ­non-rival, ­non-excludable digital informa- That said, the economics of such bads tion, and the public ­Internet-based posting are relatively straightforward. In contrast, of educational materials. Correspondingly, the more challenging policy question for Acemoglu, Laibson, and List (2014) empha- ­non-rival digital goods is whether the gov- sizes that digital education will lead to a more ernment should intervene through copyright equal distribution of educational resources. policy to enforce excludability despite the There are, however, situations in which ­non-rival nature of the goods. welfare may decrease because of a decision 4.3 How Do Digital Markets Affect not to exclude digital goods from wide- Copyright Policy? spread copying. The decision not to exclude ­non-rival goods can reduce the incentives to As the Internet first diffused in the late produce information goods, a subject we dis- 1990s, copyrights of music (and text) were cuss below in the context of copyright pol- often ignored as people freely posted copy- icy. It can also create negative externalities. righted goods online. Because of the non-rival­ For example, Acquisti and Tucker (2014) nature of digital information, one posted show that policies that mandate “open data” copyrighted item could be useful to millions by government may lead to data leakages of people, potentially replacing sales. At the (or privacy breaches) that affect individ- same time, music industry revenue began to uals’ ­welfare offline. Openness, almost by fall (Waldfogel 2012a) and this was widely definition, implies a reduction in privacy. blamed on changes brought by the Internet. Relatedly, Acquisti and Gross (2009) show Optimal enforcement of copyright has that using public data online makes it pos- therefore been a key focus of the digital eco- sible to predict an individual’s social security nomics literature. The early work focused number. This feeds back, in general, to the on the revenue consequences of free online idea that while non-excludability­ may be copying. This was referred to as “file­ sharing” attractive in principle, it can lead to ques- to those who believe it should be allowed, tions of appropriate data security practices and as “piracy” by those who didn’t. The Goldfarb and Tucker: Digital Economics 15 direct effect of free online copying of media so quality rose. Results are similar in ­movies is that revenues from the sale of copies of (Waldfogel 2016) and books (Waldfogel and that media fall. At the same time, revenues Reimers 2015). This contrasts with the eco- could rise if the free copies are merely sam- nomic history literature, which suggested that pled and consumers buy what they like (Peitz copyright alone could increase the quality of and Waelbroeck 2006). Revenues could also creative output (Giorcelli and Moser 2016). rise for complementary goods like live per- In addition to affecting incentives to inno- formances (Mortimer, Nosko, and Sorensen vate, digital challenges to copyright protec- 2012). Finally, revenues could rise if the free tion may affect incentives to build on prior copies are limited to developing markets for work. Williams (2013) demonstrates this products with network effects (Takayama point in a different intellectual property 1994). Empirically, though a small num- context and shows that intellectual property ber of studies have found positive effects protections limit follow-on­ innovation in (Oberholzer-Gee­ and Strumpf 2007), most gene sequencing. Heald (2009) shows that studies have found that free online copy- copyrighted music is less used in the movies ing reduces revenues in music (Rob and than ­non-copyrighted music. Nagaraj (2018) Waldfogel 2006, Zentner 2006, Liebowitz shows that copyright protection of old sports 2008, and Waldfogel 2010), in video (Rob and magazines reduces the quality of Wikipedia Waldfogel 2007; Liebowitz and Zentner 2012; pages decades later. This phenomenon is Danaher, Smith, and Telang 2014b; Danaher not unique to the digital context. Biasi and and Smith 2014; and Peukert, Claussen, and Moser (2018) show that eliminating copy- Kretschmer 2017), and in books (Reimers rights of German books during World War II 2016). This echoes a ­non-digital historical led to a substantial increase in US scientific literature (Li, MacGarvie, and Moser 2015; output, measured by PhDs in mathematics and MacGarvie and Moser 2015) suggesting and patents that cited the German books. a continuity between policy governing digital Another challenge for copyright policy technologies and earlier policies. driven by the shift in costs of replication is that How does copyright affect the creation of it has made it easier for other firms to repli- new works? This is a more difficult research cate digital content and attempt to aggregate question, as it requires some attempt to it. This practice has been particularly preva- measure counterfactual quality and quan- lent in the news media, where policy makers tity of goods had copyright law not existed have been encouraged to take action to pro- (Varian 2005; Waldfogel 2012b; and Danaher, tect the interests of the newspapers that actu- Smith, and Telang 2014b). Waldfogel (2012a) ally originated this news content. However, addresses this challenge using two measures in general the work in economics that has of music quality: historical “best albums” lists evaluated the effect of these aggregators has and usage information over time. In both been to emphasize that such aggregation pro- cases, he shows that the quality of music motes more exploration, rather than neces- began to decline in the early 1990s and sarily cannibalizing content (Calzada and Gil stopped declining after the arrival of free forthcoming; Chiou and Tucker 2017; Athey, online copying in 1999. Why did quality rise Mobius, and Pal 2017). despite declining revenue? He argues that Overall, copyright law is more import- simultaneously with the decline in revenue ant in digital markets because goods can be came a decline in the cost of producing and copied at zero cost. Stricter enforcement of distributing music. Digitization affected the copyright appears to increase revenue to the supply side as well as the demand side, and copyright holder, increase some incentives 16 Journal of Economic Literature, Vol. LVII (March 2019) by potential copyright holders to innovate, 5.1 Does Distance Still Matter If but reduce incentives by others to build Transportation Costs Are Near Zero? on copyrighted work. Nevertheless, the literature also shows that, despite ease of Low transportation costs for information copying, digitization has not killed creative mean that the cost of distribution for digital industries because production and distribu- goods approaches zero and the difference in tion costs have fallen and because the tech- cost of nearby and distant communication nology has caught up to facilitate copyright approaches zero. enforcement. The potential implications of low transpor- tation costs have been explored in the popular press. Cairncross (1997) suggests that this fall 5. Lower Transportation Costs in the costs of transporting information would Related to replication being costless, the lead to a “death of distance.” Isolated indi- cost of transporting information stored in viduals and companies would be able to plug bits over the Internet is near zero.4 Put dif- into the global economy. Rural consumers ferently, the cost of distribution for digital would benefit by having access to the same goods approaches zero and the difference in set of digital products and services as every- the cost of nearby and distant communica- one else. There would be a global diffusion of tion approaches zero. knowledge. Friedman (2005) identifies sev- In addition, digital purchasing technol- eral of the same themes in predicting a “flat ogies have reduced transportation costs. world,” in which businesses anywhere could Consumers buy physical goods online, partic- plug into the global supply chain and produce. ularly when offline purchasing is costly or dif- Being in the United States would not confer ficult (Goolsbee 2000; Forman, Ghose, and a meaningful advantage relative to India. Goldfarb 2009; and Brynjolfsson, Hu, and Both Cairncross and Friedman suggested the Rahman 2009). Furthermore, Pozzi (2013) potential arrival of a global culture, in which shows that consumers also use online shop- everyone everywhere would consume the ping to overcome the transportation costs of same information, an idea with its roots in carrying things from the store. In this way, the McLuhan (1964). This idea is implicit in the Internet facilitates stockpiling, allowing peo- trade model of Krugman (1979): countries ple to buy in bulk when a discount appears consume the same goods as transport costs because delivery means there is no need to approach zero. Rosenblat and Mobius (2004) carry the large quantity of items purchased. formalize some of these ideas in a different Therefore, for information, digital goods, context, using a network model of collabora- and physical goods, transportation costs are tion in which long distance collaboration rises lower online. but coauthor similarity in other dimensions (such as field of research) also rises. A less extreme question than “Is distance 4 While transportation costs could be positive and even high due to network congestion, in practice this has not dead?” is “Does distance matter more or less been an issue. Early on, such network congestion was a than it used to?” The most definitive answer key focus of the literature. For example, one of the first to that question comes from Lendle et al. volumes on Internet economics, Mcknight and Bailey (1998), has several articles on congestion pricing. This (2016). They compare ­cross-border sales early literature on backbone competition and congestion on eBay with international trade data. They ended up influencing our understanding of the economics demonstrate that, while distance predicts of net neutrality discussed above (Cremer, Rey, and Tirole 2000; Laffont et al. 2001; Besen et al. 2001; and Laffont both online and offline trade flows, distance et al. 2003). matters substantially less on eBay. Goldfarb and Tucker: Digital Economics 17

The digital economic literature has empha- retailers went online first. In their review sized what factors influence the extent to of the literature on online–offline­ compe- which distance still matters. tition, Lieber and Syverson (2012) provide As Lemley (2003) notes, “No one is ‘in’ some additional evidence that offline options cyberspace” (p. 523). Therefore, offline affect online purchasing. Similarly, in the options matter. Balasubramanian (1998) digital media context, evidence suggests that examines the importance of offline options online media consumption substitutes for, using a circular city Salop (1979) model with and is replacing, offline media consumption / the cost of using the direct retailer as con- (Wallsten 2013 and Gentzkow 2007). stant for all locations, but the cost of using the In addition to the offline option, the fact stores located around the circle dependent on that tastes are spatially correlated also mat- transportation costs. The model shows that ters for the persistent role of distance. Blum the benefit of a direct (online) retailer will be and Goldfarb (2006) examine the interna- largest for those who live far from an offline tional Internet surfing behavior of about retailer. Forman, Ghose, and Wiesenfeld 2,600 American Internet users, and demon- (2008) provide evidence to support this strate that Internet surfing behavior is con- model, demonstrating that when a Walmart or sistent with the well-established­ empirical Barnes & Noble opens offline, people substi- finding in the trade literature that bilateral tute away from purchasing books on Amazon. trade decreases with distance (Overman, A number of other studies also demonstrate Redding, and Venables 2003; Anderson and how offline retail affects online purchasing. van Wincoop 2004; and Disdier and Head Related models include Loginova (2009) and 2008). In other words, even for a product Dinlersoz and Pereira (2007), which examine with zero shipping costs (visiting websites), the role of loyalty to the offline store in driv- people are more likely to visit websites from ing the more price sensitive customers online. nearby countries than from faraway coun- Empirically, Brynjolfsson, Hu, and Rahman tries. This relationship between distance (2009) show that online sales at a women’s and website visits is much higher in taste-de- clothing retailer are lower from places with pendent categories (and loses statistical many offline women’s clothing stores. This significance in the ­non-taste-dependent cat- effect is driven by the more popular prod- egories). Distance matters because it prox- ucts that are likely to be available in a typical ies for taste similarity. Alaveras and Martens offline store. Choi and Bell (2011) shows that (2015) replicates this core result using much online sales of niche diaper brands are higher richer data on website visits by users in a large in places where they are unlikely to be avail- number of countries. Sinai and Waldfogel able offline. Goolsbee (2001), Prince (2007), (2004) also shows that highly populated areas and Duch-Brown­ et al. (2017) all show sub- produce more content, and that because stitution between online and offline sales tastes are spatially correlated in the sense of personal computers. Gentzkow (2007) that people are more likely to consume local demonstrates substitution between the media than distant media, people in highly online and offline news in Washington DC. populated areas are particularly likely to go Seamans and Zhu (2014) and Goldfarb and online. This geographically specific nature Tucker (2011a, 2011d) demonstrate substitu- of tastes is also reflected in the consumption tion between online and offline advertising. of digital goods such as music (Ferreira and Gertner and Stillman (2001) show how chan- Waldfogel 2013) and content (Gandal 2006). nel conflict interacts with vertical integration Quan and Williams (2018) demonstrate that and show that vertically integrated apparel accounting for spatial correlation in tastes 18 Journal of Economic Literature, Vol. LVII (March 2019) reduces the estimated ­consumer surplus and Douglas (2009) shows that same-city­ from increased online variety by 30 percent. sales on eBay and MercadoLibre (a Brazilian In addition to offline choices and spa- electronic commerce platform) are dis- tially correlated tastes, another factor that proportionately high, likely because some explains the continuing role of distance is the products are observed and delivered in presence of social networks. Much online person. Furthermore, Forman, Ghose, and behavior is social, and social networks are Wiesenfeld (2009) shows that Americans fol- highly local (Hampton and Wellman 2003). low the online product recommendations of Therefore, while zero transportation costs others who live near them. of information mean that you can commu- 5.2 Can Policy Constrained by Geographic nicate with anyone anywhere in the world Boundaries Shape Digital Behavior? for the same price, the vast majority of most people’s email comes from those who either Early work worried that the Internet could live at the same home or work in the same undermine local regulation and national sov- building. Gaspar and Glaeser (1998) specu- ereignty (Castells 2001). The results of some late that because of the spatial correlation of research is consistent with this idea: Online social networks, the Internet may be a com- sales have been higher where the differ- plement to cities. More efficient commu- ence between online and offline tax rates is nication would be especially important for highest (Goolsbee 2000, Ellison and Ellison those who communicate frequently. In other 2009b, Anderson et al. 2010, and Einav et al. words, though the relative costs of communi- 2014). When local regulation prohibits offline cation fall more for distant communication, advertising, similar online advertising is more the overall importance of local communica- expensive (Goldfarb and Tucker 2011e) tion might mean that cities benefit most. and more effective (Goldfarb and Tucker Agrawal and Goldfarb (2008) provide 2011a). This substitution suggests that online some evidence in support of this hypothe- and offline markets should be considered sis by showing that as new universities con- together in the context of antitrust (Goldfarb nected to a 1980s Internet-like­ network, they and Tucker 2011f; Brand et al. 2014). increased their collaboration rate with those At the same time, regulation can mean already connected. The biggest change in that users experience the Internet differ- collaboration rates were for co-located­ uni- ently in different locations. At the extreme, versities in different quality tiers. The paper regulation can prohibit certain content, emphasizes the likely local social networks making the experience of using the Internet of researchers in the same city. Looking at different across locations. Zhang and Zhu online “crowdfunding” of music, Agrawal, (2011) examine the effect of the blocking Catalini, and Goldfarb (2015) provide further of Wikipedia in China in October 2005 on evidence of the importance of local social the motivations of others outside China to networks by showing that musicians’ early contribute. Therefore, a key online website funding tends to come from local supporters was available in some places and not others. who the musicians knew prior to joining the More generally, some countries regularly crowdfunding platform. As a musician gains block access to certain websites, changing prominence on the website, the later fund- the nature of the Internet across locations. ing often comes from distant strangers. Regulation can also change what users Finally, in the absence of the improve- find available across locations. Copyright ments in verification discussed below, trust policy leads to variation in the availability is easier locally. Hortacsu, Martinez-Jerez, and consumption of media across locations Goldfarb and Tucker: Digital Economics 19

(­Gomez-Herrera, Martens, and Turlea 2014; Bailey, and Brynjolfsson 2001; and Bakos Chiou and Tucker 2017; Athey, Mobius, and 2001). Even first-degree­ price discrimina- Pal 2017; and Calzada and Gil forthcoming). tion seemed like it might become more than Privacy policy leads to different advertising a theoretical curiosity. and different website success (Goldfarb and One form of price discrimination that has Tucker 2011d and Tucker 2015). Trademark received a great deal of attention in the the- policy leads to different search experiences ory literature on digital markets is behavioral (Chiou and Tucker 2012 and Bechtold and price discrimination (see Fudenberg and Tucker 2014). ­Villas-Boas 2007, 2012 for reviews). This lit- Therefore, when regulation does not erature emphasizes that the low cost of col- reach into the online sphere, the zero trans- lecting digital information makes it easier for portation costs of information in the online companies to ­price discriminate based on channel generate a disproportionate benefit an individual’s past behavior. The research of online information in regulated contexts. builds on a large price discrimination liter- However, when regulation does reach the ature that does not specifically emphasize online sphere, it can have a substantial effect digital markets (Hart and Tirole 1988; Chen on the nature of the Internet across locations. 1997; Fudenberg and Tirole 2000). Broadly, the research explores the benefits and costs of identifying previous customers for monopolies 6. Lower Tracking Costs (Villas-Boas­ 2004) and competing firms (Shin The first three drops in costs, those asso- and Sudhir 2010; Chen and Zhang 2011). ciated with search, replication, and distance, Fudenberg and Villas-Boas­ (2012) summarize were well discussed in the early digital eco- this literature to conclude that under monop- nomics literature. However, the importance oly, firms benefit from the additional informa- of the lowering of the next two costs we tion, but under competition the information discuss, tracking and verification, has only may increase the intensity of competition. become clear in the last decade. Furthermore, the benefits of the information Digital activity is easily recorded and stored. to a monopoly may lead consumers to strate- In fact, many web servers store information gically withhold information. In other words, automatically, and firms have to make a delib- consumers become ­privacy sensitive (Taylor erate decision to discard data. Reductions 2004; Acquisti and Varian 2005; Hermalin in tracking costs enable personalization and and Katz 2006). In the opposite direction, the creation of ­one-to-one markets, leading rules that restrict the flow of information hurt to renewed interest in established economic firms’ ability to price discriminate and there- models with asymmetric information and dif- fore may leave some consumers unwilling to ferentiated products such as price discrimina- buy at the offered prices (Taylor and Wagman tion, auctions, and advertising models. 2014; Kim and Wagman 2015). Another form of price discrimination that 6.1 Do Lower Tracking Costs Enable Novel has received attention in the digital eco- Forms of Price Discrimination? nomics literature is versioning. Bhargava The ability to use digital technologies to and Choudhary (2008) provide a model of track individuals enables personalized mar- versioning when variable costs are zero. Fay kets. Several economists recognized this and Xie (2008) explore versioning based on potential for digital price discrimination probabilistic selling. For example, airlines as the Internet commercialized in the late and hotels offer low-price versions of their 1990s (Shapiro and Varian 1998; Smith, products on Priceline.com, in which there is 20 Journal of Economic Literature, Vol. LVII (March 2019) buyer uncertainty about the specific product for personalized pricing of goods online, it being bought. is perhaps a surprise that for many of these Empirical support for digital price dis- goods, consumers face a price of zero (Evans crimination is limited, despite the rich 2009). Therefore, perhaps the most striking theoretical discussion of the potential for effect of the creation of low online tracking personalized pricing. For example, version- costs has not been to use personalized pro- ing is a basic form of ­third-degree price files to charge different consumers different discrimination that precedes most digital prices, but instead to show these different markets (Maskin and Riley 1984; Deneckere consumers more appropriate, relevant, and and McAfee 1996; Corts 1998; Fudenberg profitable advertising. and Tirole 1998). Rao (2015) provides exper- Variants of these ideas appear in a rich the- imental support for the value of versioning ory literature on two-sided­ markets, empha- digital products, demonstrating that online, sizing the digital context (Baye and Morgan limited-time “rentals” can increase profits 2001; Anderson and de Palma 2009, 2013; by segmenting high- and low-value con- White 2013; Athey, Calvano, and Gans 2018). sumers. Despite the ease of even this most Baye and Morgan (2001) demonstrate that straightforward form of price discrimina- an information intermediary will price low tion, Shiller and Waldfogel (2011) argue that to consumers, while charging advertisers a digital firms may not be versioning, or more high enough price that some choose not to generally ­price discriminating, as much as participate. Anderson and de Palma (2009) would be optimal. In particular, they puz- and Athey, Calvano, and Gans’s (2018) papers zle over the surprisingly uniform nature of each model consumer attention as scarce pricing for digital music. They argue that and explore advertiser competition for that uniform pricing of music appears to lead to attention. Athey, Calvano, and Gans (2018) ­lower-than-optimal profits for firms, but do emphasize that if an advertiser wants to send not provide a clear answer to this puzzle. a message to a customer offline, they need to While there is evidence of broad versioning rely on noisy signals based on media demo- of online media (Chiou and Tucker 2013; graphics. In contrast, online targeting tech- Lambrecht and Misra 2017), the theoreti- nology is such that an advertiser can target cal literature on digital price discrimination a particular consumer. In the presence of seems to be ahead of the empirical work and multiple media outlets and ­multi-homing by of firm practices. While there is evidence of consumers, the equilibrium outcome is that first-degree price discrimination in higher online advertising prices can be much lower education (Waldfogel 2015), the only online than offline advertising prices even though the research example we found is Dube and online advertising is in fact more useful to the Misra (2017), who demonstrate the feasibil- advertiser. However, Gentzkow (2014) argues ity and profitability of targeting many prices that the price of attention is not lower online to different customers of an online service than offline, which challenges this prediction. based on a large number of characteristics. Perhaps because of these forces, many of the largest online companies—in 6.2 Why Has There Been a Shift in terms of revenues, profits, and users—are Academic Emphasis from Personalized advertising-supported.­ Low-cost­ tracking Pricing to Personalized Advertising? means that what distinguishes online adver- Given the emphasis of the theoretical lit- tising from offline advertising is that it is tar- erature on the ease and practicality of behav- geted (Goldfarb and Tucker 2011b, Goldfarb ioral price discrimination and the potential 2014). This difference is highlighted in Goldfarb and Tucker: Digital Economics 21

­models that explore competition between wasted. Simonov, Nosko, and Rao (2018) use online and offline advertising (Athey and data from Microsoft’s Bing search engine Gans 2010, Bergemann and Bonatti 2011, to show that the results for eBay may be and Johnson 2013). Athey, Calvano, and driven by the strength of eBay as a partic- Gans (2018) and Levin and Milgrom (2010) ularly ­well-known brand. Less ­well-known use very different models to demonstrate that advertisers seem to benefit from search better targeting may not help online media. advertising. Athey, Calvano, and Gans (2018) show that While much better than prior ways to mea- improved tracking can increase competition sure advertising effectiveness, there are still between media outlets. Levin and Milgrom substantial challenges. Correlational research, (2010) show that too much targeting can lead even with detailed data, typically yields inac- to insufficient competition among advertisers curate measures of advertising effects because for the user attention sold by a monopolist the ­signal-to-noise ratio for advertising’s effect media firm. on sales is low (Lewis, Rao, and Reiley 2015; This better targeting has led to a thriving Gordon et al. 2016). Furthermore, even with literature that measures advertising effec- experiments, advertising effects are subtle rel- tiveness. Because ad messages are sent to ative to the variance in purchase behavior, and individuals in bits (rather than broadcast so studies need to be highly powered (Lewis through billboards and newspapers), it is and Rao 2015). relatively easy to identify consumers that see A large literature also emphasizes the ads, to randomize which consumers see ads, role of targeting as a distinct and important and even to track those consumers through feature of online advertising. Goldfarb and purchase. Until recently, this was very diffi- Tucker (2011c) shows that targeted banner cult, and so there were few studies that could advertising is effective, but only as long as deliver credible empirical measures of adver- it does not take over the screen too much. tising effectiveness. Low tracking costs make Targeting works when subtle, in the sense it relatively easy to run field experiments that it has the biggest effect on plain banner online, and large scale field experiments ads, relative to how it increases the effective- have been the focus of the recent literature. ness of other types of ads. Lambrecht and Research on online advertising effec- Tucker (2013) and Tucker (2012a) demon- tiveness has been largely conducted by strate the effectiveness of other types of research economists working with indus- online advertising targeting. try. For example, Lewis and Reiley (2014) As noted above, online media support use a field experiment on 1.6 million Yahoo their business by selling scarce consumer customers that connects online advertis- attention to advertisers. New technologies ing to offline department store sales. They are emerging that allow consumers to block find that online advertising increases offline advertising online. Such ad blocking may sales in a department store. Blake, Nosko, reduce revenues and, perhaps counterintu- and Tadelis (2017) show that in many cases, itively, increase the quantity of ads shown search engine advertising—the key reve- to those without ad blockers (Anderson nue generator for Google—does not work. and Gans 2011). In a test of these ideas, In particular, they demonstrate with a large Shiller, Waldfogel, and Ryan (2018) use field experiment at eBay that consumers data on ad blocking and website visits to will often click on the “organic” link anyway show that widespread use of ad blockers and navigate to the advertiser’s page. They may decrease the quality of websites on the argue that much search engine advertising is ­advertising-supported Internet. 22 Journal of Economic Literature, Vol. LVII (March 2019)

6.3 Why Are Online Goods and Services This idea also appears in Varian (2010), which Often Sold by Auction? describes the benefits of ­computer-mediated transactions with respect to decentralized The rise of online advertising, along with price discovery, and therefore more finely ­individual-level tracking technologies, has based price discrimination. While auctions created a difficult pricing problem: how can for goods (rather than advertising) still exist a firm choose prices for thousands of adver- online, Einav et al. (2017) show that goods tisements that might be priced differentially auctions are in decline as online markets to millions or even billions of customers? As have matured. The prominent role of auc- economists have ­long-recognized, auctions tions in economic theory means that a sep- are a particularly useful tool for price discov- arate literature has used the digital setting ery. Consequently, digital markets typically as a context to test ­long-established theory. use auctions to determine prices for adver- This research, pioneered by Lucking-Reiley­ tising. Auctions are also used to price some (1999), is not about digital markets per se, but other goods. uses the digital context to inform a broader Originally, advertising on Yahoo!’s search theory literature (Roth and Ockenfels 2002, page in the 1990s was priced according to Bajari and Hortacsu 2003, and Einav et al. a standard rate. Goto.com’s insight—that 2018). an auction could leverage the fact that the 6.4 How Do Digital Markets Affect Privacy value of advertising depended on the search Policy? term—led to a new way to price discrimi- nate in advertising. Rather than price for the Low tracking costs have led to a renewed search page, price could be at the level of interest in the economics of privacy, as high- the search term. Google and Bing’s ad auc- lighted by a recent review in this journal tions run on this insight. A large literature (Acquisti, Taylor, and Wagman 2016). has arisen to develop auction formats for this In general, the economics literature on context (Varian 2007; Edelman, Ostrovsky, privacy, both offline and online, grapples and Schwarz 2007; Levin and Milgrom 2010; with the question of how privacy should be Arnosti, Beck, and Milgrom 2016). Today, treated in terms of the consumers’ utility advertising auctions, particularly for display function. Should economists treat privacy as advertising, often take into account addi- an intermediate good—that is, a good whose tional information provided by online track- value simply lies in the way it can moderate ing technologies, such as websites visited in the achievement of another good—or as a the past and products observed. final good—that is, a good that should be Less related to tracking costs, online auc- enjoyed and valued for its own sake (Farrell tions have also been used for price discovery 2012)? Much policy­ making is grounded on for goods, most notably on eBay. An early the idea that privacy is a final good where a review of the auction literature is provided in distaste for others intruding on or gathering Ockenfels, Reiley, and Sadrieh (2006). They knowledge about an individual’s personal emphasize that the transactions costs of con- domain is valid as a driver of an individual’s ducting and participating in auctions are utility. However, much of the theoretical lit- lower in the digital context. Furthermore, erature analyzes privacy as an intermediate many digital goods are not standardized in good because of the implications for per- the sense that buyer valuations vary over sonalized pricing that are discussed above time and location, and so the price discovery (Taylor 2004, Acquisti and Varian 2005, function of the auction is particularly useful. Hermalin and Katz 2006). Goldfarb and Tucker: Digital Economics 23

Privacy regulation can affect the nature and medicine technologies: regulations that gave distribution of economic outcomes (Goldfarb consumers control over disclosures enhanced and Tucker 2012a). Edelman (2009) and adoption, but regulations that imposed con- Lenard and Rubin (2009) emphasize that sent requirements decreased adoption. there is a ­trade-off between the use of online Privacy regulation puts a cost on tracking customer data to subsidize zero-price­ goods information flows. The welfare effects of and advertising performance. Goldfarb and these costs may be ambiguous. Tucker (2011d) show that European privacy First, there may be ­knock-on effects to regulation that restricted online tracking led industry structure from privacy regulation. to a substantial decline in the effectiveness of Campbell, Goldfarb, and Tucker (2015) show online advertising in Europe. Johnson (2014) that because privacy regulations typically estimates the financial effect of privacy pol- require firms to persuade their consumers icies on the online display ad industry, sug- to give consent, which in turn imposes a cost gesting that an opt-in­ policy or a tracking ban on the consumer, small firms and new firms would reduce welfare substantially, though are disproportionately affected because it is an opt-out­ policy would have little effect. harder for them to obtain consent under the Johnson’s paper is very useful for under- regulation. standing the effect on publishers (rather than Second, welfare complications of privacy advertisers) of privacy regulation. policies are also hard to assess due to a pri- Kim and Wagman (2015) show that regula- vacy paradox, where consumers state an affin- tion of sharing financial information increased ity for privacy, but then act in ways that are defaults on loans during the financial crisis. not consistent with this stated preference. Miller and Tucker (2009, 2011) show that Athey, Catalini, and Tucker (2017) provide US healthcare privacy regulation reduced some evidence about the extent to which hospital adoption of electronic medical small incentives, distracting information, records, leading to worse health outcomes. and small navigation costs can lead to a gap On a more positive note in favor of privacy, between stated privacy preferences and actual Tucker (2014) shows that ­firm-implemented behavior. Furthermore, assessing the value privacy controls designed to encourage con- of privacy is complicated for many reasons, sumers’ perceptions of control can actually including that privacy preferences for the enhance the performance of online adver- same individual change over time (Goldfarb tising. Tucker (2012b) compares this result and Tucker 2012b). with work that suggests there may be bene- Third, much of the work in the econom- fits from addressing consumer privacy con- ics of privacy has understandably focused cerns, building on research that illustrates on questions relating to industrial organi- how perceptions of control influence privacy zation, there are also implications of digital concerns in general (Brandimarte, Acquisti, technologies and privacy for the economics and Loewenstein 2012). of national security. In addition to improving In general, the precise nature of privacy the ability of firms to track consumers, digital protection can be expected to matter a lot for technology allows government crime-fighting­ the direction of innovation: it is not a matter of agencies to track a broad swathe of the a simple binary choice to have privacy protec- population. Marthews and Tucker (2014) tion or not. This is emphasized in Miller and show that increasing consumer awareness Tucker’s (2018) work, which shows that differ- of government data use leads to increased ent types of privacy protections had very dif- ­privacy-protecting behavior among consum- ferent effects on the ­adoption of personalized­ ers in their interactions with firms. 24 Journal of Economic Literature, Vol. LVII (March 2019)

7. Reduction in Verification Costs past buyers and sellers are posted for future market participants to see. The marketplace The reduction in tracking costs has also that has received the most attention in the led to a reduction in costs associated with the literature is eBay. As mentioned above, one verification of identity and reputation. This reason eBay has received so much attention was not anticipated by the early literature by economists is that it provided a useful set- in economics because the earliest reporting ting to test auction theory. Another reason on the Internet suggested that it would be relates to reputation mechanisms. eBay rec- a vehicle for anonymity—“On the Internet, ognized the challenges of getting people to nobody knows you’re a dog.”5 Furthermore, buy from strangers whom they will not meet in addition to tracking cost falling, digital in person (Resnick and Zeckhauser 2002 and technologies have also made it easier to verify Livingston 2005). To address this issue, they identity and also create a digital reputation. built, and continually adapted and improved, In the absence of such technologies, a a ratings system. The effectiveness and ­long-standing solution for firms to provide development of this ratings system has been credible information about quality was to the subject of hundreds of papers in econom- develop a reputation in the form of a brand ics and management. For example, Ba and (Tadelis 1999, Smith and Brynjolfsson 2001, Pavlou (2002) shows how a ratings system and Waldfogel and Chen 2006). However, can enable trust in the absence of repeated digital markets involve thousands of small interactions. A number of papers empirically players. Furthermore, these small players demonstrate that ­better-rated sellers have can be unfamiliar to potential customers. higher prices and higher revenues (Melnik Einav et al. (2017) estimate that 88 percent and Alm 2002, Livingston 2005, Houser and of online Visa transactions are with a mer- Wooders 2005, and­ Lucking-Reiley et al. chant that the customer does not visit offline. 2007). Cabral and Hortacsu (2010) demon- Alternative mechanisms to ­brand-based strates differences between positive and reputations are needed. The literature on negative feedback, emphasizing how the rat- verification costs builds on economic mod- ings system acts as a disciplining force in the els of reputation, exploring when the expe- marketplace in which sellers with low ratings riences of previous buyers and sellers can exit from eBay’s platform. enable market exchange in the presence of Therefore, the original emphasis of the asymmetric information about quality and reputation literature was as a platform for trustworthiness. This emphasis on repu- establishing trust in long-distance­ transac- tation models distinguishes the literature tions. Dellarocas (2003) recognizes early on on verification costs from the literature on that the application of these feedback mech- tracking costs, which emphasizes price dis- anisms was not limited to online exchange. crimination, advertisement targeting, and Instead, Dellarocas argued that such mech- other forms of personalization. anisms would enable a variety of market activities, both online and offline. As long as 7.1 How Do Online Reputation Systems incentives to deviate are not too high, such Facilitate Trust? systems can provide credible quality signals The most common such mechanism is an in a variety of settings (Dellarocas 2003 and online rating systems in which ratings from Cabral 2012). One key application is to provide informa- tion on product quality. Rather than enhance 5 The New Yorker on July 5, 1993. information about a particular seller, ratings Goldfarb and Tucker: Digital Economics 25 can inform consumers about the best prod- the ability to more securely and easily ucts available within a platform. It might make payments.­ This is demonstrated by be in the platform’s interest to provide such Economides and Jeziorski (2017), who information so that consumers are directed show the power of using mobile devices to the highest-quality products. Comparing to digitally verify identity in Tanzania. changes in reviews on Amazon relative to They show that this power enables the use Barnes & Noble, Chevalier and Mayzlin of mobile payments networks to transfer (2006) demonstrate that positive reviews money to others, but also, equally impor- lead to higher sales. tantly, to transport money over short dis- More recently, the literature has focused tances. People appear to deposit cash after on how online tools reduce verification costs work, walk home, and then pick up the cash in offline settings. Luca (2011) shows how at home. The verification system enables online restaurant reviews on Yelp affect easy deposits and withdrawals, thereby restaurant demand, particularly for indepen- reducing the risk of robbery. Digital ver- dent restaurants. Overall, his results suggest ification, in the form of DNA databases, that Yelp led to a decrease in the share of has also been shown to reduce crime chain restaurants relative to independents. (Doleac 2017). Hollenbeck (2018) finds a similar result for As technology improves, verification may hotels. continue to become easier. Researchers It is easier to establish an online reputa- have speculated that the blockchain is a tion using online reputation mechanisms, promising technology for reducing veri- but the mechanisms for damaging that rep- fication costs further (Catalini and Gans utation in the form of consumer complaints 2016). Blockchain is a technology that have also become easier. Historically, com- combines insights from game theory and plaints were registered with letters, and then cryptography to enable the exchange of calls into call centers. Social media enables value between two distant untrusting par- rapid widespread communication of com- ties without the need for an intermediary. plaints to both the firm and a wider audi- Transaction attributes, or information on ence. Gans, Goldfarb, and Lederman (2016) the agents involved, can be cheaply veri- use data from Twitter to explore ideas on the fied if stored on a distributed ledger. This relationship between market power and con- means that trust in an intermediary could sumer voice first sketched out in Hirschman be replaced by trust in the underlying code (1970). They show that consumers are more and rules that define how the network can likely to voice their complaints via Twitter in reach agreement. Currently, most of the lit- locations where airlines have a higher share erature on blockchain technologies focuses of flights. In turn, airlines are more likely on specific applications of the technology to respond to consumers in these markets. such as cryptocurrencies (Böhme et al. 2015 Tucker and Yu (2017) show some positive and Catalini and Tucker 2017). However, effects of digital technologies, in that the if blockchain technologies achieve the use of mobile apps to receive complaints promise highlighted in Catalini and Gans can actually advantage less-educated con- (2016), then we might see a diverse liter- sumers who are more likely to suffer from ature emerge over the next few years on ­employee–consumer discrimination in the the consequences of low-cost­ verification— treatment of their complaints. and the associated changing role for inter- A benefit of improved online verifica- mediaries—across a variety of empirical tion procedures for individuals has been settings. 26 Journal of Economic Literature, Vol. LVII (March 2019)

7.2 Is There a Role for Policy in Reducing ­examining worker and firm behavior on an Reputation System Failures? online labor market. They show that new workers benefit from affiliating themselves Given the important role of such systems with an agency. in generating demand, it is perhaps unsur- The platforms also work to improve their prising that the economics literature has reputation systems. Fradkin, Grewal, and focused on questioning when reputation sys- Holtz (2017) document two experiments tems fail. Often the failures relate to incom- made at Airbnb with this aim: offering plete ability to verify the person doing the monetary incentives to submit reviews and rating online. One type of failure relates to implementing a simultaneous review pro- a selection bias: not all consumers provide cess to reduce strategic reciprocity. Hui et ratings. Nosko and Tadelis (2015) show evi- al. (2016) show, in the context of eBay, that dence of such a selection bias, in which buy- platforms benefit by having both reputation ers with a bad experience do not bother to systems and regulations to expel bad actors. rate the seller. They instead stop buying from In each of these cases, it has been the pri- any sellers on the platform into the future. vate sector that has reduced these reputa- Poor service by a seller therefore creates an tion system failures. To the extent that there externality. The failure of the reputation sys- has been a role for policy, it has been in the tems hurts the platform, rather than the indi- enforcement of contracts and prevention of vidual seller. Another type of failure relates fraud. At this point, the literature does not to direct manipulation of the ratings by the point to a specific digital policy with respect firms or their competitors. Mayzlin, Dover, to reputation systems failures. and Chevalier (2014) and Luca and Zervas One aspect of policy related to verification (2016) show evidence of manipulation, in is the nature of intellectual property tools which firms seem to give themselves high rat- such as trademarks. Trademarks allow cus- ings while giving low ratings to their compet- tomers to verify whether a brand is indeed itors. This evidence of manipulation suggests the brand it claims to be. Chiou and Tucker that ratings systems alone are insufficient. (2012) and Bechtold and Tucker (2014) doc- The challenges of ratings systems were ument that, online, consumers use trade- recognized relatively early in the digital eco- marks to search ­proactively. The trademark nomics literature. Consider the market for therefore serves two purposes: it verifies collectible baseball cards. When buyer and identity and it provides a path to search for seller are in the same place, the buyer can related products. Trademark policy needs to inspect the quality of the card in the store. be narrow enough to facilitate search related They can look for rips, folds, or frayed edges. to trademarks, but broad enough to ensure Online, quality is hard to assess. Jin and Kato that such search does not sow confusion on (2006) provide evidence of fraud in these brand identity. markets. They show that the online reputa- 7.3 How Do Digital Markets Affect tion system is insufficient in many ways. In a ­Antidiscrimination Policy? companion paper (Jin and Kato 2007), they show how a professional grading industry A second policy issue driven by changes grew to help solve the information asym- in verification relates to discrimination. If metry between buyers and sellers online. people were indeed truly anonymous on Stanton and Thomas (2016) shows the the Internet, then there could be no direct value of online intermediaries in providing­ discrimination. However, the drop in ver- ­information beyond platform ratings by ification costs and the ability to identify an Goldfarb and Tucker: Digital Economics 27

­individual and also their characteristics the suitability of employees. They find con- makes discrimination possible (and poten- siderable use of social networking sites for tially low cost) in a digital environment. ­potentially discriminatory purposes. Similar The question, then, for policy makers is results have been found in a variety of other whether there is something unique to the online contexts (Pope and Sydnor 2011 and online setting that requires additional regu- Edelman and Luca 2014). lation beyond existing antidiscrimination­ law. Both online and offline, discrimination One area where this is hotly debated is in the is prevalent. Open questions remain as to use of algorithms to parse data and auto- whether discrimination is more prevalent mate the allocation of resources and decision online or offline, and as to whether policies making. This is investigated in Lambrecht aimed at reducing online discrimination spe- and Tucker (forthcoming), which shows that cifically will reduce discrimination overall, algorithms may lead to apparently discrim- or simply push discrimination into another inatory outcomes for innocent reasons. In setting. particular, they show that ads for STEM edu- cation are disproportionately shown to men 8. Consequences of Digitization for by online algorithms because advertising to Economic Actors men is less expensive overall than advertising to women, and so advertisers who are indif- As people spend more time consuming ferent to gender end up showing their ads to digital media and buying products online, men more often. and as business and government increasingly Broadly, on the one hand, while tracking use digital technology, it suggests a broader is easier, such tracking may focus on dimen- question: how does storing information in sions that are legally and morally less contro- bits rather than atoms affect welfare? As versial, such as preferences rather than race. search, reproduction, transportation, track- If digital transactions mean that gender and ing, and verification costs fall, has that had race information is not revealed, then dis- an effect on the economy? crimination may fall. Morton, Zettelmeyer, Broadly, the literature has tackled this and Silva-Risso (2003) show that Internet question in four different ways: ­country-level car purchasing reduces gender- and effects, region-level­ effects, firm-level­ ­race-based price discrimination. Cullen and effects, and ­consumer-level effects. ­Pakzad-Hurson (2017) show that a reduc- 8.1 ­Country-level Effects tion of privacy of wages in online platforms decreases pay differences across workers The macroeconomic productivity litera- (though it also reduces average pay). ture with respect to Internet technology has On the other hand, if gender, race, or its roots in the Solow (1987) claim that “you other sensitive information is revealed, it is can see the computer age everywhere but in possible that, in the absence of other infor- the productivity statistics.” This “productiv- mation, discrimination is high. For example, ity puzzle” persisted for many years. A large Ayres, Banaji, and Jolls (2015) and Doleac growth accounting literature has arisen to and Stein (2013) show that sellers receive examine this puzzle and measure the overall lower prices when a black hand is shown with effect of digital technologies on the econ- the item than when a white hand is shown. omy. While we view this literature as beyond Acquisti and Fong (2013) present the results the scope of this article, Jorgenson, Ho, and of a field experiment to study how employers Stiroh (2008) and Bloom et al. (2010) both use information on social networks to filter summarize it to suggest that there was a 28 Journal of Economic Literature, Vol. LVII (March 2019)

­post-1995 productivity surge that was largely direct effect of the Internet find a decrease driven by digital technology investment and in the role of distance in trade (Freund and usage. Weinhold 2004, Clarke 2008, Lendle et al. Still, measuring the productivity shifts is 2016, and Hui forthcoming), while other difficult. Haltiwanger and Jarmin (2000) lay papers identify other weaker forces moving out several of the anticipated challenges in in the ­opposite direction. Consistent with measuring the effect of the digital economy: an effect of easy international communica- service industry output, data on digital tech- tion on trade, Gorodnichenko and Talavera nology spending, price deflators, et cetera. (2017) show that exchange rate pass-through­ A key challenge relates to intangible capital is faster online. (Corrado and Hulten 2010), which has been 8.2 ­Region-level Effects found to affect productivity measurement in both the United States and the United Another question is the extent to which Kingdom (Corrado, Hulten, and Sichel the Internet has led to redistribution of 2009; and Marrano, Haskel, and Wallis economic benefits within countries and, in 2009). Soloveichik (2010) takes on this mea- particular, between cities and rural areas. surement challenge and identifies about $65 Gaspar and Glaeser (1998) notes that digi- billion in intangible capital related to books, tal communication could be a substitute or a movies, music, and television. complement to cities. Overall, the literature A different stream of work on country-level­ suggests that the biggest beneficiaries of dig- effects examines how digital communication ital technologies and data have been in large may affect trade flows for digital and physi- urban areas. The prime early beneficiaries of cal goods. Freund and Weinhold (2004) pro- online media were in urban areas because the vide suggestive evidence that the Internet highest quality online content was produced increased trade in physical goods due to a in urban areas. This might be one reason reduction in the cost of international com- why Savage and Waldman (2009) find that munication. The asynchronous nature of urbanites have higher willingness to pay for email communication may be particularly broadband. Eichengreen, Lafarguette, and important for reducing the cost of commu- Mehl (2016) show that efficient electronic nication across many time zones (Borenstein communication in foreign exchange mar- and Saloner 2001). ­Gomez-Herrera, kets led to an increase in offshore currency Martens, and Turlea (2014) suggest, how- trading and the consequent agglomeration ever, that this increase may disproportion- of currency markets in London and a small ately benefit ­English-language countries. number of other major financial centers. Several of the papers highlighted earlier in Forman, Goldfarb, and Greenstein (2012) this review demonstrate that the Internet shows that wealthy cities were the primary facilitated trade in digital services (Blum beneficiaries of the business Internet. and Goldfarb 2006, Alaveras and Martens The mechanism through which cities 2015, and Lendle et al. 2016), and this might appear to have benefited has been shown lead to offshoring of certain jobs (Tambe to depend on agglomeration effects, par- and Hitt 2012). While there is some debate ticularly with respect to skilled workers in about whether distance matters less over- local labor markets. Forman, Goldfarb, and all than it did prior to the diffusion of the Greenstein (2005, 2008) show that Internet Internet (Leamer 2007, Cristea 2011, and adoption by businesses is higher in cities and Krautheim 2012), our reading of the liter- in large companies but the advantage associ- ature is that those papers that focus on the ated with being in a city or a large company Goldfarb and Tucker: Digital Economics 29 are substitutes for each other. This indicates direct link from digital technology adop- the importance of agglomeration effects. tion and usage to productivity growth at the Dranove et al. (2014) finds similar results for firm level. By using micro data and various hospitals. econometric techniques to address selec- In contrast to the above work, there is tion, omitted variables bias, and simultaneity, some evidence that Internet adoption has this literature has found that digital tech- some benefits for isolated individuals and nology adoption and usage does enhance rural areas. Autor (2001) and Gaspar and ­productivity. However, the story is not as Glaeser (1998) speculated that the Internet simple as it seems at first. Only some types might reduce the need for task-specific­ of firms experience improved productivity. workspace, thereby increasing the preva- Various factors enhance or mitigate this rela- lence of “telecommuting” and reducing the tionship, including organizational change, need for home and work to be nearby. Kolko skills, geography, regulation, firm size and (2012) shows that broadband disproportion- age, and the potential for spillovers and or / ately benefited people in low density areas network externalities. in terms of employment, though the over- Reviews by Brynjolfsson and Saunders all effect is small. Furthermore, while the (2010) and Draca, Sadun, and Van Reenen primary result in the Sinai and Waldfogel (2009) conclude that ICT adoption and (2004) study cited above is that urban areas usage increase firm performance. This con- have higher quality Internet content, they clusion is driven by a large number of papers also show that isolated individuals consume and a variety of settings. The correlation disproportionately more Internet news. For between IT and productivity is even stronger example, blacks in white neighborhoods con- when ICT investment is modeled with a lag sume more Internet news. Finally, Forman, (Brynjolfsson and Hitt 2003). Goldfarb, and Greenstein (2005) show that There are also specific case studies on the basic Internet technologies have (perhaps effects of ICT on productivity. Baker and disproportionately) benefited rural and iso- Hubbard (2004) show that ICT improved lated cities. productivity in trucking. Jin and McElheran Overall, two forces are at play. (2017) show improved productivity in manu- Agglomeration effects mean that cities dispro- facturing. Agrawal and Goldfarb (2008) show portionately benefit. Low-cost communica- that BITNET increased academic produc- tion, however, can benefit the geographically tivity at ­middle-tier universities. In health isolated. In any particular context, the overall care, Athey and Stern (2002) show that ICT, result depends on the balance between these in the form of Enhanced 911, improved forces. Generally, the more difficult the tech- emergency response; Miller and Tucker nology is to use, the more likely that agglom- (2011) and McCullough, Parente, and Town eration effects dominate. (2016) show that electronic medical records (EMRs) improve patient outcomes; Dranove 8.3 ­Firm-level Effects et al. (2014) show that EMRs reduce hospital As noted above, the growth accounting costs in the presence of complementary skills literature has suggested a compelling link but not otherwise; and Lee, McCullough, between digital technology investments and and Town (2013) show that EMRs increase productivity growth at the country level; hospital productivity. however, causal inference is difficult with Bloom, Sadun, and Van Reenen (2012) ­macro-level measurement. There is a large use a large-scale­ multi-country­ firm-level­ and growing literature that documents a panel database on ICT and productivity. 30 Journal of Economic Literature, Vol. LVII (March 2019)

Their database contains 19,000 firms in thir- 8.4 ­Consumer-level Effects teen EU countries over eleven years, plus a smaller panel of US firms over the same Measurements that focus on productivity time period. They conclude that ICT does or national income accounts do not measure increase productivity, though they find con- consumer surplus. To the extent that much siderable heterogeneity in this effect across of the most valuable content online is free, countries and type of firm. They emphasize measures of productivity and GDP may miss the importance of ­organizational capital, a potential increase in consumer surplus showing that US multinationals operating driven by the Internet (Scott and Varian 2015; in the United Kingdom experienced the Brynjolfsson, Eggers, and Gannamaneni same productivity miracle as US-based­ 2017; Greenstein and McDevitt 2011; and establishments. In contrast, other multi- Goolsbee and Klenow 2006). With time use nationals (and other firms) in the United data, Wallsten (2013) demonstrates that we Kingdom did not. The title communicates are spending an increasing proportion of our the idea well: “Americans do I.T. better.” leisure time online, substituting for offline They argue that US firms are organized in leisure (including television), and to a lesser way that allows them to use ICT more effi- extent work and sleep. Also with time use ciently. This essential role of organizational data, Goolsbee and Klenow (2006) estimate a capital and organizational structure in mak- consumer surplus of $3,000 per ­person-year ing productive use of ICT investments is a in 2005. Goldfarb and Prince (2008) shows recurring theme elsewhere in the literature that this effect is heterogeneous. Overall, (Bresnahan, Brynjolfsson, and Hitt 2002; rich educated Americans are more likely to Brynjolfsson and Saunders 2010; Garicano adopt and therefore, overall consumer sur- 2010; Tambe, Hitt, and Brynjolfsson 2012; plus disproportionately goes to the wealthy. and Brynjolfsson and McElheran 2016). At the same time, conditional on adoption, In addition to change in the organiza- ­lower-income people spend more time tional structure, the most effective use of online. Therefore, among adopters, con- advanced ICT also involves “coinvention,” sumer surplus (at least relative to overall con- the process of adapting ICT to the organi- sumption) is higher for ­lower-income people. zation’s needs (Bresnahan and Greenstein Many studies arrive at specific estimates of 1996). Such process innovation is easiest for the consumer surplus from ­Internet-related firms in places that have a pool of local ICT technologies. Greenstein and McDevitt expertise to draw on (Forman, Goldfarb, and (2011) measures the consumer surplus Greenstein 2008; and Dranove et al. 2014). associated with broadband diffusion at $4.8 This of course reflects the extensive litera- to $6.7 billion between 1999 and 2006. ture on skill-biased­ technological change, Brynjolfsson and Oh (2012) estimate the con- which is long and beyond the scope of this sumer surplus from free online services to be review. As reviewed in Acemoglu and Autor close to $100 billion. Cohen et al. (2016) esti- (2012), given that prior generations of IT are mate billions of dollars in consumer surplus ­skill-biased, it is perhaps unsurprising that from the UberX car service alone.6 use of the Internet to enhance productivity is also ­skill-biased. Correspondingly, in the context of the Internet, Akerman, Gaarder, 6 Greenstein and Nagle (2014) estimate an intangible and Mogstad (2015) provide evidence that benefit of digitization distinct from consumer surplus: the value of open source. It shows that open source software broadband diffusion in Norway dispropor- Apache generates at least $2 billion in unmeasured bene- tionately benefited skilled workers. fits to the US economy. Goldfarb and Tucker: Digital Economics 31

Brynjolfsson, Eggers, and Gannamaneni costs. We have identified five such costs: (2017) provide perhaps the most compre- search, reproduction, transportation, track- hensive estimate of the consumer surplus ing, and verification. These themes inform of the Internet by using (incentive compat- our understanding of the nature of digital ible) choice experiments. For example, in economic activity, and of the interaction one study, they asked people how much they between digital and ­non-digital settings. would need to be paid in order to not have In defining the scope of this article, we access to Facebook for a month. They then drew boundaries. For example, we did implemented the result by actually block- not discuss work on ­skill-biased technical ing their respondents’ access to Facebook in change. Because skill­ bias is not primarily exchange for payment.­ They estimate a value driven by the storage of information in bits, of Facebook of about $750 per user per year, and because there are several other reviews or $18 billion for the United States. They of that literature, we instead refer to Katz and also generated user-level­ survey estimates of Autor (1999), Acemoglu (2002), Goldin and the consumer surplus from other free online Katz (2008), and Acemoglu and Autor (2012). services such as search engines ($16,000 per Similarly, we limit the discussion of the digi- user per year) and online video ($900 per tal technology growth accounting literature, user per year). referring the reader to Jorgenson, Ho, and Before concluding, it is important to rec- Stiroh (2008) and Bloom et al. (2010). We ognize that there are other, perhaps negative, also limited our discussion on three topics changes to overall welfare that may result that have already received reviews in the from shifts in Internet consumption that Journal of Economic Literature: privacy are not captured by these surplus measures. (Acquisti, Taylor, and Wagman 2016), online Belo, Ferreira, and Telang (2014) show a auctions (Bajari and Hortacsu 2004), and reduction in grades associated with schools telecommunications pricing and universal adopting broadband, perhaps because online service (Vogelsang 2003). games distracted students. Bhuller et al. This overview highlights that changes (2013) argue that Internet diffusion may have to economic behavior that result from the increased sex crime, likely due to increased change of costs inherent in the digital con- consumption of pornography (not because text are not as obvious as basic economic of reporting or matching between offenders models might imply. Key open questions and victims). Similarly, Chan, Ghose, and remain with respect to each of the cost Seamans (2016) suggest an increase in racial changes highlighted. Further, other catego- hate crimes associated with the Internet, and ries of costs may shift downwards as digital Falck, Gold, and Heblich (2014) suggest that technology evolves. Internet availability reduces voter turnout in elections. References Aaltonen, Aleksi, and Stephan Seiler. 2016. “Cumula- tive Growth in User-Generated Content Production: 9. Conclusions Evidence from Wikipedia.” Management Science 62 (7): 2054–69. Across a variety of fields, economists Acemoglu, Daron. 2002. “Technical Change, Inequal- examine how digital technologies change ity, and the Labor Market.” Journal of Economic Lit- economic activity. While these papers often erature 40 (1): 7–72. Acemoglu, Daron, Philippe Aghion, Claire LeLarge, have different perspectives and cite different John Van Reenen, and Fabrizio Zilibotti. 2007. literatures, a core theme is that digitization “Technology, Information, and the Decentralization has reduced a number of specific economic of the Firm.” Quarterly Journal of Economics 122 32 Journal of Economic Literature, Vol. LVII (March 2019)

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