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The Wall Street Journal has described Hal Varian as the Adam Smith of Googlenomics. As the tech giant’s chief economist, he revolutionized Google’s business strategy, and is known now as perhaps the most prominent skeptic of America’s official, sluggish productivity numbers. He joined the podcast to discuss the tech industry, the future of the economy, and much more.

In addition to serving as Google’s chief economist, Hal Varian is a professor emeritus at the University of Berkeley and a fellow at the Guggenheim Foundation, the Econometric Society, and the American Academy of Arts and Sciences. He’s also the author of two economics textbooks, and the co-author of the bestselling business strategy book, Information Rules: A Strategic Guide to the Network Economy.

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JAMES PETHOKOUKIS: As my listeners know, frequently I’ll have guests on and we will talk about the productivity paradox (including here, here, and here). It’s the idea that we seem to be witnessing all sorts of tech advances, not least of which is the ability to find all manner of information via a bit of glass in our pockets. But yet the official productivity numbers, as measured by the government, are terrible. So how do you square the circle on this?

HAL VARIAN: It’s a tough problem. I think one of the issues that I’ve dug into quite a bit is the measurement issue — whether we’re measuring the right things.

And there’s two aspects of that. One is are we measuring welfare or consumer well-being with these numbers correctly, which is a different thing than GDP? And two is, given that we want to measure GDP, are we measuring GDP correctly? So let me say a word or two about the first one.

Let’s take an example of photography, all right? So in 2000, there were 80 billion photos produced. We know that because there were only three companies that produced film. And fast-forward to 2015, there are about 1.6 trillion photos produced. Back in 2000, photos cost about 50 cents apiece. Now they cost zero a piece essentially. So any ordinary person would say, wow, what a fantastic increase in productivity, because we’ve got a huge amount of more output and we’ve got a much, much lower cost.

But if we go look at that from the GDP lens, it doesn’t show up in GDP for the most part because those photos are typically traded among friends and put in albums and things like that. They’re not sold on the market. GDP is the market value of transactions out there, and anything that’s not sold or has a zero price isn’t going to show up in GDP.

So we are missing important things in the GDP measurement, but that’s not the whole story to the productivity paradox that you describe because it’s not just the technology sector that’s showing this gap. It’s all over; every sector pretty much is showing us.

It’s across sectors and it’s also just not the United States.

Absolutely. It’s international as well. Of course, now, a lot of these technologies are available internationally so they’re still seeing that.

Another example, same general theme, is look at the GPS. Back in 1990, GPSs were expensive, $1,000. Trucking firms used them, commercial vehicles, but they were above consumers’ price point.

What’s happened is the prices come down, down, down, real GDP is going up, up, up, because the price of the goods has gotten cheaper until it hit zero. When it hit zero, it’s out of GDP so now everybody has GPS on their phone and we’ve got, again, what any normal person would say is a big productivity improvement, but it doesn’t show up in GDP because of the zero price.

Now those are two compelling stories that you’ve told. And the idea, which Joel Mokyr from Northwestern has said, is we have all these measures meant for a wheat-and-steel economy and we have a digital economy.

See also: When the West got rich: A short-read Q&A with economic historian Joel Mokyr

But do you think that’s enough to explain why productivity growth has been so sluggish? You could absolutely be correct, but, one, even if you add all that stuff in, we’d still have low productivity growth, and, two, that’s always been the case. There’s always been this uncounted surplus from technologies, so that’s always been the case and it’s not getting any worse.

So do you think that something is different and it’s a bigger piece? And does it get us all the way back to a healthy productivity number if you included all this?

So it definitely does not get us all the way back. It’s a component. It’s a feature of what’s going on because we’ve got all these new technologies, new business models, new capabilities and we’re still working on figuring out how to measure them appropriately. So it’s a piece of the action, but it’s not the entire action.

If you ask what’s left over, again, I can’t say I’m going to give you an entire solution, but I’ll give you a good place to look. A good place to look is to look at the leaders and laggards. If you look at the leading companies that are doing the best, that are the most advanced at using these new technologies, they’re doing pretty well in terms of productivity, where we think of output per worker, output per hour worked.

But then there are still a lot of laggards who aren’t really adopting the new technologies and aren’t as productive as the leading firms in their industry. And there, I think, what we rely on or we hope for is diffusion of this knowledge through the different indices, and we need to take advantage of the potential productivity gains that are there.

So we’re now in a situation which we’re on our way, we believe and hope, to a more productive economy, but it just hasn’t sprung up everywhere.

To some degree this has always been the case, but is it worse now that you have this frontier leading edge of companies that are benefiting greatly from this new technology, and then you have everybody else? So we have productivity and innovation, it’s just locked up in not enough companies? Is there something different this time about that process, and do you see the diffusion beginning to happen in any of the data?

So absolutely I see the diffusion beginning to happen. And it’s not so different than 100 years ago when you look at the assembly line: Henry Ford comes out with the assembly line, they are hugely productive compared to other automobile assemblers, which is really what they were at that point. But the technology, the assembly line, permeated through the economy and now that’s how we do most manufacturing.

So if we go look at the online world, a lot of these technologies, like machine learning and artificial intelligence and robotics, those are being used in frontier-level firms but they have not diffused widely through the entire economy.

But we’re seeing it happen. We’re seeing more and more companies becoming interested in adopting these technologies. We’re seeing a huge change in the universities with students all wanting to get a degree in data mining or data science or computer engineering. So the expertise is being dialed up.

We want to see that technology spread beyond only the leading group of companies that we’re all aware of. But then there’s the issue of really using that technology and optimizing the use where you have to figure out the best way to use it.

And the classic example is with electric motors — that even when we had electricity, the motor took a while for factories to figure out how to use them. They had to rearrange the factory floors, and it took quite a long time. And part of the Robert Gordon argument is that this information technology has already been around for a while, so we’ve already figured out how to use it and we’ve already gleaned whatever productivity gains we can have from it.

So do you think, especially now that we see artificial intelligence advancing, that there’s just a long ways to go before we really figure out the best way to use these technologies, perhaps even at these leading-edge firms?

Right. Well, some of it is just failure of imagination — that people aren’t quite sure what they can do with the technology, they don’t know, they don’t have an example they can see and so it’s hard for them to really envision making that change.

One of the nice places to look at this is on Kaggle. It’s a startup that was acquired by Google about six months ago. They run competitions in machine learning. So real businesses come with real problems and real money and want a real solution to their problem. So you can see these examples of how the technology can be used in ordinary businesses.

See also: Peak America: Is our most innovative century behind us? A long-read Q&A with Robert Gordon

So I’ll give you a couple of examples. One example is the Heritage Health Prize. That was a health foundation. What they did is they offered a $1 million prize to the teams that could produce the best forecast of hospital readmissions. So somebody’s discharged from the hospital and has to come back in a couple of months later; that’s viewed as a problem for the health care industry and they would really like to be able to forecast that more effectively.

Zillow, the online real estate site — they have a house price forecasting system which estimates the market value of houses based on the characteristics. They came up with a $1 million prize for whoever could improve on their forecasting system, and so on and so on and so on.

There are many companies that have offered this kind of capability because it’s a cost-effective way to get expert solutions to their problems.

I just want to finish up on the productivity paradox idea. One other factor people have pointed out, too, is the lack of business investment. Perhaps that’s just the hangover effect from this very terrible financial shock.

But others have said, well, maybe something is actually different. Maybe businesses are investing differently than they used to. They don’t need to invest a lot in heavy capital equipment. You have these companies which probably are not doing as much investment as much older companies, but have much higher market valuations.

So maybe the modern technology driven economy simply requires less capital and investment. So we can’t really look at business investment as a reason to explain the low productivity, nor maybe should we expect business investment to be the way it used to be because we’re investing differently. It’s just a different kind of economy.

Well, that is also an interesting mystery. I would say I really adhere to the simpler view, the hypothesis that it’s due to hangover from the recession. Companies have become very wary of expansion. They don’t want to expand output until they see demand is there.

We’ve got the usual GDP dynamics that as income increases, employment rate falls, firms are in capacity with what they were producing, you start expanding capacity, and, you know, income grows again. We’re in a very good phase of the business cycle now, and if you look at most surveys of businesses and of consumers, they’re quite optimistic for the next year or two.

Do you think that at some point we will see these advances show up in the economic statistics as we basically currently formulate them, or are we going to have to come up with something different?

No, no. I think we’ll see it. I mean, look at all of the press these days over retail. They’re all scared of Amazon because Amazon is very effective in terms of building up clientele and providing products in an efficient way.

But competition is alert to that. You’re seeing Wal-Mart, you’re seeing Target, you’re seeing all of these offline companies invest very heavily in providing online services. And I think we will see significant technological change in the retail sector starting now, based on this challenge that comes in from the digital sector.

So it’s not the case that we’ve extracted the value we can from the IT revolution, that these new technologies — whether it’s artificial intelligence, autonomous vehicles, drones, 5G wireless — are just not comparable to electricity, public sanitation, or the combustion engine. Again, for those who don’t view these new technologies as being this kind of general platform universal kind of technology, is that just the lack of imagination about what these technologies can do? Because they seem like they would be pretty important.

Right. I would say the general purpose technology of our time in this decade is clearly the mobile phone and mobile devices in general because we’ve got all of this money that’s gone into developing the component parts, the cameras and the touchscreens and everything else. Those component parts now have become dirt cheap. They’re finding their way into all sorts of other products like Amazon’s Echo and Google’s Home and these personal digital assistants that we’re so fond of accessing.

I’ll give you a nice statistic. Everyday there are 500 million views of YouTube videos that are how-to videos: how to solve a quadratic equation, how to repair a screen door, how to bake a soufflé, how to play the guitar, on and on and on. There are millions of these videos available to anybody at any time for free.

So when have we ever had educational infrastructure that was so widespread and so widely available to anybody who wants to use it? So the acquisition of human capital just in terms of knowhow has become much, much more broadly distributed than ever before.

When I speak to groups I’ll talk about technology, and there’s always a lot of concerns about job loss, and they will ask about how we educate our future workers. Do you see technology really changing how we educate people in a more fundamental way than simply giving everyone laptops? Will technology will really transform how we educate, so that people can have these great new jobs?

Right. I think it already has in a sense. If you have kids in school or you talk to people with kids in school, their kids are learning a heck of a lot from YouTube, and it might be the Khan Academy because they’re learning cognitive stuff or it might be artistic stuff or it might be all sorts of other things that people can pick up on an as-needed basis.You talk to Millennials — this is a survey we ran. Ninety percent of the millenials say I can learn anything I want on YouTube, which is pretty amazing. They may not be imaginative enough about what they might learn but it’s still a belief that they will articulate.

You have a rule named after you, the Varian Rule. The idea is that you can forecast the future by looking at what rich people have today, and then in another decade or so the middle class will have it, and in two decades the poor will have it.

We had Tim O’Reilly on here for an interview not long ago. He mentioned the rule and the examples he gave were small class sizes and concierge medicine as things that wealthy people have, eventually the rest of us will get as well.

Do you have any ideas about the kinds of things that will be subject to the Varian Rule?

Well, let’s go back to the mobile phone. At one point, only rich people had them. Now pretty much everybody has them in the US and we’re rapidly moving toward a situation where everybody around the globe has them. The mobile phone is exploding in India, for example. And we’ve got these $50 mobile phones or $70 mobile phone with very cheap data plans, and you’re seeing a revolution really in the country in terms of connectivity. People that were not connected to the rest of the world before in a meaningful way now have complete connectivity. And all those YouTube videos we’re talking about are available globally.

Do you think this time is different? In the past people worried about technological change, that machines will take all the jobs, and while they did take some jobs that always created new jobs as people started doing different things. There were periods that were highly disruptive, where people lost jobs and wages didn’t go up very much, but the ending of that story has turned out pretty good. We’re much wealthier than we were before the Industrial Revolution. And so when I talk to economists, they will give me that story. They will give me the happy ending story.

But when I talk to people in the technology sector, they seem less confident in that story. They think, well, there may be a medium-term happy ending, but longer term — AI is going to take the jobs and that’s why we’re talking about basic income and some of these other ideas.

There seems to be much more acceptance of the idea that disruption will be closer to destruction for the American labor market when I talk to technologists versus economists. So where do you come down on how this is ultimately going to affect labor markets, and are we going to be able to adjust as we have in the past?

Well, everybody wants more jobs and less work. And that’s pretty much what technology has delivered. You look over the last 200 years, we had a working week of 70 hours a week a couple of hundred years ago and now we’re down to 37 in the US. We’re down to 29 hours a week in the Netherlands, a whole day less than we’re working.

So technology has delivered on that promise. We’ve got more leisure. We’ve got more time. We’re not working in dangerous, physically stressful, difficult activities to the extent that we were a couple of centuries ago. So when we look at work, we want less of it. And jobs — meaning the income-producing activity — we want more of it.

Well, I would say our challenge for the next couple of decades, because it’s pretty hard to look out much further than that, is actually the topic you raised originally, the productivity issue. And let me explain that.

If we look at the labor force, the labor force is growing at about half the rate of the population now. Without immigration, the labor force in the US would be decreasing. We’ve got retirement of the baby boomers and every retiree just from being working to being retired is now producing less stuff, but they expect to continue consuming the same amount. And so if we are able to have sufficient technological progress to keep that level of production going, which is what we need to keep consumption going, then we’ll be in great shape.

And the only way to really achieve that is via technology. And we, the US, are better than most other countries. Look at Japan, Korea, China, Germany, Italy — all those countries have a terrible demographic time bomb and they’re going to have fewer workers relative to the total population for the next 25 years.

So if we want to grow anywhere near as fast in the future as in the past, productivity and innovation have to do more of the heavy lifting.

Absolutely.

I understand when I talk to a regular person, they’ll be concerned about job loss and there will be pushback. But then I hear somebody like Bill Gates talk about a robot tax, in part as a way of slowing down progress and giving workers a chance to adjust. So do we need this fast productivity growth, or is it maybe moving too fast and we have to slow it down so workers can adjust?

Well, next decade, the 2020s, we’re going to see the lowest growth in the labor force ever, ever since we started measuring it at the end of World War II.

So what that means is we’ve got the population to labor force balance shifting in favor of more retired people, more non-working people and fewer working people. So how do we deal with that? That’s pretty close — the 2020s, only in a couple of years from now.

So we’ve got to really think about improving productivity now, not delaying it. Now, I grant you, if there’s some fantastic new technology that suddenly explodes and sucks a lot of jobs out of the market, that’s reason for concern. We should be aware of that possibility, but overall when you look at the next 25 years, we’re going to be facing tight labor markets. And that simply comes from looking at the demographic statistics.

All of our expectations have been built up in our lifetimes by looking at periods when we had two big shocks to the labor market. One was baby boomers, all the baby boomers coming of age and joining the market in the ’60s and ’70s. And, at the same time, we had this big influx of women entering the labor market.

So we’ve had a period of time when generally it wasn’t so hard to find workers because there were lots of people available. That’s completely turning around. Women’s participation in the labor market has plateaued and in fact it’s decreasing along with aging. And, of course, the baby boomers are retiring and leaving the labor market.

So that means we’re going to have tight labor markets for the next 20 or so years. And that means we’d better get some productivity boost there or else we’re going to have problems.

I believe I quoted this in my blog more than once, but you wrote this in the Financial Times last year.

Competition in tech is robust for both large and small companies, resulting in low prices, high-quality products and innovation that benefits consumers worldwide. So why all the fuss about tech companies and competition? Technological change is naturally disruptive. We saw widespread industry restructuring throughout much of the 20th century and we can expect the same to happen in the 21st. Incumbents are understandably worried about being disrupted or even displaced and this anxiety boils over into demands that regulators “do something”. Unfortunately, this often means restricting competition rather than enhancing it.

So we recently had an event here. I called it, “Should Washington break up Big Tech?” We had Luigi Zingales of the University of Chicago, Andrew McAfee from MIT, a few other folks. And I’m not an antitrust attorney, and neither are you, but the one criticism that I pay most attention to is one also given by Farhad Manjoo of the New York Times, who puts Google into his frightful five group of big companies.

One of his major criticisms is that these companies are suppressing innovation, either by buying this company or that company, or preventing these other companies from getting bigger. Do you think at this point that the big technology firms are in any way part of the innovation problem in this country that is reflected in the weak productivity growth that we’ve been talking about for so long here?

No. Should I say more?

I would be delighted if you said more.

Well, you look at these large technology companies and what critics leave out of the picture is the fact that they are competing very intensely among themselves.

Imagine a world where Apple only made devices, where Google only provided search, where Microsoft only made operating systems — that would be a very different world than what we have now because you’d have these silos that in that case, in that potential world, really were monopolizing a sector.

But what happens now is you look at search and you’ve got Google doing search, Microsoft is doing search, and Amazon is doing commercial search for sure. That’s where all the money is. You look at the digital assistants. Well, Google has Google Assistant and Amazon has Alexa and Microsoft has Cortana and Facebook has M, and so on and so on and so on. Everybody is providing cloud. And we could mention Samsung as an example of a company that also has an assistant.

See also: Are the mega-platforms good or bad for tech innovation? An interesting conversation

So they’re all investing heavily. Everybody’s investing heavily in AI. Cloud computing is widely available. It’s never been easier to be a startup because you can go out and buy your little piece of a data center and you’ve got the open source software and you’ve got your data and your programming expertise and entry is robust, in fact.

Now, the exit question that people have raised, what you mentioned of acquisitions, well, as you know, I’m sure, that there has been a great reluctance for IPOs over the last several years. Companies want to mature much longer before they do an IPO and several of those companies would rather have an acquisition IPO. There are four times as many, four times as many, acquisitions as IPOs.

And so how could you imagine that innovation would be improved if you tried to restrict acquisitions? You see, it’s the acquisitions that are providing the payoff to the innovation investment.

One other thing some of the critics point to is that these big companies have such a monopoly on data that you just can’t compete with them. As someone said, boy, if you were trying to get startup money for a company and your pitch was, I’m going to beat Google, I’m going to beat Facebook, I’m going to beat Amazon, no one would give you a dime because there’s no way anybody could ever compete.

Now, the flippant answer is to go back and look at these old Fortune magazine covers saying the search wars are over, Yahoo has won; or the cell phone wars are over, Nokia has one. So for companies that looked like they had insurmountable, dominant positions — just wait a little bit and they don’t. Do you think it’s going to be any different? Can these big tech companies ever be challenged? Are they forever dominant?

Well, of course I think there’s possibilities for new companies to come in and to be successful. Let’s take a simple example.

We were talking about retail earlier and we were talking about how Amazon has, of course, been doing phenomenally well, but still online commerce is still only 10 percent of total retail. And, believe me, these other companies that are competing with Amazon in terms of providing typically offline retail services are acquiring firms that can help with the product search capability, with the bill processing, with the delivery technology, on and on and on.

So it’s not as if Amazon will waltz in and take away retail in-store shopping because the existing retail shopping stores are competing both in offline and online retail. And it’s the same thing if you look at search: Google, you know, there’s 94 percent of the clicks are in fact organic and only 6 percent of them are ad clicks.

So if you look at what you would have to do to effectively compete with Google, you’d have to basically spend a huge amount of money to provide their organic click capability just in the hopes of getting those few commercial clicks.

So what happens? There’s robust entry in the commercial click business. There are businesses all over the place that are saying, we’re going to help you do your commercial search, whether it’s for airlines or housing or groceries or whatever because that’s where the money is.

We have not much time left, so two questions here. One, I mentioned Europe. Why doesn’t Europe have big, successful technology companies? We see them in the United States. We see them in China and elsewhere in Asia, but not in Europe. They have smart people in Europe. They have big markets.

Well, everybody forgets about SAP, which is the 50th biggest company in the world.

Right. But they’re still 50th.

But they have a very strong position in their market segment and I think they will continue to have that for some time. And there’s lots of really good venture-funded companies in Europe, in Berlin, in London, a few other places where they are really taking advantage of this highly educated and capable resource.

My own speculation is that their big problem is in financing, not at the venture level and not even at the IP level, but that in-between level where you want private capital. And those markets are just not as developed in Europe as they are here. You can’t fund startups using bank capital. It’s just the wrong kind of investment because it’s far, far, far too risky.

Here we have pools of that venture capital funding that just aren’t available in Europe and you see a lot of European companies when they do become successful and are on their road to maturity, they will seek out the US capital.

And last question: We’re in Washington and there’s this big tax bill going through Congress. When you hear the phrase pro-growth or pro-innovation policy, what do you think about?

Well, my favorite example is, of course, the internet, as you might guess. That was funded by NSF and DARPA. They also funded the Autonomous Vehicle Program; it was funded by DARPA. It was patient money in a sense that they funded five or six universities to do research on autonomous vehicles for 10 years. They’re now funding robotic surgery. There was in fact a digital libraries program. There were three search engines that came out of the digital libraries program. That was Inktomi, Lycos, and Google. So Google got its start basically from that funding for basic research.

Learn more: After tax cuts: what a pro-growth agenda should look like

So, from my point of view, the answer to your question is absolutely we have to keep funding basic research. China is funding basic research.

I mean, should we care when we read these headlines about China going big into AI, China winning the AI wars — should I take that seriously?

Well, it depends on whether they have an exclamation point in the headline — (laughs) — because I will say it’s a situation where you do want to keep up with your competition. You were just talking about the situation in Europe where they don’t have the top companies. One of the reasons could easily be the funding of basic research.

But the technology will diffuse even if China comes up with it. I mean, it’s not all going to be used for secret military projects.

I think that’s right. Yeah. So the point is it’s advantageous from the viewpoint of the entire world to have some money spent on these public goods such as basic research. But it’s still the case that there is a competitive aspect to this as well. I don’t want to exaggerate it to be hyped up a lot in the newspapers, but it’s still there.