The Rise of Digital Advertising and Its Economic Implications

Firms have increasingly relied on digital platforms to direct consumers to their products, with digital advertising becoming a major source of revenue for big tech companies, often allowing them to offer free access to their platforms. Who hasn’t noticed the ads targeted at their interests while shopping online or scrolling their social media feed? Despite the growing importance of the sector, data on the digital advertising market are scant. In this blog post, we present some estimates of the importance of digital advertising in the U.S. and discuss its macroeconomic impact.

Rise of Digital Advertising

The figure below shows the evolution of advertising (digital and nondigital) as a percentage of aggregate output using two measures of advertising expenditures. The first measure is derived from advertising deductions reported by U.S. companies on their income tax returns. The second measure reflects historical advertising data compiled by Robert J. Coen.For a description of this data, see “The Expansion of Varieties in the New Age of Advertising” by Salome Baslandze, Jeremy Greenwood, Ricardo Marto and Sara Moreira, which appeared in the October 2023 issue of the Review of Economic Dynamics, pp. 171-210. As the figure illustrates, total advertising has averaged about 1.3% to 2% of U.S. gross domestic product (GDP) over the past 20 years.To put these numbers into perspective, research and development spending accounted for about 3.5% of GDP in 2020.

Total Advertising Spending as a Percentage of U.S. GDP, 1994-2020

SOURCES: IRS; Baslandze, Greenwood, Marto and Moreira (2023); and authors’ calculations.

Digital advertising was a tiny fraction of total advertising in 1994, when one of the very first digital ads appeared as part of AT&T’s “You Will” campaign. Since then, widespread use of the internet and the advent of smartphones have sparked marked growth in digital advertising. In 2015, digital advertising corresponded to about 50% of total advertising spending and more recent estimates point to a share closer to 65% of total advertising spending.See Baslandze et al. (2023). That represents about 0.6% to 1.1% of GDP.

Big tech firms’ financial statements suggest that the size of the digital advertising market might be closer to the estimate’s upper bound of 1.1% of GDP and that this share will likely rise in the coming years. The following figure depicts the share of revenue from digital ads as a percentage of GDP for major tech firms. The advertising revenue generated by Alphabet/Google, the largest digital ad platform, represented 0.85% of U.S. GDP in 2023, and Meta/Facebook accounted for another 0.47% of aggregate output (digital advertising made up about 77% of revenue for the former and 98% for the latter). Other major players have also scaled up their advertising businesses. For instance, Amazon’s digital advertising revenue totaled 0.17% of 2023 GDP.

Digital Advertising Revenue at Big Tech Firms as a Percentage of U.S. GDP, 2002-2023

SOURCES: 10-K annual reports filed with the U.S. Securities and Exchange Commission, U.S. Bureau of Economic Analysis and authors’ calculations.

Digital Advertising and Market Power

The information collected through online search and shopping behavior has allowed firms to better infer consumers’ tastes and hence target them with products they may like to purchase. This appears to have played an important role in the expansion of products that firms offer to consumers. From 1995 to 2015, the number of products made available to consumers increased 115%, with technological improvements associated with digital advertising explaining about 39% of the increase over that period.See Baslandze et al. (2023). When digital ads improve the quality of the match between what firms offer and what consumers want, both consumers and firms benefit.

However, the improved targeting that digital ads provide might also allow firms to infer consumers’ willingness to pay for their products, which would likely translate into higher markups and more market power for both firms selling products and big tech companies.See Ricardo Marto’s July 2024 Economic Synopses essay, “What Is Behind the Rise in Markups?” The next figure shows profit percentage, a measure related to market power, for four big tech companies and for an average firm in the services sector.The notes to the third figure define profit percentage.

Profit Percentage among Big Tech Firms, 2002-2023

SOURCES: Compustat and authors’ calculations.

NOTES: Profit percentage is equal to (revenue minus variable costs)/variable costs, where variable costs correspond to the cost of goods sold and to selling, marketing, general and administrative expenses. The services sector average is the weighted average of profit percentages for all firms in the services sector (NAICS code 42-81), where the weight for each firm is the sum of cost of goods sold and selling, marketing, general and administrative expenses over the total for services firms.

The average profit percentage for firms in the services sector fluctuated around 23% between 2002 and 2023, which means that on average these firms earned $1.23 for every $1 spent on producing their services. The profit percentage for three of the four big tech firms was at least twice as large as the services sector average. Although digital ads have allowed firms to offer new products that are better targeted at consumers’ tastes, their effect on consumer welfare depends crucially on the extent to which firms selling products and big tech companies have gained market power through the information collected on consumers’ online behavior.

Notes

1. For a description of this data, see “The Expansion of Varieties in the New Age of Advertising” by Salome Baslandze, Jeremy Greenwood, Ricardo Marto and Sara Moreira, which appeared in the October 2023 issue of the Review of Economic Dynamics, pp. 171-210.
2. To put these numbers into perspective, research and development spending accounted for about 3.5% of GDP in 2020.
3. See Baslandze et al. (2023).
4. See Baslandze et al. (2023).
5. See Ricardo Marto’s July 2024 Economic Synopses essay, “What Is Behind the Rise in Markups?”
6. The notes to the third figure define profit percentage.