Innovate or Legislate
From the March 5, 2012, issue of NR.


Reihan Salam

In 2012, a number of institutions that long defined how Americans communicated are teetering near the brink of collapse. Major newspapers in cities across the country have stopped publishing. Strip-mall anchors from Circuit City to Blockbuster to Borders have filed for Chapter 11 bankruptcy protection. The U.S. Postal Service struggles under the weight of crushing pension obligations, as e-mail, Facebook, Twitter, and Skype render it all but obsolete. In politics, traditional modes of wielding power are also being disrupted. One prominent example is the recent battle over the Stop Online Piracy Act, or SOPA, in which grassroots activists defeated once-powerful Hollywood lobbyists.

What’s toppling these formerly invincible companies and institutions? In almost every case, the proximate cause is the Internet, and the disruption it has wrought on inefficient businesses in every corner of the economy. And so we are now engaged in a war over its future.

The Internet’s enemies have proven vocal, organized, and effective, while the vast majority of consumers, workers, and entrepreneurs it has enriched have proven anything but, and the fight over SOPA must be understood in this larger context. 

A McKinsey Global Institute study published last spring found that, worldwide, 2 billion people were connected to the Internet and almost $8 trillion exchanged hands via e-commerce. The United States captures 30 percent of all the revenues generated by the global Internet economy, and 40 percent of the net income. Moreover, the Internet has been a powerful driver of economic growth and job creation. In a survey of small and medium-sized enterprises, McKinsey found that for every job destroyed by the Internet, 2.6 were created. In the advanced countries that were included in the survey, the United States among them, Internet consumption and expenditure accounted for 21 percent of economic growth over the past few years. 

One is reminded of Jack Kemp’s call in the 1970s and 1980s for “enterprise zones,” blighted urban areas in which regulations would be eliminated, and taxes lowered, to spark entrepreneurship and growth. The Internet has been the ultimate enterprise zone. Just as Hong Kong’s freedom and prosperity contrasted vividly with China’s desperate poverty for much of the last century, the Internet stands out as an island of low regulation and taxation in a broader economy that grows less free with each passing year. The question is whether we will allow Internet-enabled innovation to continue transforming the economy — dramatically reducing the cost and raising the quality of our education and health sectors, for example — or, alternatively, we will allow the Internet’s growth to be choked off by cronyism.

For now, the Internet represents the great exception to the rising tide of state-guided capitalism, in which government favors politically connected firms and industries. As Ian Bremmer observes in his ominous book The End of the Free Market, the governments of the world’s rising economies seek to dominate key economic sectors. The global markets for energy, aviation, shipping, power generation, arms production, telecommunications, metals, minerals, petrochemicals, and much else are increasingly being manipulated by state-owned enterprises and sovereign wealth funds. 

Even the United States, long the bulwark of entrepreneurial capitalism, has moved in a dirigiste direction. During his recent State of the Union address, President Obama celebrated the bailouts of GM and Chrysler, promising that “what’s happening in Detroit can happen in other industries.” What happened in Detroit is that taxpayers gave a massive infusion of cash to politically connected workers and investors in a collapsing industry.

When we think of state capitalism, we tend to think of the Rust Belt, where automobile manufacturers and steel producers have been clamoring for bailouts and protective tariffs for decades. But in the 21st century, it is Hollywood that has been the most effective at securing handouts. Until 2001, only four U.S. states had programs to encourage film production, typically through tax breaks and other giveaways. That year, the total amount offered was in the neighborhood of $1 million. Between 2001 and 2010, however, the number of states offering incentives went from four to 40, and the amount offered increased to $1.4 billion — note the change from “m” to “b.” Thankfully, a handful of states have abandoned their film-incentive programs since 2010, having recognized that they were a bad deal for taxpayers.