NR Digital

Innovate or Legislate

by Reihan Salam & Patrick Ruffini

How the Hollywood establishment used SOPA to try to regulate its competition away

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.

Yet film-incentive programs are just the tip of the iceberg. Hollywood has pursued a number of strategies to enrich itself at the expense of the broader public. One of the most egregious has been the ongoing extension of copyright terms.

Article I, Section 8 of the U.S. Constitution gives Congress the power “to promote the progress of science and useful arts, by securing for limited times to authors and inventors the exclusive right to their respective writings and discoveries.” Congress has quietly acquiesced to several extensions of copyright terms over the past 35 years, with overwhelming bipartisan support. Only with the 1998 Sonny Bono Copyright Term Extension Act did anyone notice that these extensions weren’t serving the purpose stated in the Constitution. It is one thing to offer longer copyright terms for new works “to promote the progress of science and useful arts.” But to extend the copyright terms of existing works simply allows incumbent firms to extract value from old ideas whose creators expected that their copyright would expire after a “limited” time that has now passed. When asked to strike down the 1998 law, the Supreme Court declined — in an uncharacteristically literal-minded spirit, it noted that repeatedly extending copyright terms for existing works a few decades at a time does not in itself make copyright unlimited. But it should be beyond dispute that endless extensions of existing copyrights violate the spirit of the Constitution.

Among defenders of today’s copyright regime, including at least some conservatives, there is a conviction that intellectual property should be protected the same way that any other kind of property would be. But this has not been the outcome. As the attorney and Bush-administration veteran Stewart Baker has argued, copyright has come to resemble “a constantly expanding government program run for the benefit of a noisy, well-organized interest group.”

Before 1976, for example, one had to place a copyright notice on the title page of a book, file with the copyright office, and file to renew the copyright after 28 years, at which point the copyright term was extended for another 28 years. These requirements were hardly onerous, yet they helped manage the growth of copyright litigation by limiting copyright to those who explicitly sought its protection. Now, however, every work, including doodles sketched on a napkin, is automatically given copyright protection. This has led to an “orphan works” problem, in which works abandoned by their creators are left in legal limbo.

During the mid-1980s, Hollywood made a concerted effort to destroy the VCR on the grounds that it was designed to facilitate copyright infringement. In the end, the courts decided that because the VCR had a substantial non-infringing purpose — to shift the time when people watched television programs — its makers could not be held liable for their users’ infringing activities. But in 1992, the recording industry succeeded in pushing to passage the Audio Home Recording Act, which mandated that digital-audio devices have industry-approved copyright protection built in. The new law also created a new tax on empty cassettes and other blank media, which was meant to pay for the costs of piracy. In 1997, the No Electronic Theft Act dramatically increased the statutory charges for copyright infringement and, separately, the recording industry attempted to ban MP3 players, a bid that narrowly failed.

In 1998, the Digital Millennium Copyright Act (DMCA) essentially gave the motion-picture and recording industries veto power over the design of all digital-media devices in the name of controlling piracy. The DMCA gives an organization called the DVD Copy Control Association control over the design of all DVD players; as a result, DVDs are often encoded with software that controls the viewing experience — for example, by preventing consumers from skipping commercials at the start of a film. The Prioritizing Resources and Organization for Intellectual Property Act of 2008 represented yet another expansion of copyright protection. Taken together, this wave of legislation and litigation has helped destroy a number of innovative business models, including My.MP3.com, an early-2000s service that aimed to enable consumers to listen to their own legally purchased CDs while on the road.  

And the Obama administration has greatly expanded the federal government’s efforts to protect the interests of copyright holders, tasking the overburdened bureau of Immigration and Customs Enforcement with seizing foreign websites accused of copyright infringement.

Just as copyright terms have grown ever longer and more restrictive, we’ve seen a parallel strengthening of patent rights. As the George Mason University economist Alex Tabarrok has argued, this has tended to reduce innovation. In Launching the Innovation Renaissance, Tabarrok observes that strong intellectual-property protections at times create a “resting on laurels” effect. Rather than invest in innovation to outcompete their rivals, firms stockpile patents and attack potential competitors with lawsuits. In the technology industry, billions are now being diverted from research and development to acquire patent portfolios. As Microsoft founder Bill Gates presciently warned in 1991, “I feel certain that some large company will patent some obvious thing” and use the patent to “take as much of our profits as they want.” Microsoft, alas, has since played the role of the large company, as have innumerable patent trolls.

That, in essence, is where Hollywood finds itself today. As consumers and entrepreneurs seek new, more convenient ways to consume media, Hollywood is fighting desperate rearguard actions to force people to consume media in the ways it finds most congenial. The industry’s prodigious success in translating glitz, glamor, and well-timed campaign contributions into political influence has lulled it into believing that the federal government can save it from the need to innovate. While Hollywood failed to ban the VCR and the MP3 player, it succeeded in suing My.MP3.com and a streaming-film service called Kaleidescape out of business.

The entertainment industry claims, and it really is true, that media piracy has increased over the last decade. Last summer, a survey sponsored by the American Assembly, a public-affairs forum affiliated with Columbia University, found that 46 percent of U.S. adults had acquired unauthorized music or video, a number that rises to 70 percent among those younger than 30. But only 2 percent acquired most of their media collections through piracy, and the emergence of legal streaming-music and -video services has curbed the appetite for unauthorized content. The emergence of Netflix’s streaming-video service, for example, has coincided with a marked decline in the number of searches for BitTorrent, a hub for pirated media. The convenience of iTunes has similarly reduced piracy as a share of digital-media consumption. Last year, the Social Science Research Council published Media Piracy in Emerging Economies, the most comprehensive study of the piracy problem to date. The report, which was notably not funded by the entertainment industry, concludes that the key to curbing media piracy isn’t heavy-handed legislation. Rather, it is the kind of business-model innovation that allows users to consume content conveniently and affordably.

It’s understandable that big media companies are reluctant to embrace business-model innovation, since the old model was incredibly lucrative for them. Joe Karaganis, a leading expert on media piracy based at American Assembly, observes that while the transition from CDs to MP3s has dramatically reduced distribution costs for the major record labels, they’ve until recently resisted returning more of the wholesale price to artists — who make the same 15 to 20 percent on wholesale that they did before the collapse of distribution costs — or cutting retail prices for consumers. A number of indie labels and digital-streaming services, in contrast, return 50 to 90 percent of the wholesale price to artists. It is hardly surprising that consumers and artists have been flocking to streaming-music services such as Spotify, which has just reached 3 million members — they offer a much better deal to artist and consumer alike by eliminating the middleman, which is exactly what the Internet does best.

Michael Masnick, a blogger and venture capitalist who has taken a leading role in technology-policy debates, recently released a report on how the rise of digital consumption has changed the entertainment industry — and his core finding is that the entertainment industry is booming. Between 2005 and 2010, the global music industry increased in value from $132 billion to $168 billion. Despite a weak economy, the share of total household spending devoted to entertainment increased by 15 percent in the U.S. over the same period. Employment in the U.S. entertainment industry increased by 20 percent from the late 1990s to the late 2000s, in part because of an explosion of activity that occurred outside the largest media companies.

The entertainment industry relies heavily on the notion that artists have been devastated by increasing piracy. Yet it turns out that only legacy media firms that are reluctant to embrace the digital revolution have been hurt; artists willing to adapt to the new environment, and to the desire of consumers for a more direct relationship with the artists they admire, have flourished. According to the Bureau of Labor Statistics, the number of independent artists increased by 43 percent from 1998 to 2008 as it grew easier to make a living without being signed by a major recording company. This has proven particularly advantageous for artists who appeal to culturally conservative consumers, a market niche that the big media companies have largely ignored.

Essentially, those companies are trying to enlist the federal government in an effort to save their failing business model, under the pretense of looking out for artists and workers. It would be far more accurate to say that digital consumption has benefited artists and workers as well as consumers. But like the Big Three, Big Media wants a bailout. And until recently, it had reason to think it would get its wish. After all, it has managed to deploy government power against a number of similarly promising Web-based technologies. Hollywood contributes vast sums to political candidates, particularly on the left, through the Motion Picture Association of America and Recording Industry Association of America, both powerful lobbies. For decades they won almost every political battle they joined, in part because they tended to strike deals behind closed doors. The winning streak, however, has come to an end.

At the outset of the most recent legislative debate over online piracy, Hollywood was poised to extend its flawless copyright-expansion win streak. Under the guise of blocking foreign “rogue” websites, the Protect IP Act, or PIPA, an earlier Senate counterpart to SOPA, achieved levels of bipartisan co-sponsorship unseen in all but 19 other bills out of the 1,900 the current Senate had considered as of November, according to OpenCongress.org. In May 2011, the legislation passed the Judiciary Committee by voice vote, without hearings. There was no reason to think that the House version, which became SOPA, would be any different.

But when House Judiciary Committee chairman Lamar Smith (R., Texas) delivered a bill in late October, alarm bells went off in start-ups and venture-capital firms throughout Silicon Valley and New York City. Brad Burnham, a co-founder of Union Square Ventures and the first institutional investor in Twitter, helped mobilize the early protests, which would inspire the larger blackouts of Wikipedia, Reddit, and more than 100,000 other websites in January of this year. “The infrastructure of the Internet, chips, routers, and microprocessors were conceived and created a long way from Washington, and the entrepreneurs and investors who built those businesses liked it that way,” Burnham reflected. “Politics had little impact on this insulated world.” But slumber was no longer an option: An industry that had shunned lobbyists now paid the price in legislation that placed in legal jeopardy the business model of allowing users to freely share content without pre-screening or approval — the basis of the modern Internet. (The original version of SOPA would have criminalized sites’ taking “deliberate actions to avoid confirming a high probability” of copyright violations.)

That Congress was blithely preparing to regulate an industry it did not understand was on full display in December’s House mark-up hearings, at which proponents of SOPA professed ignorance of the workings of the Domain Name System, a fundamental piece of Internet architecture that SOPA proposed radically to alter. North Carolina Democrat Mel Watt, an early sponsor of the bill, made the memorable confession “I’m not a nerd.”

To the tech community, stopping SOPA would become a life-or-death struggle. On top of its censorship provisions, SOPA sought to give copyright holders the right to sue U.S.-based websites; it also would have required that search engines censor results pointing to sites that had been accused of piracy and granted legal immunity to Internet-service providers that voluntarily shut off access to websites suspected of piracy.

Ultimately, the indictment of SOPA as a complex regulatory boondoggle may prove more instrumental to its collapse than have been the Internet’s cries of censorship. So suggests Republican lawmakers’ decision to dump the bill en masse.

Like most examples of Beltway cronyism, SOPA was the product of an out-of-touch bipartisan lobbyist elite, and it understood precious little about the networked and decentralized medium it proposed to regulate. This elite badly underestimated the political power of an “Internet public” connected by social media and smartphones. A guerrilla force of techies and populists, ranging across the political spectrum from MoveOn.org to the Tea Party Patriots, joined forces to mount an unconventional assault on Hollywood’s lobbying arm, which had spent $94 million lobbying for copyright legislation in 2011. The result: the January 18 Web blackout that prompted millions of calls to Capitol Hill, forced dozens of lawmakers to switch sides, and consigned SOPA to the dustbin of history — for now.

After both sides of the SOPA debate had been heard, it was conservatives who were quicker to rally to the side of the rebels. At one point hours into the Internet blackout, 26 of the 29 legislators who had switched sides were Republicans. Minnesota Democrat Al Franken, who had fashioned himself the Senate’s chief defender of the “open Internet,” would go on to send an e-mail message to supporters defending the Protect IP Act in the name of “middle class workers — most of them union workers” who work in industries that depend on intellectual-property law. Franken, himself a card-carrying member of the Screen Actors Guild, represented in microcosm the coalition of Hollywood and labor threatened by the disruptive forces of technology. Senators Chuck Schumer and Kirsten Gillibrand, both New York Democrats, privately seethed at Republicans who withdrew their co-sponsorship, among them Florida Republican senator Marco Rubio.

Behind the scenes, Republicans were using the piracy debate to register their displeasure at Harry Reid and his imperious management of the Senate. When Reid put the Protect IP Act on the Senate floor schedule, the bill’s main Republican proponents were not even consulted. A few days before the scheduled floor vote, a group of Republican senators, including chief Republican sponsor Chuck Grassley and Utah conservative Mike Lee, called upon Reid to delay consideration of the bill indefinitely.

Republican opposition to SOPA, though influenced by many factors, is rooted in conservative skepticism about the imposition of regulations rigged to favor powerful corporate insiders. This skepticism wasn’t on display for most of the Bush era, when many in the GOP reconciled themselves to being part of a pro-business rather than a pro-market and pro-freedom political movement. Public hostility to the Wall Street bailouts and the rise of the Tea Party provided a useful corrective, and conservatives in Congress now wish to be on the side of consumers and the entrepreneurs who serve them, rather than that of crony capitalists who use state power to extract rents.

It is not just media companies that seek to stifle Internet innovation. It is every established industry that fears disruptive change and wants to build protective barriers against Internet-enabled competition. Real-estate agents, mass-transit agencies, cab companies, and purveyors of wines and spirits are just a few of the special interests that have tried to regulate away competition from Web entrepreneurs.

Perhaps the most important example of an industry that fears the Internet and seeks to contain its power is the education sector. Across the country, teachers’ unions have fought bitterly against online-education efforts that promise to lower the cost and improve the quality of instruction. Traditional colleges and universities have been waging rear-guard actions against online universities that do things such as offer “all you can eat” pricing plans, which allow students to take as many courses as they can handle for a flat fee. The medical profession, similarly, has been reluctant to embrace Internet-enabled technologies that empower patients and in the process drive down costs. These are the sectors most plagued by inefficiency, those in which political imperatives trump market competition more often than not. Fortunes are made in health care and education not by meeting the needs of consumers, but by securing political favors.

The Internet represents a radical alternative to crony capitalism. Larry Downes, a right-leaning technology analyst and one of the most insightful chroniclers of the fight against SOPA, has described what he calls “the political philosophy of the Internet”: “Its central belief is the power of innovation to make things better, and its major tenet is a ruthless economic principle that treats information as currency, and sees any obstacle to its free flow as inefficient friction to be engineered out of existence.” This belief is rooted in the open, meritocratic nature of the Internet itself. And it is a belief that is very much in keeping with core conservative values.

The Internet, and the phenomenal success of technology entrepreneurs such as Steve Jobs, Mark Zuckerberg, Sergey Brin, and Larry Page, and countless others, is a vivid example of markets at their best. The world’s most deregulated industry has, not coincidentally, seen corporate empires rise and fall with astonishing speed. Yet the chief beneficiaries haven’t been Silicon Valley billionaires. Rather, they’ve been citizens, workers, and consumers who’ve been given the power to choose something other than the status quo.

We have described the Internet as our Hong Kong, our beacon of economic freedom. But whereas the Mainland swallowed up Hong Kong, there is a chance that the dynamism of the Internet could take over and revitalize our overtaxed, overregulated, moribund economy. Let’s not blow it.

– Mr. Salam writes National Review Online’s domestic-policy blog, The Agenda, and is a policy adviser at the economic-research think tank e21. Mr. Ruffini is a founder of Engage, a Republican digital-media firm.

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