Nathan Newman's ENODE:

Vol. II no. 4

Three Myths about Government, Markets and the Net

by Anders Schneiderman, PhD.

"A cutting-edge, history-making blueprint." That's what Newsweek columnist Steven Levy calls the Clinton Administration's grand plan for the Internet's future. "A Framework for Global Electronic Commerce" was released on July 1 to a chorus of favorable reviews. Some commentators fretted about its position on encryption and privacy, but overall, it earned high marks.

The reason for this praise? Because, as Levy says, "the report bluntly asserts that the most important thing the govern can do about [the Net] is get the hell out of the way." Let the free market work its magic.

The Clinton Administration report is a perfect example of how far Newt Gingrich and others have come in creating the myth of Government Bad, Free Enterprise Good. If we patiently troll through this document's murky prose, we can reveal glimpses of our society's confusion about how markets and government work.


The Clinton Administration's report is based on a simple principle: "the private sector should lead." Why? Because "innovation, expanded services, broader participation, and lower prices will arise in a market-driven arena, not in an environment that operates as a regulated industry."

This raises an obvious question. If the government is so incompetent, why did the Internet come from Uncle Sam and not CompuServe or AOL? Why did the private sector have to play catch-up with this stellar innovation?

The report knows this is a problem, so it tries to gloss over this unpleasantness as quickly as possible. It says, "though government played a role in financing the initial development of the Internet, its expansion has been driven primarily by the private sector."

But the only reason the private sector is in the driver's seat is that Uncle Sam handed over the keys. As Nathan reported in "How Netscape Stole the Web" (Vol. 2, No. 2), Netscape succeeded because it ripped off the University of Illinois and U of I didn't fight back. More generally, the Clinton Administration pulled the government out of the business of developing the Net. You can argue whether or not this was a good decision, but it's hard to see the Net's history as evidence that the private sector must lead.

Our myopia about the Net's history is a classic example of the trouble Americans have acknowledging how government facilitates the economy. Conservatives like to say, let's get back to the glory days of the 1950s, when the government left the private sector alone. And they're right, it did mostly stay out of the market. Except for the military, which nurtured the electronics and computer industries. And the FHA and VA, which underwrote half the houses in the 'burbs. And the massive highway building programs that helped people commute between the 'burbs and the city and expanded the auto market. And the GI Education Bill and government grants that paid for the explosive growth of higher education. And the NIH, the NSF. Medicare, and Medicaid programs that poured massive money into the health care system. And the tax breaks that underwrote a new system of pensions. And of course there's agriculture. And banking. But aside from computers, electronics, housing, construction, cars, education, health care, agriculture, and banking--and, indirectly, steel, plastic, and concrete--government hasn't done a thing to help our economy.


Even if the government did a great job creating the Internet, maybe it's time to turn it over to the free market. The Internet is moving so fast that government bureaucrats may not be able to keep up. That's what the Clinton Administration thinks. According to the Executive Summary, "The Internet should develop as a market driven arena not a regulated industry."

But this bold statement isn't the whole story. The report also says that "governments must adopt a non-regulatory, market-oriented approach to electronic commerce, one that facilitates the emergence of a transparent and predictable legal environment to support global business and commerce." In other words, the government should butt out, except for one, little, minor task. It must create a vast new infrastructure to make Net commerce work.

The problem is simple. If the government really butts out, Internet commerce will die. The day the report came out, Sun Microsystems director Dennis Tsu complained to the press that the U.S. wasn't aggressive enough about expanding intellectual property rights, patents, and copyright protection. Net commerce depends on them. So if Net commerce is to flourish, we need to radically change our legal system.

For example, in the next few years there will be a huge brawl over copyright law. Right now, most Netizens ignore copyright rules. The Net grew so rapidly because no one worried about whether they were violating intellectual property law. "Information wants to be free!" was the Net's motto. But now that there's money to be made, Sun and Microsoft and IBM and Time-Warner and all the other players want a new set of rules that make damn sure this attitude goes away. And they need the government to do it for them.

The government is also needed to create online equivalents of money, signatures (for signing contracts), and other fundamental features of Net mass commerce. The industry can take the lead in developing these standards, but none of it will work if the government doesn't enforce them, because ultimately only the government can create legally-binding courts or cash.

The report tries to get around this paradox by using one of the clever shell games conservatives have adopted: we don't want 'government,' just contracts and courts. When the government must intervene, the report says, it "should establish a predictable and simple legal environment based on a decentralized, contractual model of law rather than one based on top-down regulation."

For those of you who have an infant, I have a piece of advice: tape that sentence over their crib. It's the Corporate Lawyer Full Employment Act. The computer world is already lawsuit-crazy, and if Clinton--a lawyer by training--has his way, we'll be up to our eyebrows in 'em. This isn't less government, it is more lawyers.

Far from decreasing the scope of regulation, this approach will increase it. Nathan's column in this issue of E-Node tells the story of the ISPs and AT&T, where attempts to get the government out of the market have led to more government, not less.

This paradox is evident throughout the report. The report warns against "potential areas of problematic regulation," one of which is "rate regulation of [Internet] service providers." But while protecting us from Internet service providers (ISPs) is bad, protecting ISPs from the phone companies is good. The report warns that "monopolies or dominant telephone companies often price interconnection well above cost, and refuse to interconnect because of alleged concerns." In other words, if Clinton really let competition loose, the phone companies would simply refuse to let ISPs connect up to their customers: you want to serve 'em, you run wires to their houses. So government should butt out--except where it must butt in.

As a result of this sophistry, the report is littered with sentences like, "genuine market opening will lead to increased competition, improved telecommunications infrastructures, more customer choice, lower prices and increased and improved services." Translation: every few years, we will hold a fascinating philosophical debate over the proper definition of a "genuine market." Federal courts and bureaucrats will hand out billion-dollar prizes to the debate winners in the form of regulations and court decisions, which spell out in excruciating detail how we will ensure we have "genuine markets." This is less government?

Finally, as someone who loves the Internet, I'd argue that if some of the anti-government fears are realized and the government does slow down the pace of innovation a little, that might not be such a bad thing. As I noted last year (Vol. 1, No. 1), competition has lead to Just-Too-Fast development. Companies scrambling to survive are forced to throw in new features and create new toys without knowing whether they work well or are even useful. To solve many serious Net problems, we need more thoughtfulness, not more speed. Maybe a little sand in the wheels is a good thing.


The last myth is that market competition is good for everybody. As noted above, the report insists that "Innovation, expanded services, broader participation, and lower prices will arise in a market-driven arena, not in an environment that operates as a regulated industry." That's why "where governmental involvement is needed, its aim should be to support and enforce a predictable, minimalist, consistent and simple legal environment for commerce," and not, say, justice, fairness, or other bleeding-heart concerns.

This approach makes cheery assumptions about the world that experience does not bear out. In a recent issue of Salon Magazine, Andrew Leonard points out one example that's already reared its ugly head: privacy. The Administration wants the market to take the lead in developing standards for protecting consumer privacy. But so far, says Leonard, the market-driven Open Profiling Standard proposal has no means "for taking care of the basic problem of whether or not information should be collected in the first place." There's a good reason for that: "The desire for online privacy runs directly at odds with one of the most attractive aspects of doing business online -- the Net's capacity for helping target marketing and advertising efforts directly at specific users." Consumer choice ends where corporate needs begin.

Experience has also shown us that increased competition can have a paradoxical effect: sometimes more competition means that fewer, not more, people benefit. In a terrific article in Newsweek last year, Marc Levinson showed that in the the financial world, banks don't want to compete for most of us. On average, "20 percent of households account for almost all of consumer-banking profits, while three out of five customers are money losers." That means that if there's more competition, the banks will compete to attract the 20 percent who generate profits and they will compete to dump the 60 percent who don't.

As Nathan demonstrated in his last two E-Node columns, we see similar economics in electrical and telephone services. When competition kicks into high gear in some markets, companies understandably focus on "cream skimming" the customers who can turn a profit. If the same holds true for Internet commerce in general, then far from leading to high-quality universal access, more competition could leave a lot of us worse off.

The final example of the disconnect between who markets are supposed to help and who they really do help is the tricky issue of taxes. Most accounts of the report's conclusions about taxes make the same mistake that Steven Levy makes. According to Levy, the report argues that "one thing governments should most decidedly not do is tax the Internet"--it should be a "tariff-free zone." In other words, the government should not stifle the Net's explosive growth with taxes.

There's an obvious problem with this approach. If the Net is tax-free, then anybody with any sense will move every sales transaction onto the Net that they can. Even if Net commerce isn't more efficient--even if it's a little less efficient--you'll save money. Needless to say, that would strongly penalize many people who don't have access to the Net, particularly poor folk. But the most devastating effect would be on state and local government.

On June 24th, a few days before the report was due out, the U.S. Conference of Mayors passed a resolution telling the Feds to butt out of the question of how Net commerce should be taxed. That's because state and local governments are terrified. Without revenue from sales taxes, local services and the people that depend on them will be road kill (for more details, see the report, "Prop 13 Meets the Internet."

And that's the reason why the Administration's report does _not_ advocate making the Net tax-free. This is what the report says: "the United States believes that no new taxes should be imposed on Internet commerce." No new taxes, but what about the old ones? The report doesn't really say. Its authors know that there is a problem. At one point, it proclaims that "no tax system should discriminate among types of commerce, nor should it create incentives that will change the nature or location of transactions." But this is more of a wish than an answer.

So how does the Administration propose solving this problem, this life-and-death issue that will determine the fate of all state and local governments and the people who rely on them? Very simply: "No new taxes should be applied to electronic commerce, and states should coordinate their allocation of income derived from electronic commerce." Got it? No "new" taxes. Just somehow, magically, we're going to collect the same revenue local governments used to obtain from sales tax and we'll divvy it up so it works out just like it used to.

Having dumped the readers into a very murky swamp, the report then pushes us in further with its next sentence: "Of course, implementation of these principles may differ at the [state and local] level where indirect taxation plays a larger role." And in case our heads are still above water, one more shove: "the system should be simple and transparent," "capable of capturing the overwhelming majorities of appropriate revenues" while "minimiz[ing] burdensome record keeping and costs for all parties."

This is a cutting-edge, history-making blueprint? This is more like one of those challenges they give engineering students where they say, here's 20 boxes of toothpicks, 100 bowls of Lime Jello, and a magnifying glass, now build us a working model of La Guardia Airport. This is a recipe for disaster.


Economic markets are a wonder to behold. Like natural ecosystems, they can produce marvels that are hard to imagine occurring any other way. And like nature, ultimately they resist our control. Even with the best of intentions, clumsy attempts to nurture or direct economic markets can turn around and bite us. The experience of Europe's ham-handed attempts to force the creation of a European computer industry was not so different from the experience of people who live in flood plains, who learn the hard way that Mother Nature respects no engineer.

But at the same time, we need to be careful that in respecting the power of markets we don't blind ourselves to the crucial role played by our government. Because when we do turn a blind eye, we stop debating an important question: who benefits? Who will reap the harvest from our tax dollars? Instead, those questions are settled in private, behind closed doors. That's not right. If Uncle Sam must ask his family to help tend the garden of the Internet, then all members of his family should partake of its bounty.

ENODE: to loose, untie a knot; to solve a riddle.

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