Gilded Cages

Our first few tales of the information sector were little more than heralds of things to come. We are in the early stages of a full-blown transition to the information age. The challenges facing our software and music industries will be but the first of many.

Then again, they may be wrong. After all, the transaction costs that enabled their business models always combined technological and legal barriers. The costs that consumers bore in granting the legal rights were only the costs that the laws added over the technology. But as techno­logical barriers plummeted, the laws that grew to replace them became more and more expensive. Incumbents intent upon preserving their revenue streams in light of these reduced barriers clamor for increasingly intrusive laws imposing increasingly expensive transaction costs. Legis­lators often accede to their pleas without analyzing the costs they impose. There’s no way for us to know whether we’re still getting a good deal— or whether we’re overpaying by a considerable amount—without recon­sidering the inherent costs and benefits.

But as in any policy debate, winners—or at least some particularly vocal winners who have fared well with reduced technological barriers— would like to take all. Some Napster backers, for example, insist that record companies have no legitimate rights, despite Congress’s decision to protect their IP. That can’t be right. Even in the absence of distribu­tion, the record companies add tremendous value to their products—at a bare minimum in the areas of scouting, selecting, producing, and branding musical acts. We need to motivate innovation in these arenas, as well. We may still need some legal transaction costs, even in an era of plummeting technological barriers. Finding the right balance, though, will take some work. And it will undoubtedly lie somewhere between insisting that profit streams remain untouched by technology and insist­ing that once-important policy goals have become irrelevant.

The software and entertainment businesses may prove to be among the industries best suited to weather this transition. Their leading corporations are wealthy, diverse, and geographically dispersed. Their workers are better educated than average, technologically adept, and already comfortable in the information sector. Their management has navigated changes to both technology and business models before. They have high public profiles. Government pays attention to them. Above all, they know that their existing business models are living on borrowed time. And so they adapt.

Traditional software companies are reconciling themselves to open­source development, and some, like IBM and Sun, have become ardent supporters. Growing segments of the music industry are coming to recognize—grudgingly—that their future may lie in relinquishing their distribution rights and retaining only their rights to compensation and attribution. They’re exploring new “digital rights management” (DRM) technologies, and seeking viable ways to develop subscription-based services. When Microsoft’s integration of WMP into Windows XP included DRM technologies keyed to its own proprietary format, WMA (rather than to the MP3 open standard), some of the record labels approved.

The revolution in information-sector business models may run even deeper. Many recent media mergers⁵ were designed to marry conduit to content, essentially betting that in the near future, content no longer will be king, and royalties will flow primarily to those capable of delivery. Many software companies, including Microsoft, Oracle, and other open-source opponents, foresee a similar future for themselves under the “application systems provider” (ASP) model. ASPs are service providers, not software sales forces. ASPs offer their customers access to software residing on their own servers via high-speed connections. Customers pay monthly subscription fees for the service. Software, like music, may soon join electricity, gas, water, and telephony as ubiquitous monthly utility bills.⁶

The notion of music as a utility would mark a radical departure for the record companies. While many hurdles still remain, this utility model promises to employ legal rights that work with technology, not against it. It appears to be a business model well suited to the music industry of the future. But it takes a certain amount of courage for the record com­panies even to contemplate it. After all, it’s hard to tell whether their profits will grow or shrink once the transition is complete. As a result, if we want them to adopt it—or to adopt some alternative model that modifies IP rights so that they reinforce technology and motivate inno- vation—we may want to think about ways to ease the transition, not to mention to compensate the existing rights holders for the rights that they’ll have to relinquish.

But that’s just part of transition management. The true key lies in rec­ognizing that it’s in the enlightened self-interest of a transition’s putative winners to compensate its putative losers. Our economy becomes “more efficient” when it grows. But even though society as a whole wins when the economic pie gets bigger, not all of society’s members win. Those poised to lose will understandably fight to prevent generally beneficial changes. If the pie is truly bigger, though, no one should have to lose. In an ideal transition, the economic pie will grow, society as a whole will gain, some members of society will win overtly, and no one will lose— possibly because the overt winners will compensate putative losers.⁷ But not all forms of compensation are equally appropriate. Programs that help people adjust to the future are much better than those that help them cling to the past. Investments in education, training, employment counseling, and relocation assistance are critical.

The past few generations have witnessed a number of painful transi­tions; we’ve handled some more smoothly than others. The United States began as an agrarian nation, and the family farm still plays a uniquely important role in American mythology and in the American psyche. It does not, however, play an important role in the American economy. Family farms stopped being economically viable in the developed world decades ago. Small farms tend to do fine in good years. But as soon as weather conditions either curtail production (driving volumes down) or lead to an unusually bountiful harvest (driving prices down) they teeter on the verge of insolvency. Large corporate agribusinesses diversify their farming across so many different crops in so many different parts of the world that they can always sustain themselves. Family farms can support only a few crops in a single weather zone. Were it not for government subsidies, family farms in the developed world would have become a memory long ago.

All of us in the developed world must ask ourselves: Are we really helping these family farmers? Are these direct subsidies a good form of transitional assistance? It may be true that our subsidies help middle­aged and elderly farmers live out the life that they know and love—and keep the myth alive. That’s all for the good. But what of their children? Is it fair to trap today’s children in that same life, destined to remain reliant on government subsidies? Wouldn’t we be better off helping them adjust to the modern age? Shouldn’t we emphasize education and skills that will help them contribute to the future? Shouldn’t we help them relocate to wherever the greatest opportunities exist? Programs like these would help the children of today’s farmers have better futures; instead, we just trap them on the farm.

To make matters worse, our “helping” subsidies also create two other problems. We’re giving large parts of our farm subsidies to wealthy agribusinesses that neither need it nor deserve it, and we’re making things harder for people who can run economically viable small farms—pri­marily in the developing world. And lest you think that agricultural sub­sidies have little to do with the information sector, bear in mind that our global economic network connects all sectors. In the Uruguay Round of trade negotiations leading to the founding of the World Trade Organi­zation (WTO), the developed and developing worlds struck a deal.

Subsidies supporting vestigial forms of agriculture serve as a poignant example of a transition that we should have managed better. Instead, we fell into a trap that only can be attributed to our best intentions and our sense of justice. It seems unfair that technological advances run amok should upend anyone who means well, works hard, and relies on long­standing expectations. Often, we express our sympathy by trying to lock their expectations in place. Such sympathetic lock-in is a trap.⁹ Every transition produces people whose plans are dashed and whose incomes collapse despite hard work and exceptional skill. While it’s not fair, and it offends our sense of justice, the most obvious fix—legislating their incomes in place—inevitably leads down a path towards even greater injustice. It locks us all in and impedes our growth.

Already we can see the battle lines forming over the next set of tran­sition issues. Though we as workers may be sand in the Vaseline, unable to reorient our skill or to relocate quickly enough to keep up with the flows of other resources, our jobs are becoming increasingly mobile. By late 2003, people began to notice that even service-sector jobs, once con­sidered safe from offshore outsourcing, were losing that immunity.¹⁰ Our information-sector entrepreneurs not only were learning how to turn production industries into service industries, they were learning how to increase their efficiency by relocating those service industries.

As always, advocates of two extreme positions scream loudest about this newly noticed phenomenon. One pole insists that the trend is healthy, and that the economy will eventually create more new jobs than it loses. This argument is correct, but it ignores the significant pain of transition. The other pole features shrill protectionist rhetoric, pro­mising to lock workers into their present dead-end jobs. Such policies would serve as a short-term palliative while recreating the unfortunate consequences of our farm policy. They would trap American workers in dead-end jobs while deterring or delaying the developing world’s liberalization. As the years go by, these protectionist policies would require us to work ever harder to keep ourselves ever poorer—as restric­tions on free trade always do.

Neither approach can solve the underlying problem. Our remarkable infrastructure investments over the past few decades have taught us how to move finances, physical objects, information, and increasingly jobs, much more quickly than we can reallocate workers and skills. Those who would do nothing are content to wait for workers and skills to catch up on their own. Those who favor barriers would slow the reallocation of all resources to the speed of labor. The intelligent solution is to find infra­structure investments that improve our labor mobility. Investments in retraining and relocation, tying unemployment benefits to skill acquisi­tion, encouraging immigration, and helping employers and employees find each other, are all likely to be critical. And though these investments may be expensive up front and may generate tax burdens and/or deficits that some would prefer not to bear, they are critical to maintaining our world leadership. The nation that best invests in this next great infra­structure development will dominate the twenty-first century—and the rest of the information age.

We need to navigate our ongoing transition to the information age wisely. But transitions raise tough questions that we’d prefer to avoid. Sound transition management requires investments that we might prefer not to make. We’ve gotten used to the way things are, and it often seems cheaper in the short run to prop them in place. We recognize people’s interests in the status quo, and gild their cages to trap them into envi­ronments and business models that will never again succeed. We do it with farming. We do it with steel. We do it with textiles and sugar and mohair and who knows what else. If some have their way, we’ll be doing it soon with music, with movies, with software—maybe even with garage-door openers. And it won’t stop there. We must avoid this trap as the information sector continues swallowing broad swaths of the economy. Our spending on education, training, employment, and relocation must increase. Our labor markets must become as lubricated as our financial markets. Because when they do, we’ll all become richer.

And yet, we’re already falling into the same old trap. We noticed IP rights eroding and advocated technological solutions to promote encryp­tion and data security. Then we noticed that crackers could circumvent such technology, so we passed an anticircumvention provision. Then we realized that people might be willing to figure civil penalties into the cost of doing business, so we criminalized circumvention. All to help com­panies protect antiquated business models that limit the benefits that we can reap from technological advancement. People on the inside clamor for stronger protection. Every time technology reduces a transaction cost, they want more gilding. And every time that we accede, they retreat even further into an unsustainable business model—and we lose part of our ability to explore and to innovate. Yet, while some of the current players in those industries probably wouldn’t make the transition successfully if we uncaged them, it’s not at all clear that the industries as a whole wouldn’t soar in the clear skies of the information sector.

Falling into the trap of favoring lock-in over growth in easy. Incum­bent distributors are established entities, often boasting strong political connections, seeking to protect identifiable interests. Lock-in serves them well. Growth, and in particular network growth, is nebulous, and its benefits are diffuse. Growth serves the broad public interest in ways that are typically hard to predict. The voices clamoring for lock-in are invari­ably vocal and powerful; those favoring growth are invariably diffuse and at times inaudible. And so, we adopt policies that sacrifice growth in favor of lock-in. Every now and then, we should ask ourselves who we’re really helping—and at what cost.