The party of innovation: copyright reform, looser licensing, and an agenda for a tech-savvy GOP.

Khanna, Derek

In 200 years the United States went from being a colonial backwater to being the world's dominant economic and military power. How did our nation arise from obscurity, break free from the grip of the most powerful empire on earth, and skyrocket to global leadership? With a government focused on innovation--not control.

Historically, the Republican Party has led on technological innovation. President Abraham Lincoln earned a patent and facilitated the first transcontinental railroad system. President Hoover played a key role in the early development of radio broadcasting, and President Coolidge created our national airways system. Dwight D. Eisenhower inaugurated NASA and DARPA, while Richard Nixon launched the cable television industry through deregulation. President Ronald Reagan made GPS available for civilian use and greatly expanded science research.

But today policymakers and the regulatory state are smothering the force that allowed us to become the world's economic superpower. Incumbent industries have co-opted the legal and regulatory systems to go after their competitors, and both political parties have been complicit in this cronyism. Acceptance of these regulatory and legal barriers is a root cause of our abysmal "new normal" of 2 percent annual GDP growth.

To confront cronyism we must revise our laws and regulations to foster what Joseph Schumpeter called "creative destruction." Market entry by entrepreneurs is the disruptive force that spurs economic growth, even as it destroys the value of established companies. For new and more efficient market models to evolve and competition to be robust, companies that don't innovate must die.

Real innovation, particularly disruptive innovation, often--though not always--comes from the small players and new entrants into the market. Clayton Christensen's classic work The Innovator's Dilemma details this phenomenon in depth, explaining how big, successful companies are often slow to innovate, yet it is the big companies that hold the most sway in influencing policy.

The GOP used to understand this; it was traditionally the party of small businesses. Today, however, for many Republicans "small businesses" means mom-and-pop grocery stores rather than cutting-edge innovators. Both are important, but one is where expansive job growth is coming from.

Start-ups have been the heart of America's economic success story. New research proves that job growth does not come from small businesses in general but specifically from new small businesses. A recent report published by the Kauffman Foundation, a nonprofit that specializes in entrepreneurial research, found that without new businesses job creation in the United States would have been negative over the last three decades. Incredibly, almost all net new job creation comes from companies less than one year old. On average, existing businesses shed a net 1 million jobs a year, whereas new firms in their first year create an average of 3 million jobs per year. One sector has been leading the charge: the high-tech sector has been 23 percent more likely than other sectors of the economy to witness new-business formation--and the communications technology subsector has been 48 percent more likely.

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This revelation, that new small businesses primarily create jobs and economic growth, demands a complete rethinking of economic policy for the United States. If Republicans understand this and thereby embrace the mantle of innovation, not only will they be expediting a new wave of ingenuity, but they will also share credit with entrepreneurs for the next tech boom.

This requires creating a regulatory and legal climate that fosters "permission-less innovation." True innovators often can't afford--either in terms of money or mental energy--to hire lobbyists and change the law. Entrepreneurs should not be wasting their start-up capital on lawyers, consultants, and PAC donations.

Given the stakes--the future of the economy--a political party that is not serious about technology and innovation is a party that is not serious about economic growth and job creation. Thus far, the Republican Party is not serious about technology and innovation. Republicans talk about regulatory reform but in practice do little about it.

Worse, they often implement or strengthen laws that inhibit innovation. At the behest of big corporate donors, politicians establish protective legal and regulatory structures to exclude new market participants. Republicans have been complicit in the choosing of winners and losers--something they rightly accuse Democrats of doing. This cronyism kills jobs, stifles innovation, and stunts economic growth.

The GOP has traditionally been the party against excessive regulation, but it has in recent years come to be perceived, especially by young people, as protecting big corporations and incumbent businesses rather than defending small and emerging businesses that are often more vulnerable to the impact of regulation.

To tear down the legal and regulatory barriers to entry for innovative new competitors, this article proposes an ambitious platform to enact at the state and federal levels. If it is implemented as an initial step in a new approach to policymaking, unprecedented innovation will follow from entirely new market models.

A few basic precepts must guide a party of innovation. At the state level, rolling back rules that limit access to markets--thus allowing new market models such as those of Uber and Tesla Motors to compete against the old ways of doing business--while scaling back licensing requirements will open markets in scores of industries to fresh competition. At the federal level, reforming copyright and patent law--restoring it to the explicit purpose for which the Founding Fathers intended it--will stop established industries from abusing copyright and patents to crush innovative competitors.

The State Level: Market Access

Uber provides a clear example of state law run amok. This service allows users to request a town car, SUV, or taxi by using a smartphone app. Uber is an innovation that makes the city traveling experience more enjoyable and more efficient, and it helps enterprising drivers who get to keep more of the profit than with conventional taxi fleets. It's a clear win for all parties. But Uber needs help--specifically, it needs to be left alone.

Many markets are completely off limits to the service due to state laws or city ordinances that protect the taxi cartel. In Miami, Uber can't compete at all. Washington, D.C. has tried to implement regulations that would require Uber to charge 500 percent of the "drop rate for taxicabs." If Americans prefer to spend time flagging down what are generally cash-only yellow taxis, they can do so. But the force of law shouldn't declare that every other market model is illegal.

The challenges that Uber faces also affect other innovative transportation services like Sidecar and Lyft and threaten to impede future technologies as well, such as a fully autonomous taxi-car system. These laws forestall logical progressions of the market.

Another market-restructuring new competitor that faces unnecessary obstacles at the state level is Tesla Motors. In many jurisdictions--including, embarrassingly for conservatives, Texas--government-imposed monopolies prohibit Tesla from selling cars directly to consumers, instead requiring Tesla to sell through traditional dealerships. In Texas, the law prevents anyone involved in selling new cars except a dealer from offering test drives, discussing price points, or even directing buyers to a website.

The rules restricting direct sale of cars are silly. They force manufacturers to develop an automobile and invest millions of dollars of start-up capital in production capacity without knowing if dealers will even carry the vehicle--thus government creates a chicken-and-egg problem. These regulations protect the dealers' monopoly rents on the market, ultimately creating a higher barrier to entry for new car manufacturers and in effect a tax of 6 to 9.3 percent upon the final price of every car in America (and those estimates are likely conservative).

This is a formula for killing innovation and jobs. Even the U.S. Justice Department came to this conclusion in a 2009 report that found, "As a matter of economics, arguments for state bans ... are not persuasive."

Unfortunately, as a matter of politics, a different calculation applies. Republican-controlled Texas allowed contributions to hijack the free market, as the website CleanTechnica.com revealed: while Tesla spent between $255,000 and $565,000 on lobbying efforts, the dealer lobby donated $2.5 million to election campaigns and kicked in another $750,000 for lobbying against direct sales of automobiles. Competing with $3.2 million just to get legal permission to enter the market in a single state is something that most new market participants can't afford--and no free-market supporter should expect them to pay it.

The last successful new car manufacturer to start up in the U.S. was Chrysler in 1925. The lack of new entrants into this market for nearly a century is a direct result of these laws. Carsdirect.com was one start-up designed to allow Americans to buy any car online, but when founder Scott Painter discovered that his website would require 2,000 car-dealership licenses to operate across the country, he closed the service.

If Americans enjoy the shenanigans of their local car dealers, they are free to buy their vehicles through that system. But new market models should be encouraged, not banned, and Republicans in every state ought to be aware of how their laws affect companies like Tesla.

State-level occupational licensing is among the worst instances of crony-capitalist influence. According to a 2010 study published in the British Journal of Industrial Relations, 29 percent of the U.S. workforce is required to hold a license, up from 5 percent in the 1950s. For some professions, such as lawyers and doctors, licensure is defensible. But increasingly, license restrictions are being abused by established business interests. All 50 states require licenses for anyone working with hair, for example--and the profession's standards boards are composed of licensed salon owners with an interest in imposing standards that exceed legitimate health and safety concerns in order to limit competition.

Consider a few egregious examples of licensing abuses from across the country, as compiled by the Institute for Justice and other sources:

* In Alabama, it's a crime for anyone but a licensed dentist to offer over-the-counter teeth-whitening services.

* In New York, there are laws prohibiting renting out your own apartment, and Airbnb users who rent out their apartments have been sued--the Attorney General recently subpoenaed the information of 15,000 users of this smartphone app for further legal action.

* In Portland, Oregon, it's illegal for limos or sedans to charge rates competitive with taxis.

* In Washington, D.C., giving a tour of local sights and attractions without a license can land you in jail for 90 days.

* In North Carolina, it's a crime to give nutrition/dieting advice without a license, which has landed blogger Steve Cooksey in hot water for his website Diabetes-Warrior.net, where he wrote about his exercise and "paleo diet" for dealing with diabetes.

* In Louisiana, it's a crime for anyone but a licensed funeral director to sell "funeral merchandise," including caskets, which caused a group of 38 monks to be unable to sell caskets at their monastery. (They recently won the right after a successful suit.)

* Four states have license requirements for individuals who advertise themselves as interior designers.

* In Kentucky, new entrants in the moving business must demonstrate to a state board dominated by incumbent movers that there is a "need" for their service.

* State licensing requirements to be a money transmitter cost companies as much as $500,000 per state, according to a Digital Transactions magazine report. One company spent over $10 million and five years' time to get its first 41 licenses. This requirement has stifled payment-provider innovation, which is expected to be a massive industry in the digital economy.

The consequences of regulations like these are significant: there are over 700,000 cosmetologists, 21,000 funeral homes, and 333,000 taxi drivers and chauffeurs. They have tens of millions of customers, who ultimately have to pay more for their services.

Milton Friedman devotes a chapter of Capitalism and Freedom to this topic. Licensure is "essentially the medieval guild kind of regulation" where "the state assigns power to members of the profession."

He explains that these "measures ... almost inevitably becomes a tool in the hands of a special producer group to obtain a monopoly position at the expense of the rest of the public." The principle for reform is simple: occupational licensing should be limited to what is strictly necessary to protect the general public.

These examples are just a few of the restrictions that limit free market competition at the state level. In the cases of Uber, Tesla, and frivolous occupational licensing, government intervention is unnecessary, counterproductive, and immoral. Republicans can't say they are serious about regulatory reform unless they are spearheading the attack on these regulations, state-by-state and locality-by-locality. In fact, Republicans must be proactive to clear the way for innovation, not reactive to the problems when they manifest themselves.

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The Federal Level: Copyright and Patent Reform

Copyright and patents are the government's most powerful tools for fostering innovation. Employed correctly they incentivize technological development and content creation--and the U.S. is a world leader in both. But when used improperly, these laws have the opposite effect.

The Constitution provides a single, exclusive reason for the regulatory instruments of patents and copyright, "To promote the Progress of Science and useful Arts." This is the only Congressional power with a specific enumerated purpose--to a textualist, this is substantial evidence of its importance.

But this is not the perspective of Hollywood lobbyists, who for good reason have long favored the Democratic Party. As a result of lobbying by groups like the Motion Picture Association of America (MPAA), our copyright laws today stifle numerous innovations and content creation. Former MPAA President Jack Valenti's 1982 Congressional testimony in favor of effectively banning the videocassette recorder illustrates the copyright lobby's perspective on such innovations in general:

I say to you that the VCR is to the American film producer and the American public as the Boston strangler is to the woman home alone.

... When there are 20, 30, 40 million of these VCRs in the land, we will be invaded by millions of 'tapeworms,' eating away at the very heart and essence of the most precious asset the copyright owner has, his copyright.

Valenti almost got his wish: in 1984 the Supreme Court came within a single vote of deciding Sony Corp. of America v. Universal City Studios, Inc. in favor of Hollywood, a ruling that would have made retail sales of videocassette recorders virtually impossible. Yet according to the Entertainment Merchants Association, just two years after the Supreme Court decided in favor of the VCR, the MPAA's studios made more money from movies on videocassette than they did from the box office.

The VCR is not the only technology that Hollywood lobbyists have tried to kill. In the recent past, copyright laws have threatened legitimate technologies like satellite TV, digital video recorders (DVRs), streaming movies over the Internet, and digital audio players like the iPod. In 1992 the recording industry actually succeeded in using copyright law to levy a "private" tax on empty cassettes, blank compact discs, and CD-recorders.

It's fairly simple:

* If you believe that these are good innovations, then we need a regulatory and legal climate that allows for these and future technologies to be offered without legal permission; or,

* If you believe that these are malicious innovations that should be banned, then you support the current laws that have resulted in the companies that offered the first DVR (ReplayTV) and Digital Audio Player (the Rio) being bankrupted through lawsuits; laws that prop up old industries and create higher barriers for competitors; laws that legally barred satellite TV companies from selling TV to those who could access cable.

James Madison, warned future generations that as "monopolies," grants of copyright and patent must be "guarded with strictness [against] abuse." Today a clear clause in the Constitution, to "Promote the Progress of Science and useful Arts," has been re-interpreted to allow the possibility of banning whole classes of legitimate technologies.

In January 2012, over seven million people contacted their members of Congress to ask them to oppose the Stop Online Piracy Act/Protect IP Act (SOPA/PIPA), which would in effect have censored the Internet for Americans in the name of stemming piracy and protecting copyright. Experts testified that the law wouldn't stop piracy, would cause irreparable damage to the Internet itself, and threatened U.S. commerce and innovation. But Congress continued to plow ahead, receiving $94 million in lobbying checks in 2011 alone from pro-SOPA groups.

To many in the younger generation this was a seminal political moment: thousands of websites online were blacked out in protest. While SOPA/PIPA was supported by more Democrats than Republicans, Republicans co-sponsored the legislation in spite of vociferous opposition to the legislation from conservative groups such as Freedom Works and Heritage Action. In the end, under pressure from their constituents, Republicans stood up against the Hollywood lobbyists and killed the bill. At one point, 26 of the 29 legislators who switched sides were Republican--but they only did so after the White House came out against SOPA/PIPA.

For many in the digital generation, this was their first opportunity to engage in the political process, and they saw Republicans who couldn't even bother to pay attention: during the debate on SOPA/PIPA, the most important technology/innovation legislation in a generation, Iowa Republican Rep. Steve King tweeted that he was "so bored" by the debate that he was "killing time by surfing the internet." Republicans thus missed the opportunity to win support among a new generation, and they almost enacted the worst technology bill since the creation of the Internet.

Then in 2013, when the Librarian of Congress--under authority from a copyright law, the Digital Millennium Copyright Act--acted to ban cellphone unlocking, Republicans again failed to take the banner of the free market.

Cellphone unlocking alters a phone's software to allow it to be used on a different cellular network. The ruling by the Librarian of Congress made millions of Americans potential felons for the crime of running a computer program to take their phone from one provider to another. The decision meant that individuals who chose to exert their property rights over their own device were liable for up to five years in prison and $500,000 fine.

FCC Commissioner Ajit Pai called for a reversal: "Let's go back to the free market. Let's allow contract law--not copyright or criminal law--to govern the relationship between consumers and wireless carriers."

The Librarian of Congress's decision was a classic example of cronyism. The Competitive Carriers Association, representing over 100 phone carriers, petitioned the librarian to keep phone unlocking lawful, as it allows small carriers to compete in the free market. But lobbyist dollars won out: just how much power the two major wireless companies--AT&T and Verizon--exercised to shape the debate is suggested by the $32.6 million they spent on lobbying in 2012 alone. Their industry association, CTIA, spent $12 million that year.

Only when President Obama came out in favor of unlocking did the GOP reluctantly act to support the free market, sponsoring legislation that has now passed the House. But that legislation would continue to delegate authority on this issue to the Librarian of Congress. The Senate has still refused to take up this legislation, despite the fact that phone unlocking is good for competition and the consumer.

These types of issues are easy wins for Republicans if they become serious about free markets, innovation, and personal freedom. Conservatives support constitutional copyright, not Mickey Mouse copyright. The laws that Congress has chosen to implement to protect copyright have unintended consequences that stifle innovation. As a small sample:

* Entrepreneurs have been held personally liable for their companies' dual-use technologies--which can be used for legitimate purposes or potentially misused to violate copyright--because copyright infringement pierces the "corporate veil."

* Venture capital firms have been sued for investing in dual-use technologies that could be abused for piracy.

* Lawyers have been sued for providing advice on the legality of dual-use technologies.

* Copyright infringement results in unprecedented statutory damages for potential liabilities that may be thousands of times above actual damages. For most torts, companies are only liable for the harm caused. But in the case of copyright infringement, entrepreneurs can be liable for up to $150,000 per copyrighted work. In the case of an entire class of technology, like the VCR, the potential liability for copyright claims can be millions multiplied by $150,000. Potential damages could theoretically be in the trillions--well above world GDP.

Dual-use technologies includes the VCR, iPod, DVR--even the Internet itself. Tim Wu's book The Master Switch notes that when Google crawled the internet to create its search engine, this act of copying and indexing was arguably copyright infringement: "certainly at the time, the legality of what was done wasn't entirely clear; and truth to tell, if a copyright lawyer had been among Google's founders, it's doubtful the thing would have gotten off the ground."

Today we have a system of copyright that has often stifled innovation and content creation, hurt the consumer, and provided lucrative opportunities for cronyism. Republicans' abdication of the traditional conservative position is especially surprising given the longstanding tradition on the right in favor of copyright reform, with pro-reform conservatives and libertarians including Nobel-laureate economists Friedrich Hayek, Milton Friedman, Ronald H. Coase, and Kenneth Arrow; activists such as Phyllis Schlafly and former presidential candidate Steve Forbes; and leading conservative jurists and constitutional scholars such as Richard Posner and Glenn "Instapundit" Reynolds.

In fact, there is no tradition among conservatives that favors modern copyright policies as espoused by the special interests and enacted by Congress with a rubber stamp.

Despite this strong tradition within the conservative movement--an intellectual consensus, in fact--some elected Republicans have embraced the Hollywood-lobbyist version of "zombie copyright" that cannot die: where copyright exists forever in clear violation of the Constitution. As former George W. Bush administration official Stewart Baker has explained, modern copyright has come to resemble "a constantly expanding government program run for the benefit of a noisy, well-organized interest group."

Our Founders' copyright term was a 14-year term with a 14-year extension. But over time, lobbyists have extended copyright to automatic life plus 70 years, and every 20 years the copyright lobby petitions to extend copyright again, perpetually. When special interests can't influence Congress to enact the cronyist policies they want, they resort to "policy laundering" and use international treaties to circumvent the legislative process: special interests are now secretly at work on a new treaty, the Trans-Pacific Partnership (TPP), that would make it impossible to restore copyright to terms more consistent with the Founders' original public meaning.

Republicans can choose to favor a system of indefinite copyright, they can support the status quo that stifles innovation--but they can't call it conservative. These policies are a radical and unprecedented departure from our Founding tradition. In 2012, the House Republican Study Committee (RSC) released a report which I authored on fixing copyright law, and it received widespread support from the conservative movement. While the RSC ultimately took the report offline under special interest pressure, the conservative approach on copyright reform resonates with a lot of young and tech-savvy demographic groups who are not traditionally in the Republican camp--and whose votes the GOP needs--but most importantly, the conservative understanding of copyright is consistent with the Constitution and promises to result in substantial economic growth.

The problems with current patent law are similar to those of copyright. Today most economists believe that the patent office gives patents for things that should not be patentable. George Mason University economist Alex Tabarrok, in Launching the Innovation Renaissance, observes that excessive patenting can create a "resting on laurels" effect. Rather than investing in innovation to out-compete their rivals, firms stockpile patents and attack potential rivals with lawsuits.

As Microsoft founder Bill Gates presciently warned against 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." He foretold where this might lead: "A future startup with no patents of its own will be forced to pay whatever price the giants choose to impose. That price might be high. Established companies have an interest in excluding future competitors."

Gates's warning is precisely what is happening in many technology sectors. On the iPhone, the slide-to-unlock function and "rounded rectangle" form factor are two examples of patents for technologies that are not so original and novel that competitors ought to be banned from using those "inventions" unless they're willing to pay licensing fees to Apple.

So-called patent trolls--patent-owning entities that exclusively license and legally protect their patents but do not make use of them--were estimated in the Cornell Law Review to have cost the economy $29 billion in direct legal costs in 2011 alone; that's not counting the diversion of resources, loss of market share, and delays in bringing new products to market that result from this abuse. Many entrepreneurs find themselves slammed with false patent claims, yet with no choice but to pay up to avoid bankrupting litigation costs. Ironically, this is a result of government intervention in the market to "promote the Progress of Science."

Policymakers can create a better system to achieve that end: enact legislation to stop providing patents for things that are not truly novel. Unfortunately, while Congress is seriously considering patent reform, the critical issue of patent quality, the underlying problem, has hardly been discussed. Republicans should be leading the effort to improve the quality of patents because a successful effort would lead to incredible innovation and economic growth.

For copyright and patent law alike, the traditional conservative position is to prefer less government intervention and less regulatory uncertainty, with a system that compensates rights holders and inventors but that does so for the constitutionally enumerated purpose of spurring innovation and content creation, not at the cost of inhibiting it.

Our policymakers have allowed the sweet taste of campaign contributions to overpower good governance and conservative principles. If we want to create millions of new jobs--and jobs that are better than those lost during the Great Recession--the way to do so is to unleash the full entrepreneurial potential of our society, and Republicans should in the vanguard of the effort at both the state and federal levels.

Republican National Committee Chairman Reince Priebus has tried to rebrand the GOP as the party of "Growth and Opportunity." But growth and opportunity come from innovation: we won't grow our way out of our debt and deficit without exponential increases in innovation.

A Party of Innovation will know it has succeeded by looking at one simple metric: the return on investment (ROI) from research and development must be higher than the return on lobbying (ROL). When that's true, companies will allocate their resources to innovate rather than legislate their way to growth.

Derek Khanna is a fellow with Yale Law School's Information Society Project.