Is Government Strangling the New Economy?

CIAO DATE: 8/01

Is Government Strangling the New Economy?

On The Issues

May 2000

American Enterprise Institute for Public Policy Research

On April 3, a federal judge ruled that Microsoft has violated U.S. antitrust laws. That finding hurt the stock not only of Microsoft but also of other high-technology companies, including Microsoft's competitors. Shares of those companies suffered because investors are alarmed by the increased threat of government intervention in technology markets.

It's not hard to understand why Microsoft's stock price plummeted in the wake of the unfavorable court ruling on April 3, but what explains the decline of the other high-technology companies that dominate the Nasdaq Stock Market?

Just look at Microsoft's competitors, the companies that were supposed to benefit from the federal government's lawsuit. Scott McNealy, CEO of Sun Microsystems and one of the most aggressive Microsoft antagonists, was gloating in a press release after Judge Thomas Penfield Jackson's ruling. But Sun's stock dropped $3.75 that day. America Online owns Netscape Communications, whose complaint touched off the federal suit. AOL stock fell 7 percent in two days. RealNetworks, cited by Judge Jackson as suffering from Microsoft's "oppressive thumb on the scale of competitive fortune," was down 13 percent. Two makers of operating systems that compete with Microsoft's—Red Hat Software and Apple Computer—also dropped.

Changing Environment

The rout in Nasdaq stocks in April was broad and deep. The breakdown of settlement talks in the Microsoft case was only the catalyst. What investors are realizing is that the environment that helped produce the high-tech boom—low regulation, low taxes, minimal government intervention, and a low level of corporate rent-seeking—is changing profoundly.

In the past, no one told the entrepreneurs in the garages of Silicon Valley what products to invent, how to sell them, what prices to charge, or what deals to offer. Now, the new economy is beginning to look more like the old—an environment in which the winners are not necessarily the companies that please customers the most but the companies that do best at keeping government at bay—or, better yet, at using government to thwart competitors. Stock prices are falling because the risks to real innovators are rising.

The pundits continue to argue that technology stocks are in a "bubble." They said the same thing a year ago, when the Nasdaq was 40 percent lower than today—not to mention five years ago, when it was 80 percent lower. By this reasoning, stock prices are falling because they are too high. It is as if the law of gravity suddenly decided to kick in at, oh, around 5000 on the index.

But the question is why now? The answer is the increased threats of intervention in technology markets—threats made especially vivid by the Microsoft decision. To be specific:

Doing a Smith & Wesson. The same team that gang-tackled the makers of cigarettes and guns is going after not just Microsoft but smaller high-technology companies. The Justice Department, state attorneys general, and plaintiffs' lawyers are setting their sights on such firms as DoubleClick, the Internet advertising company accused of privacy abuses. "We want to do a Smith & Wesson-like thing with DoubleClick," said Jennifer Granholm, attorney general of Michigan.

Commenting on Ms. Granholm's statement, legal critic Walter Olson wrote: "We suppose this means that she and her colleagues want to invent far-fetched legal theories to attack business practices that have long been regarded as lawful; file a great flurry of suits in multiple courts so as to overwhelm the designated opponent; use the threat of bankrupting legal expense to muscle it into submission . . . and instill fear into other businesses that the same thing could happen to them unless they cooperate." DoubleClick, by the way, is down 38 percent since the onslaught began.
Biotech blast. In a March statement, President Clinton and British prime minister Tony Blair made veiled threats about ending private ownership of human genome information. Prices of biotechnology stocks tumbled one-third (though later Mr. Clinton backtracked on his remarks).
Taxing e-commerce. Ever since Congress nearly unanimously approved a moratorium on new Internet taxes, the National Governors' Association has pushed aggressively to tax electronic sales across state lines. Gov. Jim Gilmore of Virginia, who heads the federal commission examining the matter, worked hard for a ban but failed. Studies show that sales taxes would throttle the rapid growth of e-commerce and depress revenues of Internet companies.
Revenge of the middleman. One of the joys of the Internet is that buyers can go directly to manufacturers for their purchases, cutting costs all around. But dealers, suppliers, and agents are feeling the squeeze. Rather than devise new clicks-and-mortar strategies, these middlemen run whining to politicians for help.

In South Carolina, auto dealers are pushing a bill that would prohibit car makers from owning dealerships and would explicitly bar Internet sales unless local dealers get a piece of the action. Charles Condon, attorney general of South Carolina, said of the bill: "What if we passed a statute saying cars couldn't be sold on a particular highway? Wouldn't there be outrage? Why is there no outcry when cars cannot be sold on the information superhighway?"
Broadband slowdown. Companies are appealing to politicians to increase telecommunications regulations on the Internet—an effort that threatens to hold up faster broadband technologies, already delayed by bottlenecks caused by local telephone companies. For a year America Online campaigned in Congress, in state legislatures, and in city councils across the nation to get laws passed that would force cable companies like AT&T and Cox to permit AOL to use, at government-fixed terms, their high-speed cable pipelines. Then, in January, AOL announced it was buying Time Warner; suddenly the shoe was on the other foot.

But, as George Gilder pointed out in the Wall Street Journal recently, it may be too late to say "Never mind." The San Francisco Board of Supervisors is on the verge of mandating cable access, and decision by a Portland, Oregon, municipal body regulating Internet-by-cable is now in the courts. If Portland wins, thousands of local governments can become Internet regulators.

General Carnage

No one ever knows for sure why a stock falls on a given day, but my interpretation of Nasdaq's sharp decline is that investors, jarred by the Microsoft decision, have suddenly woken up to these threats of government intervention. If they haven't woken up, they had better. And so should Al Gore. The Clinton administration likes to take credit for a stock market that has quadrupled in the past decade. It can't avoid the blame for Nasdaq's collapse.

While Joel Klein and his Justice Department lawyers were publicly and distastefully celebrating Judge Jackson's decision, the market capitalization of Microsoft was dropping by more than $200 billion. That's not some theoretical figure. It is a loss in real wealth—in many cases, in retirement savings—of more than two million direct shareholders of Microsoft and of tens of millions more who have substantial holdings of Microsoft in their mutual funds and annuities.

But Microsoft is only part of the story. The Nasdaq carnage has been wide-ranging. And why not? The Internet intervention of government, often in league with trial lawyers, threatens every high-technology firm in America.

James K. Glassman is a DeWitt Wallace-Reader's Digest Fellow at AEI. He is a member of the advisory board of Americans for Technology Leadership, a group supported by Microsoft and other technology firms. This article appeared in the Wall Street Journal on April 6, 2000.