In our report, The Revenge of the Disintermediated: How the Middleman is Fighting E-Commerce and Hurting American Consumers, PPI documented how incumbent producers in a wide range of industries, including wine and beer wholesalers, auto dealers, travel agents, pharmacies, mortgage brokers, and others, are fighting against robust e-commerce competitors.   The growth of laws and regulations many at the state level, that protect incumbent "bricks and mortar" companies from e-commerce competitors is a major threat to the growth of e-commerce. 

There are a number of things Congress can do to make sure American consumers have the choices they deserve in the new digital economy: 

• Congress and the Administration should resist protectionist pleadings and oppose actions designed to protect the status quo against e-commerce competition.   

• As the federal agency charged with protecting consumer rights, the Federal Trade Commission is well situated to weigh in on the side of the consumer in these debates at the state level.  As a result, Congress should support the FTC's e-commerce advocacy efforts.

• While it's important to try to convince states to repeal or modify their restrictive laws and regulations, at the end of the day persuasion is likely to go only so far.   As a result, Congress should seriously consider creating on an industry-by-industry basis uniform national standards that enable e-commerce competitors to sell more easily in all 50 states.  The Gramm-Leach-Bliley Financial Services Modernization Act, which gave states four years to have a uniform licensing requirement or reciprocity for insurance or face federal preemption, is a model to build upon and apply to other areas.   In some cases, Congress may need to let e-commerce companies doing business in areas currently regulated by states to be governed by new federal statutes.

In summary, it is incumbent upon policymakers at all levels of government, and in all branches, to resist the pressure from the disintermediated and ensure that e-commerce competitors are allowed to compete on a level playing field and are not burdened with unfair and discriminatory rules, regulations, and laws. 

Thank you for the opportunity to appear before you.

Mr. Chairman, members of the Subcommittee, I am Rob Atkinson, Vice President and Director of the Technology and New Economy Project of the Progressive Policy Institute.   PPI is a think tank whose mission is to define and promote a new progressive politics for America in the 21st century.  It is a pleasure to testify before you on the issue of how middlemen are erecting legal and regulatory barriers to e-commerce.  For several years, PPI has been keenly interested in promoting public policies to foster e-commerce, since we see it as a major driver of economic growth.   However, we see the growth of laws and regulations that protect incumbent bricks-and-mortar companies from e-commerce competitors as a major threat to the growth of e-commerce. 

As Americans realize they can save money¾often a lot of money¾by buying everything from books and CDs to contact lenses and airline tickets over the Internet, e-commerce continues to grow. [i]  Notwithstanding the recent dot-com shakeout, the U.S. Census Bureau reports that in the second quarter of 2002 e-commerce retail sales grew 10 times faster than all retail sales.   Almost 60 percent of American households are online and that number continues to grow.  

While e-commerce is a progressive force for economic growth, not everyone benefits from its lower prices, expanded consumer choice, and enhanced convenience.  In particular, a host of brick-and-mortar retailers, distributors, brokers, and agents¾all manner of intermediaries-are at risk from the tide of e-commerce.  For example, 15 percent of airline tickets are now purchased online, reducing the market share of bricks-and-mortar travel agents.  But rather than compete fairly in the marketplace, travel agents and a host of other middlemen are seeking to erect all manner of barriers¾including government legal actions, laws, and regulations¾particularly at the state level, to hobble their online competitors.  These are not just about intra-industry fights for competitive advantage; rather, they go to the heart of consumer welfare as protectionists in many industries limit consumer choice and keep more efficient competitors from the market.   In a free market economy, consumers, not vested interests colluding and using the political process to impede competition, should decide how commerce is structured. 

Why Domestic Free Trade Matters 

In the old economy, people purchased most goods and services through companies or professionals located in their state.  Even if people wanted to buy from out-of-state providers, with the exception of a small mail order catalogue industry, most consumers couldn't.  Today, the rise of e-commerce enables Americans to buy a wide array of goods and services from sellers located in different states, all without going through a local middleman.    

Using the Internet to bypass these bricks-and-mortar middlemen can bring dramatic savings to consumers.  Selling homes on the Internet can reduce agent commissions by half.   Buying a car directly from the manufacturer is estimated to lead to savings of thousands of dollars.  Selling corporate and municipal bonds directly over the Internet can eliminate most of the 2 percent to 5 percent commission charged by middlemen.  Trading futures contracts through the Internet is at least 50 percent cheaper than through bricks-and-mortar exchanges like the Chicago Board of Trade.  Drawing up a will or other simple contract online can be 75 percent to 80 percent cheaper than using a lawyer.  In short, e-commerce holds the key to boosting productivity growth in a host of industries. 

But e-commerce is important not just because it saves consumers money, but because it gives them more choices.  Consumers are no longer dependent upon local businesses to stock the products or provide the services they want, they can use the Web to search the world and find what they need.  

The Middlemen Fight Back 

In PPI's report, The Revenge of the Disintermediated: How the Middleman is Fighting E-Commerce and Hurting American Consumers, I documented how incumbent companies in a wide range of industries¾including wine and beer wholesalers, auto dealers, music stores, travel agents, pharmacies, mortgage brokers, real estate agents, auctioneers, the U.S. Postal Service, lawyers, radiologists, and even college professors¾are fighting against robust e-commerce competitors.  

While some of these battles are fought at the federal level, many are playing themselves out in the states because that is where many industries are regulated.   In the old economy, where the buyer and seller met face-to-face in the same state, states were the logical nexus for applying these industry-specific consumer protection laws and regulations.   However, many of these laws and regulations that may have not been a barrier when most commerce was intra-state now unintentionally hinder e-commerce.  In other cases, middlemen have been able to convince state legislators and governors that in the face of new competition, new protections are needed.  In all cases, the simple fact that national e-commerce businesses are subject to 50 different state laws can raise their costs of doing business significantly.  Some illustrative cases at the state and federal level are: 

• In Colorado, representatives of the bricks-and-mortar pharmacy industry successfully lobbied to have legislation introduced to make it illegal for pharmacy benefit manager programs to impose lower co-pays for drugs purchased from pharmacies but through mail order and web orders.

• In Maine, optometrists lobbied for a prohibition against releasing prescriptions to their patients, to prevent consumers from ordering contact lenses online.

• Texas, at the behest of car dealers and their trade groups, stopped Ford Motor Co. from marketing used cars on the web, despite potentially huge savings to consumers.

• Seventeen states require companies brokering a mortgage to hire residents of the state and maintain a physical office there. 

• The National Customs Brokers and Forwarders of America have fought against a proposal by the federal government to create an International Trade Data System to electronically collect all information for the federal government processing of trade.

• On anti-trust grounds, the travel agents and their trade associations have lobbied Congress and the administration to shut down Orbitz, the online travel site.

States differ widely on the extent to which their laws and regulations hinder e-commerce.  In PPI's report, The Best States for E-Commerce, we ranked the states on 11 factors, including eight directly related to middleman resistance.  The least restrictive states were Oregon, Utah, Indiana, and Louisiana.  The most restrictive were South Carolina, New Mexico, Alabama, and somewhat surprisingly, California.   But no state had a perfect record; all had at least one law or regulation that imposed barriers to e-commerce and consumer choice.  

These restrictions are costly.  PPI estimates that American consumers annually pay a minimum of $15 billion more for goods and services as a result of such e-commerce protectionism by middlemen.[ii]  Net Choice, a coalition of tech firms and associations that promotes consumer choice on the Internet, is drafting an analytical report on the costs to U.S. consumers of these barriers to be published in concurrence with the FTC workshop in October on this topic.  I would anticipate that the reported costs will be even larger than PPI's preliminary, conservative estimates.

Consumer Protection or Producer Protectionism? 

To listen to middlemen one might believe that without these laws consumers would be subject to the worst kinds of abuses.  Wine wholesalers and retailers say that laws prohibiting wine sales on the Internet are needed to protect state tax revenues and limit underage drinking.  Travel agents claim that they "act as the public's representatives and help keep prices low," while providing the buying public with choice.[iii]  Car dealers claim that cars are so complex that dealers are needed to protect the consumer.[iv]  Optometrists argue that buying contact lens' online will lead to eye damage.  Pharmacists claim that without them, people will be buying inferior-quality drugs. 

The reality is that states can design regulatory regimes that protect consumers without squashing competition.  States that allow direct purchases over the Internet require that wine or beer shipments use a carrier that requires proof of age upon delivery.  States can require that patients present a valid prescription order to obtain a prescription from an online pharmacy, and can pass reciprocity laws giving consumers legal recourse to file suit against out of state doctors.  

In many cases, the claims of consumer risk are just a smokescreen for protectionism. For example, as the suit by 33 state attorneys general against the American Optometrist Association states, "The industry has hidden behind claims of health concerns requiring that individuals get their contact lenses from certain professionals, but there is no scientific basis to that claim," since the lenses sold online are identical to those sold in the optometrist's office.[v]   Travel agents' argument that they provide consumers with more choice and unbiased fare selection than online services is simply not true.   The fact that many consumer groups have opposed many of these protectionist practices, including the auto dealer franchise and contact lens restrictions, suggests that these laws and regulations are not designed to protect consumers, but rather to protect producers. 

If industries' claims of protecting consumers are a smoke-screen, what is their real motivation?  It's much simpler: They seek to limit competition.  For example, praising a decision by the state of Texas to prohibit Internet car sales by anyone other than car dealers, one Texas car dealer was quoted, in a moment of unusual forthrightness, as saying, "... I hope they [Internet car dealers] never take over."[vi]  The head of the Texas car dealers' association, in explaining his support of the restrictive franchise laws, stated that the association would always be about "the property rights of its members.  Don't expect us to change that."  We shouldn't expect these groups to change. But we also shouldn't expect policymakers or the judiciary to protect the narrow interests of a select few in business over the broader interests of American consumers. 

The disintermediated rely on another argument to defend these laws; they claim that consumers don't really want to bypass the middleman and therefore there is no need to go to all the work to dismantle these protections.  On the contrary, if they are right and consumers don't want to buy online (the experience suggests otherwise), then these companies have nothing to fear from a level playing field.  The National Association of Automotive Dealers put forth perhaps the most creative defense.  They claim that even if car manufacturers tried to sell cars directly to consumers online, "they would still face a myriad of legal challenges and would run a great risk of breaking the law."[vii]  But buying online directly from the manufacturer is against the law precisely because car dealers have pushed so hard to make it so. 

Finally, many tribunes of industries justifying protectionist regulatory regimes claim that while other industries may be protectionists, they are not.   Robert J. Maguire, the chairman of the National Automobile Dealers of America states, "For one thing, the role of the middleman is not the same from industry to industry. This is especially true of new car dealerships; their presence in the local community has long been recognized as "in the public interest" by state governments and the courts."  At the end of the day, the fact that each of these laws or regulations has its own unique justification and call on the public interest does not mean that it's still not protectionist.  

What Can Congress Do?  

Some of these e-commerce battles, like that concerning Orbitz and online travel, are being waged at the national level.  As a result, the first step Congress and the administration can take is to resist protectionist pleadings and oppose actions designed to protect the status quo against e-commerce competition.   This requires thoroughly analyzing the claims made by incumbents regarding consumer harm or gain.           

But the federal government can also play an important role in helping to dissolve these state-level barriers.  As the federal agency charged with protecting consumer rights, the Federal Trade Commission is well situated to weigh in on these debates at the state level.  For example, the FTC recently provided formal comments to the Connecticut Board of Examiners for Opticians on a case regarding a restrictive interpretation of state laws related to the sale of contact lenses.  The FTC can also file amicus briefs in court, as they did recently in federal district court in the matter of Powers v. Harris, which dealt with Oklahoma legislation that prevents anyone other than state-licensed funeral directors, including online sellers, from selling caskets.  As a result, Congress should support the FTC's e-commerce advocacy efforts.  

While it's important to try to convince states to repeal or modify their restrictive laws and regulations, at the end of the day, persuasion is likely to go only so far.   For many states, the political forces for protection are strong and organized (in-state companies) while the beneficiaries of reform are diffuse (unorganized consumers) or not even in the state (e-commerce competitors).  As a result, Congress should seriously consider creating on an industry-by-industry basis uniform national standards that enable e-commerce competitors to sell more easily in all 50 states.  At one time it made sense for states to regulate local industries since all the activity was between sellers and buyers in the same state.  The rise of national e-commerce makes this legacy regulatory framework a barrier to economic growth.  As a result, Congress could require states to develop uniform model legislation that does not discriminate against e-commerce competitors.  The Gramm-Leach-Bliley Financial Services Modernization Act used this approach to give states four years to have a uniform licensing requirement or reciprocity for insurance, and if they don't act, the federal system of insurance regulation would be imposed.  This model could be applied to other areas.  For example, Congress should also consider the possibility of requiring states to develop reciprocal licensing arrangements so that doctors licensed in any state could practice in any other, including practicing telemedicine.  

In some cases, Congress may need to let e-commerce companies doing business in areas currently regulated by states to be governed by new federal statutes.  For example, most non-bank financial service providers are subject to state laws, and are not eligible for national licensing.  Congress should consider developing a national standard based on best-in-class requirements that states currently impose.  E-commerce financial service companies would still have to abide by effective consumer protection laws, but they would have only one law to follow and it would be a law designed to promote e-commerce.  There are other areas where a national standard makes sense.  For example, the FTC should do what it did in 1979 for eyeglasses: simply say that prescriptions for contact lenses must be given to consumers, who can then choose where they want the prescription filled. 

Some will argue that such federal preemption violates states' rights.  In our view, this is a misleading interpretation of the notion of states' rights.  The framers of the Constitution respected the rights of states to govern internal activities, but made it clear that they could not restrict interstate commerce.  James Madison wrote, "Such a use of the power by Cong (sic) accords with the intention and expectation of the States in transferring the power over trade from themselves to the Govt. (sic) of the U. S." [viii]   Federalism for the New Economy is not a paean to unlimited state freedoms.  Rather, it requires a new bargain between Washington and states:  on the one hand giving states more flexibility and accountability in many areas, as the Leave No Child Behind Act did; and on the other, developing national e-commerce governing frameworks in areas such as digital signatures, privacy, SPAM, or e-commerce protectionism.  In these cases, state preemption is required to create a vibrant cross-border e-commerce marketplace. 

Conclusion 

The economic history of the United States is rife with business, labor, and professional organizations attempting to use the powers of government to protect their economic interests.  During periods of rapid technological change, such as the present one, that produce new sets of winners and losers, political opposition to economic change increases significantly.  It is incumbent upon policymakers at all levels of government, and in all branches, to resist the pressure from the disintermediated and ensure that e-commerce competitors are allowed to compete on a level playing field and not burdened with unfair and discriminatory rules, regulations, and laws. 

Thank you for the opportunity to appear before you. 

Notes:

[i] It should come as no surprise that a large number of dot.com companies are in trouble.  Much of the investment made in the last few years was focused on attempts to become a market leader, beating out all the other companies.  There are compelling historical parallels. The 1930s saw the bankruptcy of scores of automobile companies, but it was the takeoff point for the explosive growth of the auto industry.  There is no reason to suspect that the current situation in e-commerce is any different.  Moreover, the winners in e-commerce may not be the pure play dot.coms, but instead might be the Aclicks and mortar@ companies that use the Net to sell directly to consumers.  In this case, pure-play dot.coms might not grow significantly, but e-commerce would.

[ii] Robert D. Atkinson, Revenge of the Disintermediated, Progressive Policy Institute, January 2001 at  http://www.ppionline.org.

[iii]. Elizabeth Wasserman, AStuck in the Middle,@ Industry Standard (March 6, 2000).  Wasserman quotes Paul Ruden.

[iv]. David Hyatt, AFranchise Laws in the Age of the Internet,@ White Paper, National Automobile Dealers Association, McLean, VA, January, 2001.

[v]. State of California, et al against The American Optometric Association, et, al, in United States District Court, Eastern District of New York, January 17, 1997.

[vi].  Robert Elder and Jonathan Weil, ATo Sell Cars in Texas, Online Firms Are Forced to Enter the Real World,@ The Wall Street Journal, January 26, 2000, Texas Journal, p. T1.

[vii]  NADA, op. cit.

[viii] James Madison to Joseph C. Cabell, 18 Sept. 1828.  http://press-pubs.uchicago.edu/founders/documents/ a1_8_3_commerces18.html