Over a month ago I testified at the Senate Homeland Security and Governmental Affairs Committee hearing on Bitcoin. I’ve been asked by the committee to submit answers to additional questions, and I thought I’d try to tap into the Bitcoin community’s wisdom by posting here the questions and my draft answers and inviting you to post in the comments any suggestions you might have. I’d especially appreciate examples of innovative uses of Bitcoin or interesting potential business cases. Thanks for your help!

Post-Hearing Questions for the Record Submitted to Jerry Brito From Senator Thomas R. Carper

“Beyond Silk Road: Potential Risks, Threats, and Promises of Virtual Currencies” November 18, 2013

1. Overall, how would you assess the federal government’s activities thus far regarding virtual currencies and in what areas do you believe more work needs to be done?

The federal government’s approach to virtual currencies thus far has been understandably cautious.

On the anti-money-laundering and terrorist-financing front, FinCEN has issued guidance that adequately addresses virtual currencies, and it is heartening to see recent reports that the agency is clarifying for entrepreneur and consumers how they plan to apply that guidance. Additionally, with the tools already at their disposal, law enforcement has also successfully taken down the Silk Road online black market, as well as Liberty Reserve, a centralized digital currency favored by online criminals and responsible for laundering billions of dollars.

On the consumer protection front, state financial regulators are currently developing guidelines for the licensing of money transmitters, which are meant to ensure that such businesses are well-run and adequately capitalized. As noted in a question below, however, virtual currencies like Bitcoin are still not in use by very many consumers, and those who do use them likely understand the risks involved, giving regulators the luxury of seeing how the market develops and whether any problems arise before intervening.

One area where more guidance may be necessary is tax compliance. The IRS has indicated that it is working on guidance related to virtual currencies. Clear and simple rules for the tax treatment of virtual currency capital gains and other tax questions would be welcome.

2. Do you believe virtual currencies, including Bitcoin, fit into our current legal and regulatory framework? Do you see any gaps in our statutes and regulations regarding virtual currencies? Which agencies do you believe need to be at the forefront of the federal government’s work on virtual currencies?

To date we have seen that regulators have been able to apply existing law to virtual currencies. In the future, there may be situations in which existing law may not be able to fully account for virtual currencies. For example, to the extent we may some day see a Bitcoin futures market, the Commodities Future Trading Commission may want to exercise its authority over “foreign-exchange forwards” or “foreign-exchange swaps.” However, it would be difficult to justify that virtual currencies are “foreign” currency, which Congress did not define in Commodity Exchange Act presumably because the meaning was obvious at the time. That said, the CFTC would have no problem treating bitcoins as commodities, since “commodity” is defined very broadly by the Act. What this suggests is that rather than attempt to predict how current law may not become incompatible with virtual currency use, a better approach may be to wait for actual “cases and controversies” to arise and to intervene only if regulators cannot apply existing law. To do otherwise may invite unintended consequences or simply waste time and resources.

3. As I understand things, currently there is still a relatively very small group of people that use Bitcoin. That being the case, the full scope of the ramifications of the use of Bitcoin remains to be seen.

a. Can you share with us some examples of uses that might have a positive impact for consumers or the broader economy? What are some of the promises of this new technology, as you see them?

b. What kinds of businesses and opportunities might emerge around Bitcoin if the currency continues to grow?

I would refer you to pages 10 – 20 of Bitcoin: A Primer for Policymakers in which my colleague Andrea Castillo and I detail the ways Bitcoin may positively affect the economy, as well as the business opportunities it presents.

4. Since its introduction in 2008, Bitcoin has experienced a number of significant price swings. For example, in 2013, the price per Bitcoin fell from $266 in early April to $50 in late April, but today is hovering around $1000.

a. What factors have contributed to this volatility?

There are at least three reasons that the price of Bitcoin fluctuates so wildly. First, the total value of all outstanding bitcoins is still relatively low. This means that even a small absolute increase in interest in Bitcoin can send prices soaring.

Second, a large fraction of the existing stock of bitcoins seem, for now, to be held as a long-term investment. This means that the market is not very liquid.

Finally, when there is a change in the demand for Bitcoin, the supply of Bitcoin cannot adjust to accommodate it, so all of the adjustment has to happen in the price, rather than in the quantity. This effect may be somewhat offset for now by the fact that many bitcoins are held as investments, but it means that Bitcoin is likely to be relatively volatile even if people stop holding bitcoins as investments.

b. For those companies who are trying to build businesses around this technology, doesn’t this volatility concern you? What can be done so the price is not so volatile?

Merchants that accept payment in bitcoins and companies trying to build businesses around the protocol no doubt already take the volatility into consideration. For example, merchants that accept bitcoins often use a payment services like BitPay, which deposit dollars into merchant accounts on a daily basis, and companies like BitPay hedge against currency volatility. That said, as more and more consumers begin to use Bitcoin, the market will become more liquid and volatility should subside. Additionally, the development of a bitcoin futures market may also help stabilize the currency. Regulators can help combat volatility by allowing such a market to develop.

5. Most of the recent research and media coverage on virtual currencies has focused on Bitcoin. Are there other virtual currencies that we should be paying attention to?

It is important to keep in mind the difference between centralized and decentralized digital currencies. Centralized currencies like the defunct Liberty Reserve are of greater concern to law enforcement, as Special Agent Edward Lowery explained at the hearing. As for decentralized digital currencies, it is not surprising that Bitcoin has earned the lion’s share of attention since it is the first ever decentralized currency as well as the largest. Indeed, the economy of the next largest decentralized digital currency—Litecoin—is less than one-tenth that of Bitcoin. Competing decentralized currencies are very important, especially as they develop technical innovations, but the regulatory and law enforcement issues they raise are essentially the same as Bitcoin.

6. The point has been made to me that the way to see Bitcoin and virtual currencies today is a bit like we saw email or the internet itself 20 years ago. At the time, we thought email might replace mail but it was sort of complicated and difficult to work unless you were more technically minded. Obviously as the technology matured it became easier to use and more widely adopted and it’s changed the way we communicate in fundamental ways. With that said, if you could hazard a guess, what do you see for Bitcoin 20 years from now?

Email is a good analogy, but a better one might be the World Wide Web. As Mike Hearn, an engineer at Google who serves as one of Bitcoin’s core developers, says, “The Web started out as scientists simply showing documents to each other. You could link documents and embed images, but the true potential of the Web really came when these pages became interactive and started gaining more and more features allowing people to build things like Facebook or online shops. Those things are not documents, and now probably half the time people use the Web they aren’t really interacting with documents; they are actually using applications.”

Unlike email, the Web is a platform, which means that it can be programmed to be just about anything. Bitcoin is similarly a platform that can be programmed. As a result, it’s difficult to predict what developers and entrepreneurs allowed to freely innovate may come up with. However, some innovations that Bitcoin may make possible include micropayments, smart property, decentralized assurance contracts, and competitive arbitration services.

7. What can we as policymakers and legislators be doing to encourage innovation by good actors interested in being involved in the virtual currency space?

As I said in my testimony, policymakers’ first imperative should be to do no harm. Bitcoin and other decentralized digital currencies are an experiment, just as the wider Internet once was. The Internet has become the amazing engine of innovation and economic prosperity because it has largely been left alone by regulators. This was a deliberate policy articulated by President Clinton’s chief policy counsel Ira Magaziner, who was in charge of crafting the administration’s Framework for Global Electronic Commerce in July 1997. Its recommendations read in part:

1. The private sector should lead. The Internet should develop as a market driven arena not a regulated industry. Even where collective action is necessary, governments should encourage industry self-regulation and private sector leadership where possible.

2. Governments should avoid undue restrictions on electronic commerce. In general, parties should be able to enter into legitimate agreements to buy and sell products and services across the Internet with minimal government involvement or intervention. Governments should refrain from imposing new and unnecessary regulations, bureaucratic procedures or new taxes and tariffs on commercial activities that take place via the Internet.

3. Where governmental involvement is needed, its aim should be to support and enforce a predictable, minimalist, consistent and simple legal environment for commerce. Where government intervention is necessary, its role should be to ensure competition, protect intellectual property and privacy, prevent fraud, foster transparency, and facilitate dispute resolution, not to regulate.

4. Governments should recognize the unique qualities of the Internet. The genius and explosive success of the Internet can be attributed in part to its decentralized nature and to its tradition of bottom-up governance. Accordingly, the regulatory frameworks established over the past 60 years for telecommunication, radio and television may not fit the Internet. Existing laws and regulations that may hinder electronic commerce should be reviewed and revised or eliminated to reflect the needs of the new electronic age.

5. Electronic commerce on the Internet should be facilitated on a global basis. The Internet is a global marketplace. The legal framework supporting commercial transactions should be consistent and predictable regardless of the jurisdiction in which a particular buyer and seller reside.

The same principles should apply to Bitcoin today. If there is one thing policymakers could do today to encourage innovation by good actors in the Bitcoin space it is to signal to the traditional financial sector—especially in banking—that while Bitcoin presents some challenges, it is nothing to be feared, and they will not be penalized by regulators for servicing, working with, and even investing in Bitcoin-related businesses.

A common question among smart Bitcoin skeptics is, “Why would one use Bitcoin when you can use dollars or euros, which are more common and more widely accepted?” It’s a fair question, and one I’ve tried to answer by pointing out that if Bitcoin were just a currency (except new and untested), then yes, there would be little reason why one should prefer it to dollars. The fact, however, is that Bitcoin is more than money, as I recently explained in Reason. Bitcoin is better thought of as a payments system, or as a distributed ledger, that (for technical reasons) happens to use a new currency called the bitcoin as the unit of account. As Tim Lee has pointed out, Bitcoin is therefore a platform for innovation, and it is this potential that makes it so valuable.

Eric Posner is one of these smart skeptics. Writing in Slate in April he rejected Bitcoin as a “fantasy” because he felt it didn’t make sense as a currency. Since then it’s been pointed out to him that Bitcoin is more than a currency, and today at the New Republic he asks the question, “Why would you use Bitcoin when you can use PayPal or Visa, which are more common and widely accepted?”

He answers his own question, in part, by acknowledging that Bitcoin is censorship-resistant. As he puts it, “If you live in a country with capital controls, you can avoid those[.]” So right there, it seems to me, is one good reason why one might want to use Bitcoin instead of PayPal or Visa. Another smart skeptic, Tyler Cowen, acknowledges this as well, even if only to suggest that the price of bitcoins will fall “if/when China fully liberalizes capital flows[.]”

Another reason why one would use Bitcoin instead of PayPal or Visa is that it’s cheaper. Posner disputes this, arguing that Bitcoin’s historic volatility makes it risky to hold Bitcoins, necessitating hedging, and therefore making it no less costly than traditional payments systems. (Cowen was one of the first to make this argument.) But this is not true.

First of all, I would argue that there’s nothing inherent in Bitcoin that makes it necessarily as volatile as it has been; its volatility to date comes largely from the fact that it’s thinly traded. If its adoption continues apace, and its infrastructure continues to be developed, there’s no reason to think it will forever be as volatile as it has been to date. But that’s conjecture. More to the point is the proof that’s in the pudding: There are tens of thousands of merchants accepting bitcoins for payment today (and growing), and the number of transactions accepted by those merchants has been exploding as well, setting a record on Black Friday. Can it be that even with the necessary hedging, Bitcoin is cheaper?

At least for some types of transactions I think the answer is unquestionably yes. Take international remittances, which is a $500 billion industry. Sending money to Kenya using Western Union MoneyGram or some other traditional money transmitter costs around five to ten percent of the amount being sent, and can take days for the deposit to take place. A new startup, BitPesa, is looking to charge only three percent, and to carry out transfers virtually instantaneously. So hedging costs would have to be more than five to ten percent to make this not worthwhile. It’s an empirical question, but it seems to me the fact that so many are jumping in helps give us a hint as to the answer. Perhaps we can look to Bitpay’s 1% fee as a market estimate of the cost of hedging.

Well then, so far I count two things that Bitcoin can do that traditional payments systems cannot: it is censorship resistant and it is cheaper. Oh, wait. I actually mentioned another one: it’s faster. Traditional wire transfers can take days or even weeks to clear, while Bitcoin takes minutes. And yet there’s more.

As Eli Dourado just pointed out in a previous post, built into Bitcoin is a facility for decentralized arbitration. Essentially, Bitcoin allows for transactions that require two out of three signatures to verify a transaction, thus allowing payer and payee to turn to an arbitrator if there is a dispute about whether the payment should go through. Paypal and credit card companies essentially provide this service today, but as Eli points out, decentralized arbitration would likely be cheaper and would certainly enjoy much more competition. That’s four things Bitcoin can do that traditional payments networks cannot, but let me quickly add a fifth. There’s no reason that the arbitrator must be a human; using Bitcoin’s scripting language the arbitrator can be a trusted automated source of information that on a regular basis broadcasts facts such as the price of gold, or price of stocks, or sports scores. Make that data stream your arbitrator and, voila, you have a decentralized predictions market. (Ed Felten at Princeton is working on executing the concept.)

One more before I sign off and go drink with the rest of the Tech Liberation gang at our 15th Alcohol Liberation Front this evening, to which you’re all invited. Bitcoin allows for microtransactions in a way that’s never before been possible. First of all, because bitcoin transactions can be cheap, you can send incredibly small amounts (say five cents or half a cent) that would be cost-prohibitive using traditional payments systems. There’s a start-up called BitWall that essentially allows publishers to easily charge tiny amounts for their content. Now, believe me, I know all the arguments for and against micropayments for content. My only point is that Bitcoin has the potential to further reduce the friction of such payments. But that’s not the exciting part. More interesting are really, really small microtransactions.

Bitcoin transactions are cheap, but you wouldn’t think they’re cheap enough that you could conduct hundreds per second. But the thing is, you can, using the micropayments channels feature of the Bitcoin protocol. It’s not yet been widely exploited, but it’s there in the spec waiting to be. I won’t go into the technical details in this post, but essentially you transmit one large transaction to the network (you can think of this like a deposit, say of $10), then you conduct as many tiny transactions between payer and payee not broadcast to the network (therefore ‘free’), and finally you broadcast how much of the initial amount remains with each party. What this means is that you can now offer metered services based on microtransactions.

One good example of how this would be useful is Wi-Fi access, which Mike Hearn explains in this video. Today we are surrounded by wi-fi hotspots, but we can’t use them because they are password protected, in part because there’s no good way to charge for their use. When you can pay to use a wi-fi hotspot, it usually entails creating an account with the provider and then purchasing a block of time, perhaps more than you need. Now imagine if you could connect to any open hotspot, without first creating any kind of account, and paying your way by the second or the kilobyte. That’s possible today with Bitcoin, it’s just going to take some time to be implemented. And think of all the other as-yet unimagined ways that this ability to meter could be put to use!

That’s six ways to answer the question, “Why would you use Bitcoin when you can use PayPal or Visa.” There are more. Hearn discusses a bunch in the video. These are all very real in the sense that they are all technically possible today, but certainly speculative in that there remain regulatory and market hurdles ahead. I can certainly understand why some would be skeptical of Bitcoin’s long-term success (I for one am not certain of it), but I really hope we can get to the point were that skepticism is based on more than misunderstandings about what Bitcoin is or what it can and cannot do.

Washington Post columnist Ezra Klein had a terrific column yesterday (Human Knowledge, Brought to You By…) on one of my favorite subjects: how advertising is the great subsidizer of the press, media, content, and online services.  Klein correctly notes that “our informational commons, or what we think of as our informational commons, is, for the most part, built atop a latticework of advertising platforms. In that way,” he continues, “it’s possible that no single industry — not newspapers nor search engines nor anything else — has done as much to advance the storehouse of accessible human knowledge in the 20th century as advertisers. They didn’t do it because they are philanthropists, and they didn’t do it because they love information. But they did it nevertheless.”

Quite right. As I noted in my recent Charleston Law Review article on “Advertising, Commercial Speech & First Amendment Parity,” media economists have found that advertising has traditionally provided about 70% to 80% of support for newspapers and magazines, and advertising / underwriting has entirely paid for broadcast TV and radio media. And it goes without saying that advertising has been an essential growth engine for online sites and services. How is it that we’re not required to pay per search, or pay for most online news services, or shell out $19.95 a month for LinkedIn, Facebook, or other social media services? The answer, of course, is advertising.  Thus, Klein notes, while “we see [] advertising as a distraction… without the advertising, the information wouldn’t exist. So the history of information, in the United States at least, is the history of platforms that could support advertising.”

And the sustaining power of advertising for new media continues to grow. As I noted in my law review article:

Advertising is proving increasingly to be the only media industry business model with any real staying power for many commercial media and information-producing sectors. Pay-per-view mechanisms, micropayments, and even subscription-based business models are all languishing.  Consequently, the overall health of modern media marketplace and the digital economy—and the aggregate amount of information and speech that can be produced or supported by those sectors—is fundamentally tied up with the question of whether policymakers allow the advertising marketplace to evolve in an efficient, dynamic fashion. In this sense, it is not hyperbole to say that an attack on advertising is tantamount to an attack on media itself.

In this sense, I would have liked to seen Klein connect the dots between recent privacy-related legislative and regulatory proposals and the long-term health of online communities and services. As several of us here at the TLF have noted too many times to mention, there is no free lunch. What powers the “free” Internet are data collection and advertising. In essence, the relationship between consumers and online content and service providers isn’t governed by any formal contract, but rather by an unwritten quid pro quo: tolerate some ads or we’ll be forced to charge you for service.  Most consumers gladly take that deal—even if many of them gripe about annoying or intrusive ads, at times.

If new privacy regulations break this quid pro quo, there will be consequences. Namely, there will likely be costs in the form of prices for sites and services that relied on more targeted forms of advertising. Of course, we can hope and pray that older, more “spammy” forms of advertising (think big banner ads and pop-ups) can fill the gap and continue to sustain the online ecosystem, but it’s a big gamble. Thus, I wish Klein would have pointed out that online advertising is currently under attack in both the legislative and regulatory arena and that, if new privacy mandates are put on the books, then (a) consumers should not be surprised if they have to pay more, and/or (b) we shouldn’t be surprised to get less of those media and communications platforms and services in the future.

Regardless, kudos to Ezra Klein for being willing to so eloquently defend advertising’s essential role as the great sustainer of media and information in America. Please do read his entire essay. Truly outstanding.

Additional Reading:

• Adam Thierer, “op-ed: “Privacy Regulation and the ‘Free’ Internet”
• Adam Thierer, Berin Szoka, and W. Kenneth Ferree, Comments of the Progress & Freedom Foundation in the Matter of the Federal Communications Commission’s Examination of the Future of Media and Information Needs of Communities In a Digital Age, The Progress & Freedom Foundation, May 5, 2010, 28-38.
• Adam Thierer, Public Interest Comment on Protecting Consumer Privacy in an Era of Rapid Change (Arlington, VA: Mercatus Center at George Mason University, February 18, 2011).
• Berin Szoka & Adam Thierer, Online Advertising & User Privacy: Principles to Guide the Debate, Progress & Freedom Foundation, Progress Snapshot 4.19, Sept. 2008.
• Berin Szoka & Adam Thierer, Targeted Online Advertising: What’s the Harm & Where Are We Heading? Progress & Freedom Foundation, Progress on Point 16.2, June 2009.

Charleston Law Review Essay on Advertising and the First Amendment [PDF]

I’m reading David Brin’s 1998 classic The Transparent Society and I’d like to share a passage that I found especially interesting in light of the recent Do-Not-Track bill introduced by Sen. Rockefeller.

On this blog, Adam Thierer has often written about the implicit quid pro quo between tracking and free online services. It seems to me that many folks find this an abstract concept. Here is Brinn writing in the late 90s about the possibility of an explicit quid pro quo:

An Economy of Micropayments? I cannot predict whether such an experiment would succeed, though using a “carrot”—or what chaos theorists call an “attractor state”—offers better prospects than the [IP owner’s] coalition’s present strategy of saber rattling and making hollow legal threats. In fact, the same approach might be used to deal with other aspects of “information ownership,” even down to the change of address you file with the post office. Perhaps someday advertisers and mail-order corporations will pay fair market value for each small use, either directly to each person listed or through royalty pools that assess users each time they access data on a given person. Or we might apply the concept of “trading-out”: getting free time at some favorite per-use site in exchange for letting the owners act as agents for our database records. It could be beneficial to have database companies competing with each other, bidding for the right to handle our credit dossiers, perhaps by offering us a little cash, or else by letting us trade our data for a little fun. Proponents of such a “micropayment economy” contend that the process will eventually become so automatic and computerized that it effectively fades into the background. People would hardly notice the dribble of royalties slipping into their accounts when others use “their” facts—any more than they would note the outflowing stream of cents they pay while skimming on the Web.

That is essentially what happened, except without all the transactions costs. It seems to me that all Do Not Track will do is introduce the transactions costs that we have so far avoided to the benefit of innovation. Who will this change benefit? The few people who are not willing to make the trade and who today have options to opt out. This leaves the majority of us who are willing to make the bargain in a very un-Coasean world.

As I’ve mentioned here previously, PFF has been rolling out a new series of essays examining proposals that would have the government play a greater role in sustaining struggling media enterprises, “saving journalism,” or promoting more “public interest” content. We’re releasing these as we get ready to submit a big filing in the FCC’s “Future of Media” proceeding (deadline is May 7^th).  Here’s a podcast Berin Szoka and I did providing an overview of the series and what the FCC is doing.

In the first installment of the series, Berin and I critiqued an old idea that’s suddenly gained new currency: taxing media devices or distribution systems to fund media content. In the second installment, I took a hard look at proposals to impose fees on broadcast spectrum licenses and channeling the proceeds to a “public square channel” or some other type of public media or “public interest” content.

In our latest essay, “The Wrong Way to Reinvent Media, Part 3: Media Vouchers,” Berin and I consider whether it is possible to steer citizens toward so-called “hard news” and get them to financially support it through the use of “news vouchers” or “public interest vouchers”?  We argue that using the tax code to “nudge” people to support media — while less problematic than direct subsidies for the press — will likely raise serious issues regarding eligibility and be prone to political meddling.  Moreover, it’s unlikely the scheme will actually encourage people to direct more resources to hard news but instead just become a method of subsidizing other content they already consume.

I’ve attached the entire essay down below.

The Wrong Way to Reinvent Media, Part 3: Media Vouchers

by Adam Thierer & Berin Szoka*

PFF Progress on Point 17.4 [PDF]

Should the government play a greater role in the media sector in the name of sustaining struggling media enterprises, “saving journalism,” or promoting public media?  In this ongoing series of essays, we’ve been analyzing proposals that would have public policymakers use taxes, subsidies, or regulations to accomplish those objectives.

Part 1 of this series examined proposals to fund media content via a tax on consumer electronics, broadband service, or cell phone bills.^[1] Part 2 critiqued proposals to impose fees on broadcast spectrum licenses and channeling the proceeds to a “public square channel” or some other type of public media or “public interest” content.^[2] Other essays in this series will address proposals to tax private advertising revenues to support public media; expand postal subsidies; directly subsidize out-of-work journalists; and to prop up or bail out failing media entities.  A wrap-up essay will then focus on some potentially constructive policy reforms that could assist media enterprises without a massive infusion of state support or regulation of the press.

In this installment, we will consider whether it is possible to steer citizens toward so-called “hard news” (“serious” journalism)—and get them to financially support it—through the use of “news vouchers” or “public interest vouchers”?  We will argue that using the tax code to nudge people to support media—while less problematic than direct subsidies for the press—will likely raise serious issues regarding eligibility and be prone to political meddling.  Moreover, it’s unlikely the scheme will actually encourage people to direct more resources to hard news but instead just become a method of subsidizing other content they already consume.

Funding Hard News is Hard

Funding “hard news” has always been challenging.  Financing a team of dedicated local beat reporters, investigative journalists, national desks, foreign bureaus, and all the associated production facilities and support staff is an extremely expensive undertaking.[3] And, for all that trouble and expense, hard news rarely turns a healthy profit.  Often it has been considered a “loss leader” for media companies and has been cross-subsidized by other types of content or services.[4] This is why “bundling” has been such a popular model for many media operations such as newspapers, magazines, and cable television.  By tying news production to other types of content or services, media operators have been able to sustain the production of hard news, despite its general unprofitability on its own.

It’s worth recalling that a business model to sustain hard news production and dissemination on a mass scale really only developed mid-way through our Republic.  The early history of media in this country was characterized by the “partisan press” due to the heavy reliance on a patronage model and direct association with political parties and figures. This changed with the rise of large daily newspapers in the mid-1800s and then broadcast radio and television in the early half of the 20 ^th century.[5] Media providers were able to cross-subsidize news production independent of private or political patronage thanks to three things: (1) high-speed printing presses or broadcast facilities, (2) geographic-based market and pricing power, and (3) the widespread advertising base that was made possible by (1) and (2).

Over just the past 15-20 years, we’ve seen this traditional model upended.  Increased competition and technological/platform proliferation are placing an enormous strain on traditional media operations and business models. Schumpeterian “creative destruction” is at work in a serious, and for many, painful, way.

This is what is keeping the Federal Communications Commission,[6] the Federal Trade Commission,[7] some in Congress,[8] and many media worrywarts up at night: the fear that, as traditional financing mechanisms falter (advertising, classifieds, subscription revenues, etc.), many traditional news-gathering efforts and institutions will disappear.  And that’s leading to calls for government intervention or assistance of some sort to prop up struggling entities or directly subsidize the hard news that many of them have traditionally provided but may not be able to for much for longer.

Can Vouchers “Nudge” Citizens to Support Hard News?

One much-discussed proposal would create a “public interest voucher” or what Robert W. McChesney & John Nichols, authors of the new book The Death and Life of American Journalism, call a “Citizenship News Voucher.”^[9] This is a variant on the “artistic freedom voucher,” an idea first put forward in 2003 by economist Dean Baker as an alternative to copyright law as a means of incentivizing artistic creation.[10] The regulatory activist group Free Press, which McChesney founded, has also endorsed a news voucher scheme.[11]

The idea is fairly straightforward: give every American a voucher (McChesney and Nichols propose $200) to support the non-profit news entities of their choice by listing those entities on their tax return.  (If half of all adult Americans actually used their voucher, that would cost at least $20 billion/year.[12])  They assume this would be an efficient way of channeling money to hard news providers while avoiding the serious concerns that arise when government officials or agencies are the ones providing or steering the subsidies.  McChesney and Nichols go so far as to call their tax-and-redistribute proposal “a libertarian’s dream,” since “people can support whatever political viewpoint they prefer or do nothing at all.”[13]

McChesney and Nichols seem to be building on the approach popularized by Richard Thaler and Cass Sunstein in their highly influential 2008 book Nudge: Improving Decisions about Health, Wealth, and Happiness.^[14] Based on behavioral economics studies, Thaler and Sunstein argue that both government and private actors must inevitably make decisions about “choice architecture” and that, by setting defaults, incentives and rules smartly, “choice architects” can and should improve private decision-making—but only where they can do so without blocking, fencing-off or significantly burdening choices.^[15] While their proposal might not qualify as a nudge in the strict sense defined by Thaler and Sunstein, the essential similarity between the concepts lies in trying to restructure the choices Americans make about media consumption by changing how they spend money on media—with the declared goal of “improving” both media consumption and the media itself (by “freeing it” of supposedly evil corporate influences).

Problems with the News Voucher Proposal

While nudges might be less objectionable in circumstances where it’s objectively evident what’s really “good” for us, the same can hardly be said for media consumption.  “Nudging” consumers towards better media choices isn’t based on clear science about, say, eating better or getting more exercise, but on highly subjective decisions about what kind of information consumption is really good for individuals, communities, and polities.  For policymakers to imagine that they can steer the public’s tastes or behavior in more desirable directions through law (including media subsidy schemes) is a profoundly elitist enterprise.^[16] In the case of “news vouchers,” the hope is that the public can be encouraged to at least channel some additional support to news-gathering activities and institutions.  The problem, however, is that some people just don’t much like being “nudged” by officials from afar and they’ll often take steps to evade such paternalism—however ostensibly “libertarian” it might be.  And it could lead to a host of unintended consequences, discussed further below.[17]

As a general matter, it simply isn’t possible to make consumers choose the “right” media in an age of information abundance.^[18] With so many voices competing for our attention, it’s impossible make people watch, listen, or read if they don’t want to.  That’s especially true with hard news, which has never netted major ratings.  As Ellen P. Goodman of the Rutgers-Camden School of Law has noted: “Given the proliferation of consumer filtering and choice, these kinds of interventions are of questionable efficacy.  Consumers equipped with digital selection and filtering tools are likely to avoid content they do not demand no matter what the regulatory efforts to force exposure.”[19] As Goodman rightly argues, “regulation cannot, in a liberal democracy, force viewers to consume media products they do not think they want in the name of the public interest.”[20] There’s no reason to believe this situation has ever been different or will ever change:  Writing in 1922, famed journalist Walter Lippmann noted that, “it is possible to make a rough estimate only of the amount of attention people give each day to informing themselves about public affairs,” but “the time each day is small when any of us is directly exposed to information from our unseen environment.”[21]

McChesney and Nichols’ effort to sell this scheme as “a libertarian’s dream” is a huge stretch.  There aren’t too many libertarians—or anyone else for that matter—who favor sending more money to the federal government only to win back the right to spend it on “qualifying media entities.”  And regarding their claim that “people can support whatever political viewpoint they prefer or do nothing at all,” well, people are already free to do whatever they want with their money when it comes to media products!  Why do we need to send money to Washington first and then have policymakers tell us how we can spend it?  This seems like a needless nudge—and one that would likely result in government bureaucracy taking a cut of the money or meddling in media markets.

Analogies to educational vouchers don’t work because we long ago decided to treat education as a public good and force everyone to pay for it.  “Voucherization” may make sense as a more efficient and “libertarian” way to fund such traditional public goods, when we absolutely have to force people to spend money on certain goods or services.  While McChesney and Nichols claim that the time has come for the government to fund media as such a public good, most people probably wouldn’t agree, since the private provision of media services has worked quite well for some time—being funded by a mix of advertising and subscription revenues for centuries.  They repeatedly claim that era is over (with little substantiation) but, in reality, it is their policies that would end private, for-profit media by taxing and regulating it to death.[22]

Second, what counts as a “qualifying media entity,” and how will the IRS make that call?  Can just any outlet that purports to gather and report “news” draw support from this new federal program?  McChesney and Nichols aren’t clear: They want the IRS to “determine eligibility—according to universal standards that err on the side of expanding rather than constraining the number of serious sources covering and commenting on issues of the day.”[23] They specify only that the entity must be a non-profit (though not necessarily a federally-recognized 501(c)(3)); not accept advertising; “do exclusively media content”; “cannot be part of a larger organization or have any non-media operations”; and that everything the medium produces must be made available immediately upon publication on the Internet and made available for free to all.”[24] But, anticipating objections about the dangers of political meddling, they also insist that “the government will not evaluate the content to see that the money is going toward journalism.  Our assumption is that these criteria will effectively produce that result, and if there is some slippage so be it.”[25] The only mechanism they can suggest for reducing fraud and ensuring “seriousness” is that, “for a medium to receive funds it would have to get commitments for at least $20,000 worth of vouchers” (100 full donations of the $200 voucher).[26]

But will policymakers really let citizens redeem their vouchers on The National Inquirer or People magazine?  How about the satirical The Onion or Jon Stewart’s Daily Show?  “This is a risk we are more than willing to take,” McChesney and Nichols say since they are “operating on a gut instinct that people will use their vouchers to fund serious media while reaching into their pockets to pay for copies of The National Inquirer at the supermarket checkout.”^[27] Of course, it’s always easier to take such risks when you are playing with other people’s money!  (Nearly half of all Americans don’t pay any Federal income taxes,[28] so their $200 news voucher is definitely coming out of someone else’s tax bill.)

But it’s naïve to believe this idea is going to change the face of journalism in any serious way.  Most people will spend their vouchers on whatever media outlets and content they are currently consuming, which probably isn’t what McChesney and Nichols (or most policymakers) would prefer.  “The program may not develop exactly the type of journalism our greatest thinkers believe is necessary,” McChesney and Nichols admit.[29] But the real question is: What sort of demands will policymakers begin making if the voucher program ends up channeling money into media entities that don’t measure up to their standards or desires?  Qualification criteria would inevitably become the tool of political meddling.

The Inevitable Strings & the Political/Constitutional Paradox

This raises a fourth concern: How long will it be before government starts attaching more strings to the vouchers?  To borrow a recent headline from The Wall Street Journal, how long will it be before the “Economic Policy ‘Nudge’ Gives Way to a Shove?”^[30] Although, in theory, the news voucher idea lets consumers figure out how to steer the funds, it’s unlikely much of those funds would go toward hard news, civic-minded or “high brow” content if consumers were actually free to choose.  How do we know this?  Because we already know what consumers choose today—and those “poor” choices are part of the supposed “problem” to be solved by media vouchers.  Once people start redirecting taxpayer dollars to content that the elites and policymakers don’t like, the nudge will become a shove and more interventions will follow in the form of “voucher guidance and compliance” hearings, rules, etc.

But the pressure for strings won’t just come from the top down because, as Thomas Jefferson famously put it in the 1786 Virginia Act for Establishing Religious Freedom, “to compel a man to furnish contributions of money for the propagation of opinions which he disbelieves, is sinful and tyrannical.”[31] That is, we naturally—and rightly—resent subsidizing speech that is antithetical to our own values.  McChesney and Nichols dismiss this natural (presumably bourgeois?) indignation by saying, “people will have to accept that some of the vouchers are going to go to media that they detest.”^[32] In one sense, they are dead wrong: People won’t just accept that.  They may accept subtle, indirect subsidies, but the more clear it becomes that they are being forced to pay for media they detest—and that could scarcely be more clear than with a refundable tax credit “voucher”—they will protest and demand that certain viewpoints, or at least kinds of content, be deemed out of bounds.

But in another sense, McChesney and Nichols are probably correct: For such a scheme to work, it probably can’t come with any content strings, because this is probably what the First Amendment would require.  Yet they don’t actually explain that point, stopping only to say that we all just have to become more tolerant of “dissent”— i.e., subsidize those who disagree with us!  In this sense, news vouchers therefore would likely fall prey to a common paradox faced by proposals for the government to subsidize speech: What’s politically feasible is unconstitutional and what’s constitutional is politically impossible.  Specifically, the kinds of eligibility restrictions necessary to push a voucher scheme through Congress would probably cause the courts to strike down the whole scheme.  Even if the courts were willing to strike down only the eligibility provisions as “severable” from the rest of the scheme, the whole scheme would likely die in the very next federal budget if the courts require the funding of “offensive” or “frivolous” content.  Understanding why this is the case requires a brief overview of key First Amendment case law.

In general, “when the Government appropriates public funds to establish a program it is entitled to define the limits of that program.”^[33] Thus, in its 1991 Rust v. Sullivan decision, the Supreme Court upheld a law forbidding federal funding for family planning services to go to abortion counseling.^[34] But the Supreme Court later clarified that such viewpoint discrimination is permissible only “[w]hen the government disburses public funds to private entities to convey a governmental message.”^[35] By contrast, where subsidies are “designed to facilitate private speech,” government may not discriminate against viewpoints it does not like.^[36] Thus, the government may not fund legal services but bar funding for defendants trying to amend or otherwise challenge existing welfare law.^[37]

The First Amendment prohibits not only such viewpoint discrimination but content discrimination as well.  In 2003, the Supreme Court held that the University of Virginia could not exclude religious groups from drawing on the University’s Student Activity Fund, even though the Fund’s eligibility requirements did not discriminate against any particular religion.^[38] Yet in 1995, the Court had upheld another content restriction: a requirement that the National Endowment for the Arts (NEA) “take into consideration general standards of decency and respect for the diverse beliefs and values of the American public” when making grants to “help create and sustain not only a climate encouraging freedom of thought, imagination, and inquiry but also the material conditions facilitating the release of . . . creative talent.”^[39] The Court concluded, in an 8-1 majority, that the “’decency and respect’ criteria do not silence speakers by expressly threaten[ing] censorship of ideas.”^[40] This decision rested largely on the fact that “Educational programs are central to the NEA’s mission” and “it is well established that ‘decency’ is a permissible factor where ‘educational suitability’ motivates its consideration.”^[41] The Court left the door open to future First Amendment challenges to the statute “as applied,” such as “[i]f the NEA were to leverage its power to award subsidies on the basis of subjective criteria into a penalty on disfavored viewpoints.”^[42]

What explains these starkly different outcomes is that the Court decided that the University of Virginia’s Student Activity Fund constituted a “limited public forum”^[43] intended to “encourage a diversity of views from private speakers,” but the NEA did not.  The University had funded all speech except “religious editorial viewpoints” from its Student Activities Fund, into which every student paid a $14 mandatory fee each semester.  By contrast, the NEA made only a limited number of grants through a “competitive process” according to principles of inherently content-based principles of “excellence” as well as “geographic, ethnic, and esthetic diversity.”  Thus, it was permissible, in principle, for the NEA to exclude “indecent” content.

The Supreme Court’s decision in U.S. v. American Library Association, Inc. (2003) also suggests that content restrictions regarding Citizen News Vouchers would be struck down.  The Court held that the First Amendment did not bar Congress from requiring in the Children’s Internet Protection Act (CIPA) that “a public library may not receive federal assistance to provide Internet access unless it installs software to block images that constitute obscenity or child pornography, and to prevent minors from obtaining access to material that is harmful to them.”^[44] Critically, the Court held that libraries were not public fora:

A public library does not acquire Internet terminals in order to create a public forum for Web publishers to express themselves, any more than it collects books in order to provide a public forum for the authors of books to speak. It provides Internet access, not to “encourage a diversity of views from private speakers” … but for the same reasons it offers other library resources: to facilitate research, learning, and recreational pursuits by furnishing materials of requisite and appropriate quality.^[45]

But what is the purpose of the news voucher scheme if not to “encourage a diversity of views from private speakers?”  Indeed, this is precisely how McChesney and Nichols attempt to sell their scheme—as a “libertarian’s dream.”  But, paradoxically, the more “libertarian” and broader subsidies for speech are, the more likely the political/constitutional paradox mentioned above is to arise.

The Citizenship News Voucher Fund proposed by McChesney and Nichols strongly resembles the University of Virginia’s Student Activity Fund:  In both cases, consumers are taxed to finance a fund that is, in theory, available to any entity that meets certain basic eligibility criteria.  No attempt is made in either case to ensure the quality of content or activities being funded.  Indeed, McChesney and Nichols explicitly reject such oversight of voucher spending and insist that taxpayers must accept that much of the fund will simply be wasted on media that falls well short of the “hard” or “serious” news they’re trying to save.  (By contrast, the Corporation for Public Broadcasting, whose budget McChesney and Nichols propose increasing nine-fold to fund more public media,[46] more closely resembles the NEA as a selective grant-maker.)

Also distinguishing the Court’s decision upholding CIPA’s content-based restrictions is the fact that both Justice Kennedy in his concurrence and Justice Souter in his dissent (joined by Justice Ginsburg) agreed that First Amendment problems could be solved to the extent that adults could opt-out of filtering.^[47] But with news vouchers, the government either restricts the eligibility of certain publications to receive vouchers depending on their eligibility or it does not.

Furthermore, unlike with CIPA or the NEA, the Citizenship News Voucher wouldn’t be related to educational settings, so it’s not even clear a “decency” requirement like that Congress imposed on the NEA’s grant-making could be imposed on voucher eligibility.[48] Magazines like Playboy offer a mix of pornography and thoughtful commentary on the news, proving that there is a market for such combination of journalism and controversial entertainment and photography.  Going even further, “Naked News” is a daily show whose buxom anchors strip while delivering the news.^[49] Why wouldn’t millions of Americans, especially younger men, use their voucher for such content?  Who’s going to draw the line between porn-spiced news and “serious” content?

The typical taxpayer will be outraged by having to subsidize some media outlet, whether because of its objectionable viewpoint or indecent or unserious content.  He will fiercely resist being compelled “to furnish contributions of money for the propagation of opinions which he disbelieves and abhors,” as Jefferson put it.  Good luck getting even the most “tolerant” gay voters, for example, to accept being taxed to pay for fundamentalist Christian perspectives on the news—or vice versa!  McChesney and Nichols don’t actually say anything about the First Amendment, but do recognize that, for their program to be accepted, the American people will have to swallow the “hard pill” of accepting that “some of the vouchers are going to go to media that they detest” and “embrace dissent in reality and not just rhetoric.”^[50] They seem to think this “hard pill” is a benefit of their scheme because it would teach us all to be more tolerant of “dissent.”  That’s easy for an endowed professor at a taxpayer-funded university and avowed neo-Marxist like Robert McChesney to say, but it’s not likely to fly with most Americans.  Disputes over “qualifying entity” eligibility will only add new rancor to the Culture Wars (over sex, abortion, religion, politics, etc.).

Realistically, it would likely take years for a news voucher bill to make its way through Congress, and if it ever did pass, it would likely be tied up in the courts for years, requiring at least one visit to the Supreme Court.  If any content strings are included, the law could well lead to the same kind of ordeal as with the 1998 Child Online Protection Act, which spent nearly 9 years in litigation and went up to the Supreme Court twice.^[51] Yet somehow McChesney and Nichols imagine their proposal will save media today at this critical moment of technological transition.

Down with Copyright, Down with Capitalism?

There’s another problematic caveat to the McChesney-Nichols variant of the news voucher idea: They would disallow any copyright protection or advertising support for an entity who receives voucher funds.  That’s an effort by the authors to steer even more media activity away from the commercial sphere and toward what might be thought of as a “public option” for the press—what McChesney and Nichols euphemistically (and repeatedly) call “post-corporate” media.

Let’s not forget that McChesney has argued (during an interview on the Canadian-based “Socialist Project”) that “the ultimate goal is to get rid of the media capitalists,” and that, “unless you make significant changes in the media, it will be vastly more difficult to have a revolution.”  So, it’s important to keep his true intentions in mind when he starts claiming to have found “a libertarian’s dream” of a solution to what ails America’s media sector.^[52] It sounds more like a central planner’s dream.  The true “libertarian’s dream” would be to leave Americans free to make their own choices about media without additional meddling from the State, and to look to innovation to fund media through a combination of advertising, sponsorship, subscriptions and micropayments.

Related PFF Publications

• The Wrong Way to Reinvent Media, Part 2: Broadcast Spectrum Taxes to Subsidize Public Media , Adam Thierer, Progress on Point 17.2, March 2010.
• The Wrong Way to Reinvent Media, Part 1: Taxes on Consumer Electronics, Mobile Phones & Broadband, Adam Thierer & Berin Szoka, PFF Progress on Point 17.1, March 2010.
• Testimony at FCC’s Hearing on “Serving the Public Interest in the Digital Era”, Adam Thierer, March 2010.
• Public Option for Press Should Get the Red Pen, Adam Thierer, The Daily Caller, Jan. 2010.
• Chairman Leibowitz’s Disconnect on Privacy Regulation & the Future of News, Adam Thierer & Berin Szoka, Progress Snapshot 6.1, Jan. 13, 2010.
• Socializing Media in Order to Save It, Adam Thierer, City Journal, March 2009.
• A Manifesto for Media Freedom, Adam Thierer and Brian Anderson, 2008.
• Media Ownership Proceedings, W. Kenneth Ferree, Testimony before the Federal Communications Commission, Nov. 3, 2009.
• Media Myths: Making Sense of the Debate over Media Ownership, Adam Thierer, June 2005.

[1] Adam Thierer & Berin Szoka, The Progress & Freedom Foundation, The Wrong Way to Reinvent Media, Part 1: Taxes on Consumer Electronics, Mobile Phones & Broadband, PFF Progress on Point 17.1, March 2010, www.pff.org/issues-pubs/pops/2010/pop17.1-the_wrong_way_to_reinvent_media.pdf.

[2] Adam Thierer, The Progress & Freedom Foundation, The Wrong Way to Reinvent Media, Part 2: Broadcast Spectrum Taxes to Subsidize Public Media, Progress on Point 17.2, March 2010, www.pff.org/issues-pubs/pops/2010/pop17.2-wrong_way_part_2.pdf

[3] “Until now, the iron core of news has been somewhat sheltered by an economic model that was able to provide extra resources beyond what readers—and advertisers—would financially support. This kind of news is expensive to produce, especially investigative reporting.” Alex S. Jones, Losing the News: The Future of the News that Feeds Democracy (2009) at 4.

[4] “For a long time, publishers have used news as a ‘loss leader,’ a product sold below costs to create other sales.” The Media Consortium, The Big Thaw: Charting a New Future for Journalism, July 2009, at 36, www.themediaconsortium.org/thebigthaw.

[5] James T. Hamilton notes that, “nonpartisan reporting emerged as a commercial product in American newspaper markets in the 1870s.  Before that time, many papers openly proclaimed association with a particular political party.”  James T. Hamilton, All the News That’s Fit to Sell (2004), at 3.

[6] The Federal Communications Commission (FCC) recently kicked off a new “Future of Media” effort with a workshop on “Serving the Public Interest in the Digital Era.” See Federal Communications Commission, FCC Launches Examination of the Future of Media and Information Needs of Communities in a Digital Age, FCC Public Notice, GN Docket No. 10-25, Jan. 21, 2010, at 2, http://hraunfoss.fcc.gov/edocs_public/attachmatch/DA-10-100A1.pdf

[7] The Federal Trade Commission (FTC) has hosted two workshops asking “How Will Journalism Survive the Internet Age?” www.ftc.gov/opp/workshops/news/index.shtml

[8] Both the Senate and House of Representatives have held hearings about “the future of journalism,” and Senator Benjamin L. Cardin (D-MD) recently introduced the “Newspaper Revitalization Act,” which would allow newspapers to become nonprofit organizations in an effort to help them stay afloat—but also curtail their political editorializing.  See http://cardin.senate.gov/news/record.cfm?id=310392.

[9] Robert W. McChesney & John Nichols, The Death and Life of American Journalism (2010) at 201-206. McChesney discussed this idea in more detail when he spoke at the recent FTC event on saving journalism.  Robert W. McChesney, Rejuvenating American Journalism: Some Tentative Policy Proposals, Presentation to FTC Workshop on Journalism, March 10, 2010, www.ftc.gov/opp/workshops/news/mar9/docs/mcchesney.pdf

[10] Dean Baker, The Artistic Freedom Voucher: An Internet Age Alternative to Copyrights, Nov. 5, 2003, www.cepr.net/documents/publications/ip_2003_11.pdf.

[11] Free Press, Saving the News: Toward a National Journalism Strategy, May 2009, at 36, www.freepress.net/files/saving_the_news.pdf.

[12] McChesney & Nichols, supra note 9 at 205.

[13] Id. at 204.

[14] Richard H. Thaler & Cass R. Sunstein, Nudge: Improving Decisions About Health, Wealth, and Happiness (2008).

[15] They define choice architecture as follows:  “A structure designed by a choice architect(s) to improve the quality of decisions made by homo sapiens. Often invisible, choice architecture is the specific user-friendly shape of an organization’s policy or physical building when homo sapiens come into contact with it. Examples of choice architecture include a voter ballot, a procedure for handling well-meaning people who forget a deadline, or a skyscraper.”  Nudge Glossary of Terms, www.nudges.org/glossary.cfm.

[16] See Adam Thierer & Berin Szoka, The Progress & Freedom Foundation, What Unites Advocates of Speech Controls & Privacy Regulation?, Progress on Point 16.19, Aug. 11, 2009, www.pff.org/issues-pubs/pops/2009/pop16.19-unites-speech-and-privacy-reg-advocates.pdf.

[17] As Glen Whitman notes in challenging such “nudging”: “the new paternalism carries a serious risk of expansion. Following its policy recommendations places us on a slippery slope from soft paternalism to hard. This would be true even if policymakers — including legislators, judges, bureaucrats, and voters — were completely rational. But the danger is especially great if policymakers exhibit the same cognitive biases attributed to the people they’re trying to help.”  Glen Whitman, The Rise of the New Paternalism, Cato Unbound, April 5, 2010, www.cato-unbound.org/2010/04/05/glen-whitman/the-rise-of-the-new-paternalism.

[18] Adam Thierer, The Progress & Freedom Foundation, Why Expansion of the FCC’s Public Interest Regulatory Regime is Unwise, Unneeded, Unconstitutional, and Unenforceable, Testimony Before the Federal Communications Commission Hearing on “Serving the Public Interest in the Digital Era,” March 4, 2010, www.pff.org/issues-pubs/testimony/2010/2010-03-04-Thierer_Remarks_at_FCC_Hearing.pdf.

[19] Ellen P. Goodman, “Proactive Media Policy in an Age of Content Abundance,” in Philip M. Napoli, ed., Media Diversity and Localism: Meaning and Metrics (2007) at 370, 374.

[20] Id.

[21] Walter Lippmann, Public Opinion (1922), at 53, 57.

[22] For example, among other things, McChesney and Nichols call for a 5% tax on consumer electronics, a 3% tax on monthly ISP & cell phone bills, a 2% sales tax on advertising, and a 7% tax on broadcasters.  See McChesney & Nichols, supra note 9 at 209-11.

[23] Id. at 202.

[24] Id.

[25] Id.

[26] Id.

[27] Id. at 205.

[28] http://www.taxpolicycenter.org/UploadedPDF/1001289_who_pays.pdf

[29] McChesney & Nichols, supra note 9 at 205.

[30] Jonathan Weisman, Economic Policy ‘Nudge’ Gives Way to a Shove, Wall Street Journal, March 8, 2010, http://online.wsj.com/article/SB10001424052748704869304575103980232739138.html.

[31] http://religiousfreedom.lib.virginia.edu/sacred/vaact.html

[32] McChesney & Nichols, supra note 9 at 205.

[33] Rust v. Sullivan, 500 U.S. 173, 194 (1991).

[34] Id. (emphasis added).

[35] Rosenberger v. Rector and Visitors of Univ. of Va., 515 U.S. 819, 833 (1995) (emphasis added).

[36] Legal Services Corp. v. Velazquez, 531 US 533, 542 (2001).  The Court in Rosenberger noted:

even in the provision of subsidies, the Government may not “ai[m] at the suppression of dangerous ideas,” Regan v. Taxation with Representation of Wash., 461 U.S. 540, 550 (1983), and if a subsidy were “manipulated” to have a “coercive effect,” then relief could be appropriate. See Arkansas Writers’ Project, Inc. v. Ragland, 481 U.S. 221, 237 (1987) (Scalia, J., dissenting); see also Leathers v. Medlock, 499 U.S. 439, 447 (1991) (“[D]ifferential taxation of First Amendment speakers is constitutionally suspect when it threatens to suppress the expression of particular ideas or viewpoints”). In addition…, a more pressing constitutional question would arise if Government funding resulted in the imposition of a disproportionate burden calculated to drive “certain ideas or viewpoints from the marketplace.” Simon & Schuster, Inc. v. Members of N. Y. State Crime Victims Bd., 502 U.S. 105, 116 (1991).

Id. at 587.

[37] 531 U.S. at 542.

[38] Rosenberger v. Rector and Visitors of Univ. of Va., 515 U.S. 819, 833 (1995).  The University’s rule prohibited funding of any group that “primarily promotes or manifests a particular belie[f] in or about a deity or an ultimate reality.”

[39] National Endowment for the Arts v. Finley, 524 U.S. 569, 574 (1998).

[40] 524 U.S. at 583 (quoting R. A. V. v. St. Paul, 505 U.S. 377 (1992) (internal quotations omitted).

[41] Id. at 584 (citing  Board of Ed., Island Trees Union Free School Dist. No. 26 v. Pico, 457 U.S. 853, 871 (1982); see also Bethel School Dist. No. 403 v. Fraser, 478 U.S. 675, 683 (1986)).

[42] Id. at 587.

[43] 515 U.S. 819 (1995).

[44] U.S. v. American Library Association, Inc., 539 U.S. 194 (2003).  See generally Robert Corn-Revere, United States v. American Library Association: A Missed Opportunity for the Supreme Court to Clarify Application of First Amendment Law to Publicly Funded Expressive Institutions, Cato Supreme Court Rev. 105, 2003, www.cato.org/pubs/scr2003/publiclyfunded.pdf.

[45] Id. at 207 (quoting Rosenberger, 515 U.S. at 834).

[46] McChesney & Nichols, supra note 9 at 192, 199.

[47] “If, on the request of an adult user, a librarian will unblock filtered material or disable the Internet software filter without significant delay, there is little to this case.” American Library Association, 539 U.S. at 214 (Kennedy, J. concurring).  Justice Souter agreed that it would ‘‘tak[e] the curse off the statute for all practical purposes’’ if adult patrons could obtain an unblocked Internet terminal ‘‘simply for the asking,’’ but doubted this would actually happen in practice.  Id. at 232.

[48] Cf. Rosenberger, 515 U.S. at 584 (“Educational programs are central to the NEA’s mission.… And it is well established that ‘decency’ is a permissible factor where ‘educational suitability’ motivates its consideration.”).

[49] See www.nakednews.com.

[50] Id. at 205.

[51] See Adam Thierer, Closing the Book on COPA?, Technology Liberation Front, Jan. 21, 2009, http://techliberation.com/2009/01/21/closing-the-book-on-copa/.

[52] Adam Thierer, The Progress & Freedom Foundation, Free Press, Robert McChesney & the “Struggle” for Media, Aug. 10, 2009, http://blog.pff.org/archives/2009/08/free_press_robert_mcchesney_the_struggle_for_media.html

Wrong Way to Reinvent Media Part 3 – Media Vouchers [Thierer & Szoka – PFF] http://d1.scribdassets.com/ScribdViewer.swf

Oh yeah, that was me. And a lot of others. Well, we were wrong. The mobile app store market (Apple, Android, etc) is brimming with a bonanza of micro-business opportunities for producers and consumers alike. I am consistently amazing by the range of offerings available today, the vast majority of which remain free of charge. But what is more impressive is the growing array of applications and games available for mere pennies. Sure, some are more than a buck — but not that much more. I was just looking through the 40+ apps that I’ve got on my Droid right now (not really sure how many I’ve downloaded overall since I’ve deleted a lot) and I would guess that I paid for at least 25% of them–many after being “upsold” by first trying the free versions and then buying. Yes, I know there continues to be a debate about what counts as a “micropayment,” but the fact that so many more people are paying just a couple of bucks or less for content in these mobile app stores suggests that its only going to easier for people to pay even smaller sums for content in coming years.

What got me thinking about all this was slide #75 in Mary Meeker’s latest slideshow about Internet trends. The Morgan Stanley web guru notes that users are more willing to pay for content on mobile devices than they are on desktop computers for a number of reasons, but the first of which she listed was: “Easy-to-Use/Secure Payment Systems — embedded systems like carrier billing and iTunes allow real-time payment.”  The important point here is that the combination of these slick, well-organized online app stores + secure, super-easy billing systems have combined to overcome the so-called”mental transaction cost problem,” at least to some extent. We’re not nearly as reluctant today to surf away when something says “$0.99” on our screen. Increasingly, we’re hitting the “Buy” button.

The really interesting question, of course, is to what extent we can expect this model to grow and become more widely utilized for other types of content.  A lot of folks in the news business remain hopeful that a micropayment model can help them monetize their content in an age of business model uncertainty and highly disruptive change.  I’m skeptical that micropayments are going to “save the news,” since funding hard news and “broccoli journalism” is really expensive, and micropayments alone will never cover the costs. But perhaps they don’t have to. Micropayments could become just one part of an array of new business models that media operators could tap in an effort to reinvent themselves and thrive going forward. Subscriptions, advertising support, foundational / philanthropic funding, and more could also be part of the answer. We just don’t know what will work going forward. But I’ve grown at least a tad bit more optimistic that micropayments can at least be considered part of the conversation again.

This morning I spoke at a Georgetown Center for Business and Public Policy event on, “The Crisis in Journalism: What Should the Government Do?” The panel also included Steven Waldman, senior advisor to FCC Chairman Julius Genachowski, who is heading up the FCC’s new effort on “The Future of Media and the Information Needs of Communities in a Digital Age; Susan DeSanti, Director of Policy Planning at the Federal Trade Commission. (The FTC has also been investigating whether journalism will survive the Internet age and what government should do about it); and Andy Schwartzman, President of the Media Access Project. Mark MacCarthy of Georgetown Univ. moderated the discussion.  Here’s the outline of my remarks. I didn’t bother penning a speech. [Update: Video is now online, but not embeddable and sound is bad.]

____________

What Funds Media? Can Government Subsidies Fill the Void?

1)      Public media & subsidies can play a role, but that role should be tightly limited

• Should be focused on filling niches
• bottom-up (community-based) efforts are probably better than top-down proposals, which will probably end up resembling Soviet-style 5 year plans
• regardless, public subsidies should not be viewed as a replacement for traditional private media sources
• And I certainly hope we are not talking about a full-blown “public option” for the press along the lines of what Free Press, the leading advocate of some sort of government bailout for media, wants.

2)      Indeed, public financing would not begin to make up the shortfall from traditional private funding sources

• Free Press wants a $50+ billion endowment; would produce annual funding of $1.5 billion. But this is a drop in bucket compared to aggregate private media expenditures which total in the hundreds of billions each year
• $270 billion spent on advertising in 2008
• according to the Census Bureau, when aggregated together, U.S. “information industries” include over 140,000 establishments and have over 3.3 million employees.  And the publishing industries alone (not including the Internet) are a $300 billion a year sector.
• are public subsides going to fill that void?
• and where will all this money come from in tight fiscal times!
• does Congress or the taxpaying public really have the appetite for massive media bailout?  It seems unlikely.

3)      Shouldn’t force taxpayers to foot the bill for things they might not want or find offensive

• Should liberals be forced to help fund the next Fox News or Rush Limbaugh?
• Should conservatives have to support Keith Obermann or Bill Moyers?

4)      Greater government involvement—even in the form of subsidies—will raise profound questions about press independence & First Amendment rights

• Ken Ferree on FCC’s “Future of Media” public notice: “The problem is that the very act of initiating such an inquiry will chill protected speech; government inquiries into what is and is not working in the area of news, information, and media is itself an affront to the First Amendment. And it is no answer that the Commission has embarked on this journey with beneficent motives, it has no power to derogate from the protections of the First Amendment in the name of what one group of bureaucrats may think are important government interests.”
• Chilling effect could be very real… “Regulation by ‘raised eyebrow’ has become a well-established tool for a number of federal agencies, including the FCC, but with this inquiry the Commission has taken the concept to a level heretofore unknown – this inquiry is regulation by penetrating leer.” – Ken Ferree
• In particular, putting journalists on the public dole, as some like Free Press have advocated, compromises their independence [Free Press has proposed “a journalism jobs program to support veteran, qualified reporters and simultaneously to engage young people in journalism” that would be part of AmeriCorps.]
• The prospect of a large swath of the American media sector being treated as publicly funded wards of the State isn’t just a small leak in the important wall between Press and State, it is the end of that wall.  It would dynamite that wall to the ground. It could potentially open the door to a fundamental corruption of the journalistic profession by public officials who would not likely be able to resist the urge to pressure those who are subservient to the State.

5)      Oh, by the way, where exactly does the FCC and FTC derive the authority to be playing these games?

• Sure, they’re just studying the issue. But neither agency has the power to act expansively in this area, yet both agencies can simultaneously threaten media operators with other forms of regulation. Such indirect intimidation could have the chilling effect mentioned previously

What Can Be Done to Promote Journalism / Assist Media Operators?

1)      First, Do No Harm… Be patient and humble.

• We are in a gut-wrenching evolution with a great deal of creative destruction taking place, but we should be careful to not to head off potentially advantageous marketplace developments, if even some are highly disruptive

2)      Exercise extreme caution re: new or existing public interest regulatory obligations, which won’t make media reinvention any easier

• localism requirements
• educational programming mandates / advertising restrictions
• political airtime or advertising regs
• speech controls
• other public interest requirements

3)      Beware new advertising restrictions at both FCC & FTC

• If the complaint is that private media funding streams are drying up or being fragmented,  crippling advertising is the last thing we should be doing!
• And yet, there’s a plethora of new regulatory proposals pending; many fronts in “Washington’s war on advertising”
• FCC
  • content-based ad blocking being studied
  • new children’s television advertising restrictions rumored
  • FCC investigating product integration advertising
  • talk of regulating erectile dysfunction ads in Congress
• FTC
  • Increasing signs that agency is on warpath to regulate online advertising / targeted ads
  • continues to put pressure on re: marketing of violently-themed entertainment to children
  • now stepping up oversight of online product placement or “blogola”
  • there’s also legislation pending that would require the FTC to regulate “advertising, promoting, and marketing directed at children and youth” to promote healthier lifestyles
• Regardless of how well-intentioned these or other regulatory efforts may be, as the FCC & FTC continue their inquiries into the future of news and journalism, they would do well to remember that an attack on advertising is tantamount to an attack on media itself
• If Washington goes to war on advertising, private media will suffer because advertising is the very mother’s milk of private media in this country.
• Biggest threat of all = Free Press is calling for “small tax” on advertising to fund public media programs
  • in other words, FP wants to tax private media operators to fund public media competitors
  • Now there’s a sure-fire way to destroy private journalism… force private media providers to fund their own, publicly-subsisted rivals!!
  • It’s precisely what the French, masters of socialized media, have recently proposed

4)      Gov’t must be willing to allow business model flexibility

• micropayments
• paywalls
• other subscription-based schemes
• more personalized, targeted, and potentially more profitable, advertising
• even if they don’t work, experimentation must be allowed

5)      Ownership flexibility needs to be part of the solution

• It’s no silver bullet, but essential to allow flexibility to determines what works

6)      Non-profit BUT non-governmental options should be allowed

• But non-profit status shouldn’t come with all sorts of strings attached
  • Ex:  Sen. Cardin’s “Newspaper Revitalization Act,” which would forbid political editorializing in exchange for non-profit status.  It would protect incumbents from criticism.
• and, again, ownership flexibility will need to be part of this for non-profits to work
  • hybrid arrangements including co-op models & joint ventures will need some scale to survive
  • useful to remember that many foreign “public media” efforts have massive scale & if we expect private non-profit operators to survive, they’ll likely need some serious scale as well.

Additional Reading:

• Ken Ferree – Another Naïve Proposal for Government Entanglement with the Fourth Estate
• Ken Ferree –  A Chill Wind Blows
• Adam Thierer – A “Public Option” for Media? The Free Press Plan to Put Journalists on the Public Dole
• Berin Szoka & Adam Thierer – Chairman Leibowitz’s Disconnect on Privacy Regulation & the Future of News
• Adam Thierer – The Dangers of Subsidized News, Continued
• Adam Thierer – Public Option for Press Should Get the Red Pen
• Adam Thierer – Free Press, Robert McChesney & the “Struggle” for Media

by Adam Thierer & Berin Szoka, Progress Snaphot 6.1

Stephanie Clifford of the  New York Times posted a very interesting article this week summarizing a recent “on-the-record chat” the Times staff had with Federal Trade Commission (FTC) chairman Jon Leibowitz and FTC Bureau of Consumer Protection chief David Vladeck.  The interview [discussed by Braden here] is profoundly important in that it reveals an alarming disconnect regarding the relationship between “privacy” regulation and the future of media, which were the subjects of their discussion with Times staff.  Namely, Leibowitz and Vladeck apparently fail to appreciate how the delicate balance between commercial advertising and journalism is at risk precisely because of the sort of regulations they apparently are ready to adopt.  Because the value of online advertising depends on data about its effectiveness and consumers’ likely interests, and because advertising is indispensable to funding media, what’s ultimately at stake here is nothing short of the future of press freedom.

The “Day of Reckoning” Is Upon Us

Leibowitz and Vladeck spend the first half of The Times interview wringing their hands about “privacy policies,” the declarations made by websites and advertising networks about their data collection and use practices (for which the FTC can and must hold them accountable).  But the two feel that privacy policies don’t adequately inform consumers.  Chairman Leibowitz claims that online companies “haven’t given consumers effective notice, so they can make effective choices.”  And Mr. Vladeck states that advise-and-consent models “depended on the fiction that people were meaningfully giving consent.” But he and the FTC seem ready to abandon the notice and choice model because the “literature is clear” that few people read privacy policies, Vladeck told the Times.  He and Leibowitz continue:

“Philosophically, we wonder if we’re moving to a post-disclosure era and what that would look like,” Mr. Vladeck said. “What’s the substitute for it?” He said the commission was still looking into the issue, but it hoped to have an answer by June or July, when it plans to publish a report on the subject. Mr. Leibowitz gave a hint as to what might be included: “I have a sense, and it’s still amorphous, that we might head toward opt-in,” Mr. Leibowitz said.

This clearly foreshadows the regulatory endgame we have long suspected was coming.  When the FTC released its “Self-Regulatory Principles for Online Behavioral Advertising” eleven months ago, we asked: “What’s the Harm & Where Are We Heading?”  Their answers to both questions have become clearer with each new calculated comment—all apparently intended to slowly “turn up the heat” on the advertising industry so that the proverbial frog will stay in the pot until the water finally boils.  Leibowitz’s FTC has simply dodged the “harm” question with a four-part strategy:

1. Cobble together a “record” full of sympathy-evoking anecdotes submitted by advocates of regulation in comments and the FTC’s ongoing “Exploring Privacy” Roundtables;
2. Let the most extreme Chicken Littles fulminate about the grand conspiracy of “neuromarketing manipulation” and the like (and sometimes even shout down FTC staff in panel discussions) in order to redefine the “reasonable center” of the debate;
3. Define-down “harm” as purely a matter of “consumer expectations” or consumers’ “dignity interests” (whatever that vague and infinitely elastic term means); and
4. Attack the effectiveness of “consent” itself by suggesting that consumers cannot be trusted to understand privacy policies or be expected to make any effort to protect their own privacy.

Conveniently, this strategy leads right back to the “day of reckoning” Chairman Leibowitz threatened was coming last February: We are heading precisely where he told us we would be—to full-on, opt-in regulation.  The writing on the wall becomes more apparent every day: Leibowitz set out to bring online advertising to heel even before becoming Chairman, and his Commission is reprising almost precisely the same approach that led to the passage of the Children’s Online Privacy Protection Act (COPPA) of 1998: building a case for new authority, dismissing industry self-regulation as ineffective, and finally presenting a report to Congress intended to produce a rapid legislative response.  After the FTC presented its report on the need for regulation in congressional testimony in June 1998, it took Congress just four months to pass COPPA—and much of that time was consumed by the summer recess.  In short, Leibowitz is mounting a carefully choreographed campaign for increased regulation.

The only real question is whether Leibowitz will somehow try to use the FTC’s existing authority over “unfair or deceptive” trade practices or wait for expanded authority from Congress.  While most observers typically assume that such expanded authority would come in the form of a privacy-specific bill—be it a broad “baseline” privacy bill or one specifically focused on online data collection for advertising purposes—the authority Leibowitz yearns for could just as easily come in the form of increased rulemaking authority as part of a broader bill that allows the FTC to preemptively regulate practices that are not deceptive but merely deemed “unfair.”

This would take the agency “ Back to the Future”—to the late 1970s, when the agency reached the height of its efforts to regulate purely on “unfairness” grounds by trying to ban advertising to children.  The agency’s behavior earned it the moniker “National Nanny” from the Washington Post, hardly a bastion of regulatory skepticism.[1] That outpouring of popular resentment caused a heavily Democratic Congress to cut-off the Democratic-led agency’s regular funding and prohibit it from regulating advertising merely on the grounds of “unfairness.”  In essence, they told the agency to “go back to its knitting” and focus on protecting consumers from demonstrated harms.^[2] Duly chastened (and actually shut down for several days), the FTC formulated a meaningful legal standard for “unfairness,” which Congress codified in 1994: for a practice to be unfair, the injury it causes must be (1) substantial, (2) without offsetting benefits, and (3) one that consumers cannot reasonably avoid.

Under this statutory standard, as FTC Commissioner Thomas Rosch has argued, the commission must carefully consider:

[the] legitimate pro-consumer and pro-competitive benefits that result from [targeted advertising]. Absent hard data weighing these benefits against the limited “invasion of privacy interests” involved, it would seem difficult to conclude that treating that practice as an actionable violation of the “unfairness” prong of Section 5 will pass muster.[3]

So Leibowitz and Vladeck either need to get serious about weighing the costs and benefits of targeted advertising—or, in the absence of such actually measuring these trade-offs, get Congress to give them the authority to regulate.  But one thing is clear from their past statements: they are in a hurry to do  something. As Vladeck told The Times last August, “There is a sense of urgency around here… Consumers, I don’t think are sufficiently protected under the current regime.”  Apparently, the case is closed in their minds.

“Left Hand, Meet Right Hand”

The second half of the  Times interview concerns the future of news. Chairman Leibowitz is not optimistic:

“There are some areas where you clearly see positive creative destruction,” Mr. Leibowitz said, giving the example of travel agents who were replaced by Orbitz and other online-booking systems. The news, he said, was not one of those. “When you’re dealing with something as critical as news is to a democracy, you need to ensure, certainly, that it’s independent, but also that it’s vibrant going forward,” he said. Areas like investigative reporting, foreign and domestic bureaus, and state-house reporting, he said, would likely falter under blog operations because of “economies of scale.”

He said he wasn’t sure what the solution was, but threw out a few ideas discussed at the conference: maybe special tax treatment for newspapers, a Corporation for Public Broadcasting-like fund, or for the newspaper industry to charge fees for the re-use of its content, similar to the model that the American Society of Composers, Authors and Publishers uses. [emphasis added]

Mr. Chairman, with all due respect, haven’t you forgotten about the solution that has powered private media for a few centuries in this country?  You know— advertising!  Indeed, what’s stunning about these comments is the complete disconnect with what Leibowitz and Vladeck said earlier in the interview.  It certainly may be the case that they said more on the subject than what The Times has reported, but given their escalating rhetoric, it seems likely that significantly increased FTC regulation is on the horizon.  And, yet, as Chairman Leibowitz marches us into this brave new world of regulating Internet media through their key funding source, he and Mr. Vladeck seem to have little appreciation of the vital role played by advertising in sustaining a truly free and vibrant press.

An Attack on Advertising Is an Attack on Media Itself

Let’s step back and revisit Media Economics 101.  Almost every serious scholar in the field acknowledges this truism: Advertising cross-subsidizes media platforms and the creation of valuable information—especially news.  “Advertising is the mother’s milk of all the mass media,”  Wall Street Journal technology columnist Walt Mossberg has noted.  Similarly, Harold L. Vogel, author of Entertainment Industry Economics, the leading text in the field, has noted, “Advertising is the key common ingredient in the tactics and strategies of all entertainment and media company business models.  Indeed, it might further be said that advertising has substantively subsidized the production and delivery of news and entertainment throughout the last century.”[4] Mossberg agrees and notes, “Without ads, most editorial products and other programming would be either unavailable or prohibitively expensive.”

The reason for the indispensability of advertising is simple: Information (including news and other forms of “content”) has “public good” characteristics that make it is very difficult (and occasionally impossible) for information-publishers to recoup their investments.  Simply put, they quite literally lack pricing power: Whatever they charge, someone else will charge less for a close substitute, inevitably leading to “free” distribution of the content, even though the content is anything but free to produce.  Advertising is the one business model that has traditionally saved the day by rewarding publishers for attracting the attention of an audience.

Which raises another under-appreciated point: Private advertising promotes press independence.  “Newspapers, magazines, radio, television, and many websites all receive their primary income from advertising,” notes William F. Arens, author of  Contemporary Advertising, another leading textbook in the field. “This facilitates freedom of the press and promotes more complete information” he concludes.[5] Why?  Because, contrary to what some critics claim, advertising and marketing help keep private media providers independent of the need for taxpayer subsidies or private patrons.  This begs an even more profound question: If not advertising, then what else?

A “Public Option” for the Press?

What’s most troubling about Chairman Leibowitz’s comments to the Times is that he has apparently found his alternative to advertising: a “public option” for the press! He mentions special tax treatment for newspapers or a new CPB-like fund (don’t we already have one?) as two possibilities.  That certainly will be music to the ears of radical, pro-regulatory activist groups like the ironically-named “Free Press,” which wants to see a massive “public works” program for the media sector.

Free Press recently filed comments with the FTC in the agency’s recent workshop, “Can Journalism Survive the Internet Age?” and proposed a far-reaching industrial policy for “saving the news.”  They call for over $50 billion in subsidies for the Corporation for Public Broadcasting and other bureaucracies, a “journalism jobs program” for that would be part of AmeriCorps, a variety of new tax incentives for struggling media operations or individuals who support favored institutions, and an assortment of government incentives to encourage local ownership and media divestiture (by handing over control to smaller operators or minority-owned groups).  Ironically, “Free Press” has also floated the concept of “a small tax on advertising” as one way to pay for a press bailout.

The organization’s founder Robert W. McChesney, the prolific neo-Marxist media scholar, penned an essay with John Nichols of The Nation last year, claiming that saving journalism essentially requires that media become an appendage of the State.  Although advertising has supported journalism as a “public good” for centuries, the only way they can conceive to provide a public good is to socialize its means of production.  Thus, journalism, like education and national defense, requires constant government oversight and support: “A moment has arrived at which we must recognize the need to invest tax dollars to create and maintain news gathering, reporting and writing with the purpose of informing all our citizens.”  They ask us to consider the $60 billion in government spending they propose as a “free press ‘infrastructure project,’” which would “keep the press system alive.”

Some in Congress seem willing to listen.  The Senate has already held hearings about the future of journalism.  And Senator Benjamin L. Cardin (D-MD) recently introduced what he has called the “Newspaper Revitalization Act,” which would allow newspapers to become nonprofit organizations in an effort to help them stay afloat.  Importantly, however, the bill would also disallow political endorsements on newspaper editorial pages—which, like campaign finance restrictions, would be a boon for incumbent politicians.  That bill should serve as fair warning to journalists about the sort of strings lawmakers will attach to press-welfare efforts going forward.  What other “golden shackles” might come with media subsidies?

To be clear, Chairman Leibowitz hasn’t called for a complete press takeover along the lines of the Free Press plan.  Yet, he hasn’t answered a key question in this debate: Who pays for news?  He appears ready to endorse a bold new regulatory scheme for the Internet and online media that, in the name of “protecting privacy” would put at risk the one traditionally successful method of supporting private media operations—advertising.  As the Pew Research Center’s Project for Excellence in Journalism noted in its latest State of the News Media report, “The problem facing American journalism is not fundamentally an audience problem or a credibility problem.  It is a revenue problem—the decoupling… of advertising from news.”  There’s probably no way policymakers can stop this process, nor should they try.  But they shouldn’t be creating new obstacles to the survival of traditional media creators, either.

Unfortunately, that’s exactly what Chairman Leibowitz’s new regulatory scheme would do.  The revenue “delta” between “smart” advertising (tailored to consumers’ likely interests and measured for effectiveness in producing clicks, purchases, etc.) and “dumb advertising” (based purely on surrounding keywords or demographics of users presumed to visit the site) is difficult to measure but potentially enormous—even 10 times as great for some sites.[6] The difference between opt-in and opt-out could be nearly as dramatic, because it’s difficult to get consumers to opt-in for anything, especially for small players—which means that opt-in regulation could, perversely, force consolidation in the online advertising and content markets.  If the FTC cares about its statutory responsibility to safeguard competition, they should take this dynamic seriously and be hyper-cautious about heavy-handed mandates that could derail smarter advertising.

Finally, to be fair, in his interview, the Chairman also suggests the newspaper industry might want to find new way “to charge fees for the re-use of its content.”  We’re certainly not opposed to the notion and think that, if it could somehow be made to work (especially by removing antitrust obstacles), it could part of a diverse revenue mix for digital journalism.  But, there’s the rub.  Micropayments inevitably face the problem of “mental transaction costs”  that likely swamp the perceived value of most content and, like pay-walls, have generally worked only in media environments characterized by a scarcity of providers and a uniqueness of a sufficiently valuable product.  These cold, hard economic realities are why advertising remains indispensable.

The Principled Alternative to Regulation

Convinced that privacy policies simply don’t work, Leibowitz and Vladeck are asking what a “post-disclosure era” would look like.  We appreciate the continued sensitivities expressed by certain groups and individuals about online privacy and data use more generally.  But there is another way forward.  We have proposed the following “5-E” layered approach to concerns about online privacy, focusing on restraining government access to data as a clear harm, rather than crippling the private sector uses of data that directly benefit consumers:

1. Erect a higher “Wall of Separation between Web and State” by increasing Americans’ protection from government access to their personal data—thus bringing the Fourth Amendment into the Digital Age.
2. Educate users about privacy risks and data management in general as well as specific practices and policies for safer computing.
3. Empower users to implement their privacy preferences in specific contexts as easily as possible.
4. Enhance self-regulation by industry sectors and companies to integrate with user education and empowerment.
5. Enforce existing laws against unfair and deceptive trade practices as well as state privacy tort laws.

Such a layered approach would not only be a “less restrictive” alternative to top-down, one-size-fits-all government regulation, but also potentially more effective in key respects than government data use/collection mandates.  In an ideal world, adults would be fully empowered to tailor privacy decisions, like speech decisions, to their own values and preferences (“household standards”).  Consumers would have (1) the information necessary to make informed decisions and (2) the tools and methods necessary to act upon that information. Importantly, those tools and methods would give them the ability to block the things they don’t like—annoying ads or the collection of data about them, as well as objectionable content—while also helping them find the information and content they desire.

But of course, the devil’s in the details.  Leibowitz and Vladeck would set the bar so high as to what constitutes “effective” consumer choice that current privacy policies necessarily fail their test—if only because most users don’t care enough to make the “right” privacy choices.  Privacy policies, even if read by relatively few consumers, nonetheless allow privacy advocates, journalists and watchdog-bloggers to scrutinize what companies say they’re doing—promises to which the FTC should hold companies stringently.  That’s clearly not good enough for Leibowitz and Vladeck, who want to give up on “notice and choice” and move on to “opt-in” mandates.  But why not first try to make “notice” more effective?  The advertising industry is currently developing standardized interfaces that could communicate key information about privacy practices in a single icon, label or other easily-digested “consumer touch point.”

More radically, why focus on tinkering with consumer interfaces, when standardized data disclosure formats like the Protocol for Privacy Preferences (P3P) could distill legalistic privacy policies into “machine-readable” code?  Such disclosures could provide a powerful form of “notice” that the ordinary consumer could “use”: simply setting their own privacy preferences in a browser tool that automatically implements those preferences by blocking tracking that users object to.  Such a privacy disclosure format could also allow the FTC to automate enforcement of its existing authority to punish unfair or deceptive trade practices.

Conclusion

And so we return to the question the FTC asked in its recent workshop, “Can Journalism Survive the Internet Age?”  Answer: Not if the FTC kills the golden goose that lays the golden eggs through onerous advertising regulations and data controls in the name of “privacy.”  Chairman Leibowitz and Bureau Chief Vladeck shouldn’t foreclose the possibility that advertising can play a central role in the future of a free press in the Digital Age—just as it has done historically in the United States.  Indeed, they would be wise to remember that advertising has always been with us.  As the Supreme Court noted in its 1996 decision, 44 Liquormart, Inc. v. Rhode Island.

Advertising has been a part of our culture throughout our history. Even in colonial days, the public relied on “commercial speech” for vital information about the market. Early newspapers displayed advertisements for goods and services on their front pages, and town criers called out prices in public squares. Indeed, commercial messages played such a central role in public life prior to the founding that Benjamin Franklin authored his early defense of a free press in support of his decision to print, of all things, an advertisement for voyages to Barbados.[7]

Of course, for advertising to continue to play the role as sustainer of the press, it must be allowed to evolve.  Media operators—large and small alike—must be allowed to craft new strategies, some of which may require data collection and marketing practices that will make some privacy-sensitive users uncomfortable, but will also ensure that the goose keeps on laying golden eggs for them and everyone else.

While Chairman Leibowitz may decry the creative destruction at work in the news sector and information industries today, that shakeup will continue and, no doubt, be painful for incumbent players.  Advertising alone may not “save the day” for media as it has in the past, but it will likely remain essential to sustaining private media platforms and providers going forward— if federal policymakers allow it.  The alternative—massive government intervention into the news and media sectors—is too horrifying to think about.

[1] Washington Post, March 1, 1978.

[2] Congress terminated the FTC’s efforts to prohibit advertising to children, and barred the agency from issuing any advertising regulation predicated solely on unfairness for three years.  FTC Improvements Act, Pub. L. No. 96-252, § 11 (May 1980).  See generally J. Howard Beales, Director of the Bureau of Consumer Protection, Federal Trade Commission, The FTC’s Use of Unfairness Authority: Its Rise, Fall, and Resurrection, www.ftc.gov/speeches/beales/unfair0603.shtm.

[3] Thomas Rosch, Some Reflections on the Future of the Internet: Net Neutrality, Online Behavioral Advertising, and Health Information Technology, Remarks at U.S. Chamber of Commerce Telecommunications & E-Commerce Committee Fall Meeting, October 26, 2009, 13, www.ftc.gov/speeches/rosch/091026chamber.pdf.

[4] Harold L. Vogel, Entertainment Industry Economics (Cambridge, MA: Cambridge University Press, 7th Edition, 2007), at 46.

[5] William F. Arens, Contemporary Advertising (McGraw-Hill Irwin, 10^th Ed., 2006) at 50.

[6] See Berin Szoka & Mark Adams, The Benefits of Online Advertising & Costs of Privacy Regulation, PFF Working Paper, Nov. 8, 2009, www.scribd.com/doc/22445754/Benefits-of-Online-Advertising-Paper.

[7] 517 U.S. 484, 495 (1996), http://www.law.cornell.edu/supct/html/94-1140.ZO.html

______________________________

Related PFF Publications

• Privacy Trade-Offs: How Further Regulation Could Diminish Consumer Choice, Raise Prices, Quash Digital Innovation & Curtail Free Speech, Berin Szoka, Comments to the Federal Trade Commission “Exploring Privacy” Roundtable, November 10, 2009.
• Online Advertising & User Privacy: Principles to Guide the Debate, Berin Szoka & Adam Thierer, Progress Snapshot 4.19, Sept. 2008.
• Targeted Online Advertising: What’s the Harm & Where Are We Heading?, Berin Szoka & Adam Thierer, Progress on Point 16.2, April 2009.
• Privacy Polls v. Real-World Trade-Offs, Berin Szoka, Progress Snapshot 5.10, Oct. 2009.
• The Benefits of Online Advertising & Costs of Privacy Regulation, Berin Szoka & Mark Adams, PFF Working Paper, Nov. 8, 2009.
• Benefits of Online Advertising, Berin Szoka, Mark Adams, Howard Beales, Thomas Lenard & Jules Polonetsky, PFF Capitol Briefing, July 2009.
• Public Option for Press Should Get the Red Pen, Adam Thierer, The Daily Caller, Jan. 12, 2010.

I’ve always generally agreed with the conventional wisdom about micropayments as a method of funding online content or services: Namely, they won’t work.  Clay Shirky, Tim Lee, and many others have made the case that micropayments face numerous obstacles to widespread adoption.  The primary issue seems to be the “mental transaction cost” problem: People don’t want to be diverted–even for just a few seconds–from what they are doing to pay a fee, no matter how small.  [That is why advertising continues to be the primary monetization engine of the Internet and digital services.]

That being said, I keep finding examples of how micropayments do work in some contexts and it has kept me wondering if there’s still a chance for micropayments to work in other contexts (like funding media content).  For example, I mentioned here before how shocked I was when I went back and looked at my eBay transactions for the past couple of years and realized how many “small-dollar” purchases I had made via PayPal (mostly dumb stickers and other little trinkets). And the micropayment model also seems to be doing reasonably well in the online music world. In January 2009, Apple reported that the iTunes Music Store had sold over 6 billion tracks.

And then there are mobile application stores.  Just recently I picked up a Droid and I’ve been taking advantage of the rapidly growing Android marketplace, which recently hit the 20,000 apps mark. Like Apple’s 100,000-strong App Store, there’s a nice mix of paid and free apps, and even though I’m downloading mostly freebies, I’ve started buying more paid apps. Many of them are “upsells” from free apps I downloaded. In most cases, they are just 99 cents. A few examples of paid apps I’ve downloaded or considered buying: Stocks Pro, Mortgage Calc Pro, Currency Guide, Photo Vault, Weather Bug Elite, and Find My Phone. And there are all sorts of games, clocks, calendars, ringtones, heath apps, sports stuff, utilities, and more that are 99 cents or $1.99.  Some are more expensive, of course.

I don’t have any idea how big this marketplace is in the aggregate, but according to AndroLib, “fully 62.2% of the apps available are completely free, compared to just 37.8% that are paid apps. That’s in stark contrast to the [Apple] App Store, which now has over 100,000 individual apps, of which (by some recent counts) a hefty 77% are paid applications — although only 30% of total App Store downloads are for paid apps.” That suggests that micropayments are doing quite well in mobile marketplaces. And this Wall Street Journal piece I was reading just yesterday, “Mobile-Payment Services Grow,” suggests there are lots of innovative things are happening in this space right now.

Of course, this gets into the semantic issue of, “what is a micropayment”? Does 99 cents qualify? I don’t know. I’ve never found any widely accepted definition of the term. Moreover, even if it’s true that a lot of people are buying “small-dollar” apps in mobile marketplaces, that doesn’t mean micropayments can fund all media going forward. It’s unlikely, for example, that we can fund quality journalism one micropayment at a time. People are just not going to pay a quarter (or even a penny) every time they want to read an article.  They might, however, be willing to pay a small monthly or annual access fee for some sites or services.  But with the exception of The Wall Street Journal and a handful of other media services, that model just doesn’t seem to have legs right now. [Although take a look at Dale Jefferson’s amazing newspapers app in the Android marketplace. Very cool. Perhaps media providers will learn from aggregation efforts like that and find a way to charge a small fee for access. But at less that one British pound — the cost of Jefferson’s app — I can’t imagine that funding a lot of content. They’ll need plenty of ads and other revenue streams to make up for what they are losing.]

Anyway, I’m not saying I have any answers here, just that my mind is still open regarding the possibility of micropayments as a method of funding online services and content. It may end up being easier for the former rather than the latter, however.

Adam Thierer and I will be participating in two separate panels at the FTC’s December 7 “Exploring Privacy” workshop discussing, respectively, surveys & expectations and online behavioral advertising. Below is the cover letter I filed as part of my comments (PDF & Scribd), along with four past PFF publications and a working paper on the benefits of online advertising.

Privacy Trade-Offs:  How Further Regulation Could Diminish Consumer Choice, Raise Prices, Quash Digital Innovation & Curtail Free Speech

In general, we at PFF have argued that any discussion about regulating the collection, sharing, and use of consumer information online must begin by recognizing the following:

• Privacy is “the subjective condition that people experience when they have power to control information about themselves and when they exercise that power consistent with their interests and values.”^[1]
• As such, privacy is not a monolith but varies from user to user, from application to application and situation to situation.
• There is no free lunch:  We cannot escape the trade-off between locking down information and the many benefits for consumers of the free flow of information.
• In particular, tailored advertising offers significant benefits to users, including potentially enormous increases in funding for the publishers of ad-supported content and services, improved information about products in general, and lower prices and increased innovation throughout the economy.
• Tailored advertising increases the effectiveness of speech of all kinds, whether the advertiser is “selling” products, services, ideas, political candidates or communities.

With these considerations in mind, policymakers must ask four critical questions:

1. What exactly is the “harm” or market failure that requires government intervention?
2. Are there “less restrictive” alternatives to regulation?
3. Will regulation’s costs outweigh its supposed benefits?
4. What is the appropriate legal standard for deciding whether further government intervention is required?

We have addressed these questions in the PFF publications attached below, which I respectfully submit for the Commission’s consideration.  This executive summary highlights their findings.

• Online Advertising & User Privacy: Principles to Guide the Debate, Berin Szoka & Adam Thierer, Progress Snapshot 4.19, Sept. 2008.
• Targeted Online Advertising: What’s the Harm & Where Are We Heading?, Berin Szoka & Adam Thierer, Progress on Point 16.2, April 2009.
• Privacy Polls v. Real-World Trade-Offs, Berin Szoka, Progress Snapshot 5.10, Oct. 2009.
• The Benefits of Online Advertising & Costs of Privacy Regulation, Berin Szoka & Mark Adams, PFF Working Paper, Nov. 8, 2009. ^[2]
• Benefits of Online Advertising, Berin Szoka, Mark Adams, Howard Beales, Thomas Lenard, Jules Polonetsky, PFF Capitol Briefing, July 2009.

I. A Principled Pro-Consumer Alternative to Further Regulation

The “Privacy Wars” that have waged over how government should regulate online collection and use of data might better be referred to as the “Privacy Proxy Wars” because the most clearly demonstrated “harm” at issue seems to be from government itself, not the private sector.  The Fourth Amendment guarantees that “The right of the people to be secure in their persons, houses, papers, and effects, against unreasonable searches and seizures, shall not be violated…”  Americans have a legitimate expectation that this “security” extends to their digital “papers and effects,” yet that expectation is not given effect by current restraints on government access to consumer data in American law.  Thus, we have proposed the following layered approach to concerns about online privacy, focusing on restraining government access to data, rather than crippling the private sector uses of data that directly benefit consumers:

1. Erect a higher “Wall of Separation between Web and State” by increasing Americans’ protection from government access to their personal data—thus bringing the Fourth Amendment into the Digital Age.
2. Educate users about privacy risks and data management in general as well as specific practices and policies for safer computing.
3. Empower users to implement their privacy preferences in specific contexts as easily as possible.
4. Enhance self-regulation by industry sectors and companies to integrate with user education and empowerment.
5. Enforce existing laws against unfair and deceptive trade practices as well as state privacy tort laws.

Such a layered approach would not only be a “less restrictive” alternative to increased government regulation, but also potentially more effective in key respects than government data use/collection mandates.  In an ideal world, adults would be fully empowered to tailor privacy decisions, like speech decisions, to their own values and preferences (“household standards”).  Specifically, in an ideal world, adults (and parents) would have (1) the information necessary to make informed decisions and (2) the tools and methods necessary to act upon that information.  Importantly, those tools and methods would give them the ability to block the things they don’t like—annoying ads or the collection of data about them, as well as objectionable content.

A wide variety of self-help tools and “technologies of evasion” are readily available to all users and can easily thwart traditional cookie-based tracking, as well as more sophisticated tracking technologies such as packet inspection.  While cookie management tools that allow users to delete their cookies have been standard in browsers for some time, the latest generation of browsers incorporates far more advanced control over what kind of cookies browsers will accept from websites in the first place.  Furthermore, the extensible nature of modern browsers allows any freelance software developer who sees a way to improve a browser to do so by writing an add-on that “plugs in” to the browser using standard programming interfaces designed by each browser developer.  Many such add-ons are wildly popular, but even those users who never install a single one benefit from the acceleration of browser evolution made possible by add-ons.  We have documented examples of these tools in an ongoing series of blog posts about “Privacy Solutions,” available at www.pff.org/privacy-solutions/.

But a “layered approach” that relies on user empowerment and education need not be perfect to be “good enough,” because “privacy” is not an absolute good that trumps all other consumer interests, nor can “community standards” accommodate a diverse citizenry.  If we “make the best the enemy of the good” by insisting on perfection, consumers will be made worse off.  Advertising is indispensable to the future of online media, but it is also currently inadequate to sustain “Free” culture.  The advocates of regulation pay lip-service to the importance of advertising in funding online content and services but don’t seem to understand that this quid pro quo is a fragile one:  Tipping the balance, even slightly, could have major consequences for continued online creativity and innovation.  Something must give because there is no free lunch.[3]

II. Benefits to Users of Smarter Online Advertising

The attached working paper I co-authored with PFF Visiting Fellow Mark Adams identifies five broad categories of benefits to users from targeted advertising:

1. More relevant, and potentially less annoying/interruptive advertising for consumers;
2. Higher-quality content and services supported by advertising;
3. Better correlation between the production of content and services, and consumer preferences;
4. A more vibrant media and improved political discourse and communities; and
5. Lower prices for consumers and greater innovation throughout the economy.

The paper explains how better targeting of advertising delivers these benefits by:

• Increasing the informational value of advertising to consumers;
• Increasing advertising funding for content and services that might not be sustainable on an ad-supported basis with untargeted or less targeted advertising; and
• Reducing the costs of buying and selling (“transaction costs”).

In particular, we note that, with behavioral targeting, the value of a site’s viewers depends less on the content associated with that site (keywords) and more on the viewers themselves.  In this sense, behavioral advertising levels the playing field by allowing websites to sell access to viewers directly, rather than through the keywords associated with the website.  Better targeting democratizes the ad-supported economy by empowering consumers to direct advertising revenues to the sites they spend time on.  Targeting essentially increases the ability of Internet users to “vote with their clicks” for online content and services just as they “vote with their dollars” every time they make a purchase in the traditional economy.

Data on the precise “delta” between contextual and behavioral advertising is limited, but appears to indicate that behavioral advertising can produce significant increases in revenue for many publishers.  In particular, we note the following increased measures of effectiveness

• Increased Click-Through-Rates 94% to 225% and conversion rates up to 3,000% (2005);[4]
• Increased CTR of 670-1000% (2009);^[5] and
• Increased conversion rates of 400-900% (2008).[6]

There are a wide range of predictions on the potential value created by behavioral targeting.  As with previous innovations in online advertising, it seems likely that the performance of behavioral targeting will improve over time.  Professor Tracy Tuten, author of Advertising 2.0, predicts that a twelvefold increase in the value of page views, from $10 to $120 per thousand views.^[7] Rich Karpinski calculates that Blue Kai, an ad network, is currently selling behaviorally targeted ads a rate of $4-15 per thousand views^[8]—a significantly lower rate than Ryan suggests but higher than the current performance of print advertising ($5.50)^[9] and several times higher than the average price of non-premium display advertising ($0.60-$1.10).^[10] One experiment with re-targeting (showing users ads on one site based on actions taken towards making a purchase on one site but not completed) produced significantly higher returns:  “retargeted impressions represented only 7% of all the banner impressions delivered, [but] were responsible for over 50% of the revenue and 25% of the sales generated by the campaign as a whole.”^[11] Hallerman concludes that “Behavioral targeting is more than hype…. For publishers, it can mean making more money from undersold or unsold ad inventory.”[12]

III. The Quid Pro Quo behind “Free”

Traditionally, users “paid” for content by devoting part of their attention to ads, which have long funded the costs of generating content for radio, television, and newspapers (with subscriptions paying only for distribution).^[13] The basic reason is simple economics:  In competitive markets, prices tend to fall to the marginal cost of production, which quickly converges on zero for information.  The Internet has simply borne this theory out in full:

1. Producing the first unit of content (e.g., a news story or video) remains costly, so while the marginal cost of every additional unit is essentially zero, average cost is not.
2. The failure of micropayments online seems to confirm that, no matter how low the technological transaction costs are, the mental transaction costs involved combined with even tiny payments will exceed the perceived value of most content.
3. The world of media scarcity in which consumers could choose from only a few sources of content (e.g., news, entertainment) has given way to a world of staggering media abundance and the choices of users are no longer constrained by the tyranny of physical limitations like distance and printing costs.
4. Because pure information cannot be copyrighted (and fair use allows significant referencing and quotation), very little content is so unique that users cannot find a ready substitute elsewhere if a site (or even a group of sites) attempted to charge.

Thus, while policymakers should generally avoid preferring one business model over others, they must also recognize that the “economics of bits” will make advertising increasingly indispensable to the future of online content, services, media and culture. For that reason, they should take great care when tinkering with the economic engine that has made America the envy of the digital world as the fountainhead of online innovation and creativity.

IV. Consumer Attitudes & Expectations

While many consumers said, in a recent poll, that they don’t want ads, content and news “tailored” to their interests,[14] their actions in the real world speak louder than words: The increased click through rates and conversion rates mentioned above are evidence that consumers do, in fact, value more relevant advertising.[15] Whatever Americans tell pollsters about “tailored” ads, they also complain about irrelevant ads: A previous poll found that 72% of consumers “find online advertising intrusive and annoying when the products and services being advertised are not relevant to [their] wants and needs” and 85% say that less than 25% of the ads they see while browsing online are relevant to their wants and needs.^[16]

Until a proper experiment is conducted by trained behavioral economists that includes real-world trade-offs and makes users aware of privacy management tools, all we can say with confidence is the following:

1. Users don’t understand exactly how ads are tailored;
2. Users seem to be concerned about “tailoring” or “following” in the abstract;
3. Users are generally unwilling to pay for online content and services; and
4. Better tailoring of ads means more funding for content and services.

Only the layered approach outlined above can address all these concerns: educate users about how online advertising works and how they can implement their own privacy preferences, while constantly striving to further empower users to make privacy management easier.

Policymakers should avoid presuming they can divine the true preferences of users regarding the complex and multi-faceted trade-offs of the real world.  Instead of guessing what consumers might choose, the FTC and other law enforcement agencies should focus on holding companies to the “expectations” they set in their official privacy policies and other statements about their any use and collection practices.  In a sense, this is to approach the problem from the “supply” side rather than the “demand” side: If a browser manufacturer, for example, overstates the privacy protection offered by privacy management tools in the browser (e.g., cookie settings or a private browsing mode), this might well be considered an unfair and deceptive trade practice subject to FTC enforcement. The advantage of this approach is that the FTC can, using its existing authority, play a valuable role in ensuring consistency between theory and practice in what industry actually does— without sending into the intractable morass of subjective user preferences.  In other words, the FTC can help give effect to “household standards” without imposing “community standards” for everyone.

V. Underlying Fear of Advertising

On some level, this debate isn’t about user privacy at all, but about the common (though baseless) fear of advertising as inherently manipulative and wasteful—essentially: “Since people are stupid, ignorant and/or lazy, they’re easy to control and trick with shiny objects, pretty faces, memorable slogans, and catchy jingles.”  No better response to this sentiment has ever been made than was offered by the ad firm Young & Rubicam in this 1959 magazine ad:

There is no chestnut more overworked than the critical whinny:
“Advertising sells people things they don’t need.”

We, as one agency, plead guilty. Advertising does sell people things they don’t need. Things like television sets, automobiles, catsup, mattresses, cosmetics, ranges, refrigerators, and so on and on.

People don’t really need these things. People don’t really need art, music, literature, newspapers, historians, wheels, calendars, philosophy, or, for that matter, critics of advertising, either.

All people really need is a cave, a piece of meat and, possibly, a fire.

The complex thing we call civilization is made up of luxuries. An eminent philosopher of our time has written that great art is superior to lesser art in the degree that it is “life-enhancing.” Perhaps something of the same thing can be claimed for the products that are sold through advertising: They enhance life, to whatever degree they can.

VI. Conclusion

If misguided government regulation chokes off the Internet’s growth or evolution by starving content and service providers of much-needed advertising revenue, we would be killing the goose that laid the golden eggs.  Apart from a hardcore fringe who embrace the Marxist dogma that advertising is inherently deceptive and wasteful, most participants in this debate at least pay lip service to the economic importance of online advertising.  One might therefore be lulled into a false sense of complacency that “sensible” regulation (or government-led co-regulation) would surely avoid crippling this dynamo.  This widespread assumption calls to mind the famous quip of Chris Patten, last British Governor of Hong Kong, who paraphrased those who dismissed his concerns about the potentially negative effects of a Chinese take-over of the British colony in 1997, as follows:  “It is unimaginable that the Chinese would kill such a goose.”  To this, Patten responded, “Yet we wouldn’t need the metaphor of golden eggs and geese if history weren’t full of dead geese.”^[17] The dangers of regulation to the health of the Internet are real, but the ease with which government could disrupt the economic motor of the Internet (advertising) is not widely understood—and therein lies the true danger in this debate.

Depending on how regulation is structured, therefore, it is possible that new privacy mandates would severely curtail the overall quantity of content and services offered–and greatly limit the ability of new providers to enter the market with innovative offerings. Alternatively, or perhaps additionally, companies would change the character of their offerings and water-down sophisticated services that cater to consumer demand; in other words, the quality of service would deteriorate.

Bottom line: We live in a world of trade-offs, and regulation is not costless.  Indeed, regulation might best be understood as a giant game of economic whack-a-mole: Attempting to control one of the primary variables of price, quantity, or quality inevitably results in non-optimal adjustments in the other two variables. The absence of price as a variable in the context of “free” (i.e., ad supported) content and services means there is one less variable for the government to control in the first place. Simply stated, stifling the evolution of the online advertising marketplace will likely result in fewer free online services and less content, less high-quality online services and content, or some combination of both.

These observations are even more relevant to the online marketplace, where advertising has been shown to be the only business model with any real staying power. Walled gardens, pay-per-view, micropayments, and subscription-based business models are all languishing. Consequently, the overall health of the Internet economy and the aggregate amount of information and speech that can be supported online are fundamentally tied up with the question of whether we allow the online advertising marketplace to evolve in an efficient, dynamic fashion. Heavy-handed privacy regulation (or European-style “co-regulation,” where the government steers and industry simply rows) could, therefore, become the equivalent of a disastrous industrial policy for the Internet that chokes off the resources needed to fuel e-commerce and online free speech going forward.

[2].      Currently in draft form, pending further research quantifying the benefits of personalized advertising.

[3].      Berin Szoka & Adam Thierer, The Progress & Freedom Foundation, Targeted Online Advertising: What’s the Harm & Where Are We Heading?, Berin Szoka & Adam Thierer, Progress on Point 16.2, April 2009, www.pff.org/issues-pubs/pops/2009/pop16.2targetonlinead.pdf.

[4].      Scott Ferber, Stepping Up Search: How Behavioral Targeting Can Enhance ROI, MediaPost Publications, Jun 6, 2005, www.mediapost.com/publications/index.cfm?fa=Articles.showArticle&art_aid=30838.

[5].      Jun Yan, Ning Liu, Gang Wang, Wen Zhang, Yun Jiang & Zheng Chen, How Much Can Behavioral Targeting Help Online Advertising?, presented at World Wide Web Conference, Madrid, Spain, April 20–24, 2009, p. 262.

[6].      Erik Sherman, Want to Target Online? You Better Build Trust, Advertising Age, Apr. 14, 2008, http://adage.com/adnetworkexchangeguide/article?article_id=126242.

[7].      Id.

[8].      Rich Karpinski, Will Using Behavioral Data Lead to Smarter Ad Buys?, Advertising Age, April 20, 2009, http://adage.com/adnetworkexchangeguide09/article?article_id=136003 (subscription only).

[9].      Howard Beales, Public Goods, Private Information & Anonymous Transactions:  Providing a Safe & Interesting Internet, presentation given at the Law & Economics of Innovation Symposium at George Mason University School of Law, May 7, 2009 (copy on file with authors) at 17 (citing Media Dynamics data from 2008).

[10].    Id.

[11].    Id.

[12].    David Hallerman, Behavioral Targeting:  Marketing Trends, eMarketer, June 2008, at 2, http://www.emarketer.com/Reports/All/emarketer_2000487.

[13].    See, e.g., Walter Mossberg, Now You See ‘Em…, SmartMoney.com, June 15, 2000, available at web.archive.org/web/20061124235126/http://www.smartmoney.com/mossberg/index.cfm?story=20000615.

[14].    Joseph Turow, Jennifer King, Chris Jay Hoofnagle, Amy Bleakley & Michael Hennessy, Americans Reject Tailored Advertising and Three Activities That Enable It, Sept. 2009, http://graphics8.nytimes.com/packages/pdf/business/20090929-Tailored_Advertising.pdf.

[15].    See generally Berin Szoka, Privacy Polls v. Real-World Trade-Offs, The Progress & Freedom Foundation, Progress Snapshot 5.10, Oct. 2009, http://www.pff.org/issues-pubs/ps/2009/ps5.10-privacy-polls-tradeoffs.html.

[16].    TRUSTe, 2009 Study: Consumer Attitudes About Behavioral Targeting, March 4, 2009, at 2, 5, available at www.truste.com/about/bt_overview.php.

[17].  Tom Plate, Hong Kong Will Remain Very Much Alone After 1997, The Standard, Jan. 7, 1996, www.thestandard.com.hk/archive_news_detail.asp?pp_cat=&art_id=20783&sid=&con_type=1&archive_d_str=19960107

http://d1.scribdassets.com/ScribdViewer.swf?document_id=22384078&access_key=key-1jna9geastmkpu3z7hh&page=1&version=1&viewMode=list

Progress Snapshot 5.10 from The Progress & Freedom Foundation

A recent telephone poll conducted by professors at Berkeley and the University of Pennsylvania concluded, “Contrary to what many marketers claim, most adult Americans (66%) do not want marketers to tailor advertisements to their interest.” The study’s authors claim that their poll is the “the first nationally representative telephone (wireline and cell phone) survey to explore Americans’ opinions about behavioral targeting by marketers.” They also assert that the poll indicates that “if Americans could vote on behavioral targeting today, they would shut it down.” Advocates of regulating online data collection have trumpeted this poll as evidence consumers demand legislation to protect their privacy. “This research gives the F.T.C. and Congress a political green light to go ahead and enact effective, but reasonable, rules and policies,” declared Jeff Chester, a leading critic of online advertising.

But what is most surprising about this poll is not that 66% of users said they do not want tailored online ads, but that 34% of users said they did! The key, initial question of “whether or not you want the websites you visit to show you ads that are tailored to your interests,” presents no trade-off. The fact that anyusers said “yes” indicates that many users paused to do the rough mental math about the unarticulated trade-off between the benefits of receiving tailored ads and the costs of that tailoring.

The methodology of opinion polls necessarily affects respondents’ mental calculations, rendering polls not just easily manipulated, but inherently unreliable as indicators of real preferences. Every poll reflects the bias of its authors to some degree by the way questions are worded, the order in which they are asked, the sample surveyed, etc. The easiest way to bias the results of a poll is to omit any mention of the trade-offs at issue. This poll simply buried the issue of trade-offs in a heavily loaded follow-up question: After telling respondents that marketers “often use technologies to follow the websites you visit and the content you look at in order to better customize ads,” the interviewer asked whether the respondent would allow advertisers to “follow [them] online in an anonymous way in exchange for free content.” Only 10% of users said they would allow this voluntary exchange.

What does this tell us about whether, and how, government should further regulate online advertising? Precious little: Not only does this poll overstate the costs of targeted advertising, understate its benefits, and ignore the tools available to users to address their privacy concerns but, like any opinion poll, this one tells us more about the psychology of decision-making under the artificial uncertainty of polls than about the choices users would actually make in the real world.

User Uncertainty About Concepts Like “Tailoring” and “Following”

Even the word “tailoring”—though benign compared to other words the study’s authors could have used ( e.g., “track,” “monitor,” “record”)—is so vague as to leave respondents wondering what it really entails. One can only speculate as to what users thought the word meant (since the poll did not ask), but it seems likely that some of these scarier words probably flashed through the minds of respondents in the instant before they answered the question. Indeed, the word “tailoring” conflates both the costs and benefits of personalized advertising in a single, vague word. Given this ambiguity, it’s hardly surprising that most users would say “no”—not just to receiving tailored advertising (66%), but also to receiving tailored discounts (49%) and news (57%). If users had been asked about receiving “relevant” (rather than “tailored”) ads, the responses probably would have turned out somewhat differently—just as an additional 17% of users agreed to receiving tailored “discounts,” whose value to users is more readily apparent: saving money on potential purchases.

The second set of questions asked users whether it “Would be OK… if these ads [discounts/news] were tailored for you based on following what you do on the website you are visiting… [24% said yes] OTHER websites you have visited… [34% said yes] and OFFLINE—for example, in stores? [25% said yes].” Again, the term “follow” was not defined. A third set of questions explained to respondents that marketers “often use technologies to follow the websites you visit and the content you look at in order to better customize ads.” The interviewer then asked whether the respondent would “definitely allow, probably allow, probably NOT allow, or definitely not allow advertisers” to “follow you online in an anonymous way in exchange for free content”—and only 10% of users said yes. Thus, it appears that users are more, not less, hostile to tailored advertising when reminded of the trade-offs involved (35% yes in the first set of questions, 10% yes in the third). What explains this paradox?

The most obvious explanation is that, by the time the respondent got to the critical question about “allowing” tailored advertising, they had heard the word “follow” at least five times: once in each of the three questions about whether tailoring was OK, once in the introduction about how marketers customize ads and once in the question itself—each time increasing uncertainty as to how “tailoring” really works and more than negating any suggestion of “anonymity.” Furthermore, asking users whether something should be “allowed” implies that there are undisclosed reasons why it should not be. This much is simple psychology—obvious to anyone who wanted to craft a poll that would support a particular regulatory agenda.

But behavioral economics research tells us something even more profound about the way our brains work: human beings hate making choices, and loathe uncertainty even more. Indeed, such “mental accounting” or “mental transaction” costs appear to be the primary reason why, after a decade of efforts to develop a micropayments system that can fund online content and services, no such system has emerged—and thus why Internet publishers instead rely primarily on advertising revenues ($23.5 billion in 2008) to fund “free” offerings for consumers. In this case, merely forcing consumers to consider the costs of “tailoring” and being “followed,” and decide whether these things are “OK” or should even be “allowed” strongly tips the scales in favor of the outcome desired by the study’s authors because these considerations and decisions are significant psychological costs in themselves, which likely outweigh the diffuse benefits of tailored advertising, which users simply do not appreciate.

Indeed, the scale tips so strongly that the study suggests that 73% of Americans object to having ads tailored based on “what you do on the website you are visiting.” Would not this objection apply to purely contextual advertising “tailored” to the keywords entered by a user in a search engine or to the keywords that appear on a particular page to which a user has navigated within a site? If so, this study isn’t just about the bogeyman of “behavioral” advertising, but about essentially all online advertising, which is to some degree “tailored.” Indeed, must lawmakers protect us from the tailoring of news (71%) and discounts (62%) within websites? Or, if data collection is the real harm to consumers, what about the fact that hundreds of millions of people happily share far more personal information every day on social networks or using grocery discount cards? Opinion polls simply cannot answer these questions.

The Direct Benefit of Tailored Ads: Relevance

Whatever Americans tell pollsters about “tailored” ads, they also complain about irrelevant ads: A previous poll found that 72% of consumers “find online advertising intrusive and annoying when the products and services being advertised are not relevant to [their] wants and needs” and 85% say that less than 25% of the ads they see while browsing online are relevant to their wants and needs. Real-world experiments confirm that users reveal a clear preference for more relevant advertising. In a 2004 experiment, click-through rates (CTR) for behaviorally targeted ads were between 94% and 225% higher than for contextually targeted ads. A 2009 study found that the difference could be between 670% and 1000% percent, depending on how well-tailored the ads were. In other words, users in the real world were two to eleven times more likely to click on highly-tailored ads. Truly, actions speak louder than words: Users clearly “vote with their clicks” for ads they find relevant—i.e., they vote for “tailoring.”

Further reinforcing this conclusion is the fact that better tailoring increases not only click-through rates but also “conversion rates”—the percentage of users who actually complete the action desired by the advertiser, whether that be making a purchase or signing up for a list. A 2008 experiment found increased conversion rates of 400-900% (2008). This indicates that relevant ads really do help consumers find things they like—and that they like the fruits of tailoring, however they respond when asked about “tailoring” as an abstract concept that conflates costs (“How are they following me?”) and benefits (“What’s in it for me?”).

The Indirect Benefit of Tailored Ads: Free Content & Services

Even less apparent to poll respondents than the direct benefit of tailoring (increased relevance) are the indirect benefits: In particular, greater relevance to the user means more effective communication for the advertiser, and increased ad revenue for most online publishers per ad on their sites. Thus, there exists a clear quid pro quo: in effect, users “pay” for content and services by sharing information about their interests. Even more fundamentally, users “pay” for content by seeing ads. But both quid pro quos are implicit: Users can simply choose not to “pay” by using readily available tools in their browser to blocking ads and/or tracking. In essence, today’s system allows users who don’t like ads—tailored or otherwise—to opt out at little or no cost, much as if they simply decided not to pay for a product they bought at their local grocery store.

This creates a serious dilemma, given that advertising increasingly stands alone as the lifeblood of online content and services. Indeed, ads have long funded the costs of generating content for radio, television, and newspapers (with subscriptions paying only for distribution). The basic reason is simple economics: In competitive markets, prices tend to fall to the marginal cost of production. The Internet has simply borne this theory out in full:

1. Producing the first unit of content (e.g., a news story or video) remains costly, so while the marginal cost of every additional unit is essentially zero,average cost is not.
2. The failure of micropayments online seems to confirm that, no matter how low the technological transaction costs are, the mental transaction costs involved combined with even tiny payments will exceed the perceived value of most content.
3. The world of media scarcity in which consumers could choose from only a few sources of content (e.g., news, entertainment) has given way to a world of staggering media abundance and the choices of users are no longer constrained by the tyranny of physical limitations like distance and printing costs.
4. Because pure information cannot be copyrighted (and fair use allows significant referencing and quotation), very little content is so unique that users cannot find a ready substitute elsewhere if a site (or even cartel of sites) attempted to charge.

These forces have given birth to the world of “Free,” where few (if any) users will pay for something they can get for nothing. While there are a number of ways to fund content and services, advertising is far and away the leading business model for the new economy: Indeed, overall advertising market is expected nearly to double its share of total U.S. ad spending from 8.7% in 2008 ($23.4 billion) to 15.2% ($37.2 billion). But with 44% of advertising revenue going to search engines (which show highly “tailored” ads simply based on search terms), hundreds of thousands of publishers—from the mightiest to the tiniest—rely on $7.6 billion (33% of the total) in “display” ad revenue. Yet this base is tiny: Most websites earn a fraction of the revenue generated by offline ads: roughly $0.60 to $1.10 per thousand impressions (CPM) online versus average CPMs of $4.54 (radio) to $10.25 (broadcast). This unprofitability of online advertising, and the fact that certain kinds of online content (e.g., video and online services) does not provide the textual keywords necessary for basic contextual targeting is driving publishers to ad networks that offer behavioral targeting, which is expected to grow from $525 million in 2007 to $4.4 billion in 2012—when it will represent 25% of all display ad spending.

In short, advertising is indispensable to the future of online media, but it is also currently inadequate to sustain “Free” culture. As Adam Thierer and I warnedearlier this year: “The advocates of regulation pay lip service to the importance of advertising in funding online content and services but don’t seem to understand that this quid pro quo is a fragile one: Tipping the balance, even slightly, could have major consequences for continued online creativity and innovation… Something must give because there is no free lunch.” In 2001, long before Google mattered and before he worked for them, Kent Walker (now Google’s general counsel) put it best in a seminal law review article:

Privacy is both an individual and a social good. Still, the no-free-lunch principle holds true. Legislating privacy comes at a cost: more notices and forms, higher prices, fewer free services, less convenience, and, often, less security. More broadly, if less tangibly, laws regulating privacy chill the creation of beneficial collective goods and erode social values… Such regulation would likely increase both direct and indirect costs to the individual consumer, reduce consumer choice, and inhibit the growing trend of personalization and tailoring of goods and services.

Thus, as Jim Harper and Solveig Singleton concluded in their 2001 paper With a Grain of Salt: What Privacy Surveys Don’t Tell Us:

privacy surveys in particular… suffer from the “talk is cheap” problem. It costs a consumer nothing to express a desire for federal law to protect privacy. But if such law became a reality, it will cost the economy as a whole, and consumers in particular, significant amounts that surveys do not and cannot reveal.

We Need a Behavioral Economics Experiment, Not Just Another Poll

The Berkeley-Penn poll could certainly have done more to present these trade-offs to respondents and less to color their responses by inflating mental transaction costs. But even the most “fair” poll cannot meaningfully simulate the trade-offs inherent in the real world. If we really want to know how muchsubjective value consumers place on a particular aspect of their privacy, we must look to the preferences they reveal in the process of making real choices.

Of course, the best experiment is the one being conducted in the real world every day. No laboratory experiment can ever fully replicate all of the conditions of the real world, but a behavioral economics experiment could tell us more about the revealed preferences of Internet users than any poll. Unlike the real world, an economist could vary certain conditions in a lab experiment to tell us how various changes to current industry practice, user empowerment, or user education might actually affect real consumer choices. At a minimum, any experiment would require the following to inform policymaking about online advertising and privacy.

First, the experiment should vary the mechanisms by which notice is provided to users as to how tailoring works ( e.g., placement, interface, wording) and what those notices actually say.

Second, test subjects must make real choices in real use of the Internet with trade-offs in real money and their own time between either paying for access to a particular site or getting access for free in exchange for receiving tailored ads based on at least the three variables presented as questions in the Berkeley-Penn study: (i) users’ browsing activity on that site; (ii) their browsing activity on other sites; and (iii) offline activity or demographic information.

The second variable is critical because it addresses the value created by behaviorally tailored ads, which could be wiped out by regulation. Search engines are able to sell highly effective advertising based solely on information provided directly to the site (search keywords, which are highly indicative of user interest), and some sites can sell lucrative advertising based on purely contextual targeting because their content contains keywords that advertisers value highly ( e.g., a site for digital camera enthusiasts). But the vast majority of websites, and especially non-commercial websites, would produce little ad revenue if advertisers could only guess at the likely interests of visitors based on the keywords on that site. This, in a nutshell, is why so many sites stand to gain so much from behavioral targeting—particularly in the Internet’s “Long Tail.” To be useful, an experiment must reflect this dynamic.

In the real world, of course, it might be possible for the user to opt-out of tracking without losing access to content because today’s quid pro quo is implicit and most sites operate on a “No Cost Opt-Out” basis for tracking and even seeing ads. But in order to tell us how much consumers really care about tracking, the experiment must place some value on access to content that is supported by free content and services.

Third, the experiment must examine the extent to which user empowerment affects user choice: If some users are uncomfortable with having their browsing activity tracked, is it because they are concerned about all tracking or only tracking of certain sensitive activities, such as researching medical issues or—everyone’s favorite—viewing pornography? How does the availability of privacy management tools change user choices about ad-tailoring? Do Americans really want tailoring banned, or do they just want the ability to exercise easy choice about when they want to participate? How would those choices change when they come at a cost (e.g., seeing more ads) and privacy-sensitive users cannot simply free-ride off the value created by users whodon’t opt-out of targeted advertising (and also don’t block ads)?

Such an experiment would, by its very nature, be imperfect—but far less imperfect than any poll about opinions on privacy. Until a proper experiment is conducted by trained behavioral economists, all we can say with confidence is the following:

1. Users don’t understand exactly how ads are tailored;
2. Users seem to be concerned about “tailoring” or “following” in the abstract;
3. Users are generally unwilling to pay for online content and services; and
4. Better tailoring of ads means more funding for content and services.

There is only one approach that can address all these concerns: educate users about how online advertising works and how they can implement their own privacy preferences, while constantly striving to further empower users to make privacy management easier.

Michael Anderson from Niemanlab.org reports:

In the two months since Ann Arbor became the nation’s newest no-newspaper town, there’s been lots of talk about its status as ground zero for the new ecosystem of Web-native niche outlets. But I wanted to know: In a business that’s always been oiled by routine — midnight press runs, 6 a.m. broadcasts, 11 a.m. news meetings, 6:30 deadlines — how will tomorrow’s hyperlocal news professionals structure their day? So, a few weeks after the Ann Arbor News folded, I spent a morning with its most established successor, the one-year-old, online-only Ann Arbor Chronicle, to get a sense for the future of the newsroom routine.

Anderson’s story paints a vivid picture of entrepreneurship in news delivery, at least on the editorial side of the operation. I’d love to hear more about the business side of the venture. How much revenue are these sites generating per view or per user? How can they increase revenue? Are they experimenting with selling their ad inventory through ad networks that offer personalized (“behaviorally targeted”) ads to increase revenue? What do they think of Google’s new micropayments venture?

A coalition of ten self-described “consumer and privacy advocacy organizations” today demanded legislation that would restrict the collection and use of data online for customizing advertising based on Internet users’ interests. I’ll have more to say on this but here are my initial comments:

These so-called “consumer advocates” are actually anti-consumer elitists.  Not only do they presume that consumers are too stupid or lazy to make their own decisions about privacy, but they ignore the benefits to consumers: more relevant advertising plus more and better content. Advertising has been the “mother’s milk” of media in America since colonial times and the future of media depends on the ability of publishers to replicate that revenue model online.  Micropayments, donations, subscriptions alone simply can’t fund a vibrant marketplace of ideas.  Only personalized advertising can sustain publishers through the Digital Revolution. Regulatory advocates haven’t demonstrated any harm to consumers that would justify such sweeping preemptive regulation.  By strangling funding for new media, such regulations would amount to an “Industrial Policy” for the Internet.  Instead, policymakers should focus on educating consumers and empowering them by promoting development of better privacy management tools.

by Berin Szoka & Adam Thierer

This morning, the House Energy & Commerce Committee will hold a hearing on “Behavioral Advertising: Industry Practices And Consumers’ Expectations.” If nothing else, it promises to be quite entertaining:  With full-time Google bashers Jeff Chester and Scott Cleland on the agenda, the likelihood that top Google officials will be burned in effigy appears high!

Chester, self-appointed spokesman for what one might call the People for the Ethical Treatment of Data (PETD) movement, is sure to rant and rave about the impending techno-apocalypse that will, like all his other Chicken-Little scenarios, befall us all if online advertisers were permitted to better tailor ads to consumers’ liking. After all, can you imagine the nightmare of less annoying ads that might actually convey more useful information to consumers? Isn’t serving up “untargeted” dumb banner ads for Viagra to young women and Victoria’s Secret ads to Catholic school kids the pinnacle of modern online advertising?  Gods forbid we actually make advertising more relevant and interest-based!  (Those Catholic school boys may appreciate the lingerie ads, but few will likely buy bras.)

Anyway, according to National Journal’s Tech Daily Dose, the hearing lineup also includes:

• Charles Curran, Executive Director, Network Advertising Initiative
• Christopher Kelly, Chief Privacy Officer, Facebook
• Edward Felten, Director, Center for IT Policy, Princeton University
• Anne Toth, Chief Privacy Officer & Vice President, Policy, Yahoo!
• Nicole Wong, Deputy General Counsel, Google

That’s an interesting group and we’re sure that they will say interesting things about the issue. Nonetheless, because four of them have a corporate affiliation that fact will inevitably be used by some critics to dismiss what they have to say about the sensibility of more targeted or interest-based forms of online advertising. So, we’d like to offer a few thoughts and pose a few questions to make sure that Committee members understand why, regardless of what it means for any particular online operator, targeting online advertising is very pro-consumer and essential to the future of online content, culture, and competition.  As Wall Street Journal technology columnist Walt Mossberg has noted, “Advertising is the mother’s milk of all the mass media.”  Much of the “free speech” we all cherish isn’t really free, but ad-supported!

Our Approach

We have previously set forth a framework for analyzing advertising policy issues in two PFF reports: “Online Advertising & User Privacy: Principles to Guide the Debate” and “Targeted Online Advertising: What’s the Harm & Where Are We Heading?” At root, our model depends heavily on two common-sense, and inter-related, principles:

1. We live in a world of trade-offs; and
2. There is no free lunch.

Their Approach

We are deeply concerned that too few people are talking about—or even understand the relevance of—those two principles in the debate over targeted online advertising. It seems that too many who wish to retard the further evolution of the advertising marketplace are living a lie based upon the antithesis of our model. Many privacy advocates seem to imagine that regulatory actions don’t have consequences and that Congress can simply mandate new privacy standards for the Internet without having any impact on the free flow of ideas supported by, and direct facilitated through, advertising.

Simply put, the privacy critics often imagine that their values are indicative of everyone’s values. Our blogging colleague Jim Harper of the Cato Institute has referred to this as “preference imposition” but we’ll use a simpler term: Elitism. In essence, privacy advocates seem to believe that:

1. People are too ignorant, busy or just plain stupid, and cannot be trusted to make wise decisions for themselves (or their children); and/or
2. Everyone shares the same values or concerns when it comes to privacy such that a national “baseline” regulatory standard (namely, mandatory “opt-in” regulations for data collection and use) should govern the entire online marketplace.

Let’s be clear: Such a mandate, and the thinking behind it, would greatly impoverish the future Internet economy. Too many people think of the Internet as a magic box that just keeps cranking out free goodies. But something powers that box of goodies: advertising.  More than anything else, it’s advertising that keeps the Internet “Free, Innovative & Open,” to borrow the slogan of our friends at CDT, which seems to flirt with joining the PETD movement, despite their well-earned reputation for pragmatic skepticism of government interference with the Internet.

The regulatory advocates complain that giving consumers the right to opt-out of data collection and use isn’t meaningful because very few consumers will exercise the opt-out.  Again, they presume that this must be because users just don’t know what’s good for them because of course if they really understood what was being done with “their data,” they would never choose to just “give it away” for a few scraps from the advertisers’ table.  It never occurs to them that (i) many, perhaps most, users just don’t care and that (ii) that their “ignorance” about the all specific details of “how the sausage is made” (online data collection and use practices for targeting advertising) may be completely rational.

But just as importantly, would-be privacy regulatory don’t seem to understand—or perhaps simply don’t care—that what’s true of opt-out is also true of opt-in:  in practice, few people will bother doing either.  In a world of perfect information and infinite time, of course, there would be no difference in outcomes with the two different rules.  But in the real world with real constraints on time, knowledge and everything else, mandating opt-in would make all the difference in the world by severely limiting the ability of advertisers to target advertising.

The Ignored Trade-offs

We’ve been assembling evidence on the real-world costs of restricting targeted advertising. Here are just a few data points we’ve seen to give you a sense of what’s at stake:

• Relevance to Users: The best evidence that users prefer seeing more relevant ads is their increased likeliness to actually click on an ad—instead of just ignoring it or trying to block it. The most recent study of this issue concluded that Click-Through Rates (CTR) can be improved by as much as 670% by using basic behavioral targeting as compared to simple contextual targeting—0r even more than 1000% using more sophisticated targeting. Conversion rates (the percentage of clicks that actually result in a sale) also strongly indicate that consumers find ads more interesting, and in one 2005 study, were estimated to increase up to 3000% with behavioral targeting.
• Macro: More Revenue to Fund All Services & Content: eMarketer (in June 2008) estimated that U.S. spending on behavioral targeting would grow from $.775 billion in 2008 to $4.4 billion in 2012—representing fully a quarter of display ad spending.  The total amount of money at stake is huge:  U.S. online ad revenues totaled $23.5 billion in 2008.
• Micro: More Revenue for Individual Publishers: Estimates on the increased profitability of behavioral targeting range as high as 1200% (eMarketer).

While these examples illustrate the broad outlines of the trade-offs ignored by privacy regulatory advocates, the key dilemma to understand is this: If, under an opt-in regime, publishers would be able to target advertising for webpages based on the keywords contained within those pages, and not on other content the user has looked at, the value of most Internet content will depend not on how many eyeballs it attracts but primarily on the economic value of the keywords that are directly associated with it. Pages with keywords related to products and services will fetch a fine price because advertisers will be able to make money off ads on those pages ( e.g., a site for digital camera reviews). But content with little commercial value will generate little revenue. Indeed, this is perhaps the single greatest problem faced by journalism sites. Who wants to advertise on a story about North Korea? How many users are going to be interested in taking a honeymoon in the DMZ?

But if such websites could target advertising to users’ user’s likely interests based on an anonymous profile of their interests created by collecting data about their browsing “behavior,” web content becomes valuable because of the audience it attracts, not just because the content itself serves as a rough proxy for a user’s interests. This democratization of Internet advertising revenue is essential for sustaining the future of journalism in particular, but also for “free” culture more generally.

As we noted in our response to the FTC’s proposed self-regulatory guidelines on data collection for advertising:

Depending on how regulation is structured, therefore, it is possible that new privacy mandates would severely curtail the overall quantity of content and services offered—and greatly limit the ability of new providers to enter the market with innovative offerings. Alternatively, or perhaps additionally, companies would change the character of their offerings and water-down sophisticated services that cater to consumer demand; in other words, the quality of service would deteriorate. Bottom line: Something must give because there is no free lunch. Regulation is a giant game of economic whack-a-mole: Attempting to control one of the primary variables of price, quantity, or quality inevitably results in non-optimal adjustments in the other two variables. The absence of price as a variable in this context means there is one less variable for the government to control in the first place. Simply stated, stifling the evolution of the online advertising marketplace will likely result in fewer free online services and less content, less high-quality online services and content, or some combination of both… We stand at an important crossroads in the debate over the online marketplace and the future of a “free and open” Internet. Many of those who celebrate that goal focus on concepts like “net neutrality” at the distribution layer, but what really keeps the Internet so “free and open” is the economic engine of online advertising at the applications and content layers. If misguided government regulation chokes off the Internet’s growth or evolution, we would be killing the goose that laid the golden eggs…. These observations are even more relevant to the online marketplace, where advertising has been shown to be the only business model with any real staying power. Walled gardens, pay-per-view, micropayments, and subscription-based business models are all languishing. Consequently, the overall health of the Internet economy and the aggregate amount of information and speech that can be supported online are fundamentally tied up with the question of whether we allow the online advertising marketplace to evolve in an efficient, dynamic fashion. Heavy-handed privacy regulation (or co-regulation) could, therefore, become the equivalent of a disastrous industrial policy for the Internet that chokes off the resources needed to fuel e-commerce and online free speech going forward.

Our Challenge to the Advocates of Privacy Regulation

For these reasons, we have repeatedly issued the following three-part challenge in our previous work to those who advocate the regulation of online advertising:

1. Identify the harm or market failure that requires government intervention.
2. Prove that there is no less restrictive alternative to regulation.
3. Explain how the benefits of regulation outweigh its costs.

We’re still waiting…

We’ve also made it clear that there is an alternative to the pre-emptive, one-size-fits-all regulation demanded by the regulatory advocates:  We’ve proposed a “layered approach” based on user education, user empowerment, self-regulation and FTC enforcement of privacy policies.  Our goal is as follows:

The ideal state of affairs would be to create a system of tools and data disclosure practices that would empower each user to implement their personal privacy preferences while also recognizing the freedom of those who rely on advertising revenues to “condition the use of their products and services on disclosure of information”—not to mention the viewing of ads! Self-regulatory efforts can be refined, especially through technological innovation to better satisfy the concerns of policymakers, privacy advocates, and average consumers. For example, if websites and ad networks participating in a self-regulatory framework supplemented their current “natural language” privacy policies with equivalent “machine-readable” code [ e.g., P3p], that data could be “read” by browser tools that would implement pre-specified user preferences by blocking the collection of information depending on whether the privacy policies of certain websites or ad networks met the user’s preferences about data-use. Such robust and granular disclosure, if implemented for behavioral advertising, would exceed the wildest dreams of those who argue that users currently do not read privacy policies—without disrupting the browsing experience or cluttering websites. But this system would only work if users had to make real choices about “pay*ing+ for ‘free’ content and services by disclosing their personal information.”

A Final Word About Advertising

On some level, this debate isn’t about user privacy at all, but about the alleged evils of advertising as inherently manipulative.  Jeff Chester straddles both camps.  His rantings about the use of “neuromarketing” boil down to the same simple idea that the Neo-Marxists have been pushing for decades:  Since people are stupid, ignorant and/or lazy (see above), they’re easy to control and trick with shiny objects, pretty faces, memorable slogans, and catchy jingles. No better response to this argument has ever been made than was offered in this 1959 magazine ad by the ad firm Young & Rubicam (emphasis added for Chester’s benefit):

There is no chestnut more overworked than the critical whinny: “Advertising sells people things they don’t need.” We, as one agency, plead guilty. Advertising does sell people things they don’t need. Things like television sets, automobiles, catsup, mattresses, cosmetics, ranges, refrigerators, and so on and on. People don’t really need these things. People don’t really need art, music, literature, newspapers, historians. wheels, calendars, philosophy, or, for that matter, critics of advertising, either. All people really need is a cave, a piece of meat and, possibly, a fire. The complex thing we call civilization is made up of luxuries. An eminent philosopher of our time has written that great art is superior to lesser art in the degree that it is “life-enhancing.” Perhaps something of the same thing can be claimed for the products that are sold through advertising. They enhance life, to whatever degree they can.

Micropayments are an idea that simply won’t die. Every few years, there’s a resurgence of interest in the idea. Critics predict they won’t work. The critics are then proved right, as companies founded to promote micropayments inevitably go belly-up.

The latest iteration comes courtsey of Time magazine, which recently saw fit to run a cover story about how micropayments will save newspapers. And Shirky once again steps up to the plate to explain why micropayments won’t work any better in 2009 than they did in 1996, 2000, or 2003. (I wrote up Shirky’s arguments here and here) But for my money, the best response to the Isaccson piece is at the Abstract Factory blog:

Why did Time’s editors choose to run this article, rather than, for example, an article by Shirky or Odlyzko or any number of people who would write something more clueful? I hypothesize two reasons. First, Time’s editors themselves do not have a clue, and also do not have any problem publishing articles on a subject they have no clue about. Second, look at the author blurb at the bottom of the article (emphasis mine):

Isaacson, a former managing editor of TIME, is president and CEO of the Aspen Institute and author, most recently, of Einstein: His Life and Universe..

When you’re a member of the club, your buddies will publish any old crap you write; better you than some stupid professor nobody knows. We’ve seen this before. I mentioned irony earlier. Isaacson has filigreed the irony with extraordinary precision. His article is inferior to material produced for free online by people who draw their paychecks from other sources (Shirky and Odlyzko are both professors who also work(ed) in the private technology sector). Furthermore, it is inferior as a direct consequence of structural weaknesses of traditional magazines. Despite its inferior quality, it presumes its own superior status by ignoring or dismissing contributions to the discussion which occurred outside of traditional “journalistic” media. Finally, taking that superiority as a given, it argues, poorly, that people ought to pay money for products like itself, because (quoting Bill Gates) nobody can “afford to do professional work for nothing.” In short, Isaacson’s article not only fails to make its case, it actively undermines its own case while doing so.

Quite so. There’s more good stuff where that came from.

A few more people have weighed in on my new paper. I tend to think that if I’m angering both sides of a given debate, I must be doing something right, so I’m going to take the fact that fervent neutrality opponent Richard Bennett hated the study as a good sign.

Others have been more positive. Mike Masnick has an extremely generous write-up over at Techdirt. And at Ars Technica, my friend Julian has the most extensive critique so far.

I thought most of it was spot on, but this seemed worth commenting on:

Lee thinks that the history of services like America Online shows that “walled garden” approaches tend to fail because consumers demand the full range of content available on the “unfettered Internet.” But most service providers already offer “tiered” service, in that subscribers can choose from a variety of packages that provide different download speeds at different prices. Many of these include temporary speed “boosts” for large downloads. If many subscribers are demonstrably willing to accept slower pipes than the network can provide, companies providing streaming services that require faster connections may well find it worth their while to subsidize a more targeted “boost” for those users in order to make their offerings more attractive. In print and TV, we see a range of models for divvying up the cost of getting content to the audience—from paid infomercials to ad-supported programming to premium channels—and it’s never quite clear why the same shouldn’t pertain to online.

The key point here is the relative transaction costs of managing a proprietary network versus an open one. As we’ve learned from the repeated failure of micropayments, financial transactions are surprisingly expensive. The infrastructure required to negotiate, meter, and bill for connectivity, content, or other services means that overly-complicated billing schemes tend to collapse under their own weight. Likewise, proprietary content and services have managerial overhead that open networks don’t. You have to pay a lot of middle managers, salesmen, engineers, lawyers, and the like to do the sorts of things that happen automatically on an open network.

Now, in the older media Julian mentions, this overhead was simply unavoidable. Newspaper distribution cost a significant amount of money, and so newspapers had no choice but to charge their customers, pay their writers, sign complex deals with their advertisers, etc. Similarly, television stations had extremely scarce bandwidth, and so it made sense to expend resources to make sure that only the best content went on the air.

The Internet is the first medium where content can go from a producer to many consumers with no human beings intermediating the process. And because there are no human beings in between, the process is radically more efficient. When I visit the New York Times website, I’m not paying the Times for the content and they’re not paying my ISP for connectivity. That means that the Times‘s web operation can be much smaller than its subscription and distribution departments.

In a world where these transaction costs didn’t exist, you’d probably see the emergence of the kinds of complex financial transactions Julian envisions here. But given the existence of these transaction costs, the vast majority of Internet content creators will settle for free, best-effort connectivity rather than going to the trouble of negotiating separate agreements with dozens of different ISPs. Which means that if ISPs only offer high-speed connectivity to providers who pay to be a part of their “walled garden,” the service will wind up being vastly inferior (and as a consequence much less lucrative) than it would be if they offered full-speed access to the whole Internet.

I have generally agreed with Clay Shirky (and Tim) that micropayments either don’t work very well or just aren’t needed given other pricing options / business models. But my eBay activity over the past few years has made me reconsider. I was going back through some of my past eBay purchases tonight and leaving feedback and I realized that I have made dozens of micropayments in recent months for all sorts of nonsense (stickers, posters, small car parts, Legos for my kids, magazines, and much more). Most of these items are just a few bucks, and many don’t even break the 99-cent threshold. I think that qualifies as micropayment material. And certainly I am not the only one engaged in such micro-transactions because there are countless items on eBay for a couple of bucks or less.

Of course, just because micropayments and PayPal work marvelously in the context of the used junk and trinkets we find on eBay, that does not necessarily mean they will work as effectively for many forms of media content. Advertising or flat user fees are probably still preferable since consumers don’t like the hassles associated with micropayments. Still, they seem to be working fine on eBay, so it would be wrong to claim that they never work online.

Clay Shirky is one of my favorite commentators about the economic and social changes that the Internet is bringing to the media world. Last year I linked to his fantastic essays on the folly of micropayments. Last month, Shirky wrote this excellent post about what’s wrong with the Nick Carr brand of Internet old-fogeyism:

Prior to unlimited perfect copyability, media was defined by profound physical and economic constraints, and now it’s not. Fewer constraints and better matching of supply and demand are good for business, because business is not concerned with historical continuity. Fewer constraints and better matching of supply and demand are bad for current culture, because culture continually mistakes current exigencies for eternal verities. This isn’t just Carr of course. As people come to realize that freedom destroys old forms just as surely as it creates new ones, the lament for the long-lost present is going up everywhere. As another example, Sven Birkerts, the literary critic, has a post in the Boston Globe, Lost in the blogosphere, that is almost indescribably self-involved. His two complaints are that newspapers are reducing the space allotted to literary criticism, and too many people on the Web are writing about books. In other words, literary criticism, as practiced during Birkerts’ lifetime, was just right, and having either fewer or more writers are both lamentable situations. In order that the “Life was better when I was younger” flavor of his complaint not become too obvious, Birkerts frames the changing landscape not as a personal annoyance but as A Threat To Culture Itself. As he puts it “…what we have been calling “culture” at least since the Enlightenment — is the emergent maturity that constrains unbounded freedom in the interest of mattering.”

This is silly. The constraints of print were not a product of “emergent maturity.” They were accidents of physical production. Newspapers published book reviews because their customers read books and because publishers took out ads, the same reason they published pieces about cars or food or vacations. Some newspapers hired critics because they could afford to, others didn’t because they couldn’t. Ordinary citizens didn’t write about books in a global medium because no such medium existed. None of this was an attempt to “constrain unbounded freedom” because there was no such freedom to constrain; it was just how things were back then.

One of the core tenets of the “Internet is ruining culture” thesis seems to be that most people aren’t qualified to produce culture, and so they should shut up and consume what the officially recognized experts churn out for them. During the second half of the 20th century, Birkerts was a member of this exclusive club, producing the culture that most Americans had no choice but to passively consume. That position of influence and authority no doubt was a great source of personal satisfaction. Moreover, it was probably true that the Boston Globe performed a valuable filtering function, ensuring that (mostly) the best stuff got printed and the rest didn’t.

But as satisfying as it is to have a large captive audience who have to take whatever you dish out, I think Bikerts is mistaken to think that the world is divided into two classes of people, a beknigted few who like to produce culture and the great unwashed masses who only wish to consume it. Quite the contrary, there are a lot of people who enjoy producing culture (even not-very-good culture) of their own as much as they enjoy consuming other peoples’ culture. There are a lot of people out there who aren’t especially interested in opening their morning papers and reading about whatever book Bikerts happens to have read this week. They find the participatory culture of the web, in which they have hundreds of reviews to choose from, and can write their own reviews if they think the existing reviewers are missing the boat, much more enjoyable.

Bikerts’s complaint, at root, seems to be that he’s no longer the center of attention. He doesn’t say that exactly, choosing instead to talk about “the self-constituted group of those who have made it their purpose to do so.” But clearly one of his main objections is that the riff-raff are paying attention to each other’s opinions instead of those of him and his colleagues.

Now, it may very well be true that the average quality of literary criticism will decline as more people become amateur critics. But I don’t think that’s a problem. The good critics will still be out there, and anyone who wants to read them will be free to do so. However, as literary critics of all people should understand, the process of producing culture is at least as satisfying as the process of consuming it. Hence, the far more important result of the Web is that there will be a lot more opportunities for aspiring literary critics to find an audience, however small, and to experience the satisfaction of having others read and respond to your work. That increase in satisfaction for tens of thousands of amateur critics is far more important than the modest reduction in prominence suffered by professional culture critics.

In response to my post on network prioritization on Tuesday, Christopher Anderson left a thoughtful comment that represents a common, but in my opinion mistaken, perspective on the network discrimination question:

It’s great for a researcher building a next generation network to simply recommend adding capacity. This has been the LAN model for a long time in private internal networks and LANs with Ethernet have grown in orders of magnitude. This is how Ethernet beat out ATM in the LAN 10 years ago or so. Now that those very same LANs are deploying VOIP they wish for some ATM features such as proritization. And now they add that prioritization (‘e’ tagging for example) to deploy VOIP more often than they upgrade the whole thing to 10G. There are however business concerns in the real world. Business concerns such as resource scarcity and profit. In a ISP business model, users are charged for service. If usage goes up, but subscriptions do not (e.g. average user consumes more bandwidth) there is financial motivation to prioritize or shape the network, not to add capacity and sacrifice profit with higher outlays of capital, as long as the ‘quality’ or ‘satisfaction’ as observed by the consumer does not suffer.

Anderson is presenting a dichotomy between what we might call the frugal option of using prioritization schemes to make more efficient use of the bandwidth we’ve got and the profligate option of simply building more capacity when we run out of the bandwidth we’ve got. The former is supposed to be the cheap, hard-headed, capitalist way of doing things, while the latter is the sort of thing that works fine in the lab, but is too wasteful to work in the real world.

I think this dichotomy is false. Prioritization does not come for free. Let me highlight two ways in which I think Anderson’s argument underestimates the costs of introducing prioritization into the network. The first is the really obvious one: for a given throughput, a “smart” router with more sophisticated prioritization will require more transistors, and therefore will be more expensive, than a “dumb” router that simply routes packets on a first-in, first-out basis. That means that the choice is not between spending more money on capacity or pushing the “prioritize” button on their network control panel. The choice is between spending money on routers (and other stuff) necessary for a faster network or spending money on routers (and other stuff) necessary for smarter network.

Now, it’s an empirical question whether, for a given budget, you’ll see a larger improvement in network performance from buying faster equipment than you will from buying smarter equipment. My second-hand and very cursory understanding of the research is that this is a subject on which network engineers disagree, but that the most common view is that the “faster” option tends to work better. But obviously someone could come along and prove them wrong in the future. What’s not in doubt, though, is that to make an apples-to-apples comparison, you have to consider the costs of prioritization alongside the costs of adding capacity.

Anderson also ignores what I think are likely to be the more significant costs of a prioritization scheme, and that’s the need to build the kind of global infrastructure that would be necessary to make a network-wide prioritization scheme functional. A prioritization scheme that only worked on one network wouldn’t be terribly useful, since the high-priority packets could still get stuck in congestion the moment they left their home network. So if we’re serious about giving a customer end-to-end quality of service guarantees for their VoIP calls, we need to come up with a standard that the vast majority of ISPs adopt. Such a standard would almost certainly come with substantial overhead. Someone would have to police each user (or ISP’s) use of the prioritization flags to ensure no one simply marks all of their packets high priority. There’d need to be an elaborate billing system so that the payment for prioritization is distributed in an equitable manner to the various network owners who carried the traffic for part of its journey.

I’m skeptical about whether such a system is even feasible, but perhaps it is. What can’t be disputed, however, is that all that infrastructure would cost money. Which means that Anderson is completely wrong about this:

In capatilist system we use private ownership to distribute these resources via the communication medium of money (most efficient system discovered so far!).

In fact, money is an extraordinarily inefficient means of communicating value when the size of the transactions are small. As I’ve said before, this is precisely why micropayments never took off, and are unlikely ever to do so. It’s also why ISPs have almost entirely moved to flat-rate, rather than hourly, billing. Below a certain level, the costs of financial transactions overwhelm the value of what’s being exchanged.

In those situations, it often makes more sense to come up with non-monetary ways to allocate resources. Bartering systems such as BitTorrent are one particularly elegant solution. But in other cases, flat rate pricing and ad hoc rationing turns out to work pretty well too. There’s a reason that ISPs in the 1990s all abandoned hourly rates and implemented flat-rate billing instead. For somewhat complex reasons, it turned out that the cost of trying to bill users by the bit simply outweighed the benefits of doing so.

Now again, it’s not impossible that technological breakthroughs will change this equation and make more finely-grained pricing cost-effective. But the important point is that you can’t treat such pricing as free. The more complex your pricing scheme is, the more resources (both labor and transistors) it takes to implement it. Prioritization only makes sense if the costs–including the administrative and technological overhead–outweigh the benefits.

Last year I linked to this fantastic article by Clay Shirky on the reasons micropayments never took off. Shirky wrote:

A transaction can’t be worth so much as to require a decision but worth so little that that decision is automatic. There is a certain amount of anxiety involved in any decision to buy, no matter how small, and it derives not from the interface used or the time required, but from the very act of deciding. Micropayments, like all payments, require a comparison: “Is this much of X worth that much of Y?” There is a minimum mental transaction cost created by this fact that cannot be optimized away, because the only transaction a user will be willing to approve with no thought will be one that costs them nothing, which is no transaction at all. Thus the anxiety of buying is a permanent feature of micropayment systems, since economic decisions are made on the margin – not, “Is a drink worth a dollar?” but, “Is the next drink worth the next dollar?” Anything that requires the user to approve a transaction creates this anxiety, no matter what the mechanism for deciding or paying is.

Shirky’s argument looks as solid today as it did six years ago. He pointed to three payment methods as alternatives: aggregation (bundle the business section with the sports section), subscription (take the paper every day), and subsidy (have advertisers pay for the paper). These have all clearly taken off–subsidy especially. Shirky followed that essay up with another in 2003:

The fact that digital content can be distributed for no additional cost does not explain the huge number of creative people who make their work available for free. After all, they are still investing their time without being paid back. Why? The answer is simple: creators are not publishers, and putting the power to publish directly into their hands does not make them publishers. It makes them artists with printing presses. This matters because creative people crave attention in a way publishers do not. Prior to the internet, this didn’t make much difference. The expense of publishing and distributing printed material is too great for it to be given away freely and in unlimited quantities–even vanity press books come with a price tag. Now, however, a single individual can serve an audience in the hundreds of thousands, as a hobby, with nary a publisher in sight. This disrupts the old equation of “fame and fortune.” For an author to be famous, many people had to have read, and therefore paid for, his or her books. Fortune was a side-effect of attaining fame. Now, with the power to publish directly in their hands, many creative people face a dilemma they’ve never had before: fame vs fortune.

It seems to me that the right way to think about this is that there is still a market for content on the Internet, but the dominant medium of exchange for content is increasingly eyeballs rather than dollars. I get paid for my time, not with dollars, but with something I value more at the margin: people who are interested in what I have to say. Eyeballs have two key advantages over dollars as a medium of exchange for Internet content: first, the reader doesn’t consider his attention to be a cost, the way he would a micropayment. And second, unlike micropayments, the transaction has virtually no overhead.

In a sense, there’s nothing new about this. People in creative professions have always taken part of their compensation in eyeballs rather than dollars. Paul Krugman would doubtless be able to make a lot more money as a consultant than he does as a columnist, yet he continues to write his columns, presumably because having a million people getting his column every week is worth more to him. The vast majority of musicians never go pro–indeed, most never even turn a profit. Although they would of course like to be rich and famous, they are mostly in it because they love having people who want to hear their music. Hollywood is likewise full of people who crave the spotlight.

I think this point can be generalized: money is an efficient medium of exchange for meatspace transactions, but it tends not to work very well for transactions in cyberspace, which tend to be more numerous, lower value individually, and harder to verify due to the lack of a physical presence. This doesn’t mean that there will be no markets on the Internet. Instead, markets will tend to be mediated by things other than money. For blogs, it’s eyeballs.

BitTorrent is a market in which the bit is a medium of exchange:

Because BitTorrent relies on the upstream bandwidth of its users–and the more users, the more aggregate bandwidth is available for sharing the files–it is considered good etiquette to leave one’s BitTorrent client open after downloading has completed so that others may continue to gain from the file that has been distributed… Some clients also report the “share ratio”, a number relating the amount of data uploaded to the amount downloaded. A share ratio of 1.0 means that a user has uploaded as much data as they have downloaded. A share ratio greater than 1 means that a user has uploaded more than they have downloaded. It is generally considered good form to at least share back the equivalent amount of traffic as the original file size. Share ratios are more important on BitTorrent than they are on other peer-to-peer file sharing networks, because many BitTorrent trackers require users to maintain a minimum global share ratio. On some trackers that require users to register, the minimum global share ratio may start at around 0.5 and increase over time, so that the user has adequate time to upload and share their files. Users with a share ratio below the minimum may be put into a restricted “upload-only” mode, where they may not download until their share ratio reaches the minimum.

Bits are an obviously efficient medium of exchange on file-trading networks, since it’s something that all users value, and because they can be exchanged with trivial overhead. And as commenter George persuasively argued in this space a few months back, BitTorrent tends to use bandwidth resources extremely efficiently. BitTorrent is a market in which barter has proven more efficient than money-mediated transactions.

Open source software development is also a market that’s not mediated by money. It has two essential media of exchange. The first, as with blogs, is attention: both the attention of hackers’ peers who are impressed with a particularly elegant hack, and the attention of the broader public, who use and appreciate the software.

The other medium of exchange is code itself. The GPL is a contract among open source programmers: I’ll give you my code and let you modify it, if you give me your modifications and let me modify them further. As with eyeballs and bits, this proves to be an efficient medium of exchange, because the overhead is low, and because code sharing benefits the receiver a lot more than it costs the giver. It turns out that the benefits an open source programmer gets from having others improve his code for him exceed the monetary benefits he could have gotten from trying to commercialize the code.

Money is a very important and useful medium of exchange for high-value, tangible products. For small-value, intangible products, the costs tend to exceed the value of the transactions–especially when you add in the overhead associated with making payments at a distance. Fortunately, human beings are clever. We’ve begun to find a variety of substitutes for money that work better in cyberspace. This isn’t the repeal of market economics, but rather an extension of them to deal with changed circumstances.

I just came across this great article from 2000 by Clay Shirky. He argues that micropayments are a bad idea that are doomed to fail because they economize on extremely cheap resources (bandwidth, content) at the expense of a relatively valuable resource–the user’s time. He persuasively argues that there’s no such thing as a no-brainer transaction–if a micropayment is large enough to be worth the bother to the seller, then it’s large enough that the buyer will want to consider it before approving it. But the time and annoyance of having to think before clicking on every link the user encounters might vastly outweigh the value of the penny being transacted.

Another way to put this, I think, is that we already have micropayments: they’re called ads. Users pay for content, not with cash payments, but with their time– giving a split-second of attention to the ads on the page as they read the content. And it turns out that in most cases, advertisers are willing to pay more for ad impressions than users are willing to pay for content. And users prefer ads to micropayments because micropayments take more time and hassle to deal with than ads that can be easily and safely ignored.