Federalism in the Information Age

Published April 1, 2004

The classic argument in favor of federalism is that we all benefit from competition among the 50 states, which serve as “laboratories” for public policy. But many businesses and some consumer groups support broader federal preemption. Some federalism scholars dismiss this as shortsighted, a sacrifice of sound institutional arrangements for a merely temporary policy victory.

The time has come for some heresy in federalism scholarship. I offer five points suggesting the usual arguments in favor of federalism need reworking in the Information Age.

1. What magic makes the states the right size to supply rules for modern conflict resolution? Advances in communications and transportation have “shrunk” the states. If this doesn’t matter, on the theory that competition between jurisdictions is so great, why not have regulation by counties?

2. In tax and corporate law, competition among the states works as an important safeguard of freedom. But what about laws in the area of alcoholic beverages, car dealerships, telecommunications, banking, or insurance? Peculiarly anti-market and anti-consumer arrangements have existed in some states for decades, apparently untouched by interstate competition. If competition among the states is sometimes so weak, are there better ways to secure freedom? Making federal regulators more accountable to legislators, for example?

3. In many Information Age sectors, especially banking, insurance, and telecommunications and e-commerce, markets are national or international, not merely state-wide. Here, competition among the states will be weak, because a nationwide provider does not realistically have the option of exiting, say California or New York.

4. When competition is weak, aggressive states can impose heavy regulatory taxes on out-of-state ventures, since most of the cost will be borne by employees, consumers, and investors in other states. New York Attorney General Eliot Spitzer’s latest crusade against the Office of the Comptroller of the Currency’s new bank rules offers one example.

5. The case for the link between thriving markets and uniform law is stronger than federalism scholars allow. Historically, most of the great systems of commercial law–Admiralty law, for example–evolved towards uniformity over relatively wide geographic areas. Choice of law clauses can help supply certainty in the face of jurisdictional divides, but are they an adequate substitute?

The desire for uniformity that some see as short-sighted is bound up with the need for certainty in law-making, a fundamental aspect of the Rule of Law. Witness the dismay with which Wall Street greeted the Federal Communications Commission’s latest and strangest exercise in federalism, turning over key aspects of telecom competition rules to the states in the Triennial Review.

On the other hand, some of the arguments against federalism are just plain stale. The much-feared “race to the bottom” that led some opponents of relatively minimalist Delaware corporate law to decry federalism, in practice seems to be a bogeyman, lurking in closets of the ivory tower but not seen in real life. Pressures within the states (to raise taxes, to regulate more) are barely tempered by interstate competition, not overwhelmed by it.

And some business support for federal preemption is curiously naive, as if federal legislators have a commitment to market institutions upon which one may rely. Uniformity is not of much value if the policies adopted are hostile to markets or wildly unpredictable in themselves. Cable television, originally rate-regulated by the states, was deregulated at the federal level in 1984, then re-regulated in 1992, then re-deregulated in 1996, and now there are rumors of regulation again.

The world is changing, and some political arrangements upon which we have relied may need to change with it. This does not mean abandoning the goal of preserving freedom through institutional checks and balances. If federalism might fail us in some sectors, we need far stronger legal and regulatory reforms at the federal level than anything undertaken so far. Ultimately, international authorities bear watching as well.

Solveig Singleton ([email protected]) is a lawyer and senior analyst with the Competitive Enterprise Institute’s Project for Technology and Innovation. CEI will soon release a call for a broad program of regulatory reform as a key component of economic policy.