Oct 23, 2018

When States Get It Wrong and the Case for Federal Preemption

This is the third installment in a three-part series on federalism and technology.

This series began by discussing the benefits of state-based technology policy, but there are also serious tradeoffs and consequences from having 50 or more different regimes attempting to govern emerging technologies. In the second installment, I discussed how some of these consequences can be mitigated or overcome if states are aware of them and willing to work cooperatively. However, at times the consequences of state level regulation, both intentional and unintentional, can illustrate the case for federal preemption by the legislature or actions by federal administrative agencies to ensure that innovation can proceed and improve the lives of consumers.

Just as federalism can be market preserving by creating competition between different state and local markets, it can also be market destroying. When states erect different regulatory schemes to govern a particular product, it can increase barriers to entry. With the sharing economy, more individuals have become entrepreneurs than ever before; however, the licensing requirements in each state often vary. Not only is this a problem of visionary innovators in fields such as autonomous vehicles, who must often go through lengthy and burdensome processes to begin testing in each individual state, it is also a burden on small entrepreneurs who seek to sell homemade goods.

Depending on the product, entrepreneurs may be subject to very different requirements in each state and a decision to move states can bring burdensome and costly licensure expenses. Regulation by multiple states increases the cost of entry into each new state.

Multiple states regulating the same disruptive technology can also lead to less efficient products. As Brian Knight notes in his discussion of the regulation of FinTech, “Redundant regulations can harm the very groups that regulation seeks to help.” This can happen because complying with so many different regulations may lead to exit from the market or because the cost of compliance increases the burdens on the new technology such that it loses its advantage.

Additionally, the cost of compliance with multiple states instead of one federal regulator can require the allocation of more resources like larger legal teams and fewer product updates and/or an increased cost to consumers. One advantage of sharing economy has been its ability to lower the costs of certain products or their substitutes. When innovators are forced to comply with redundant regulations, it is likely that not all of those costs can be absorbed, reducing the competitive advantage of a lower priced innovative substitute.

To paraphrase Animal Farm, “All states are created equal, but some are more equal than others.” As I briefly discussed in the second part of this series, this is clear for populous states or those with particularly powerful markets such as New York and California. But in the case of technology regulation, particularly when technology cannot narrowly fit in geographic borders, a state with the most restrictive regulations can become a de facto national regulator by the desire of companies to have one set of standards for all users.

This is currently to the situation for digital privacy. Given the high compliance costs (including the risks of noncompliance), the EU’s restrictive General Data Protection Regulation (GDPR) may become the new global internet policy as opposed to the US’s more permissionless approach. As I have previously noted, California’s attempt at a state level internet privacy law could make it a national regulator by default, not merely because of California’s market power, but because of the burden for a company in having to exclude or develop different settings for the residents of a single state. Instead of a race to the bottom, innovations that by their very nature are borderless may instead place everyone under a single state’s regulatory regime.

While states play an important role in the development of new policies to govern disruptive technologies and encourage innovation and entrepreneurship, there is a case for federal preemption. As Brent Skorup points out in his analysis of the problem with state “net neutrality” bills, state attempts to regulate the internet could result in a balkanization that would prevent many of the internet’s benefits. Likewise, autonomous vehicles may fail to truly takeoff if they must stop at each city or state border for approval. Federal preemption for technology policy makes the most sense when state regulations put artificial borders around a naturally interstate technology.

In more traditional developments, we have been able to rely on various balancing tests for when a state should be preempted. For example, the Dormant Commerce Clause and Commerce Clause have robust jurisprudence that prevents states from creating protectionist regimes that would disrupt an otherwise competitive market. In some of these cases, such as Wickard v. Filburn, federal preemption may represent a clear federal overreach that disrupts an individual’s autonomy. In many others, preemption can prevent states from disrupting an emerging technology market or from forcing the consequences of their policy choices on others.

Still, we should be cautious to make such trades lightly and view them as necessary only when the decentralized model creates more problems than mere inefficiency. As Adam Thierer notes, “Most efforts to preempt remain muddied by all sort of regulatory baggage, and federal agencies and budgets just continue to swell without constraint. We should never forget that, at root, preemption represents the aggregation of power in a centralized fashion, and preempting without simultaneously growing the size of the federal government often proves enormously challenging.”

In many cases, states are able to promote a disruptive technology by being a first adopter and promoting its use through innovation encouraging policies; however, there are states that seem determined to rein in innovation out of an abundance of precaution. Just as with many new technologies, it is best to first test small and then expand. There are also cases where an economy of scale requires a national solution to rein in an overly precautionary state or to ensure that innovation is able to soar.

In the end, both the states and federal regulators should look to limit their interference with innovation to times when it is truly needed and consider the best level of governance for each technology as it arises. It remains clear that state and local governments have significant roles to play when it comes to retaining a society in which innovation is free and its benefits have the greatest impact.

Photo credit: Official White House Photo by Joyce N. Boghosian State of the Union 2018

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