REVEALED: MPAA's latest anti-piracy move accidentally, completely screws Hollywood studios

By David Sirota , written on February 25, 2014

From The News Desk

From Marlon Brando's civil rights statement in absentia to Michael Moore's anti-war speech, the Academy Awards ceremony played host to its share of high-profile protests. This year, though, the biggest protest will likely happen outside the Dolby Theater.

Pando has learned that visual effects industry workers plan a mass demonstration against the major studios' ongoing efforts to offshore post production work. That offshoring has led to the slow collapse of the American FX industry at the very moment digital effects have become a central ingredient in entertainment products.

The fight between the studios and the tech wizards who actually make movies possible is not new. Encouraged by ever-rising subsidies available overseas, the movie industry has for years been shipping millions of dollars of digital work outside the U.S. This kind of work is vulnerable to such offshoring because it can be done anywhere, even if logistics demand that much of the physical shooting remain in New York or Los Angeles.

Up until now, there was little the American visual effects industry could do about this. With the studios bankrolling politicians and protecting their political agenda through the $60-million-a-year Motion Picture Association of America, Washington has refused to intervene on behalf of the workers.

Unfortunately for the studios, however, Pando has also learned that the visual effects workers have just been handed a powerful new legal and political weapon, one with the potential to fundamentally change the economic dynamics throughout the entertainment and tech industries.

And here's the twist: It is a weapon the MPAA itself created in its own desperate attempt to prevent Internet piracy.

The giant sucking sound coming from the tech sector

Before getting to the case at hand, it is worth reviewing how thousands of digital artists, graphic designers, animators, and technicians in America's visual effects industry became the latest casualties of an ongoing trade war -- one that has already decimated domestic blue collar industries and is now turning the information sector into its newest battlefield.

In 2006, Princeton economist Alan Blinder famously warned that the critical economic divide in the future will "be between those types of work that are easily deliverable through a wire or via wireless connections with little or no diminution in quality, and those that are not."

This truism has upended huge swaths of the tech sector, as everything from call centers to back office services have moved offshore to countries with lower wages, more lax labor protections, and more corporate-compliant politicians than here in the U.S. Meanwhile, the "wire" (read: Internet) has allowed the final products and services from that cheaper labor to be frictionlessly transmitted back to the American market with little degradation, thus boosting corporate profit margins.

With many tech jobs subsequently moving from industrialized nations to more exploitable developing world economies, this was the digital version of the giant sucking sound that Ross Perot famously predicted.

Offshoring wasn't supposed to cause upheaval between advanced economies, because the wage and regulatory differentials in those economies were far smaller. There shouldn't be many labor expenses for companies to reduce if they uproot from the United States to, say, Britain.

These laws of "free trade" economics were supposed to provide at least some inherent job security for high-skill creative types like the roughly 9,000 people who the Bureau of Labor Statistics estimates work in motion-picture-related visual effects. Sure, those high-skill workers would still have to worry about some developing-world competitors who could offer studios cheaper labor, but they retained language and logistical advantages over those competitors. At the same time, those U.S. visual-effects workers were never supposed to have to worry about serious overhead-cost competition from other industrialized countries.

That's where governmental subsidies came along to distort the market. Violating the spirit, and the letter, of World Trade Organization regulations and U.S. domestic trade statutes, industrialized countries like Canada, Britain, Australia, Germany and New Zealand have started offering massive taxpayer-financed handouts to studios if the studios source their visual effects and post-production services in those nations. In British Columbia, for example, public subsidies pay up to 60 percent of the entire salary of visual effects workers. The United Kingdom and New Zealand have been following suit with recent efforts to further expand their own subsidies.

This never-ending taxpayer-funded bailout has grossly distorted the global market for visual effects, artificially deflating studios' overall price for visual effects in the high-subsidy nations.

The consequences in the United States have been predictable. As Pando previously reported, four decades after actor Charlton Heston urged Congress to "fight subsidy with subsidy," U.S. states are now spending roughly $1.5 billion on their own subsidies to compete with one another for what US production work still remains. Even so, the states are increasingly unable to keep up in the never-ending international subsidy race (and they are typically losing money on the projects they do manage to attract).

Consequently, as the Los Angeles Times reports, "At least a half a dozen visual effects houses have gone out of business in recent years as more work has fled to foreign countries, especially Canada and Britain, that offer generous tax breaks for postproduction work."

An upcoming documentary on the offshoring situation in Hollywood puts the number of firms lost at a whopping 21, including some of the industry's highest profile companies.

As The Verge reports:

Rhythm & Hues — the creators of Life of Pi's Oscar-winning visual effects — went bankrupt earlier this year... Digital Domain, who provided the VFX for Titanic and counted James Cameron among its founders, was declared bankrupt and sold in late 2012... (and) even DreamWorks (was) forced to lay off 350 employees earlier this year." The Los Angeles Times notes that Rhythm & Hues executives specifically "cite the damaging effect of foreign subsidies that made it increasingly difficult for the company to bid on projects.
Fast forward to the future, the Bureau of Labor Statistics predicts that even as visual effects-based content expands, job growth in the domestic visual effects industry "will be slowed by companies hiring animators and artists who work overseas" -- specifically in countries that illegally subsidize their industry.

The Visual Effects Society summed it up by saying "the amazing irony is that while 47 of the top 50 films of all time are visual effects driven and billions of dollars of profits are generated yearly, the actual people who create the work are becoming an endangered species in California." Variety boiled it down to a simple headline: "Foreign Incentives Help Crush Once-Booming F/X Biz in U.S."

For those who have survived in the domestic industry, the situation is as bleak as it has been for so-called permatemp workers in the software industry.

"Gone are the days of staff positions," says Daniel Lay, a visual effects animator who runs the influential VFX Soldier blog that tracks industry trends. "If you aren’t on a project at the company you work for, you were laid off. Smaller companies have transitioned to offering no benefits and employee misclassification."

This has been a boon to the six major studios that the MPAA represents. According to the Hollywood Reporter, those giants "combined to generate more than $4.3 billion in operating profit in 2013, up 23 percent from $3.5 billion in 2012."

The situation has also created an opaque financial market in which studios are trading tax incentives for up front cash through financial behemoths like U.S. Bank and Bank of America. It is a system that one critic calls a scheme "allow(ing) purchasing corporations to shelter income."

Forcing Big Government to confront Big Hollywood

With political power players like the MPAA so invested in offshoring, the decimated visual-effects industry hasn't had much recourse.

Even though both WTO rules and U.S. domestic laws explicitly allow for severe financial punishments against governments that distort trade by strategically subsidizing industries, there's a difference between those laws existing and governments enforcing them.

Consider what happened back in 2007 when the U.S. Trade Representative opted to ignore a coalition of Hollywood unions petitioning the Bush administration to enforce existing anti-subsidy laws against Canada. When asked to justify that decision in a Freedom of Information Act request, the administration offered just four pages of heavily redacted documents. Since then, President Obama, whose campaigns have been financed by the big studios, has refused to reopen or reevaluate the case.

Taken together, the message has been clear: presidents of both parties have been willing to use what discretion they have to defend the studios, regardless of the merits of the underlying legal argument.

But that brings us to this drama's surprise second act.

The against-all-odds protagonist in this Hollywood sequel is Daniel Lay, the 33-year-old heretofore anonymous blogger behind the website "VFX Soldier," which chronicles the tribulations of the visual effects industry. Lay, an animator who has worked for DreamWorks Animation, Sony Pictures Imageworks, and Digital Domain, enlisted the Washington law firm of Picard, Kentz and Rowe to explore whether there were legal options to fight the MPAA.

In a twist that seems crafted by professional scriptwriters, they discovered a legal document submitted by the MPAA just two weeks ago, when the organization decided to weigh in on an seemingly inconsequential International Trade Commission case involving 3-D printers. In that filing, obtained by Pando, the MPAA argued that digital goods should be considered imports and therefore subject to the stringent copyright protections the big studios so desperately want.

From the filing (emphasis mine):

To effectuate Congressional intent to protect domestic industries, the Commission can and must construe the term "articles" to include imported electronic transmissions, consistent with its own precedent and decisions from other administrative agencies and courts.

...The need to regulate the burgeoning international trade in digital intellectual property is widely recognized by U.S. policymakers. The U.S. government has consistently recognized that international trade in digital forms of intellectual property is every bit as "real" as trade in traditional manufactured goods.

The use of electronic means to import into the United States infringing articles threatens important domestic industries such as the motion picture and software industries, as well as U.S. consumers and the government at all levels. In a statement to Pando, the MPAA proudly reiterated this position.

"Congress has given the ITC broad authority to protect U.S. industries from unfair acts in importation," said spokeswoman Kate Bedingfield, adding that if the government doesn't recognize digital products as imports, "American businesses lose an important protection, which puts them at a significant international disadvantage."

On the face of it, that esoteric legal argument from the MPAA seemed unremarkable -- since the failure of SOPA, the movie industry has tried everything it can to protect its bottom line. Yet, Lay's lawyers soon realized that the MPAA's legal position had enormous implications for offshored post-production workers.

If, as the MPAA insists, movies should be recognized as imports then so too should post-production work. That means visual effects work would be subject to the same subsidy-busting provisions which previously were primarily applied to physical goods like steel and lumber.

In other words, emboldened by the MPAA's filing, the visual effects workers are now in a position to use the big studios' own arguments to compel the government to slap trade tariffs on those studios' own productions in high-subsidy countries. Those arguments will be especially powerful because the MPAA made them to the very same governmental agencies that will process the visual-effects workers' case. Additionally, the workers can now take matters into their own hands.

In a feasibility study prepared by Picard, Kentz and Rowe, the lawyers explained that workers don't have to rely on the discretion of the U.S. Trade Representative. Instead, they could invoke an existing countervailing duty law which, according to the lawyers, is "mandatory in its application" and "does not grant the Administration discretion to decline" an action.

Translated from legal-ese, this means the anti-subsidy laws are insulated from political interference, no matter how many friends in high places the MPAA has.

If visual effects workers can show the Commerce Department and the U.S. International Trade Commission that an import is benefiting from foreign subsidies and therefore illegally undercutting a domestic industry, the federal government is obligated to automatically slap a punitive tax on that import. Such a tax would in practice erase the extra profit margins the studios are gleaning from the foreign subsidies, thereby leveling the competitive playing field for American workers and eliminating the purely economic incentive for the studios to engage in mass offshoring.

With so much subsidy cash at stake, the MPAA will almost certainly try to prevent this. But here's the thing: when the workers bring their case against the subsidies and the MPAA inevitably tries to fight them, the workers can now simply cite the MPAA's own legal case and echo the MPAA's own call "to protect U.S. industries from unfair acts in importation."

They can, in short, hoist the studios on the studios' own legal petard.

The wider implications for the tech economy

With its own grounding in digital commerce, Silicon Valley has an obvious interest in how digital goods are classified. Underscoring that, Google has weighed in on the same obscure 3-D printing case, perhaps in an effort to legitimize its own current or future offshoring practices. In its filing obtained by Pando, the company insists that because "there is not a single mention of electronic transmissions" in the underlying trade law from 1922, it "appl(ies) to physical goods and not electronic transmissions."

Beyond the sheer insanity of implying that lawmakers 90 years ago deliberately excluded Internet communication from trade statutes, Google's argument was debunked by the visual effects workers' lawyers, who outlined how government agencies like the U.S. Customs and Border Protection agency and the Court of International Trade (which oversees the ITC) routinely treat digital products as regular imports.

As important, Google's case was also legally eviscerated by -- you guessed it! -- the MPAA. In its review of legislative history, the MPAA ended up debunking the idea that digital goods are not imports. In the process, the MPAA further made the visual effects industry's prospective case against the legality of the big studios' own lucrative subsidies.

David Yocis, a lawyer who has consulted with visual effects workers, says that the MPAA is caught between its two competing priorities, and that its legal filings prove it may finally be forced to choose between the two.

"The MPAA is so worried about piracy they are not going to claim that on the Internet you can do anything that you want," he said in an interview with Pando. "When push comes to shove, they are probably more concerned about preserving the ability of the government to crackdown on piracy than on preserving their subsidies."

Could political meddling still stop the law from being enforced?

Despite the MPAA inadvertently exposing the big studios to severe trade sanctions, the domestic visual effects industry still faces serious obstacles in its legal crusade to end the subsidies and create an equal economic playing field.

For instance, there is the sheer difficulty of organizing. Though Lay did manage to raise the money necessary to commission the feasibility study, and though a town hall meeting of VFX workers last year drew a huge crowd to discuss political strategies, the industry has no union. That will make it more logistically difficult -- but certainly not impossible -- to meet trade statutes' requirement to prove legitimate support for the case among the visual effects industry as a whole.

Additionally, even though the statutes in question do not give the government the same discretion it used to quash earlier cases against Big Hollywood, there remains the potential for stealth political interference. After all, the Obama administration has close ties to the entertainment industry and the MPAA is one of the capital's most powerful  lobbying groups.

On top of that, the head of the Commerce Departments' Trade Enforcement, Paul Piquado, is only a few degrees of separation from the big studios. He came to the Commerce Department from a plum position in the administration of Pennsylvania Gov. Ed Rendell, who just so happens to one of the most reliable (and handsomely paid) allies of Universal Studios' owner Comcast. Before that, Piquado cut his legal teeth at Sidley Austin, a law firm that has represented the MPAA.

These connections and others probably could not alone stop the move by the visual effects workers. However, they could potentially slow down any final enforcement action to at least temporarily give the big studios the best of both worlds, aka copyright privileges under international trade laws without the attendant enforcement of anti-subsidy provisions under those same trade laws.

For his part, Lay says that in this David-versus-Goliath battle fit for a Hollywood blockbuster, the workers' new legal strategy has the best chance of success, and certainly better than trying to match other countries in an ever escalating race to increase subsidies.

"We chose this route because it is the least political option for us, and we have very leftwing people and very rightwing people getting together to support this," he told Pando in an interview between meeting with visual effects workers at Disney and organizing the upcoming Academy Awards protest. "My generation is very cynical about the system right now, and we're trying to use the system as best as possible. What would it say about our system if it can't be used in the way it is set up to be used?"

[Illustration by Hallie Bateman for Pandodaily]