Viacom and YouTube squared off in a New York appeals court yesterday as Viacom tries to overturn last year’s judgment in YouTube’s favor. The outcome may well decide what kind of Internet economy we will have — a top-down contest between a few big companies, or a bottom-up ecology where small startups continue to invent the future as fast as they can.

The legal fight is about who bears the burden of stopping copyright infringement online. In 2007, media titan Viacom International Inc. sued YouTube Inc., then recently acquired by Google Inc. Viacom argued that among the millions of short video clips uploaded by users to YouTube were some that violated Viacom’s copyrights, and that YouTube didn’t do enough to police the site to prevent this.

YouTube insisted that it did exactly what the law — the Digital Millennium Copyright Act (DMCA) — required: When notified of an infringing clip, it promptly removed it. That’s the essential bargain Congress crafted in passing the DMCA — copyright owners have the responsibility of identifying and reporting copyright infringement, and Internet services have a duty to remove content quickly when notified.

Last year, a district court in Manhattan agreed with YouTube, and confirmed that copyright owners are the ones who must police their copyrights on the Internet. After all, only the copyright owner knows whether content is authorized to be on the Internet and, if it is, where it’s supposed to be appearing. In fact, even while complaining that its content was appearing on YouTube, Viacom secretly hired at least 18 different marketing firms to flood the YouTube service with authorized content for its own promotional purposes. Plus, in many cases the law permits a video to be posted even if copyright owners object. Parodies, reviews, short clips and other kinds of transformative works are often protected under the fair use doctrine.

That doesn’t mean Internet companies have no responsibilities. If copyright owners notify them of infringement, the DMCA requires Internet companies to process those notifications and remove content quickly. And YouTube does just that. (When Viacom delivered 100,000 notices in a single day, YouTube processed them all within a day or two.)

Viacom and its entertainment industry allies want more. They think services like YouTube should be obligated on their own to police the Internet for “unauthorized” content. If they don’t do “enough,” Viacom says, they should face the kind of billion-dollar judgments that Viacom is seeking against YouTube.

It’s obvious why Viacom and its copyright lawyers want this change in the law: It would make their lives easier to pass the burden of enforcing their copyrights onto someone else. But innovators — and end users — wouldn’t be so lucky. It would be impossible for an Internet company to know when it had spent “enough” on copyright policing without taking its chances in court. And in the process of trying to satisfy this impossible burden, it would end up shutting down many of the transformative user-generated works like parodies that the law is designed to protect.

If these were the rules, only the big companies could afford to play. YouTube today actually does far more than the law requires; its ContentID system actually scans all the videos uploaded to its site looking for likely infringing works. But developing that system took years and cost more than $30 million. It also requires YouTube employees to review complaints from people who think their videos were wrongly blocked. YouTube has also spent more than $100 million in legal fees defending itself against the lawsuit.

True, Google today can afford to do these things. But the YouTube of 2005 could never have afforded those kinds of costs. And neither could the Google of 1998, or the eBay of 1995, or the Facebook of 2004. If Viacom prevails, it will be a crushing blow for small startups — the YouTubes, Facebooks and Googles of tomorrow. The message will be that you can’t play in today’s Internet unless you’re a big fish. And that would be a disaster for innovation.

Mark Lemley is the William H. Neukom Professor at Stanford Law School and a lawyer at Durie Tangri. He represents Google, but not in this case.