Kat-
It certainly doesn't help. I find, though, that small retailers and producers do offer some things that one doesn't get from downloads--packaging, printed discs, artwork, better quality sound. The biggest thing we have to offer is guidance--most small retailers in the folk CD business have a good deal of experience in the field, and can make useful suggestions and recommendations.
   Smithsonian-Folkways is in a unique position--they didn't pay for the initial production of the recordings, and, as far as I can tell, they
aren't saddled with royalties. I suspect that if the practice spreads, it's going to severely stifle the introduction of any new recordings (or new releases of old recordings.