Policy Analysis No. 324

Dismal Science Fictions: Network Effects, Microsoft, and Antitrust Speculation

Executive Summary

The Justice Department and other parties that have aligned against Microsoft have invoked novel economic theories to justify new antitrust doctrines and to revive old ones. Those theories imply that in high-technology markets, a product or technology with a head start or large market share may have an insurmountable advantage over its rivals. The theories invoke factors called network effects, increasing returns, or path dependence. Any of those can allegedly create lock-in, leaving markets stuck with inferior products or technologies. But these theories leave out important elements of real-world markets. Reexamination of the empirical evidence demonstrates that the claimed examples of lock-in are not market failures.

Scrutiny of the economic theories brought to bear against Microsoft show similar failings. Despite allegations that Microsoft uses lock-in to engage in exclusionary and predatory business practices, exclusion and predation do not explain its behavior. Furthermore, antitrust enforcers should not focus on who has the right to control the Windows desktop. Such a right matters little because consumers can alter the desktop quite easily. At any rate, the market will eventually put desktop rights in the hands of those who value them most. Finally, progress in software inevitably involves increased functionality. A legal rule against adding functions to software products would impede progress in the software industry.

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Stan Liebowitz is a professor of economics in the Management School of the University of Texas at Dallas. Stephen E. Margolis is a professor of economics at North Carolina State University.