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Soft Microeconomics
The squishy case against you-know-who.
By Paul Krugman
I wrote this piece in WordPerfect, not Word, mainly because Word's equation editor is awful (are you listening, Mr. Myhrvold?), and I may as well use the same software for plain English articles and professional gobbledygook. I surf with Netscape Navigator and check e-mail in Eudora. So, I am not a fan of Microsoft's products. Moreover, for reasons explained below, it is in the public interest to have Bill Gates always running a bit scared of the Justice Department. Nonetheless, the more anti-MS propaganda I read, the more pro-MS I get. There is a case against Microsoft, but it is not the one you hear, and I would hate to see crude misunderstandings posing as sophisticated analysis prevail.
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![]() But how does this concentration of production take place? One of the depressing things about public discussion of the Microsoft case, even among supposedly well-informed people, is that much of it has come to be dominated by a basically primitive view about what increasing returns do to markets--namely, that they convey monopoly power purely randomly, on whoever happens to be in the right place at the right time--and that this "path dependence" allows clearly inferior technologies to become "locked in." Now path dependence has its place--but when applied to the Microsoft case it misses the point. After all, high-technology companies are themselves quite aware of increasing returns, and their strategies--above all the prices they charge when they are trying to establish themselves in a market--are very much affected by that awareness. ![]() |
![]() The same logic applies to increasing returns on the demand side: As a manufacturer, if I know that a typical customer's choice of browser depends both on the price and on the number of other people using that browser, I will initially make my own browser cheap--maybe even free--so as to build market share. In either case I must incur initial losses that are, in effect, part of the price of entry into the market--an add-on to the cost of developing a product in the first place. And because nobody will want to pay this entry fee without a reasonable hope of earning it back, only a few companies will enter a market subject to strong increasing returns. The point is that the eventual domination of an industry by a few companies--and a high rate of profit on sales for these companies in the later stages of the cycle--doesn't happen because these companies just happened to get a head start. On the contrary, it is precisely because it isn't purely a matter of luck--because everyone competes so fiercely on prices in an effort to get some of those nice increasing returns--that only a few dare enter. ![]() |
![]() So this is the case for leaving Microsoft alone: High-tech competition is, necessarily, a competition that ends up being won by a handful of players. Those who make vast fortunes may not always be the most deserving--but so what? For the rest of us, what matters is not who wins or loses, but how they play the game. And if they know or suspect that too much success will be punished--that anyone who does too well will become a target of envy-driven litigation--they will have that much less incentive to play hard. ![]() |
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![]() But the fact is that MS has been very careful not to use its undoubted power to practice any crude, obvious version of what is known in the trade as "vertical foreclosure." WordPerfect and Netscape work just fine on my Windows-based machine. This restraint may partly reflect Microsoft's market strategy--after all, Microsoft beat Apple partly because Apple did practice vertical foreclosure, and as a result inhibited the development of complementary software (although the main problem was Apple's persistent belief, despite all the evidence to the contrary, that everyone would be willing to pay a premium price for a niftier machine). For sure, however, Microsoft has mainly been restrained by the knowledge that any crude use of its power would indeed land it in court. ![]() |
![]() Here's what worries me: Given the subtlety of the real issues here, what is the chance that this stuff will be decided on its merits? When you hear that despite the fact that he has economists who know better, the Justice Department's Joel Klein apparently either believes or chooses to claim that this case is about path dependence, you start to wonder. And when you hear that the anti-Microsoft side has retained the services of that economic and technology expert Bob Dole, you start to despair. ![]() |
![]() ![]() An article in the Feb. 25 Wall Street Journal ("QWERTY Spells a Saga of Market Economics") is a good example of the mistaken view that path dependence is the core of the case against Microsoft. Nicholas Economides, who really understands these things, took the Wall Street Journal to task in a letter that it, of course, did not print. His useful site also contains a good, slightly anti-MS discussion of the vertical foreclosure issue on browsers as well as a set of links to just about everything relevant to the case. Paul Krugman is a professor of economics at MIT. His new book, The Accidental Theorist and Other Dispatches From the Dismal Science, will be published this month. His home page contains links to many of his other articles and essays.
Illustrations by Robert Neubecker.
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