Economic Viewpoint
UNCLE SAM HAS NO BUSINESS BUSTING UP MICROSOFT
BY GARY S. BECKER

06/19/2000
Business Week
36
(Copyright 2000 McGraw-Hill, Inc.)

The Justice Dept. wound up its antitrust case against Microsoft Corp. by calling for a radical and rarely used remedy: splitting the company into two independent parts. An operating-systems company would own the Windows operating system and related assets, while an applications company would own the Internet Explorer, Excel, Word, and other Microsoft applications. The government argues that Microsoft's economic power and business practices have discouraged innovations in the computing industry, so this radical step is necessary to encourage a faster rate of technological progress.

I believe that the government's emphasis on innovation is the right one for this industry. The rate of technological progress is more important for computers and the Internet than any monopoly effects on prices of operating systems, browsers, and other products. However, the claim that a breakup of Microsoft will hasten the rate of progress in the industry is unconvincing.

The Justice Dept. and its experts argue that progress is spurred by competition and that the Windows and applications companies will compete against each other much more fiercely than if they remained part of Microsoft. But a presumption that competition fosters innovation is a weak foundation for breaking up this company.

For one thing, the theoretical argument that competition increases technological progress is more complicated than many other economic propositions. For example, Harvard University professor Joseph A. Schumpeter (1883-1950), a pioneer in the theory of economic development, argued just the opposite: that monopolies stimulate a faster rate of progress. In his judgment, monopolies encourage rapid innovations because they have protected markets. As a result, they do not have to worry that competitors will copy their new products and then compete more effectively against the innovators.

An adequate analysis has to consider potential entrants. In the past, new computer companies undermined established companies--whose positions seemed as unassailable as Microsoft's does now. The government's antitrust case against IBM's monopoly proceeded slowly through the 1970s. But during the same decade, its dominance was being undermined by Apple Computer Inc. and others that were developing user-friendly personal computers.

Schumpeter coined the term ``creative destruction'' to describe the process whereby new companies innovate in order to take over markets dominated by others. This may have already started to happen to Microsoft through the introduction of systems that entirely bypass Windows to provide access to e-mail and other parts of the Internet.

The Justice Dept. has not presented any quantitative evidence that Microsoft's dominant position in operating systems slowed down progress in the computer industry. The government and its experts cite a few potential innovations that were supposedly discouraged by Microsoft's aggressive behavior. Even if these examples are valid, the government does not consider whether there have been other innovations stimulated by a large market for new software applications made possible by the dominant Windows platform. NO PRODUCTIVITY PINCH. Moreover, the case for breaking up one of the top companies in the world should be based on more than a few examples of allegedly adverse effects of its business practices on innovations. There should be at least major circumstantial evidence that Microsoft's policies had detrimental effects on productivity. But the evidence suggests loudly that the government should leave this sector alone.

During the past four decades, the computer-Internet industry has experienced one of the most prolonged and rapid rates of technological progress of any in modern times. According to a recent study by economist Robert J. Gordon of Northwestern University, an expert on productivity, the computer industry's rate of production improved annually almost 20% between 1961 and 1999. Prices of computers, adjusted for these improvements, fell at about the same annual rate.

Microsoft built its powerful position in operating systems during the second half of this 40-year period, but the rate of progress in this industry did not slow down then. Indeed, Gordon finds that it accelerated during the 1990s, especially during the second half.

This evidence explains why the computer sector is so important to the U.S., and why it is admired everywhere. Government officials reacting to complaints of competitors should not break up a leading company in a remarkable industry.