- The Washington Times - Tuesday, May 30, 2000

If his questions in court last Wednesday are any indication, Judge Thomas Penfield Jackson is about to break up Microsoft into several smaller pieces. The judge signaled his intention to impose the Justice Department's "wish list" against Microsoft, and then invited the government to go even further. He also indicated that he is so anxious to hand down his decision that he will forego further hearings on the economic impact of that decision. Never mind the fairness and wisdom of the judge's action. Never mind the imprudence of substituting optimism about innovation for in-depth analysis of the breakup's effect on consumers. And never mind the recklessness of overhauling the rules for an industry that is driving our current prosperity.
Never mind all that. Let's make things simple and look at just one thing: What will a breakup do to prices? It's textbook economics, and this is how it goes.
The science is pretty basic and the lesson is as simple as the familiar tale of the razor and the razor blade. Razors sell for less than they might otherwise because the companies that sell them also sell the blades that fit. So it's worth holding down the price of the razor to sell more blades. This idea of creating customers with an irresistible deal on the first purchase is common in the world of software. Indeed, it no longer turns heads when a software maker offers the plain-vanilla version for the cost of shipping in hopes of selling the whipped cream and hot fudge. And in the Microsoft trial, experts from both sides agreed that the opportunity to sell applications software everything from the Excel spreadsheet to the Encarta Encyclopedia gave Microsoft a reason to hold down the price of Windows.
The government's chief expert economic witness estimated that an extra copy of Windows in use would lead to the sale of about $160 in other software for Microsoft. If the government divides Microsoft into a Windows company and an Applications company, the Windows company won't be getting that $160 anymore, and so would raise its price. The consequence is clear: Consumers will end up paying more for the Windows operating system if the Department of Justice gets its way and cleaves Microsoft in two (or three, if Judge Jackson follows through on his not-so-subtle hints).
How much more? Now we're probably asking too much from economic science. But if you take the formula the government's economist used one I happen to disagree with the profit maximizing price for Windows would triple from $65 to about $225.
Although economists could debate the precise amount of the likely increase with as much success as we've debated the "natural" rate of unemployment, there/s not much disagreement about the direction of the change: Windows prices go up, applications prices don't go down, consumers lose.
Of the three chaired economics professors the Justice Department entrusted to tell the court why it should break up an integrated company an extraordinarily rare event in the history American antitrust two of them didn't appear to know that consumers could end up paying a lot more money for their operating systems. Another just shrugged it off, saying that "companies selling complementary products commonly find ways to solve the complementary monopolies' problem."
Which raises some questions: Has the Justice Department carefully thought through the impact of its remedy proposals on the public? Miss Reno's economists didn't tell the court how the Department's remedies would affect the prices or the quality of software or anything else that regular people care about. Instead they claim that the government's remedies will unleash a wave of innovation an assertion that appears to have been resoundingly rejected by investors, as the Nasdaq plummeted in the wake of the government's leaked proposal. And these economists espouse a view that only those so remote from the real world of business could possibly hold that breaking up a sizeable American company and regulating the parts would impose no serious costs. Indeed, these Polyannas managed to take both the dismal and the science out of economics. Antitrust remedies are supposed to make consumers better by preventing companies from hobbling competitors. They aren't suppose to punish the company that violated the civil antitrust laws; fines and jail terms are reserved for criminal violations like price-fixing that Microsoft has never been accused of. And they certainly aren't supposed to punish the public, whose interests the antitrust laws are designed to serve.
Why, then, has the government put forth a proposal that would almost certainly cost consumers a lot of money? The Justice Department convinced itself and the court that Microsoft had violated the antitrust laws despite overwhelming evidence that Microsoft was making consumers better off through lower prices, greater output, and faster innovation. Now it can't figure out how to fix the nonexistent problem.
Perhaps somewhere deep in the bowels of the administration two other questions are being asked: How did Janet Reno and Joel Klein get into this mess? And how can we get the American public out of it?

David Evans is a senior vice-president of National Economic Research Associates and a consultant to Microsoft.



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