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"Smile, It's Over!"--A Commentary by Prof. George Priest

(This essay originally appeared in the Monday, November 4, 2002, edition of The Wall Street Journal.)

Smile, It's Over!
By George L. Priest, John M. Olin Professor of Law and Economics

This time the Microsoft case really is over. In a series of orders and opinions, District Judge Colleen Kollar-Kotelly has put the matter to rest. The Justice Department's settlement, placing restrictions on various Microsoft contract and business practices, will go into force for five years. The claims of the eight litigating states asking for stronger constraints are dismissed.

Judge Kollar-Kotelly's four opinions are careful and exceptionally thorough. Her predecessor, Judge Thomas Penfield Jackson, held a hearing of only a few hours and devoted just four paragraphs to the issue of remedy. Judge Kollar- Kotelly, in comparison, held hearings for 32 days and has written nearly 600 pages of opinion. There are no realistic grounds for appeal, and the litigating states would be foolish to attempt it.

This resolution has nothing to do with politics. The case was brought by the Clinton Justice Department. It was settled under the Bush administration, but entirely on terms dictated by the opinion of the D.C. Circuit Court of Appeals by a unanimous en banc panel evenly divided between conservatives and liberals. The settlement was challenged vigorously by eight state attorneys general, most of whom are Democrats. Their advocacy was taken seriously by Judge Kollar- Kotelly, who is a Clinton appointee. Her dismissal of their claims and approval of the Justice Department settlement is entirely on the merits.

The problem was that the Justice Department's theory of the case was weak to begin with. Justice began by conceding that Microsoft had acquired its Windows operating system monopoly totally legitimately by producing a superior product. There were absolutely no illegal practices by Microsoft in acquiring the monopoly that they could point to. But the legitimacy of the monopoly caused Justice immense trouble because it stood throughout as proof -- as we all know -- of the vast consumer benefits from the creation of a standardized operating system.

Faced with the fact of these consumer benefits, the Justice Department created an evil. According to Justice, Microsoft's success had established what it called the "applications barrier to entry." There were so many software applications written for Windows that it was hard for any other software firm to compete with Microsoft. It was possible, however, that two non-Microsoft software products, Netscape's Navigator browser and Sun's Java, might over time potentially develop into platforms for applications that could compete with the Windows operating system. Justice had to concede that this development was totally hypothetical. These products hadn't developed into platforms yet; but they might some day do so.

The Justice Department's case, then, was that Microsoft had violated the antitrust laws by engaging in various business practices that made it harder for these "nascent competitive threats" to ever succeed. What had Microsoft done? First, Microsoft developed its own browser, Internet Explorer, and made it superior to Navigator. Second, Microsoft had integrated Explorer into Windows, making Windows more valuable to consumers. Third, Microsoft had entered a number of exclusive dealing contracts and had designed parts of Windows that gave Windows an advantage over Navigator and Java. On these claims of illegality, Justice sought to end the exclusive dealing contracts and other preferential business practices but, more importantly, to require Microsoft to sell Explorer separately from Windows, to constrain the ability of Microsoft to further improve Windows by integrating new software features (the tying arrangement claim) and, finally, to break up Microsoft into separate applications and operating systems companies.

Judge Jackson accepted the argument wholly and ordered the break-up. The Court of Appeals, however, applied some common sense. Why should Microsoft's development of a superior browser be regarded as an antitrust violation? How is a court to determine with any confidence what is the optimal design of an operating system? The exclusive dealing contracts and preferential business practices may be unfair. They distorted competition on the merits and so should be enjoined. But practices of this nature, even if illegal, do not provide a sufficient justification to break up Microsoft. Again, the Justice Department had conceded that Microsoft had acquired the monopoly legitimately. As a consequence, as the District Court put it, the appropriate remedies in the case should be designed "not to terminate the monopoly, but to terminate the exclusionary acts and practices." The Justice Department's settlement does so.

Many have compared the Microsoft case to AT&T. We all have experienced the enormous benefits that have followed the break-up of AT&T. Why shouldn't we expect similar benefits from breaking up Microsoft?

The comparison, however, is inapposite. The AT&T monopoly of telephones was not acquired and maintained, as was Microsoft's, by triumph in the market. It was enforced by state and federal regulation which AT&T had manipulated to its great advantage. The "break-up" of AT&T more closely resembles a privatization. It consisted of a restructuring that separated the natural monopoly divisions which continued to be regulated (though that regulation has diminished over time) from those divisions that could and should face competition. Actually, the constraints proposed by the eight litigating states and rejected by the District Court would have subjected Microsoft to a form of regulation somewhat like that of AT&T prior to the break-up.

No one can claim that the Microsoft litigation has resulted in large societal benefits. The business practices, now prohibited, were never an important part of Microsoft's business plan nor were they responsible for much of Microsoft's success. Fortunately, the good sense of the Court of Appeals and of Judge Kollar-Kotelly has rejected the far-reaching remedies that once were sought. The lesson, we would suppose, is that it is appropriate in a capitalist economy controlled by law that, in every generation, the largest and most successful firm in the nation should be subjected to a serious antitrust investigation. Microsoft has suffered that investigation. Some relatively minor practices have been enjoined, but it remains largely free to continue to improve its products long into the future.


Mr. Priest teaches law and economics at Yale Law School. He has been a consultant to Microsoft, but was not involved in the litigation.