International Think-Tank on Innovation and Competition
The Punishment of Innovation
February 15th, 2005
The recent decision confirming the heavy sanctions on Microsoft represents a puzzling outcome for those who believe in the benefits of competition and innovation. Beyond the largest fine in the history of antitrust, the bottom line in this case is that we now have two dangerous precedents. The first is the principle in which antitrust authorities can indirectly forebid price reduction: it looks paradoxical, but Microsoft has been punished for giving Media Player (an application able to download audiovideo contents) for free with its operating system Windows. It's a bit as if a telephone manufacturer was prevented from inserting answering machines in its mobiles. The second is the possibility for antitrust authorities to reveal business secrets which are the fruit of years of research for a company, as are the source codes which Microsoft will now have to make public. This is almost like asking Coca Cola to reveal the secret formula of its famous drink and allow anybody to use it.
The first factor will reduce competition, the second will jeopardize investments in R&D by high-tech companies. The saddest aspect of this is that Europe is doing it, after a decade of low growth which is primarily due to poor competition in most sectors and lack of substantial R&D investments in Europe!
It is important to understand the reasons for such a myopic European point of view. I can point out at least three of them. The first one derives from an obsolete approach to antitrust. This is not an absolute judgment. For instance, many of the initiatives undertaken in the last years have been important and correct. However, the new economy requires a new vision. What antitrust authorities have been doing is basically to fight against dominant firms and to promote entry so as to increase the number of firms in each industry. This is a correct approach for most of the traditional industries, but a misleading one for high-tech sectors, where certain firms are dominant because of their merits and the structure of their sectors, and not because of barriers to entry or collusive actions. This is the case of market leaders as Microsoft and many other aggressive competitors in high-tech industries with network effects (which feature important economies of scale). In the last years some economists, including myself, tried to emphasize the necessity of a new vision on antitrust at least in the arena of scientific research. In dynamic and open sectors (open because entry is free) dominant firms have a "pro-competitive" role reducing market prices, improving product quality and pushing innovation: the fact that these firms are dominant is the consequence of these positive actions and not the evidence of a monopolistic power.
Antitrust authorities have been fighting both barriers to entry and dominant firms with partial success either against one or the other: the results on market prices are usually small and sometimes even negative. The problem is that such an approach can be extremely misleading. A main example of its fallacy is in the use of indexes of market concentration as measures of market power. Whenever there are few firms and they have very unequal market shares, a sector becomes suspect of collusive behaviour, the leading firm being the main culprit. In reality, in dynamic industries the opposite is usually true and even a sector dominated by a single firm can be perfectly competitive and extremely cost efficient as long as (potential) entry is free. That's why anti-trust authorities should shift their priorities and move ahead only with the promotion of free entry. Such a view is gradually spreading in US and UK, but is less popular in continental Europe . Unfortunately, as of now, the priority in the EU appears to be fighting market leaders: this keeps delivering poor results in sectors with high barriers to entry and even negative results in sectors where there are not effective barriers to entry!
A second reason behind the European approach to antitrust is related to a vague understanding of the role of leading firms in technological innovation. Even most economists are used to thinking about market leaders as firms with weaker incentives to invest in R&D. In reality, in 2000 Microsoft spent more than 16 % of its turnover in R&D, but even apart from this unique case, Intel spent 11,5 %, Motorola 11,8 %, Nokia 8,5 %, IBM, Hewlett Packard and Xerox between 5 and 6 %, and so on. The fact that these companies remain at the top of the technological frontier in their respective industries is not the sign of a monopolistic position in the traditional sense, but the fruit of their investments. Modern economic research, based on old ideas of the austrian economist Joseph Schumpeter, have clarified such a mechanism. For instance, in the software sector, one cannot speak about competition in static terms: competition is purely dynamic, that is, focused on investment in innovation. Microsoft and its rivals invest today to obtain results tomorrow, and these results are better products. It is an open race, as in any field of research: the winners dominate a market until someone else has a better idea. There are not even patents on most of these ideas. The race never stops and consumers gain when it is harder and more open. In front of such a competition, again, the priority should be to grant free entry of competitors with good ideas and not to limit the reward for brilliant ideas. Fighting dominant firms and the fruits of their innovation can only reduce those investments in R&D which are nowadays the main engine of growth.
Finally, there is a structural issue which derives from the same spirit underlying the EU, which is a compromise between liberal and socialist positions. This compromise has brought the EU toward a bias for centralization and excessive activism, resulting in the attempt to coordinate anything (and not always properly) at the EU level, even when there is no need, in using antitrust as a way to organize markets rather than to make them work properly, and even in a well known protectionist attitude in trade policy. I cannot even exclude that a protectionist inspiration lies behind the punishment of an American company as Microsoft. This is certainly not a noble inspiration. Moreover it is counterproductive: at the end, it will mainly hurt European consumers, those of today and, even more, those of tomorrow!
The EU should rather promote innovation, subsidize companies investing in R&D and experiencing businness success, and preserve their intellectual property rights. The recent decision against Microsoft goes in the opposite direction, and will have negative consequences for competition and innovation in Europe in the years to come.
