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path dependence
``` [I mentioned the other day that a Wall Street Journal columnist was defending Microsoft by disputing the existence of the economic phenomenon of path dependence; I treated this as just short of flat earthism. To be fair, I should circulate something by the guys that the columnist got his arguments from, Stan Liebowitz and Steve Margolis, with Liebowitz's kind permission. You can find more about their views at SL's Web page, whose URL is http://wwwpub.utdallas.edu/~liebowit/netpage.html ]
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[by Stan Liebowitz and Steve Margolis]
In its most general meaning, path dependence is the condition that some result is sensitive to the particular events that lead to that result. As it has recently been applied in economics, path dependence means that the final resting position of a system is itself related to the events leading up to that resting place (Arthur, David, Krugman, North). This concept generates much interest in part because it appears to conflict with traditional economic models that normally derive an equilibrium without taking any account of the sequence of events that lead to that equilibrium.
This concept has a natural appeal since it seems obvious that events that occur in the process of adjustment to a change must influence the final outcome. This appeal, however, must be tempered by the realization that any theory is a simplification of reality. Thus it remains a crucial question whether theories that leave out such effects are leaving out something important.
The phrase "lock-in by historical events," (Arthur 1989) captures what is perhaps the best expression of the alleged importance of path dependence for economics. Lock-in has special meaning here. In some sense, of course, we are always locked in to a number of things; to eating, breathing, and remaining in our solar system to name three. But this is not what lock-in means in this literature. Path dependence lock-in is a lock-in to something bad, or at least a lock-out of something better. It constitutes an inferior economic outcome such as an inferior standard or product where superior alternatives exist, are known, and where the costs of switching are not high. These events, in Arthur's terminology, are "small" or "insignificant".
The insignificance of these historical events is not their effects--for their consequences are alleged to be large, but rather that they may seem inconsequential at the time they occur. There is an implicit allegation that such events are neither inevitable, in which case they might be taken as instances of the stinginess of nature, nor the product of significant conflict or deliberation, in which case they are the unavoidable consequence of human folly. A part of the appeal of the path dependence literature is the implicit allegation that these lock-ins, these bad economic outcomes, are avoidable by small but prudent interventions.
Path dependence is an idea that has spilled over to economics from intellectual movements that arose elsewhere. In physics and mathematics the related ideas come from chaos theory. One potential of the non-linear models of chaos theory is sensitive dependence on initial conditions: Determination, and perhaps lock-in, by small things, insignificant events. In biology, the related idea is called contingency -- the irreversible character of natural selection. Contingency implies that fitness is only a relative notion: Survival is not of the fittest possible, but only of the fittest that happen to be around at the time. Scientific popularizations like James Gleick's book Chaos, Mitchell Waldrop's Complexity, and Stephen J. Gould's Wonderful Life have moved these ideas into the public view.
The warm reception given to path dependence in the social sciences is undoubtedly due in part to the attention given to these related ideas in the physical sciences. We must caution, however, that the analogies are incomplete. If turtles become extinct, they will not reappear suddenly when circumstance change to make it advantageous to have a shell. But if people stop using large gas guzzling engines because gasoline has become expensive, or begin to apply strict liability in product defects, they can always revert to their old ways if they came to regret the switch. Stephen J. Gould, who has made the affirmative case for contingency in biological evolution, nevertheless has noted the limitations of the analogy to social evolution.
What may have also been lost in social sciences' borrowing of this concept are the active debates in the real sciences about the generality or applicability of chaos and contingency. Christian DeDuve, for example, argues that contingency applies only within important constraints in biological evolution. While all of our particulars are not inevitable, some things about us, perhaps the most important things, may well be.
Similarly, path dependence and chaos have an apparent unity that may be illusory. In chaos theory small events or perturbations do tend to cause the system to evolve in very different ways but the system never settles down in any repeatable path or fixed equilibrium. The essence of "chaos theory" is that this seemingly endless pattern that never finds an equilibrium is not random and turns out to have a particular structure. Path dependence in economics has imported the view that minor initial perturbations are important, and has grafted this on to a theory where there are a finite number of perfectly stable alternative states, one of which will arise based on the particular initial conditions. The never ending "disequilibrium" that seems the essence of chaos theory is thus missing from the economic analysis of path dependence.
We have been critical of the use of path dependence in the literature. Our critique has followed several lines. We have explored and refined the concept of path dependence in our article in the Journal of Law, Economics and Organization. (V. 11. N 1 pp. 205-26) This article, we believe, provides a foundation for discussion of the importance of path dependence. We demonstrate that there are at least three very different kinds of claims that have been associated with the title "path dependence." The distinguishing characteristic amongthese claims is whether there is an implicit or explicit assertion about efficiency. A crucial condition is the implied state of knowledge that occurs when choices are made.
In our view, some of the confusion surrounding path dependence has resulted from a failure to distinguish among these types of path dependence. We show that the common cases of path dependence, the ones that cause almost everyone to agree that path dependence exists, in fact, do not pose any counter to the neoclassical paradigm. Only a particularly strong form of path dependence poses such a counter, and we demonstrate that the conditions required for this form of path dependence are quite stringent.
In all of this, we make no assertion that durability is unimportant in economics. Durability is important. The first two forms of path dependence that we identify, the weaker forms, constitute simple recognition that some things are durable. We also note that there are important durabilities, such as institutions and standards, that transcend the simple durabilities of individual capital goods. But we also contend that economics has always recognized the importance of these durabilities, and that much of the current excitement around path dependence has to do with strong-form claims that path dependence is a new kind of market failure. The JLEO article offers documentation of these claims.
A second thread of analysis examines the concept of network effect (externality), a related concept that is often considered a prerequisite for path dependence. Here, we have noted that not all network effects are externalities, and that not all externalities lead to inefficiency (e.g. pecuniary externality). Additionally, any garden variety form of increasing returns can lead to the same results as occur in the set of models claiming to demonstrate path dependence. In fact, path dependence may be thought of as a variation of natural monopoly, where the winning monopoly does not have the lowest cost curves, but merely the lowest cost due to its larger output. Our work on this can be found in Research in Law and Economics (1995), and the Journal of Economic Perspectives (Spring 1994).
The third strand of our work has been the debunking of the empirical support often claimed for path dependence. These cases are the QWERTY typewriter keyboard, the VHS videorecorder, the DOS/Intel computer design, and so forth. Although frequently cited, and charming to tell, these stories of markets gone astray turn out to be based on poorly documented evidence that dissolves upon closer inspection. Our article in the Journal of Law and Economics (April 1990) debunks the QWERTY keyboard myth. The JLEO article discusses the VHS-Beta story. Several of our articles make the case that the Macintosh interface won, but that it is now called Windows 95 (e.g. Harvard Review of Law and Technology).
This third strand is crucial to the path dependence literature, as least as related to the strong-form claims of market failure. It is not possible to prove theoretically (a non-existence proof, if you will) that society can never get stuck with wrong products or standards, just as we can't prove that angels don't walk among us. We can only show that the required conditions appear rather stringent. However, if we are to take the strong form of path dependence seriously, then it seems reasonable to insist that at least a few (and presumably many) good cases should be at hand. Yet in our view no such cases have been brought forward that can survive scrutiny.
Finally, for this audience, there is the claim that path dependence enhances the value of economic history. We think not. If historians only record facts and dates, then by pinpointing the "small" event that caused a market to go astray, they might be thought to have achieved their highest calling, presuming that they can identify, ex post, these small events. If, however, historians provide explanations for events, then the strong form of path dependence would make their job empty, since path dependence claims that small, unpredictable, events are responsible for final outcomes, eliminating the ability of historians to describe truthfully the grand forces at work in the economy. By analogy, do you think weathermen are of greater or lesser value in a world where weather is controlled by the flapping of butterfly wings, or by larger and more predictable forces? While we will all presumably agree that self-interest is an inappropriate basis for making scientific judgments, we at least should understand that path dependence is not likely to usher in a golden age for economic historians.
References
Liebowitz, S. J. and Stephen E. Margolis. April 1990. "The Fable of the Keys," 22 Journal of Law and Economics 1-26. ____________________. 1994a "Network Externality: An Uncommon Tragedy", 8 Journal of Economic Perspectives 133-50 (Spring) . ____________________. 1994b "Are Network Externalities a New Source of Market Failure?" 16 Research in Law and Economics. ____________________. "Path Dependence, Lock-In and History" Journal of Law, Economics and Organization, April, 1995. ____________________. "Should Technology Choice be a Concern for Antitrust? "Harvard Journal of Law and Technology (Summer 1996). ```
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