Although Microsoft has all but settled its antitrust difficulties with the Department of Justice, nine hold-out states continue to demand in a D.C. courtroom that Microsoft license a stripped-down (no browser, no video player) or “modular” version of its Windows operating system to computer manufacturers. Microsoft holds that that such a regulation would compromise severely the overall quality of the Windows operating system. The states maintain that such a regulation would be good for competition and ultimately good for consumers.

Most of the states’ witnesses have whined that their companies would do more business if only the federal government were to strip Windows of some of its application goodies. Now that seems true enough; Microsoft would do less business and the competitors would do more. But so what? What does any of that have to do with increasing competition or making consumers better off? If Judge Colleen Kollar-Kotelly accepts this absurd theory of competition she flunks Economics 101 and will be reversed on appeal.

Would independent suppliers do more business if a court ordered General Motors to ship Buicks without steering wheels or radios? Sure they would, as consumers scrambled around to put together a useable product with features that they preferred. General Motors would do less business and non-GM firms would do more. But almost no economists would claim that such a regulation would increase competition in any sensible way, make any economic sense whatever, or that consumers would benefit from such an absurdity.

In it’s purest form, the states’ theory holds that any competitive advantage or efficiency that one firm offers consumers always excludes or forecloses some would-be rival from the market and that this hurts competition and consumers. But this conclusion is simply dead wrong.

As Nobel Laureate economist F.A. Hayek correctly understood, competition is a “discovery process” where consumers decide the final allocation of scarce resources by rewarding some entrepreneurs and punishing others. In addition, consumers ultimately decide the number of suppliers and the market share of the contestants. When certain entrepreneurs are excluded by consumer choice or foreclosed by efficiency from some market, it only means that consumers are reasonably satisfied with existing suppliers and will not support additional competitors. It does not mean that markets have “failed” or that competition is deficient and requires any antitrust meddling.

In free, open markets, advantages and efficiencies provided by successful firms help consumers directly and are the fruits of the competitive process. To deny these fruits to consumers by law with the guess that competitors will supply complimentary products or services of similar quality is pure speculation. Besides, the disincentive effect of such a regulation to first-mover firms would be disastrous. Where is the incentive to continue to improve a product beyond some basic level if competitors, at any point down the road, can bludgeon you with antitrust and strip away the value of your investments?

Unfortunately, Microsoft has spent the bulk of its court time arguing that it is simply not practical to strip out its browser and video applications, i.e., that the entire integrity of the Windows operating system would be affected negatively by such a regulation. Certainly Microsoft is obligated to rebut the states’ contention that the deconstruction they propose is simply not possible. But there are dangers to such a defense.

If any expert witness or plaintiffs’ attorney convinces Judge Kollar-Kotelly that Microsoft’s impracticality argument is not correct then nothing that Microsoft has argued would preclude the judge from ordering a mini-divestiture. Having conceded to the states an entirely incorrect theory of competition, Microsoft would be left defenseless until the appellate stage of this never-ending legal monstrosity.

A modular Windows may make little practical sense but the wider and more important issue is the faulty theory of competition that the states support. The states have been allowed assert that a proposal to create more competitors at any cost means more “competition” and that the antitrust laws should sanction such nonsense. They have been allowed to make the interests of the competitors of Microsoft, and not those of the consumers, the primary focus of any proposed judicial remedy. And Microsoft, despite its firm resolve and abundant resources, has missed an opportunity to expose this antitrust charade compellingly before a national audience. What a shame.