Stephen Margolis's Contributions to Economics and Political Economy.

• Author: Boettke, Peter J.
• Position: Essay

Stephen Margolis's contributions to economics and political economy deserve recognition.

Margolis is a product of the University of California at Los Angeles (UCLA) Ph.D. program during the "Golden Era" of the 1970s, receiving his degree in 1978. This was a time of great contributions to microeconomics, in particular price theory and industrial organization, by UCLA economists, including Armen Alchian, Harold Demsetz, and Jack Hirshleifer. There were also significant contributions being made in macroeconomics by Robert Clower and Axel Leijonhufvud, which attempted to provide an alternative set of microfoundations to the New Classical Economics of the Chicago School. One important characteristic of the UCLA approach was that it studied economic forces at work rather than merely focusing on equilibrium states after the economics forces have done the job. In this sense, the UCLA tradition was one that focused on market processes and how the institutional framework of property rights, contract law, and the ordinary business of politics influences that market process. The key to the analysis was the incentive structure within which individuals found themselves operating rather than the individuals' pure decision calculus.

Margolis, along with his fellow UCLA graduate Stan Liebowitz, internalized these lessons and went on to make fundamental contributions to economics, economic history, political economy, and public policy. In this essay, I briefly discuss his contributions to economics, their impact, and their potential for our understanding of the nature of the market, competition, innovation, and public policy.

By the mid-1980s, the "new learning" of industrial organization (which had resulted from the contributions made by Alchian, Ronald Coase, Demsetz, and others) was being replaced by a "new new learning" in the journals and among policy makers. Instrumental to the success of this new literature was the discovery of a whole new class of market failures caused by increasing returns and network externalities. The theoretical relevance of network effects for industrial structure, monopoly power, and economic efficiency first explored by Michael Katz and Carl Shapiro (1985, 1986) provided the foundations for the theory of increasing returns and lock-in later developed by W. Brian Arthur (1989). Arthur suggested that in the presence of network externalities, the often repeated claim that "history matters" assumes a new meaning: the decentralized decision making in an unhampered market can (and often will) lead to significant losses in productivity. For example, Paul David (1985) showed that network externalities can result in a lock-in to a suboptimal technology and discussed the case of the QWERTY keyboard. According to David, the scientific and historical consensus was that the QWERTY keyboard, which was developed to address the specific needs of mechanical typewriters, had survived the test of time notwithstanding the emergence of vastly superior competitors, among which was the Dvorak or simplified keyboard.

According to Liebowitz and Margolis's (2012) own recollection, it was the claim that large profit opportunities were being left on the sidewalk that led them to investigate these arguments more closely. In a series of papers published between 1990 and 1995, the two would strike a major blow to the lock-in literature and its relevance to economic policy making. They addressed the empirical evidence, conceptual coherence, and practical implications for public policy of the claims for pervasive market failure associated with network effects and increasing returns.

By this time, Margolis had already made significant contributions to the field of housing economics (1981, 1982), industrial organization (1985, 1989), and law and economics (1987). The latter paper, "Two Definitions of Efficiency in Law and Economics," discusses a fundamental shortcoming in the way scholars in law and economics were implicitly defining the notion of efficiency. Margolis argues that any definition of efficient allocation must, for normative and positive purposes, account for the existence and magnitude of transaction costs under all possible property-rights configurations. In "Monopolistic Competition and Multiproduct Brand Names" (Margolis 1989), he reformulates and extends Demsetz's argument against the theory of monopolistic competition. According to Margolis, in violation of the latter's prediction, a monopolistically competitive firm that supplies a variety of products under its brand will operate at a quantity such that long-run average costs are minimized. Hence, the presence of...