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* The authors would like to thank Brian Arthur, Lee Craig, Joel Mokyr, Oliver Williamson, and seminar participants at the University of Michigan Business School Remaining errors are, of course, ours. Path Dependence, Lock-In, and History S. J. Liebowitz University of Texas at Dallas Stephen E. Margolis North Carolina State University Abstract Do economies and markets make remediable errors inthe choice of products? Does the economy "lock-in" to these incorrect choices even when the knowledge that these choices are incorrect is readily available? The literature of path dependence may be understood to argue that these lock-ins and errors occur, even in a world characterized by voluntary decisions and individually maximizing behavior. In this paper we examine path dependence andillustrate three different forms of the term, each having a different implication regarding market errors and lock-in. Two of these meanings are common in the economy but provide no support for the claims that remediable errors occur. The third meaning, which does imply irremediable error, we show to be based on restrictive assumptions that are likely to be overcome in the real world. The analysis isillustrated by examining the market's choice of videorecorder formats. Path dependence has been offered as an alternative analytical perspective for economics, a revolutionary reformulation of the neoclassical paradigm. Brian Arthur, a leading figure in this literature, distinguishes between "conventional economics," which largely avoids increasing returns or path dependence, and the "new" "positivefeedback economics," which embraces them (Arthur, 1990:99). Before we stroll too far along the path dependence path, however, it makes sense to stop, take stock, and figure out where that path is leading us. The claim for path dependence is that a minor or fleeting advantage or a seemingly inconsequential lead for some technology, product or standard can have important and irreversible influenceson the ultimate market allocation of resources, even in a world characterized by voluntary decisions and individually maximizing behavior. The path dependence literature comes to us accompanied and motivated by a mathematical literature of nonlinear dynamic models, known as chaos or complexity models, for which a key finding is "sensitive dependence on initial conditions." Analogously, a keyfinding of path dependence is a property of "lock-in by historical events" (to echo the title of Brian Arthur's influential paper), especially where those historical events are "insignificant." If such path dependence does occur, it means that marginal adjustments of individual agents may not offer the assurance of optimization or the revision of

suboptimal outcomes. In turn, this implies thatmarkets fail. Although not all phenomena that have been described as path dependence imply market failure, these normative concerns have been a prominent part of the path dependence literature.1 In this paper we identify three distinct forms of path dependence. Two of these forms -which we define as first- and second-degree path dependence -- are commonplace, and they offer little in the way of anobjection to the neoclassical paradigm. Only the third and strongest form of path dependence significantly challenges the neoclassical paradigm, and as this paper shows, the theoretical arguments for this form require important restrictions on prices, institutions, or foresight. 2 Unfortunately, the three discrete forms of path dependence are often conflated in the literature. When things thatare different are grouped together and treated as things that are similar, error is assured. In this case, the error is transferring the plausibility of the empirical and logical support for the two weaker forms of path dependence (first and second-degree) to the strongest implications of third-degree path dependence. In fact, although it is fairly easy to identify allocations, technologies, or...
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