There have been rumors going about that Xbox 2 may achieve backwards compatibility with the current generation of Xbox games through emulation. Attendant to these rumors were also concerns that this would run into legal problems with Nvidia, the company that makes the graphics chips for the current Xbox, but will not for Xbox 2 (ATI got that job).
I’ve believed from the beginning of talk about the next Xbox that backwards compatibility was something that Microsoft could not afford to be without. They simply are not in a strong enough position relative to Sony and Nintendo, to just dump the current library of Xbox games and force everyone to start over again. More to the point, Halo is perhaps the one game most responsible for much of the success that the Xbox has seen. And with the much anticipated Halo 2 just over the horizon, it is hard to imagine that Xbox 2 could launch without the means of playing the platform’s most successful title to date. And it should be noted that the Playstation 2 benefitted greatly at launch from its ability to play games written for the original Playstation. Backwards compatibility lowers a lot of buyer resistance to upgrading.
Emulation has so far withstood legal challenge (but not ROM copying!). That is, emulating someone else’s hardware can be done legally if proper clean room techniques are followed. This doesn’t mean you won’t get sued, but it does mean that you will win, if you don’t run out of money defending yourself first! So if the Halo Effect holds, then expect backwards compatibility in Xbox 2. Microsoft has legions of lawyers, so if Nvidia wants to sue like a jilted lover, MS can deal with it. But of late, MS has shown little desire for legal entanglements, so some sort of licensing deal is more likely.
As always, I reserve the right to be completely wrong about all of this!