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Published by John York

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Published by: John York on Nov 03, 2013
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E. W
D. G
University of Calgary
Economic espionage can yield desirable strategic effects as well as cost savings forfirms in a spying country. The spying country will typically gain even thoughcounter-espionage operations will often be conducted by target countries. When twoproducing countries spy on each other, it is possible that both will be better off because of the technology transfer which is implicit in espionage. Economicespionage is generally beneficial to consumers. [F12, O031]
1. INTRODUCTIONEconomic espionage, it would appear, is a increasingly common phenomena. Whilethe clandestine nature of spying precludes systematic empirical verification, anecdotalaccounts in the popular media abound. For example, Pierre Marion, former director of the French intelligence services, has stated that: “It would not be normal that we do spyon the (United) States in political matters; we are really allied. But in the economiccompetition, in the technological competition, we are competitors; we are not allied.”(Security Management, 1992) Similarly, Stansfield Turner, former director of USintelligence has said that: “The United States ... would have no compunction aboutstealing military secrets to help it manufacture better weapons. If economic strengthshould now be regarded as a vital component of national security, paralled with militarypower, why should Amecica be concerned about stealing and employing economicsecrets?” (Turner, 1991) Further, a document from France’s Direction Générale de laSécurité Extérieure (DGSE) that was leaked to a news service (Time Magazine, 1993,June 7) appeared to suggest that some of the most technology-intensive in US firmswere targets for French intelligence agents. The DGSE, it seemed, was seekinginformation on manufacturing processes as well as sensitive information on corporateand government plans. It is often argued that the end of the Cold War has contributed toan increase in economic espionage by releasing intelligence resources. In addition, theperceived need for Western nations to cooperate against a common threat has eased,turning military allies into more vigorous economic competitors. The counter-argument
Volume 13, Number 2, Summer 1999
*An earlier version of this paper was presented at the 1994 meetings of the CanadianEconomics Association in Calgary, Canada. The authors acknowledge helpful comments andsuggestions from J. R. Church, T. Terriff, R. Ware and an anonymous referee. The authors,however, are responsible for any remaining shortcomings of the paper.
is that the apparent growth of economic espionage may be an overstatement bynational intelligence agencies as a ploy to protect their budget allocations. While it isdifficult to determine either the extent or growth of economic espionage, there is nodoubt that such activity does occur. Why do countries conduct economic espionage? Will foreign governments respondwith defensive or offensive intelligence activities of their own? This paper will showthat there may be indirect strategic benefits from spying that go beyond the moreobvious direct benefits from access to valuable economic secrets. In such situations,economic espionage may shift profits from foreign firms to domestic firms and,thereby, provide an additional channel through which national welfare could rise.Nonetheless, the potential gains of the spying country are indeed limited by theresponses of foreign governments and firms. Porteous (1993) and Brander (1997) havesketched the argument for espionage as a form of strategic trade policy. This paperwill both formalize and extend the analysis of economic espionage. Consequently, thepaper is closely related to work on strategic trade policy by Brander and Spencer(1985), Dixit (1984), Eaton and Grossman (1986), Dixit and Kyle (1985), Branson andKlevorick (1986), and Grossman (1986) and others. Since information plays a vitalrole in economic espionage, there are also some parallels with the work on informationsharing in oligopolies by authors such as Gal-Or (1985) and Vives (1984). Many types of sensitive information may be obtained by means of economicespionage. If spying unearths the blueprints of a product or the source code for software,the fixed costs associated with Research and Development can be reduced for domesticfirms. In such a case, there are direct benefits for domestic firms, but no strategic benefitsbecause the behaviour of the domestic firms in global markets will remain unchanged.On the other hand, information on contract bids, marketing plans, or costs of rival foreignfirms may give rise to strategic benefits in global markets even though there are no directbenefits. Finally, if the production technology of foreign firms is obtained, there will beboth a direct benefit from lower total costs for domestic firms and a strategic effect onglobal markets due to lower marginal costs. This paper will focus on espionageperformed to obtain marginal-cost reducing production technologies.While this paper considers espionage by the government on behalf of domesticfirms, the analysis could easily be adapted to allow for spying by the firmsthemselves. Government spying, however, may have advantages over corporateespionage. National spy agencies may be able to reap economies of scale and/orscope. Further, the information that is obtained by means of spying is non-rivalrous inthe sense that it can be used by all domestic firms. Thus, government conductedespionage may yield positive social benefits even if the private benefit of corporateespionage to an individual firm is negative. In a related vein, the government wouldbe able to take the favourable effects of spying on domestic consumers into accountwhereas this externality would be ignored in the case of corporate espionage. On theother hand, in some countries such as the US the business culture of arms-lengthrelationships between firms and government may make economic espionage bygovernments more problematic.
The goal of this paper is to examine the potential for economic espionage withinoligopolistic industries where the firms export a significant fraction of their outputs.Throughout the paper, a stylized version of the commercial jet aircraft industry will beused as the backdrop for the discussion. The world industry is highly concentrated,has significant barriers to entry, and is research and development intensive.Moreover, the key firms - Boeing and Airbus - export substantial proportions of theiroutputs. The commercial jet aircraft industry has been a popular focus for studiesconcerning strategic trade policy. For example, this industry is central in Dixit andKyle’s (1985) analysis of the subsidization of fixed costs as a means of promotingentry by a domestic firm. Nevertheless, it should be emphasized that this paper is tobe read as fiction. The paper provides a hypothetical, “what if” type of analysis and itcertainly does not provide a descriptive account of the actual firms or governments.The basic model that is presented in Section 2 shows the strategic profit-shiftingeffects of economic espionage in a simple setting. This basic model is elaborated inalternative directions in the three subsequent sections. Section 3 allows onegovernment to engage in aggressive espionage while the rival government undertakesdefensive counter espionage. Section 4 models two-way aggressive spying whereboth governments use their national intelligence service to steal secrets from the rivalcountry’s firm. The concluding section reconsiders the role of economic espionageand its status as a tool of trade policy and technology transfer.2. A BASIC MODEL OF ECONOMIC ESPIONAGEExcept where otherwise noted, we adopt a set of assumptions that are common inthe literature on strategic trade policy.(a)In each of two producing countries, France and the US, there is a single firm.(b)The output of each of the two producing countries is entirely exported.(c)The French and American firms, Airbus and Boeing, play a Cournot duopoly game.(d)The firms produce a homogeneous output.(e)The profits of each firm accrue only to citizens of the country in which the firm is located.Since the relaxation of any of these assumptions weakens the case for strategic tradepolicy (see Eaton and Grossman, 1986, and Grossman, 1986), these assumptions willbe discussed further below. We will also impose two additional simplifyingassumptions.(f)The demand by third countries is linear.(g)Both firms are subject to constant marginal production costs.The linear demand schedule of the consuming countries is:
P =
+ Q
denotes the price, and
a n d
denote the outputs of Airbus and Boeing respectively.

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