The economics of cheating

Published in Insights, The New Zealand Initiative’s newsletter, 4 August 2017

We probably all remember those school exams in which we desperately tried to copy the answers from our much better neighbours.

Ahem, I meant of course we all remember those school exams in which our struggling neighbours desperately tried to copy from us.

Well, as a strategy to pass an exam such cheating might have even worked. But the cheats never do themselves any favours in the long run. Copying answers is no proper substitute for developing your own skills.

On a much larger scale, this is the problem of industrial espionage. Just check a new paper by Albrecht Glitz and Erik Meyersson titled “Industrial Espionage and Productivity”.

Their research is the economics equivalent of a James Bond movie. It is set in divided Germany over the final decades of the Cold War, between 1970 and 1988. Its plot is the systematic industrial espionage activities by East Germany’s secret service.

East Germany was an economic basket case. But at least in the Stasi it had a world-class secret service: ruthless, brutal and efficient.

The Stasi was also superb at keeping records. It maintained a massive database of its technological spying activities in West Germany. And this is the database which Glitz and Meyersson have now analysed economically.

The results are fascinating. Their first finding is that without espionage, East Germany would have been much less productive. In technical terms, the gap in total factor productivity between East and West Germany would have been 6.3 percent larger.

The second finding is that spying was good business for the East German government. The authors estimate that the benefits to their economy were worth about 7.3 billion Deutsche Mark in 1988 (more than $7 billion in today’s money). That is a lot of money considering that the Stasi’s annual espionage budget was only a paltry 13.5 million Deutsche Mark.

In other words, spying delivered a fantastic return on investment – not just by Communist standards.

But if that makes you think that organised espionage is a good idea, their final finding might still put you off.

The authors suggest that by relying on espionage, East German firms gradually lost the capacity to conduct research and development themselves. East Germany’s industry had become the equivalent of those students who copy from their neighbours.

So that’s what we should tell cheating students (and some developing economies): Don’t do it! You might end up like East Germany.

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