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International Business Diplomacy

This chapter begins by noting that “terms of operations are highlyinfluenced by attempts of international companies and governments toimprove their own positions relative to one another.” (p. 454) Thechapter then tries to cover the many possible cases that can arise inrelationships, particularly those pertaining to bargaining and negotiations,between firms and governments. There are too many cases to cover allof them. The following notes provide an overview of the general setting.

As noted at the outset of the course, the basic structure of bi-lateralinternational interactions is as follows:

Politicians

Country A Country B

Politicians PoliticiansPoliticalInstitutions

PoliticalInstitutions

BusinessInstitutions


DomesticPressureGame


InternationalPressureGames

InternationalBusiness Game

InternationalRelations Game

The international relations, international business, and pressure gamesare almost always bargaining/negotiation games. (The text discusses thenature of this kind of pressure on pp. 457-458.) The levels of influencethat each player can bring to bear depends upon “the relative strengthsof the parties involved. These strengths are affected by such factors ascompetitive changes, the resources the parties have at their disposal,validation by public opinion, and joint efforts of other parties.” (p. 454)

The text begins with Bargaining School Theory, which “holds that thenegotiated terms for a foreign investor’s operations depend on how muchthe investor and host country need each other’s assets.” (p. 455) This

point can be generalized. I will use the Generic Negotiation Game as astarting point. The formalities are presented in Steven J. Brams, 1992,“A Generic Negotiation Game,” Journal of Theoretical Politics, 4:1, 53-66.The general theory of negotiation is presented in Howard Raiffa, 1982,The Art and Science of Negotiation, Cambridge, MA: Harvard UniversityPress.

The generic negotiation game is as follows:

NEGOTIATIONGAME Cooperate DefectCooperate <b+y,B+Y> <b,A>Defect <a,B> <a-z,A-Z>

where payoffs are of the form <row,column>, and where a>b, y>0, andz>0 for row player, and A>B, Y>0, and Z>0 for column player.

The following partial ordering of the payoffs follows from thespecifications of the parameters:

a > b, a > a-z, b+y > b for row player,and

A > B, A > A-Z, B+Y > B for column player.Since the negotiation game is specified only up to a partial order, it isconsistent with various particular games. These games constitute a richand useful array and are as follows:

PRISONER’SDILEMMA Cooperate DefectCooperate <3,3> <1,4>Defect <4,1> <2,2>

DEADLOCK Cooperate DefectCooperate <2,2> <1,4>Defect <4,1> <3,3>

HARMONY Cooperate DefectCooperate <4,4> <2,3>

Defect <3,2> <1,1>

STAG HUNT Cooperate DefectCooperate <4,4> <1,3>Defect <3,1> <2,2>

CHICKEN Cooperate DefectCooperate <3,3> <2,4>Defect <4,2> <1,1>

BULLY Cooperate DefectCooperate <3,3> <2,4>Defect <4,1> <1,2>

where 4 > 3 > 2 > 1.

U(g)

U(g-c)

U(g-f)

g-f

gg-c∆w

U(∆w)

The Negotiation Game provides a general framework for analyzing manyparticular situations. For example, the basic trade agreement negotiationgame is an instance of Prisoner’s Dilemma (Krugman and Obstfeld 1991,International Economics, New York: HarperCollins, 222-231), and thehegemonic trade negotiation game is an instance of Bully (Dacey,1994,“Inducing Fair Trade Out of Hegemonic Trade,” Synthese, 100:3).Aggarwal and Allan (1994) present other interpretations of theNegotiation Game. (Reference--Aggarwal, Vinod K. and Pierre Allan 1994“Preferences, Constraints and Games: Analysing Polish Debt Negotiationswith International Banks,” 9-49 in Pierre Allan and Christian Schmidt(eds.), Game Theory and International Relations, Hants, UK: Edward Elgar.)

The reason the text cannot cover all of the possibilities should now beclear. There are many possible game structures, and within each,infinitely many possible games. We will examine just a few.

The General Trade Negotiation GameThis game is played between nations and is carefully and fruitfully studiedin International Economics. (Again, see Krugman and Obstfeld.) Thegame-theoretic name of this game is Prisoner’s Dilemma. The payofftable is as follows:PRISONER’SDILEMMA Cooperate DefectCooperate <3,3> <1,4>Defect <4,1> <2,2>

Note that each side has a dominant strategy--defection. In this setting,defection amounts to demanding favorable conditions of trade, whilecooperation amounts to demanding fair conditions of trade. Thus, eachplayer wants favorable conditions, and the game ends at the <2,2>payoff. Note, however, each player is better off if they cooperate. Thenthe game ends at the <3,3> payoff. Such bilateral cooperation typicallyemerges under repeated play of the game. (Robert Axelrod, 1984, TheEvolution of Cooperation, New York: Basic Books and Robert Axelrod)However, it is not always so simple. (R. Dacey and N. Pendegraft, 1988,“The Optimality of Tit-for-Tat,” International Interactions 15:1, 45-64)

The key point here is the natural and unavoidable conflict. Note that ifeverything were just fine, then the game would be different, as follows:

HARMONY Cooperate DefectCooperate <4,4> <2,3>Defect <3,2> <1,1>

This game is the antithesis of Prisoner’s Dilemma. Each player hascooperate as a dominant act, and everything works out very nicely.Harmony, however, is NOT a model of the international trade negotiationprocess.

As noted, the hegemonic trade negotiation game is Bully, as follows:

BULLY Cooperate DefectCooperate <3,3> <2,4>Defect <4,1> <1,2>

The book comments on this game as follows: “If either a company or acountry has assets that the other strongly desires and if there are few (orno) alternatives for acquiring them, negotiated concession may be veryone-sided.” (p. 455) Note that the column player has defect as adominant strategy. The row player, seeing this, need only consider the<2,4> and <1,2> payoffs. Between these, clearly the former is preferredto the latter. Therefore, the row player chooses to cooperate. Theoutcome of the game is <2,4>, with the conciliatory row player gettingits second worst outcome and the hegemonic column player getting itsbest outcome. This situation is rarely stable, and often leads to seriousconflict. The role of OPEC during the 1970s and early 1980s fits thismodel, as did the role of the British in North America during the late1700s. Monopolists and monopsonists often fit this model, at least inthe short run.

The text’s discussion of company and country bargaining strength (pp.455-456) is important. The relative strength levels of the relevantparties is what determines which game is being played.

The text’s discussion of behavioral characteristics also is important (pp.461f). This discussion relates more to the general account provided byRaiffa than to the game-theoretic one given above. The key point is this--different cultures have different negotiating styles. Westerns (i.e., NorthAmericans and Europeans) tend to be impersonal, impatient, and direct.Asians tend to be personal, patient, and indirect. Latin Americans tend tobe personal, impatient, and indirect. The impatience and directness ofWesterners often costs then dearly in negotiations with Asians and LatinAmericans, respectively. (Table 13.1 presents all this in more detail.)

These generalizations can cause great difficulty. Often it is in a person’sown best interest to be misperceived by the other party to a negotiation.Since anyone can learn to behave contrary to his or her culture, it is sillyto apply the foregoing stereotypes to your adversaries. (The text hintsat this on page 462.)

THE ROLE OF LANGUAGEThe text raises this very important issue on page 463. Negotiationinvolves manipulation, which involves ambiguity. Most important,strategic ambiguity requires precision. If the other person does notunderstand exactly what you intended to have understood, then anyattempt at manipulation loses precision. The text focuses on the use ofslang, which is often misunderstood, even among one’s fellow citizens.The problem goes deeper. The use of metaphors, similes, etc. will missthe mark if they cannot be understood. It is not enough to have atranslator. A negotiator is best off if he or she is the translator. (Itshould now be clear why so many countries find the investment in foreignlanguage education so important.)

The text makes a very interesting point--“Because of conflictingpressures from different groups, an MNE can almost always be accused ofbad behavior by someone.” (p. 472) The key point here is that an MNE isplaying in at least two games simultaneously. Recall the box diagramgiven at the outset of these notes. The simplest variation is the two-level game involving a business game with a firm in another country and apressure game with the domestic government. This game is verycommon. The diagram is as follows:

Politicians

Country A Country B




DomesticGovernment

MNE

The slightly more sophisticated version of the bi-lateral setting is asfollows:

Politicians

Country A Country B

PoliticiansPoliticalInstitutions



InternationalPressureGames


MNE

DomesticGovernment

In the former, the MNE is receiving pressure form both foreigncompetitors and the domestic government, whereas in the latter the MNEis also getting pressure from the foreign government. Two points areimportant. First, the MNE may well be in a multi-lateral setting wherethere are many governments and many firms. Second, there are otherpressure groups not represented here, including groups involved inenvironmental issues, social issue, etc.

The text makes a recommendation. “A good rule for serving a givengroup is to try to maximize benefits without excessively disrupting thelocal situation.” And further, “Companies should work to increase thenumber of local supporters and dampen potential criticism.” (p. 472)Both statements seem to meet with common sense. The point is this--the common sense offered by the text does not hold in all, or even many,cases.

Protection of Intellectual Property RightsAgain, the text has changed direction. This is a big issue. Not everyonetreats intellectual property the way we presume we do. The mechanismsof protection are patents and copyrights. Both were devised for a much

earlier and technologically simpler age. Neither work well now. Shouldsomeone be allowed to patent an algorithm? A DNA sequence? A virus?Clearly, copyrighting software will not protect the software. (Copyrightprotects only the statement, not the content.) Until recently, one couldnot patent a piece of software, since it is not a physical object or aprocess. There is now a case in the legal system pertaining to softwarepatents. Obviously, trademarks do not protect the software.(Trademarks protect only the logo.)

Piracy is a basic issue. First, the model of piracy is quite simple, asfollows:

The piracy decision considered here consists of the choice betweenpurchasing and stealing software. I will presume that pirated software iscostless. If the dishonesty is caught, then there is a fine to be paid, andif the dishonesty is not caught, then no fine is paid. Let g denote thegain from the use of the software, c the acquisition cost of the software,and f the fine. For example, if the task is developing a design, then g isthe gain in income from selling the finished design, c is the cost of thesoftware, and f is the penalty for piracy. The payoff table is as follows:

buy steal probabilitypiracyis g-c g-f ppunished

piracyis not g-c g 1-ppunished

To avoid trivialities, I presume that f > g > c > 0. If f < c, then piracy isthe dominant act and every (solely) rational individual would be engagedin piracy. If c > g, then no rational member of the community would usesoftware. Finally, g > f violates the legal principle that the punishmentmust fit the crime. These assumptions are consistent with theadvertising of the Business Software Alliance--“Selling or copying piratedsoftware without authorization is against the law, with severe criminal andcivil penalties including imprisonment of up to five years, fines of up to$250,000, or both.” (See any recent issue of a PC magazine.) The fine,f, represents the individual’s assessment of the penalty that would be

imposed if the piracy were detected and punished. Clearly, the BusinessSoftware Alliance statement suggests f is greater than the value of g foralmost all individuals.

The behavior of a solely rational individual is determined by thevalues of the expected utilities of his or her acts--buy is preferred to stealif and only if Eu(buy) > Eu(steal), where Eu(buy) = pu(g-f)+(1-p)u(g), andEu(steal) = u(g-c). Substituting and rearranging terms yields the resultthat a solely rational individual prefers buying to stealing if and only if

p > u ( g ) − u ( g − c ) u ( g ) − u ( g − f )

.That is, a solely rational individual prefers buying to stealing if and only ifthe probability of detection is "high enough" relative to the payoffs g, g-cand g-f, and to the individual's preference structure and attitude towardrisk, as represented by the utility function U. Graphically, we have thefollowing:

Piracy is quite common. It is the norm in various places, e.g., China andRussia. Since neither patents nor copyrights protect intellectual property,piracy can be expected to increase.

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