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  1. Comments on “You Can Only Die Once” Peter R. Orszag The Brookings Institution April 12, 2002 The Brookings Institution, Washington,

  2. Fundamental issue • Are decentralized market forces sufficient to provide proper incentives for homeland security? • EPA official: chemical “industry has a very powerful incentive to do the right thing. It ought to be their worst nightmare that their facility would be a target of a terrorist act because they did not meet their responsibility to their community.” Statement of Bob Bostock, assistant EPA administrator for homeland security, quoted in James Grimaldi and Guy Gugliotta, Chemical Plants are Feared as Targets, Washington Post, December 16, 2001, page A1. The Brookings Institution, Washington,

  3. Decentralized approach does not necessarily provide proper incentives because of contamination • In effect, my security depends on your security effort • In good equilibrium, both invest in security and contamination muted/eliminated • In bad equilibrium: Since everyone else is not investing in security, your incentives to invest are muted. Nothing to prevent bad equilibrium from arising and being perpetuated Insight from paper The Brookings Institution, Washington,

  4. Other motivations for government intervention • Externality #1: Contamination effects (Kunreuther and Heal) • Externality #2: National sovereignty (just as an invasion of the nation’s territory by enemy armed forces) • Information costs • Bankruptcy laws • Moral hazard/bail out • Incomplete markets The Brookings Institution, Washington,

  5. Two other effects: Endogenous targets/displacement • Contamination effect suggests that my investment in security provides a positive externality for you, by reducing the risk of contamination • But opposite may be true for observable security measures, given that the selection of targets is endogenous: My investment may make it more likely that terrorists will target you, rather than me • Related work on observable and unobservable crime prevention steps • In other words, p (and perhaps q) may depend on relative security spending in addition to absolute spending • Requires continuous c, or discrete levels • Possible to have over-investment rather than under-investment The Brookings Institution, Washington,

  6. Two other effects: Incentives from public programs • Related work examines the impact of public provision of security on private incentives • Orszag and Stiglitz, “Optimal Fire Departments,” Brookings, January 2002 • Presence of a fire department (or public security program) can exacerbate the social costs associated with the underlying negative externality The Brookings Institution, Washington,

  7. Types of intervention • Insurance • Mandate vs. voluntary • Pricing • Reinsurance • Liability • Bankruptcy • Definition of adequate effort • Tax fines or subsidies • Fines: Political viability • Subsidies: Gold plating and budget outlook • Regulation • Coordinating mechanisms • Anti-trust concerns • Clusters of high-security groups The Brookings Institution, Washington,

  8. Slippery slope? • Especially given the potential for government failure and displacement effect, how to draw the line? • Forthcoming Brookings volume (Protecting the American Homeland) sets one possible standard: Loss of thousands of lives, or interruption of millions of lives for significant period • So worry about stadiums, but not small shopping malls The Brookings Institution, Washington,

  9. Possible next steps for research • Imperfect information and monitoring costs – crucial for implementing many of the suggestions • Endogenous target selection/displacement • Empirical evidence on size of contamination effect relative to direct threat/internal benefits (fn 7) The Brookings Institution, Washington,