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Continued from previous page
Sprinkler Systems,
Airline Baggage, and
Interdependent Security
A short time later, Kunreuther was
having lunch with Geoffrey Heal, an
economist at Columbia. They were
talking about a problem that long
had interested Kunreuther: the interdependent
nature of security. Suppose
you live in an apartment building and
want to invest in a sprinkler system
to receive a lower insurance rate. The
problem is that, even if you purchase
a sprinkler system for your apartment,
if your neighbor doesn't make the
same investment, his apartment next
door could still catch fire and destroy
your home. Your security is dependent
on the actions of your neighbors,
and the insurers will not reward you
with as low a premium if they know
that your apartment unit is vulnerable
due to the possibility of contagion
from others.
Airlines face a similar situation in
baggage screening. Even if an individual
airline invested in creating a tight
baggage screening system, it is only as
strong as its weakest link. The bomb
that made it onto the Pan Am flight
that exploded over Scotland in 1988
arrived via a loosely protected airline
that connected to the tragic flight. If
some airlines don't invest in security,
other airlines have much less of an
incentive to do so. Unless everyone
has an incentive to invest, no one has
an incentive to invest.
"We spent the month of October
thinking about that problem,"
Kunreuther says. "When we started
thinking about it, it raised a whole
variety of other problems." One distinctive
aspect of these catastrophic
disasters is that the risks are extremely
high, and nonadditive. "You can only
die once, your apartment can only
be destroyed by fire once, and it takes
only one bomb to destroy an airplane,"
he says. "This type of problem
has a very simple game theoretic solution:
if everyone else invests in protection,
you will also want to; but if no
one else does, then you won't. The
interesting question is whether one
is able to develop strategies short of
formal regulation to convince some
individuals or firms to take protective
actions and encourage others to do
the same. One needs to find a tipping
point and then make good things
happen."
No Prisoners' Dilemma
The dynamics of these catastrophic
risks make the situation and its solution
very different from the well-known
"prisoners' dilemma." In the
prisoners' dilemma, which might
apply to a challenge like investment
in reducing pollution, neither party
has an incentive to invest in measures
to reduce pollution individually, yet
they would all be better off collectively
if everyone invested. In this
case, the players will not resolve the
situation left to their own devices.
Regulation can sometimes fill the
void, forcing individual companies
to make decisions that are in the
general interest.
But catastrophic events that rely
upon interdependent security have
a different dynamic. First, they are
probabilistic, so the consequences
are not known. Second, at a certain
tipping point, both sides will want
to invest; and once they make these
investments, they don't have an incentive
to back off from them. Once
everyone in the apartment house has
a sprinkler system or every airline is
checking baggage thoroughly, there is
no incentive to dismantle the system.
So the question is: How do you
bring the system to the point where
the players choose protection? If you
rely upon free markets alone, individuals
and companies will underinvest
in protective measures that only help
if everyone does them. On the other
hand, regulation and legal action are
very expensive.
Kunreuther and Heal developed
an approach to this challenge of
"interdependent security" that uses
a combination of regulations, insurance,
and third-party inspections to
tip the balance toward protection at
a reasonable economic cost. As they
write with colleague Peter Orszag in
a Brookings Institution Policy Brief,
"When security is interdependent,
firms acting on their own may choose
not to invest in risk-reduction measures
even though they all would be
better off if they did."
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