Irrational Economist_ Making Decisions in a Dangerous World - Erwann Michel-Kerjan [24]
This contributes to a fuzzy distribution of the roles in preparing against future disasters and recovering from them. If one asks people on the street, “Who do you think is in charge of preparing the country against future crises?” the most cited response will likely be state and federal governments (whether as regulators or first responders). However, although government entities certainly play a crucial role, a large portion of the critical services that allow our country to operate is owned or operated by the private sector (85 percent in the United States). Indeed, we must look specifically at how private actions affect public vulnerability so that we can be better prepared.
Feature 3: Growing Interdependencies—Globalization
An understanding of this third feature is critical to the new risk architecture being proposed here: As a result of growing globalization of social and economic activities, we have reached a degree of interdependence never before experienced. What happens on one continent today can affect those on another continent tomorrow.
For economists, this means that in a more dangerous world we are now seeing the emergence of security externalities. This concept implies that failures of a weak link in a connected system could have devastating impacts on all its parts, and that as a result there may be suboptimal investment in the individual components. An illustrative example is the Pan Am 103 catastrophe in 1988, when an uninspected bag containing a bomb was placed on Malta Airlines at a small unsecured airport in Malta, transferred in Frankfurt to a Pan Am feeder line, and then loaded onto Pan Am 103 in London’s Heathrow Airport. The bomb was designed to explode above 28,000 feet, a height normally first attained on this route over the Atlantic Ocean. The plane exploded over Lockerbie, Scotland, killing all 243 passengers, 16 crew members, and 11 people on the ground. The only thing Pan Am could have done to prevent the crash would have been to inspect all transferred bags, a costly practice followed only by El Al airlines at that time.
With respect to the 2008-2009 financial crisis, the collapse of the American International Group (AIG), one of the world’s largest insurers, was mainly caused by the operation of AIG Financial Products, a 377-person London unit that was run with almost complete autonomy from the parent company. The fall of the consulting company Arthur Andersen, due in part to its Houston branch’s ties to Enron, is another corporate example.
What is fundamentally at stake here is summed up by the following question, which economists Geoffrey Heal and Howard Kunreuther have researched extensively in the past few years: What is the incentive for one country, organization, or division, or an individual employee in your organization, to invest in costly mitigation/prevention measures if that country, organization, or individual employee knows that others, upon which their activities and future might depend, are not investing (in order to be more competitive in the short run) and that their failure to do so could affect the entire system? Such interdependencies also have a critical impact on good crisis management. Indeed, each organization often rushes to protect its own interests without any consideration as to how its specific choices will affect others or whether a global concerted approach would be more beneficial for several organizations at the same time.
What can be done? In some cases a change of strategy by one agent or a small set of agents within an organization (or industry or country) can shift the equilibrium radically. This change can be referred as tipping (a term first introduced by Nobel Laureate economist Thomas Schelling in the 1970s). Tipping requires an initial mover or group of movers who begin the process.
What are the policy and strategy implications of tipping in the context of large-scale global risks? Perhaps the most important of these is that it is possible