Editors’ Note: From time to time, we receive particularly well-considered expert commentary on an issue of Cato Unbound. This month we received two such commentaries, and we are pleased to run the first of them today. It comes from Howard Kunreuther, the Cecilia Yen Koo Professor of Decision Sciences and Public Policy at the Wharton School of the University of Pennsylvania. Prof. Kunreuther writes,
The essay by William Burns on terrorism is very insightful and raises a number of important issues related to risk communication for events such as terrorism where emotions run high. At the same time one needs to recognize, as Burns does, that over time we tend to become complacent with respect to events that have not reoccurred. In the case of terrorism many people are likely to perceive that another attack will not affect them and hence we do not need to be vigilant with respect to future threats.
Other Factors to Consider
To better prepare the nation for dealing with terrorism, there are a set of elements I suggest we consider to complement the important points that Burns makes:
–Issues of blame
–Lack of interest in probabilities
–Ignoring low probability risks
–Short term horizons
Let me briefly consider each of these points before suggesting the features of a broad strategy for addressing extreme events such as terrorism:
Issues of Blame McGraw et al. (2009) show that policy makers’ decisions may be influenced by the blame they expect for failures to prevent terrorist attacks. Data from controlled experiments reveal that the public’s judgments of blame for failures to prevent terrorist attacks and the perceived likelihoods of those attacks are independent. For example, even though participants felt that terrorists would be more likely to use a truck loaded with explosives or a rocket launcher than a hijacked airplane, they wanted more funds allocated to airline security than to deterring attacks using these other two modes. The data revealed that policy makers would be blamed more if the attack was one that had occurred in the past even if it was viewed to be less likely. In other words, people’s budget priorities for preventing terrorist attacks are more strongly associated with emotional reactions, including blame, than with judgments of likelihood.
Lack of Interest in Probabilities One reason that policy makers disregard likelihood in their decisions is because the public focuses its attention primarily on the consequences of an attack. Several studies show, however, that individuals rarely seek out probability estimates in making their decisions. When these data are given to them, decision makers often do not use the information. In one study, researchers found that only 22 percent of subjects sought out probability information when evaluating several risky managerial decisions (Huber et al. 1997). People have particular difficulty dealing with probabilistic information for small likelihood events. They need a context in which to evaluate the likelihood of an event occurring. They have a hard time gauging how concerned to feel about a 1 in 100,000 probability of death without some comparison points. Most people just do not know whether 1 in 100,000 is a large risk or a small risk. In one study, individuals could not distinguish the relative safety of a chemical plant that had an annual chance of experiencing a catastrophic accident that varied from 1 in 10,000 to 1 in 1 million (Kunreuther, Novemsky and Kahneman 2003).
Ignoring Low Probability Risks Many decision makers ignore risks that are below their threshold level of concern. Property owners residing in communities that are potential sites for nuclear waste facilities have a tendency to dismiss the risk as negligible (Oberholzer 1998). Even experts in risk disregard some hazards. For instance, even after the first terrorist attack against the World Trade Center in 1993, terrorism risk continued to be included as an unnamed peril in most commercial insurance policies in the United States, and policy holders were never charged a penny for it. When the second and more devastating terrorist attacks occurred on September 11, 2001, insurers and their reinsurers had to pay $35 billion of insured losses (Kunreuther and Pauly 2005).
Short Term Horizons Individuals and firms have short time horizons when planning for the future so they may not fully weigh the long-term benefits from investing in loss reduction measures. This is a principal reason why consumers are reluctant to incur the high immediate cost of energy-efficient appliances in return for reduced electricity charges over time. There is even less interest in investing in protective measures where there is only a small chance that the individual or organization will benefit from having taken such action. The upfront costs of mitigation loom disproportionately high relative to the delayed expected benefits over time (Kunreuther, Meyer and Michel Kerjan, in press).
In addition, there is extensive experimental evidence showing that human temporal discounting tends to be hyperbolic so that events in the distant future are disproportionately discounted relative to immediate ones. As an example, people are willing to pay more to have the timing of the receipt of a cash prize accelerated from tomorrow to today, than from two days from now to tomorrow. (Loewenstein and Prelec 2001).
With respect to terrorism there may be some reluctance on the part of firms to invest in risk reduction measures just as there is a lack of interest by those residing in hazard-prone areas to invest in mitigation measures against natural disasters. The effect of placing too much weight on immediate considerations is that the upfront costs of mitigation will loom disproportionately large relative to the delayed expected benefits in losses over time.
Interdependencies There are also problems of interdependencies that decisionmakers fail to appreciate fully. For large corporations, a failure in one division can lead to disruption or bankruptcy of the entire firm worldwide. For example, a Bhopal-like accident at a chemical plant can lead to losses that are so large that they cause bankruptcy of the entire operation. An ownership group such as Lloyd’s, which controls a number of semi-autonomous syndicates, can fail if one of the syndicates experiences a severe enough loss. In February 1995, Barings Bank was destroyed by the actions of a single trader in its Singapore unit and in 2002, Arthur Andersen was sent into bankruptcy by the actions of its Houston branch working with Enron. Similar events have happened to other financial services units recently, notably the potential collapse of the American International Group (A.I.G.), the world’s largest insurer, as a result of a 377-person London unit known as A.I.G. Financial Products that was run with almost complete autonomy from the parent company. Given such an institutional structure, what economic incentive does any division have to incur the costs of protective measures that adversely affect its short-term balance sheet (and the annual bonuses of its managers), if other divisions in the organization are not taking similar actions? (Kunreuther 2009)
With respect to terrorism, weak links in an interdependent system can cause problems in other parts that had invested in risk-reducing measures. A classic example is the Pan Am 103 crash in 1988. On December 21, 1988, Pan Am flight 103 exploded near Lockerbie, Scotland. Terrorists had checked a bag containing a bomb in Malta on Malta Airlines, which had minimal security procedures. The bag was 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. Given such interdependencies among different players in a network, the above example illustrates that security for the entire network may only be as strong as its weakest link. In this case, the terrorists deliberately exploited the widely varying security procedures across the airlines. This problem is common to other transportation modes, where there are interconnections between nodes in the network (Heal and Kunreuther 2005).
Strategies for Dealing with Terrorism
Given these behavioral features, I feel it is necessary to complement Burns’ suggestions for improving risk communication by developing a strategy for dealing with terrorism that involves a private-public partnership that encourages decision makers to focus on the long run. The Wharton Risk Center has undertaken research on natural hazards that may be applicable for addressing the terrorism problem even though there are some differences between these events. In my opinion the Obama Administration should design a strategy for terrorism that incorporates the two features, which are elaborated further in Kunreuther and Michel-Kerjan, 2009. First, counterterrorism measures should include well enforced regulations and standards to deal with the tendency for individuals to ignore low-probability events as well as the interdependency problem. And second, long-term contracts should be used to overcome the myopia problem and encourage individuals to think probabilistically.
 Natural disasters are Acts of God where the actions by those at risk have no impact on the likelihood of the event occur. Terrorists, on the other hand, can modify their strategies as a function of the actions taken by those at risk. For a more detailed comparison of natural disaster and terrorism see Table 2.1 in National Research Council (2008).
Heal, Geoffrey and Howard Kunreuther (2005). “You Can Only Die Once: Interdependent Security in an Uncertainty World,” in H.W. Richardson, P. Gordon and J.E. Moore II, (eds.), The Economic Impacts of Terrorist Attacks. Cheltenham, UK: Edward Elgar.
Huber, O., Wider, R. and Huber, O. (1997). “Active Information Search and Complete Information Presentation in Naturalistic Risky Decision Tasks” Acta Psychologica, 95:15-29.
Kunreuther, H., R.J. Meyer and E. Michel-Kerjan (in press). “Strategies for Better Protection against Catastrophic Risks”, in E. Shafir (ed), Behavioral Foundations of Policy, Princeton University Press.
Kunreuther, H. and Michel-Kerjan (2009). “Market and Government Failure in Insuring and Mitigating Natural Catastrophes: How Long-Term Contracts Can Help” Paper prepared for the American Enterprise Institute Conference on Private Markets and Public Insurance Programs Wohlstetter Conference Center Washington, DC January 15.
Kunreuther, H., N. Novemsky and D. Kahneman (2001). “Making Low Probabilities Useful.” Journal of Risk and Uncertainty 23:103-120.
Kunreuther, H. and Pauly, M. (2005). “Terrorism Losses and All Perils Insurance” Journal of Insurance Regulation Summer pp. 1-17.
Loewenstein, G. and D. Prelec (1991). “Negative Time Preference,” American Economic Review, 81(2): 347-52.
McGraw, P., Todorov, A. and Kunreuther, H. (2009). “Preventing blame while preventing terrorism” (in preparation).
National Research Council (2008). Department of Homeland Security Bioterrorism Risk Assessment: A Call for Change. Washington, D.C: The National Academies Press.
Oberholzer-Gee, Felix (1998). “Learning to Bear the Unbearable: Towards and Explanation of Risk Ignorance,” Mimeo, Wharton School, University of Pennsylvania.