Tuesday, April 25, 2006

A market for airport security?

I haven't followed much on plane and airport security in US or India. In fact, to let up close my cynical self, I believe there will be a private airline crash in India in the near future and all the blame will be put up on markets and private airlines. Whereas the problem may actually lie with the over-worked Air Traffic Controllers! But that is jumping ahead of the story.

Since this is a blog with a focus on policy and market design, we will consider the question of designing airport security. It is based on a comment at the Indian Economy blog, and one which I am sure will find common resonance with you. I reproduce it below.
...the totally privatized and horribly lax security at American airports prior to 9/11. I used to travel out of Chicago’s O’Hare airport all the time back in those days, and I always got a kick out of the young Indian girls “manning” the X-ray machines and digging into handbags.They were freshly recruited from India by Indian contractors in Chicago that had the contract to manage security at O’Hare. They were totally inept. Do we really want to entrust our airport security to young girls, Indian or American, with minimal training?
The problem that we are trying to tackle is designing an institutional mechanism for airport security. How do we take into account the strengths of market-based institutions?

Let me set up a stylized account of the underlying problem. Think of room-mates in a hostel dormitory (with windows) trying to negotiate keeping their room clean from dust. If I keep my portion tidy and you don't, chances are that my portion will soon end up untidy. In either case of you cleaning or not cleaning, my cost of cleaning is unchanged. In a scenario of reduced benefit and with others not cleaning, the behaviour may finally tip to dirtiness of the room. But before you jump in and advocate government-based solutions to the problem, you should consider the authors' take on the solutions in Interdependent Security: Implications for Homeland Security Policy and Other Areas.

The most auspicious mix ... approaches is often to combine a performance-oriented standard or regulation with private market mechanisms such as insurance, and third-party inspections. The regulations are necessary to provide a backstop in ensuring that private incentives are consistent with the public good. The insurance and third-party inspection components reduce the burden of enforcing the regulations by a public sector agency. More specifically, third-party inspections coupled with insurance protection can encourage companies to reduce the risk of accidents and disasters. Under such a program, insurance corporations would hire third-party inspectors to evaluate the safety and security of firms seeking insurance coverage. Passing the inspection would indicate to the community and government that a firm has complied with the safety and security regulations. The firm would also benefit from reduced insurance premiums, since the insurer would have more confidence in the safety and security of the firm.

This system takes advantage of two potent market mechanisms to make firms safer, while freeing government resources to focus on the largest risks. Insurance firms have a strong incentive to make sure that the inspections are rigorous and that the inspected firms are safe, since the insurers would bear the costs of an accident or terrorist attack. Private sector inspections also reduce the number of audits a regulatory agency itself must undertake, allowing the government to focus its resources more effectively on those companies that it perceives to pose the highest risks. The more firms that decide to take advantage of private third-party inspections, the greater the chances that highest-risk firms will be audited by a regulatory agency. Knowing that an audit is more likely induces even the high-risk firms to adhere to standards.

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