The economics of homeland security

Kevin M. Murphy and Robert H. Topel have a model for assessing investments in national security

By Vanessa Sumo     
August 29, 2013

From: Magazine

National security is a form of insurance. When governments build roads or put money into schools, these investments provide tangible, evident benefits that are enjoyed by their populations. National security investments, by contrast, develop assets that governments hope they will never have to use. And although they may never employ these assets, governments spend money on national security because it might have enormous value one day.  

Unlike an insurance policy, however, where the cost of protection is set by a company and the claims process is transparent, national security is a black box. It is never clear if a country has invested enough or too little in national security until after the fact, though it is clear in prospect that certain events might be catastrophic. So how should governments assess the value of such investments? Chicago Booth Professors Kevin M. Murphy and Robert H. Topel developed an economic model to help policymakers do just that.

The model aims to characterize the optimal level of national security investment that maximizes societal welfare. Like insurance, investing in national security—not just the threat of armed attacks but also threats such as climate change, epidemic diseases, and cyberattacks—pays off when there is an incident that might cause extreme losses. And like insurance-policy holders, taxpayers expect very little return on these investments (even less than the risk-free rate offered by government bonds) unless a threat is realized. 

So when governments want to evaluate whether sizeable investments in national security are worthwhile, the interest rate at which future benefits are discounted should be low, the authors argue. The lower the discount rate, the bigger the present value of the benefits. 

This issue has come up in the debate over how to value the future benefits of policies designed to combat climate change. In his 2006 UK-government-sponsored policy review, Nicholas Stern of the London School of Economics argues that these benefits should be amortized using a very low discount rate, because we should value the welfare of future generations as much as our own.

Murphy and Topel agree that the appropriate discount rate should be low, but for a different reason—the investments’ insurance value: people are willing to give up some returns in exchange for living in a safer world, one where potential public catastrophes have been mitigated. 

The greater the uncertainty over the seriousness of a national security threat, the greater the value of technologies that can be rapidly scaled up, the researchers find. Such scalable technologies become more valuable  if there is a greater risk of a tail event, or what Murphy and Topel call “an extreme security threat.” 

Consider climate change. Extreme damage from greenhouse gas emissions caused by a 10°C increase in average temperatures cannot be ruled out, Murphy and Topel note. If a government reckons that the risk of extreme climate change has increased, it may consider investing in technology to remove greenhouse gases from the atmosphere on a large scale. 

Attempts to develop such technology have been criticized, partly because of concern that they could weaken incentives to reduce greenhouse gas emissions. The researchers’ model predicts a similar trade-off: if a scalable national security solution becomes available, it could reduce incentives to use precautionary measures, such as efforts to scale back carbon emissions or diplomatic efforts to prevent conflict.  

National security investments intended to mitigate certain threats can offer protection against a variety of related risks, the study contends. Investments that prepare countries for major warfare, for example, can avert smaller conflicts, protect external supplies of critical resources such as oil, and preserve the sovereignty of important trading partners. 

On the other hand, the authors argue that “peace dividends,” which benefit countries that avoid conflict, can lead to reduced national security investments, which can, in turn, leave countries more vulnerable to other dangers.

Works cited

Kevin M. Murphy and Robert H. Topel, “Some Basic Economics of National Security,” American Economic Review: Papers & Proceedings, May 2013.