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DHS Funding: Dueling for Dollars

The big-money question in securing critical infrastructures is: Who pays how much, and for what? Or, in the case of the electric power industry: Where do you draw the line between ratepayers and taxpayers?

Indeed, the government has powerful economic incentives to do so. Securing the infrastructure involves what economists call a negative externality: That is, the actions of one entity affect the well-being of other, seemingly unrelated, entities. If terrorists attack a nuclear plant, society as a whole ends up paying for indirect damageseverything from electrical outages to hospital bills to lost productivity. (This is the same kind of economic rationale for seat-belt laws.) Even in terms of direct damages, the targeted company can pay only up to the point at which it (or its insurance company) goes bankrupt. The marketplace is not great at dealing with catastrophes.

This problem is particularly acute in the energy sector. Not only do facilities like nuclear power plants, oil refineries and dams have the potential to cause calamity; the sector as a whole is essential to other components of the nation's critical infrastructure. As the blackouts during the summer of 2003 illustrated, a disruption in one part of the power grid can have a cascading effect, influencing everything from drinking water to 9-1-1 calls to ATMs. Energy is the critical infrastructure of critical infrastructures.

But energy is also a vexing infrastructure to try to protect. Largely owned and controlled by private entities, it operates within a complicated web of regulation and deregulation that can make excess operating costs difficult to pass on to customers. A company like Exelon operates nuclear, fossil-fuel-powered and hydroelectric facilities that generate electricityan endeavor that generally is unregulated. It also distributes this electricity to local utility customersan endeavor that generally is regulated by a bevy of local public-utility commissions. On one end, the business looks regulated, and on the other deregulated. In the middle, where all this electricity is actually transmitted, is the nation's vast, antiquated and incredibly complex power grid.

The result? An industry with an odd pricing system and complicated delivery mechanism, whose profits are centered on huge, long-term capital investments and whose market response time is nearly glacial in speed. In the economics of critical-infrastructure protection, it doesn't get worse than this.

"I believe very much in open markets, and I think markets do correct themselves," says Michael Assante, CSO of American Electric Power (AEP)one of the nation's largest integrated energy companiesand an outspoken critic of any governmental attempts to regulate security. "But the questions come down to, is terrorism a problem that the market can deal with in the short term?"

Many experts are concluding that the answer to that question is no. They suspect that some of the work of hardening the nation's energy infrastructure will have to be subsidized by the government. There's precedent for this: The government took over responsibility for securing part of the nation's transportation infrastructure when it put DHS's Transportation Security Administration in charge of screening airline passengers. In light of the TSA example, the question now up for debate is, which parts of securing the energy infrastructure can be passed on to DHSand how? Because existing economic models just don't work when it comes to an undertaking as massive as homeland security.