The Economics of Cybersecurity: Principles and Policy Options1

Economics puts the challenges facing cybersecurity into perspective better than a purely technical approach does. Systems often fail because the organizations that defend them do not bear the full costs of failure. For instance, companies operating critical infrastructures have integrated control systems with the Internet to reduce near-term, measurable costs while raising the risk of catastrophic failure, whose losses will be primarily borne by society. As long as anti-virus software is left to individuals to purchase and install, there may be a less than optimal level of protection when infected machines cause trouble for other machines rather than their owners. In order to solve the problems of growing vulnerability and increasing crime, policy and legislation must coherently allocate responsibilities and liabilities so that the parties in a position to fix problems have an incentive to do so. In this paper, we outline the various economic challenges plaguing cybersecurity in greater detail: misaligned incentives, information asymmetries and externalities. We then discuss the regulatory options that are available to overcome these barriers in the cybersecurity context: ex ante safety regulation, ex post liability, information disclosure, and indirect intermediary liability. Finally, we make several recommendations for policy changes to improve cybersecurity: mitigating malware infections via ISPs by subsidized cleanup, mandatory disclosure of fraud losses and security incidents, mandatory disclosure of control system incidents and intrusions, and aggregating reports of cyber espionage and reporting to the World Trade Organization (WTO).