The Cost-Benefit Fallacy: Why Cost-Benefit Analysis Is Broken and How to Fix It

DSA ADS Course - 2022

Cost-benefit Analysis, Cost-benefit Fallacy, Public Investment Planning, Forecasting, Resource Allocation, Behavioral Science

Discuss cost-benefit analysis, cost-benefit fallacy, public investment planning, forecasting, resource allocation, welfare economics, behavioral science and behavioral economics.

What if scenario estimates are highly inaccurate and biased? What are potential costs of scenario inaccuracies seriously distorting effective resource allocation?

Discuss methods and techniques to mitigate risks of serious scenario inaccuracies.

How to create a culture that thinks systemically, articulates assumptions, ask good questions and applies probability theory to scenarios - versus cost-benefit analysis as a black-box process that hides inconvenient assumptions and shuts down debate.

How to create systems to improve accuracy of scenario estimates through better data, independent audits and performance incentives. 

The Cost-Benefit Fallacy: Why Cost-Benefit Analysis Is Broken and How to Fix It - October, 2021


Most cost-benefit analyses assume that the estimates of costs and benefits are more or less accurate and unbiased. But what if, in reality, estimates are highly inaccurate and biased? Then the assumption that cost-benefit analysis is a rational way to improve resource allocation would be a fallacy. Based on the largest dataset of its kind, we test the assumption that cost and benefit estimates of public investments are accurate and unbiased. We find this is not the case with overwhelming statistical significance. We document the extent of cost overruns, benefit shortfalls, and forecasting bias in public investments. We further assess whether such inaccuracies seriously distort effective resource allocation, which is found to be the case. We explain our findings in behavioral terms and explore their policy implications. Finally, we conclude that cost-benefit analysis of public investments stands in need of reform and we outline four steps to such reform.

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