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

Published online by Cambridge University Press:  11 October 2021

Bent Flyvbjerg Open the ORCID record for Bent Flyvbjerg [Opens in a new window]  and
Dirk W. Bester
Bent Flyvbjerg*
Affiliation:
Saïd Business School, University of Oxford, Oxford, UK and Computer Science Department, IT University of Copenhagen, Copenhagen, Denmark
Dirk W. Bester
Affiliation:
Department of Statistics, University of Oxford, Oxford, UK
*
*e-mail: flyvbjerg@mac.com
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Abstract

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.

Keywords

behavioral economicsbehavioral sciencecost-benefit analysiscost-benefit fallacyforecastingpublic investment planningresource allocationwelfare economicsD60D61H00H54H80
Type
Article
Information
Journal of Benefit-Cost Analysis , Volume 12 , Issue 3 , Fall 2021 , pp. 395 - 419
Copyright
© The Author(s), 2021. Published by Cambridge University Press on behalf of the Society for Benefit-Cost Analysis

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