Sunday, January 23, 2022

Study finds a High Degree of Bias in Cost-Benefit Analyses of Public Investments

by Rod Williams, Jan. 23, 2022-  New research finds there is a high degree of bias in cost-benefit analyses of public investments. Anyone who has served as a member of a legislative body such as the Metro Council, School Board, or State legislature has seen those studies that say if you spend this amount of money on this project, the return will be widely enormous.  The message is that only a fool would not support a project with this kind of return. The project may be building a new road, a new bypass, or bridge, building a fixed rail mass transit project, building an industrial park, developing a water project, improving traffic control, building a park or greenway, building a new health clinic, financing a new sports stadium, or anything.  Always, the return will be enormous.  

If you have not served in government but work in a sector, non-profit or for-profit, that is trying to get funding from government or maybe funding from United Way or some big philanthropy organization that dispenses money, your organization may have produced such cost-benefit analysis reports or paid an outside consultant to produce them for you.

Researchers at St. Ann's College have studied this issue and have found that cost-benefit analyses underpin most public investments and that they cannot be trusted.  They find that cost-benefit analyses are highly inaccurate and biased. The benefit tends to be inflated by 50 to 200 percent according to this study.

The bottom line is that most cost-benefit analyses are BS. The benefit is highly inflated and based on an opinion that cannot be proven or disproven.  Also, the cost is often understated. Cost overruns are almost the norm on public projects.  Also, cost-benefit analysis rarely calculates the opportunity cost.  Such studies should ask if this project is not funded what will be the benefit of letting the public keep the money and spend that money to buy homes, buy cars, send their kids to college, and fund  retirement accounts.  Money not spent on the subject project does not just disappear or sit idle. It gets used for something else and that something else may have an even greater return. If you should read a news story stating a cost-benefit analysis for a certain project, take it with a grain of salt.  Assume it is most likely fantasy. 

For more on this study, follow this link.  At that link, there is a link to the full research paper for those who want to dig deeper.  For another study that comes to the same conclusion as the St. Ann study see, Too costly to be beneficial from Value Research.

This reminds me of a story: 

A growing company needed to hire someone in management to help with the companies finances. The CEO interviews three candidates, a mathematician, an accountant, and an economist. He interviewed them separately and after all of the questions about credentials and experience asked each the same final simple question. 

"What is two plus two?" he asked the mathematician. "That's easy," the mathematician replied. "It is four."

Next, he interviewed the accountant and asked, "What is two plus two?"  The accountant said, "There is a 99 percent probability that it is four with a plus or minus factor of .2."

Then he interviewed the economist. "What is two plus two," the CEO asked.  The economist, glanced both directions, leaned forward, lowered his voice, and said, "What do you want it to be?"

Substitute "consultant" for economist.  The consultant will never tell the person for whom he is consulting that the project is not worth funding. 

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