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

Journal of Benefit-Cost Analysis, October, pp. 1-25, doi 10.1017/bca.2021.9.

25 Pages Posted: 28 Sep 2021 Last revised: 18 Oct 2021

See all articles by Bent Flyvbjerg

Bent Flyvbjerg

University of Oxford - Said Business School; IT University of Copenhagen; St Anne's College, University of Oxford

Dirk W. Bester

University of Oxford

Date Written: September 6, 2021

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: Cost-benefit analysis, cost-benefit fallacy, public investment planning, forecasting, resource allocation, welfare economics, behavioral science, behavioral economics

JEL Classification: H00

Suggested Citation

Flyvbjerg, Bent and Bester, Dirk W., The Cost-Benefit Fallacy: Why Cost-Benefit Analysis Is Broken and How to Fix It (September 6, 2021). Journal of Benefit-Cost Analysis, October, pp. 1-25, doi 10.1017/bca.2021.9., Available at SSRN: https://ssrn.com/abstract=3918328

Bent Flyvbjerg (Contact Author)

University of Oxford - Said Business School ( email )

Oxford
Great Britain

IT University of Copenhagen ( email )

Copenhagen
Denmark

St Anne's College, University of Oxford ( email )

Oxford
United Kingdom

Dirk W. Bester

University of Oxford ( email )

Mansfield Road
Oxford, Oxfordshire OX1 4AU
United Kingdom

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