The Cost-Benefit Fallacy: Why Cost-Benefit Analysis Is Broken and How to Fix It
Flyvbjerg, Bent and Dirk W. Bester, forthcoming, "The Cost-Benefit Fallacy: Why Cost-Benefit Analysis Is Broken and How to Fix It," Journal of Benefit-Cost Analysis, accepted for publication.
25 Pages Posted:
Date Written: September 6, 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.
Keywords: Keywords: Cost-benefit analysis, cost-benefit fallacy, public investment planning, forecasting, resource allocation, welfare economics, behavioral science, behavioral economics
JEL Classification: H00
Suggested Citation: Suggested Citation