How (In)Accurate Is Cost-Benefit Analysis? Data, Explanations, and Suggestions for Reform

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

Keywords: Cost-benefit analysis, cost-benefit fallacy, infrastructure economics, infrastructure investment, infrastructure policy, forecasting, resource allocation, welfare economics, behavioral science, behavioral economics