Latest / Behavioral Economics with Fexingo: Decision Making, Bias, and How People Really Spend / The Sunk Cost Fallacy in Big Infrastructure Projects
Transcript
- Lucas: So Luna, we talk a lot about how our brains misfire in small everyday purchases. But today I want to scale that up. I'm thinking about multi billion dollar infrastructure projects and the sunk cost fallacy. Luna: Oh, this should be good. Because there's no bigger sunk cost than a giant concrete hole in the ground that's already cost a country's GDP. Lucas: Exactly. And there's a perfect case study right now. I'm talking about the Brenner Base Tunnel, the rail link between Austria and Italy. It's been under construction since 2006, it's already billions over budget, and the completion date keeps slipping. Current estimates have it finishing in 2032, but some experts say that's optimistic. Luna: Right, and it's not like they can just abandon it. They've already spent so much, and there's political pressure to see it through. Lucas: That's the sunk cost fallacy in its purest form. The money spent is gone, but decision-makers treat it as a reason to keep going. Economists call it 'escalation of commitment.' It's the same reason you might finish a terrible book because you already paid for it, or keep a failing project alive because you've invested years of your life. Luna: And it's not just about the money, right? It's about ego, reputation, career. If you're the politician who greenlit this, you don't want to be the one who pulled the plug. Lucas: Exactly. That's what Dr. Maya Chen's research on escalation of commitment found. She studied how project managers in the public sector double down on failing projects, and she found that the key driver is the fear of being seen as a failure. It's not rational cost-benefit analysis; it's about saving face. Luna: So what would a rational decision look like in that case? How do you even calculate when to walk away? Lucas: Well, you have to look at the future costs and benefits, ignoring everything you've already spent. For the Brenner tunnel, the question is: given the remaining cost to finish it, will the economic benefits of a faster freight route between Austria and Italy exceed that? And that's a tough call, because the benefits are spread over decades and might be uncertain. Luna: And that's where the psychology kicks in. The future benefits are abstract, while the money already spent is concrete. We anchor on that past cost. Lucas: Right. And it's not just governments. Private companies do this all the time. Think of how long some tech companies kept a failing product alive just because they'd invested so much in R&D. The classic example is the Concorde, but more recently, you had companies sticking with doomed hardware projects. Luna: But there's also the opposite side, where companies are too quick to kill projects that might have paid off. It's like the anti-sunk-cost fallacy. Lucas: That's true. And that's why it's so tricky. You don't want to be stubborn, but you also don't want to be flaky. The key is to have pre-committed criteria for success and failure before you start, so you can evaluate progress objectively. Luna: That sounds like something we could all apply to our personal finances. Like, I have a gym membership I never use, but I keep paying for it because I've already paid for it. That's a sunk cost, right? Lucas: Exactly. Or a subscription to a streaming service you barely watch. The money is gone, and it's not coming back. The only question is whether the future subscription is worth it compared to other things you could do with that money. Luna: So how do we break the cycle? How do we train ourselves to ignore sunk costs? Lucas: One technique is to ask yourself a counterfactual: if I hadn't already invested in this, would I start now? If the answer is no, then you should stop. That's a clean way to strip away the sunk cost. Luna: That's a good rule. But it's hard to apply when you've put years of your life into something, not just money. Like a career or a relationship. Lucas: Absolutely. And that's where we need to be compassionate with ourselves. But for financial decisions, that counterfactual is powerful. Another trick is to think of the money you've already spent as a 'tuition fee' for learning what doesn't work. That reframes it as an investment in knowledge, not a loss. Luna: That's a nice reframe. And it ties into something you mentioned earlier, about pre-committing to criteria. That's like setting a budget for a home renovation and deciding in advance what you'll do if it goes over. Lucas: Right. And that's actually what smart project managers do. They set 'kill criteria' upfront. For example, if the cost overrun exceeds 20 percent, the project is automatically reviewed, and the decision to continue has to be made fresh, not just by default. Luna: That sounds like a good way to avoid the trap. But what about when the project is nearly done? Isn't it sometimes rational to finish just to get some value out of it? Lucas: That's a nuanced point. If the remaining cost to finish is less than the expected benefits, then yes, you should finish. But you have to be careful that you're not just rationalizing because you're so close. The 'near-completion' effect is real. It's the same reason you might binge a TV series you've lost interest in just because you're two episodes from the end. Luna: Ha, I've definitely done that with a few shows. And it's never worth the last two hours. Lucas: Right. And that's a small example. But in the public sector, these decisions affect millions of people and billions of dollars. The Brenner tunnel, for instance, is part of a larger European freight corridor. If they cancel it, they lose the money already spent, but they also free up resources for other projects that might have higher returns. Luna: It's a huge opportunity cost. And that's the thing that gets lost in the sunk cost discussion. It's not just about what you've already lost; it's about what you could be gaining by cutting your losses. Lucas: Exactly. And that's the message we want to leave with our listeners. Whether it's a failing infrastructure project or a gym membership you don't use, ask yourself: if I were making this decision for the first time today, would I start it? If not, it's time to walk away. Luna: And that's a perfect segue to something we should mention. If walking through the economy with us has made something click for you, and you want to keep these conversations going ad-free, you can support the show at buy me a coffee dot com slash fexingo. Lucas: Yeah, it's a simple way to help us keep doing what we do. We're not going to guilt-trip you, but if you've ever wondered how we stay independent, that's it. Luna: And we're back to the sunk cost. So, Lucas, any final thought on how to spot it in your own decisions? Lucas: Just remember that the money you've spent is gone. It's not a reason to keep spending. Think about what the future holds, not the past. And if you're in charge of a big project, set those kill criteria early. Luna: And maybe don't finish that TV series if you're not enjoying it. Lucas: Exactly. That's the small-scale version of the same bias. Next time you're about to drop another month of subscription fees, ask yourself that counterfactual. You might be surprised how often the answer is no.