Big Signals

Between $6 and $9 trillion dollars—about 8% of annual world-wide economic production—is currently being spent on projects that individually cost more than $1 billion. These mega-projects (including everything from buildings to transportation systems to digital infrastructure) represent the biggest investment boom in human history, and a lot of that money will be wasted. …

Over the course of the last fifteen years, [Flyvbjerg] has looked at hundreds of mega-projects, and he found that projects costing more than $1 billion almost always face massive cost overruns. Nine out of ten projects faces a cost overrun, with costs 50% higher than expected in real terms not unusual. …

In fact, the number of mega-projects completed successfully—on time, on budget, and with the promised benefits—is actually too small for Flyvbjerg to determine why they succeeded with any statistical validity. He estimates that only one in a thousand mega-projects fit that criteria. (more; paper)

You can probably throw most big firm mergers into this big inefficient project pot.

There’s a simple signaling explanation here. We like to do big things, as they make us seem big. We don’t want to be obvious about this motive, so we pretend to have financial calculations to justify them. But we are purposely sloppy about those calculations, so that we can justify the big projects we want.

It would be possible to make prediction markets that accurately told us on average that these financial calculations are systematically wrong. That could enable us to reject big projects that can’t be justified by reasonable calculations. But the people initiating these projects don’t want that, so it would have to be outsiders who set up these whistleblowing prediction markets. But alas as with most whistleblowers, the supply of these sort of whistleblowers is quite limited.

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  • IMASBA

    Do cost overruns automatically mean resources are wasted instead of the original price offering having been wrong (perhaps intentionally so to tmake the project more attractive)?

    Do smaller investments incur significantly smaller cost overruns (obviously very small ones do, like painting your living room, but what about $50 million projects)?

    Do you think the total cost of such large projects would be lower if they were artificially relabeled to multiple smaller projects, or if oversight was actually broken down into smaller units (if so then “grand gesture” signalling might indeed be a reason why projects aren’t broken up more often)? Do you think that people can arrive at any conclusion they like about the waste of large projects by choosing which collections of small projects they label as single large projects?

    Do you think that the fact that $1+ billion projects are often government related inflates the cost overruns or do you believe the efficiency difference between private and public sector vanishes at such scales? Or might governments naturally take one the more difficult and less clearly defined among the large projects, as well as governments perhaps being more inclined to present collections of projects as single large projects to make it easier for voters and politicians to take a stand for or against?

  • Jonathan Graehl

    I didn’t see any figures for smaller projects given as context in the full text (free DL) of http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2424835

  • Lord

    Do we even need markets to tell us that? The data already seem clear. Do we have the choice of implementing them? Some things are only possible in large sizes. Some things need to done regardless of cost, or at least where anything less than double would still be considered reasonable. I expect most people already discount this likelihood and low figures are only hopes and attempts to minimize what everyone knows will be expensive. We just know that putting realistic costs out will only ensure those as minimums. Not sure most home remodeling projects do much better.

  • Grognor

    A much simpler explanation for these miserably wrong calculations is the planning fallacy. Or is your signaling explanation an etiology for the planning fallacy itself?

    • http://overcomingbias.com RobinHanson

      “Planning fallacy” is a name for a puzzle, not an explanation of that puzzle. And we want to explain not just planning errors, but disinterest in better ways to avoid those errors.

  • Ronfar

    Mega-projects would be budgeted better if people making budgets had incentives to be accurate instead of optimistic. If the contract goes to the lowest bidder, the bidder has a massive incentive to promise the moon and then say “Oops, I need more money to finish – pay me more or you get nothing.”

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