Counting the Costs (and Benefits)
Before I worked in tech, I was a civil engineer, and one of my tasks was calculating benefit-cost ratios (BCRs). In the course of this work, I learned an important thing about cost benefit analysis: it is bogus. I will explain why shortly, but first I want to emphasize why this matters. An enormous amount of government decision making rests on cost benefit analysis: infrastructure, community grants, hospital upgrades, major sporting events - everything must be justified by the all-important BCR. If the BCR is inappropriate for all but a few cases, as I will argue it is, then our decisions about how to spend money are fundamentally misguided as well. What’s more, some of the most important opportunities for the future of our nation are being neglected due to the way BCRs are biased towards short-term thinking.
What is a BCR? Simply put, it is a number that represents whether the benefits of buying something outweigh the costs. The higher the BCR, the better the investment. A BCR below 1 means the costs exceed the benefits. It’s so simple, you can see why it appeals to the public service: just plug in the numbers and the projects select themselves.
There is one small problem: what happens if the benefits are not measured in dollars? How do you measure the value of the environment, or wellbeing, or convenience, or mental health? The answer is, for all intents and purposes, make it up. Of course, there are fancy ways to make it look like it’s not made up: a formula here, a spreadsheet there, but at the core it is always based on some assumption that is made up. What is the dollar value of more green space in a suburb? What is the dollar value of better showers at the local footy club? What is the dollar value of a birthday party? The question itself is nonsense. Despite this, in BCR world it must be answered. The most credible method is finding out how much people are willing to pay for these things, but this data is almost never available or accurate, nor does it necessary reflect the true value.
It's not only the benefits that are impossible to quantify: costs are as well. For example, what is the cost of diverting building resources and labour from residential construction to major projects? We know full well this has contributed to more expensive housing, but I guarantee that cost has never figured in any BCR for Dan’s Big Build and even if it was, it was made up because such effects are impossible to predict or quantify.
Another major problem with cost benefit analysis is that it is heavily influenced by the ‘discount rate’ which discounts future benefits in favour of present ones. What should this be? 2% per year? 5%? 10%? You decide! Most likely the one that gives you the answer you want. What if the benefits grow every year as well? Well, you’d better discount them heavily because otherwise your project will have an infinite BCR!
Not only does the ‘discount rate’ approach allow for easy number fudging, it biases decision making towards short term benefits at the expense of long-term vision, and this is my biggest problem with BCR. The most significant projects our nation has undertaken: the founding of cities, the building of railways, our most recognisable landmarks, and important national institutions, all were the product of a vision for the future of Australia, not a BCR. The benefits flowed overwhelmingly not to those generations that undertook them, but to the many generations to come.
Our obsession with BCRs leaves little room for legacy, let alone grand ambition.
There is one visionary, nation-building project in particular where the narrow BCR mindset is a serious impediment: actively developing new cities and transport links.
I am an advocate of big Australia, but not big Sydney and big Melbourne. It’s my view that population growth in our capital cities has degraded our standard of living, pushed up the price of housing and forced younger generations into shoebox apartments and townhouses, needing a double income just to afford the rent. All this, in the 6th largest country in the world. This is not inevitable: with enough vision and determination, we could have multiple large cities in every state. I’m convinced that a fast and regular train connection between the new city and the capital is all it would take to precipitate the change. If the trip from Ballarat, Bendigo, or Warragul to Melbourne CBD was only an hour, the promise of a good house on a big block at a decent price would have people flocking to these places.
This kind of ambition requires a bold mindset: build it and they will come. Cost benefit analysis says don’t build it unless they are already here. Forget about the benefits of affordable housing for millions, that’s not in the calculation. Forget about the economic benefits of a larger population in 30 years. It’s been discounted by 90%.
This is just one project which I particularly care about, but it demonstrates how BCR is an impediment to long-term thinking and a big vision for Australia: something our politics is sorely lacking.
Cost benefit analysis has its place, but its use should be limited to projects where the costs and benefits are financial. For everything else, cost effectiveness (ie. bang-for-buck) analysis should be used instead: patients cured per dollar spent, commuter hours saved per dollar spent, etc. But most of all, projects should be selected based on another thing we learned as engineers: old fashioned judgement.