Monday, February 18, 2019

Sunk costs

In recent weeks, California’s new governor canceled (actually scaled back) California’s high-speed rail (previous post), Airbus canceled further work on the A-380, and Amazon has second thoughts about New York city. Is it the end of the sunk cost fallacy? Not really. The sunk cost fallacy results from the natural human tendency to not admit mistakes – and to somehow strive to redeem mistakes. Gamblers seldom walk away from a losing streak (casinos make a lot of money).  Couples and friends with relationships gone sour often stick with them for many years. (We seemingly have no data on this).

Throwing good money after bad has limits. More than half of new business fail within five years. But this is less clear when other people’s money is involved. It is also less pronounced when Bootleggers and Baptists coalitions are in play. Finally, when (especially) vain politicians think of their legacy (and “legacy projects”, e.g. Jerry Brown and the bullet train) the plot thickens. Amazon walked away from a bad prospect way earlier than California did.

I expect that many more economists teaching intro courses talk about market failure than government failure.  I will never know why.