Can Investments Be Too Efficient?

Oct 8, 2018 Diane Coyle

When it comes to investment decisions, economists focus on the most efficient use of resources, as revealed by cost-benefit analysis. But, despite the obvious advantages of this approach, optimal efficiency is not always desirable, and the long-term benefits of an investment are not always clear from the start.

CAMBRIDGE – In 1831, when Charles Darwin boarded The Beagle for its five-year voyage of exploration, ships navigated with the help of chronometers, which showed the precise time at a reference location. That time, when compared to the local solar noon, could be used to determine current longitude. To ensure precision – the motion of the waves affected timekeeping – a ship needed at least three chronometers. The Beagle had 22.

Like the nineteenth-century voyager, the modern engineer prizes redundancy, in the form of back-up and failsafe mechanisms (most would consider the standard triplicate provision to be adequate). Economists, however, privilege efficiency over redundancy – an approach that, despite its obvious merits, also has shortcomings.

To be sure, it would be a caricature to say that an economist’s perspective disparages backups in safety-critical systems. But, when it comes to investment decisions, economists focus on the most efficient use of resources, as revealed by cost-benefit analysis.

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0 Comments on this paragraph, 7 Comments on this article

Mario Iacobacci Oct 29, 2018

This piece leaves one with the impression that cost-benefit analysis rules the roost in public policy, when nothing is further from the truth. CBA certainly has its limitations, but my approach would be to understand these so that the CBA tool can be better used in practice. For example, in practice, CBA analysis rarely takes account of the flexibility of say some new infrastructure project to respond to needs other than the main ones envisaged (e.g. freight rail built 100 years ago now used to deliver commuter rail services instead).
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Claudio Migliore Oct 23, 2018

Dear Ms. Coyle,

This reminds me of the saying about richness and thinness of socialites. Although some of your arguments are solid, I think the conclusion, just like the title, are a bit misleading.

All your arguments, in my opinion, just point out to the need of much, much better cost benefit analyses, not the superiority of pure seat of the pants, irrational decisions.

True that long term benefits are sometimes ignored or unforeseable and that intergenerational generosity is at the heart of much human progress, but I am sure that quite a few boondoggles could be cited as counterexamples.

An, albeit flawed, attempt at telling vision from mirage is better than no critical analysis at all. In particular, one might point out that more solid techniques to evaluate (always math involved, I am afraid) the impact of the imponderables is desirable, since this is often just done via worst-best case scenarios rather than mathematical probabilistic analysis.

You can never be too efficient. Efficiency counts. It's just necessary to define your desired outcomes correctly.
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Erik Thomson Oct 12, 2018

Dear Diane,
Thank you for this article, and also for your blog, which has pointed my way towards a number of excellent books. I think you are an honest reviewer, who has the patience to do books justice. Thanks for that--it is rare! You've enriched my intellectual life more than you could know; I hope you take that for a serious compliment.

I worry, though, about this piece. I agree completely that cost-benefit analysis fails on certain sorts of projects; I would also agree that cost-benefit analysis is usually something that should be done. So how should we distinguish the two? Is there a sort of project with which conventional economic analysis usually fails? Where do we draw that line? Or are we forced to rely on old, prudential politics?
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Jan Rautenkranc Oct 10, 2018

Those chronometers were not such overkill as they were needed for crosschecking (one of the purpose of the expedition was to create a chain of reference points for calibration of ships chronometers on future expeditions). The need for accuracy was Paramount, and some of the chronometers were mean to be bought on shore for expeditions, where they could get damaged. Its not the point of this article, but I felt its good to know :)
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Peter Schaeffer Oct 8, 2018

The original Erie Canal was built at a cost of just $7 million. Adjusting for inflation that is $133 million now. Even allowing for higher wages the cost is just $1.5-5 billion. The cost of building the Erie Canal was greatly reduced by following the Mohawk river most of the way.
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Paul N Oct 8, 2018

Efficiency is not the ultimate goal. Especially if you consider that the most efficient government is a one person dictatorship. The checks and balances in the US political system are the antithesis of efficiency.

The most efficient economic structure would have one family or corporation owning everything. Its hard to beat that kind of economies of scale. Competition can be seen as an inefficiency. Why have three companies making the same exact product...when one can make the product and the other two can make something else.

In the end....the quest for efficiency leads to monopolies. Too much efficiency kills competition and subsequent innovation.
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