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Can Investments Be Too Efficient?

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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