SUNK COSTS IN BUSINESS AND IN POLITICS

The concept of sunk costs is widely taught particularly in the fields of economics and business. It is put to good use in making rational economic and business decisions. Unfortunately it is seldom taught or employed in the fields of politics, and seldom used by journalistic pundits and the public in general.

Sunk costs are an element in decision making at the margin. At the beginning of any project there are only estimated costs and estimated benefits. Often the benefits do not emerge until most or all of the actual costs have been incurred. At various times during a project a re-evaluation is often required in deciding whether the project should be continued or abandoned. This evaluation is usually triggered by high costs, cost overruns, or re-estimates of the benefits. One argument frequently heard in such evaluations is "why throw good money after bad?"

During such evaluations the only relevant costs are the additional costs yet to be incurred which will not be incurred if the project is discontinued. All the past costs are gone, sunk, and irrelevant. Further, the only relevant benefits are the estimated additional benefits yet to come if the project is continued. Benefits already received are counted only as a base in determining how much more benefits can be expected.

Viewing costs and benefits in this way is not always easy as sunk costs get in the way of clear thinking. Additionally the relevant costs and benefits are always estimates of the future and should be viewed in probabilistic terms rather than ignore the uncertainties.

Here is an example from the Afghanistan situation of a political attempt to depicts past sunk costs as relevant.
Abdullah Abdullah, Afghanistan's main opposition leader is quoted as follows.
"The sacrifices you [Canadians] have made here, and all your [Canadian] taxpayers' money. What for? You will have to ask that,"
"You have more than a right to stay firm in that," Mr. Abdullah said. "Not just for the sake of any Afghan persons or an Afghan movement, but for the sake of the sacrifices you have made here. You are not in the business of betraying your own people. In that sense, it is an obligation."

Those sacrifices already made are a sunk cost. They are irrelevant to any decision that must be made now. A jaded politician contemplating the reaction of constituents at the very end of a project, where an evaluation will inevitably attempt to add up all costs and all benefits, is likely to shift footing and be thinking in terms of his political costs and benefits rather than those of the project per se.

The evaluation in total at the end of a project is valid as a learning exercise, particularly in learning to make better estimates in the future and in detecting areas for improvements in operational efficiency. It is not valid in evaluating the decisions made along the way with respect to continuation or abandonment of the project.