1. Optimism Bias in Major Infrastructure Projects Dr Eamonn Molloy
Presentation to:
International Consulting Economists Association
London
18th January 2010

2. Projected infrastructure spending by region
- US$ ’000bn,
9.2
6.5
0.9
15.9
7.5
1.1
Source:
Cohen & Steers Global Infrastructure Report 2009: The $40 Trillion Challenge

3. Planned UK infrastructure investment 2010 -11 to 2014 - 15
Total
195
Source: HM Treasury, Infrastructure UK (values in prices)

4. Characteristics of major infrastructure
Inherently risky
Technology and design often non-standard
Decision-making, planning, management are complex
Project lock-in or capture at early stage
Scope and ambition changes over time
Budget and contingencies often inadequate
Misinformation about costs, benefits and risks is the norm, including business case
Cost overrun and benefit shortfalls during implementation

5. Inaccuracy of transportation project cost estimates by type of project (in constant prices)
No. of cases
Avg. cost overrun %
Standard deviation
Rail 58
44.7
38.4
Bridges & Tunnels 33
33.8
62.4
Road
167
20.4
29.9
For transportation mega-projects…
9 out of 10 projects have cost overrun
Overrun is found across 20 nations and 5 continents
Overrun is constant for the 70-year period of the study
Cost estimates have not improved over time
Source: Flyvbjerg, 2007

6. Inaccuracy of forecasts of rail passenger and road vehicle traffic
Type of project
No. of cases
Avg. error %
Std dev
Rail 25
-51.4
28.1
Road
183
9.5
44.3
84% of rail passenger forecasts are wrong by > +/- 20%
9/10 rail projects overestimate traffic
50% of road traffic forecasts are wrong by > +/- 20%
No. of roads with overestimated and underestimated traffic is about the same
Inaccuracies are global
Inaccuracies are constant over last 30 years
Source: Flyvbjerg, 2007

7. Why is this a problem?
Cost overruns and benefit shortfalls are a problem because:
Leads to a pareto-inefficient allocation of resources, i.e. waste
Leads to delays and further cost overruns and benefits shortfalls
They destabilize project management
The problem is getting bigger because projects are getting bigger

8. Garbage in = Garbage out
Example: Channel Tunnel
Longest underwater rail tunnel in Europe, connecting France and UK
At IPO, Eurotunnel told investors: “10% would be a reasonable allowance for the possible impact of unforeseen circumstances on construction costs.”
Actually… 80% over construction costs, 140% over for financing.
Revenues half of those forecast, IRR at -14.5%
Economy would have been better off if the Tunnel was never constructed
Solution: Fire the forecasters?

9. Explanation 1: Technical
Imperfect forecasting techniques
Inadequate data
Honest mistakes
Inherent uncertainty in predicting the future
Lack of skills, knowledge, experience of forecasters
Solution: develop better forecast models, better data, training forecasters and PM’s.

10. Explanation 2: Psychological: Planning Fallacy and Optimism Bias
Managers make decisions based on delusional optimism rather than rational weighting of gains, losses and probabilities
Overestimate benefits and underestimate costs
Spin scenarios of success and avoid considering potential mistakes and miscalculations
Ubiquitous cognitive bias
Solution: Simple reality checks

11. Explanation 3: Political Economic
Planners and promoters deliberately and strategically overestimate benefits and underestimate costs
This increases the likelihood that their projects, not competitors will be selected
Emphasize success scenarios and downplay failure scenarios
Lying and corruption pays off…
Solution: Accountability

12. Survival of the Un-fittest…
underestimated costs
overestimated benefits + =
funding

13. The Outside View: Reference Class Forecasting
Identify a relevant reference class of past projects
Broad enough to be statistically relevant, narrow enough to be directly comparable
Establish a probability distribution for the selected reference class
Needs credible, reliable data
Compare project with reference class distribution
Establish most likely outcome for the project
Source: Flyvbjerg and Cowi, 2004  

14. Inaccuracy of construction cost forecasts for rail projects in reference class.
Source: Flyvbjerg, 2007

15. Example: Edinburgh Tram Line 2 (2004)
Initial cost estimate of £320M made by planners was adjusted for optimism bias and acceptable risk using a probability distribution.
Resulted in revised cost estimate of £400M
Included contingencies to insure against cost overruns at the 80% level (i.e., 20% risk of cost overrun)
If Scottish Parliament accepted a 50% risk of overrun then cost estimate including contingencies could be lowered to £357M
Approach now being applied on other projects, e.g., Crossrail London, estimated £16 Billion.

16. Summary
Major Infrastructure / Mega Project spending set to increase globally
Effective delivery is crucial – failure has major economic consequences
Optimism bias and Strategic misrepresentation a significant contributory factor in overestimation of benefits and underestimation of costs
Reference class forecasting and the outside view can mitigate this when supported by appropriate governance and accountability

17. Thankyou eamonn.molloy@pmb.ox.ac.uk