Ananish Chaudhuri: Govt pivoting away from Covid 19 coronavirus elimination a good thing

Opinion

COMMENT:

It's clear the Government has begun to realise how costly lockdowns can be in terms of economic and social impact. As a result, it now seems willing to pivot away from the goal of total elimination.

This was made clear in the announcement by the Minister of Health that Auckland will most likely be allowed to drop down from the 2.5 alert level even if community transmission does not drop to zero.

This is welcome news since elimination via lockdowns was never really a feasible goal given the significant collateral damage.

Some commentators, however, would like us to "stay the course". According to this view: "We've come this far and given up so much, it would be crazy to stop now."

This is actually a common but misguided intuition. Economists call it the "sunk cost fallacy". To understand why, I relate two stories.

The first refers to an exercise I often carry out in my classes on decision making: "the $20 auction".

I start the lecture by taking out a $20 bill out of my wallet and tell my students I will sell it to the highest bidder.

I then invite students to bid on the $20 bill with one small caveat- this is an "all pay" auction. That means everyone who bids must pay, and only the highest bidder wins the money. The losers must also pay whatever they bid.

This type of situation is quite commonplace. Think about running for public office. Every candidate/party spends substantial amounts of money, but there can only be one winner and the expenses incurred by everyone else are lost.

Similarly, right now companies around the world are in a race to develop a vaccine for Covid-19. They will spend billions of dollars and finally one of them will be successful; the one whose vaccine eventually goes to the market. Investments made by others will likely come to nought.

As the auction starts, there is a general sense of amusement. But eventually someone takes the plunge and bids $1. If the bidding stops there, then this person would have $20 for $1 and makes a $19 profit. But soon other bids start to increase. Then, people actually start to bid more than $20 to win $20! Why?

Suppose you have bid $20 while someone outbids you by going up to $21. If this person wins the $20, then this person has lost $1. You are now losing the entire $20 you bid. So, even if one has to go above $20, people do it because it is a question of minimising losses.

The second story comes from my colleague Tim Hazledine, at the University of Auckland, and relates to Auckland's City Rail Link. When the link was first proposed, the benefits of the project (on a net present value basis) were estimated at about $2 billion. The construction cost was originally estimated to be about $2 billion also.

Then, in April 2019, with $700 million already spent, the costs were revised to $4.4 billion with no change in the estimated benefits and no guaranteed finish date.

In April 2020, it was announced that, because of Covid-19, costs would rise further and the impending May budget should make allowances for this. No mention was made of the possibility that Covid-19 may actually reduce the benefits of the rail link, through more people continuing to work at home rather than commute.

Hazledine wrote: "Adding in some substantial costs missing from the official calculations, the costs of disruption to business and citizens during the build, and the cost of the huge subsidy on the price of rail tickets, it seems sadly reasonable to predict that we now have a $5 billion+ monster on our hands. Even with more sunk costs incurred since last year, we are looking, in the best scenario, at having to fork out another $4 billion to finish a possibly $2 billion value project. How dumb is that?"

This behaviour lies at the crux of the sunk cost fallacy; the idea that people often pursue goals even when the benefits fall short of the costs.

Ananish Chaudhuri. Photo / Supplied

Countries keep fighting ruinous wars even when it is clear nothing remotely resembling victory is possible. Candidates keep campaigning even given a virtually zero chance of victory. In fact, substantial costs already incurred is reason for doubling down and getting in deeper.

This argument applies to our policy on Covid-19 as well. That we have incurred substantial costs does not imply we should continue when the projected benefits fall considerably short of the costs. A recent report from the Productivity Commission suggests the cost of extending our April lockdown by five days outweighed the benefits by more than 90 to 1.

So, it is good news the Government, albeit belatedly, has recognised the error and is now adopting a more practical view of controlling the pandemic.

• Ananish Chaudhuri is Professor of Experimental Economics at the University of Auckland and author of Experiments in Economics: Playing Fair with Money.