The Sunk Cost Fallacy

Las Vegas has become the fastest-growing major city in the United States because it exploits the sunk cost fallacy. Not being fools, casino managers fix the odds in favor of the house, which means that on average, gamblers consistently lose to the house. And they keep on losing.

Some atavistic trait in human psychology causes human beings to value a past investment of money, effort or some intangible quality (e.g., “credibility” or “face”) independent of the investment’s probability of paying future dividends. At its most primitive, the trait is what makes us reluctant to leave the interminable line at the DMV: the more time we’ve “invested,” the less likely we are to leave, regardless of how much longer we still have to wait and regardless of whether we could spend that time more profitably and come back another day. It is stubbornness; it is also the sunk cost phenomenon at work.

When the F-22 began development in 1986, the Air Force projected a unit cost of $86 million. Eighteen years later, the unit cost is almost $300 million, and the plane is not yet in service. The U.S. taxpayer has “invested” some $41 billion to date and still not received any discernible dividend after nearly two decades. Meanwhile, the objective conditions influencing the probability of the investment paying dividends has changed radically.

First (although this may be news to the Pentagon and congressional defense committees) the Berlin Wall fell. The F-22 became another extravagant relic of a certain stage of industrial warfare, like railway artillery and the dreadnought. Second, the bombing of the World Trade Center in 1993 ought to have demonstrated the misplaced priority of shoveling tens of billions of dollars into cold war bric-a-brac like the F-22, the Seawolf submarine, and BMD. Washington’s Iron Triangle had 8 years to prepare for 9/11; what fraction of the F-22’s $41 billion could have bought improved intelligence collection on al Qaeda, more Arabic language translators, or improved border protection and immigration control?

In 1999, a defense committee did the unthinkable: it briefly denied production funds for the F-22 on the rationale that it was starving other needs. Predictably, Air Force officials disputed the committee’s portrayal of the fighter’s unit cost–at that point already $187 million. “They pointed out that USAF already has expended more than $20 billion, a third of total program funds, developing the fighter. By factoring out that sunk cost, one arrived at a far lower “to go” sticker price–$85 million per airplane.” (1)

Equally predictable was the outcome: the Air Force prevailed. In so doing, it explicitly invoked the sunk cost argument, which was doubly fallacious because not only was it unrelated to potential dividends in a changed strategic environment, but it lowballed future development and production costs, thereby making the argument even more skewed. (2)

As a glance at the newspaper will reveal, politicians are now trying out new rationales to anesthetize public unease about the rising tab at the Great Mesopotamian Casino. The old bromides about WMD, a self-financing occupation, peace between Israel and Palestine, and the grateful acclaim of the liberated have for months elicited at best a polite cough behind the hand. And with the revelation of conditions at Abu Ghraib prison on every front page in the world, the pols’ saccharine rhetoric about lifting up our little brown brothers in freedom’s ways has turned rancid.

Fortunately for our governing class, the sunk cost argument lies ready: “We’ve come this far; there’s no turning back.” Taxpayers have committed $121 billion and military families a much heavier cost, but the U.S. government has not accomplished a single major prewar objective save deposing the senile Saddam Hussein. Nevertheless, marvelous benefits will accrue (no less than Changing the World) if we “stay the course” and don’t “cut and run”–ominous slogans from Vietnam, another classic example of sunk cost rationales. Even more ominous, the president’s 13 April press conference contains this: “As I have said to those who have lost loved ones, we will finish the work of the fallen.” There, in embryo, is sunk cost–not in money, but in precious lives.

And where is the Loyal Opposition on this weighty issue? Showing his penchant for cutting-edge thinking, the Democratic presidential challenger has issued this breathtaking proposal: add more troops and delay the handover of Iraq to its ostensible owners. Like Bill Bennett in Vegas, his gambling strategy is to up the ante.

Now just where on earth do cynics get the idea that Democrats and Republicans are two heads of the same Hydra?

(1) “Battle of the F-22, ” Air Force Magazine, September 1999.

(2) Tactical Aircraft: Changing Conditions Drive Need for New F/A-22 Business Case (GAO-04-391) is the most recent General Accounting Office analysis of F-22 costs.

WERTHER is the pen name of a Northern Virginia based defense analyst