Breaking the Chains of the Sunk Cost Fallacy: Lessons from Nepal's Persistent Investments

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A sunk cost is any cost that has already been incurred and cannot be recovered, no matter what. It could include past investments of time, effort and any other resource that cannot be recouped, and hence, should not influence present or future choices. For instance, if a business spends 10 lakh rupees on an advertisement campaign that ultimately fails, the 10 lakh rupees is a sunk cost for the business. The rational behaviour in this scenario would be to quit this particular advertisement campaign and start a new one that is more likely to succeed. However, this rational decision making does not always happen and the business might persist with the same advertisement campaign that is almost certainly destined to fail. This leads to the idea of ‘Sunk Cost Fallacy’. It simply means making a choice not based on what outcome you think is going to be the best going forward but instead based on a desire not to see your prior commitments go to waste.

 A historic example of this phenomenon is ‘The Concorde’, a supersonic airliner transport project of the French and British government. Building the aircraft seemed to be very difficult and expensive. However, instead of shutting down the plan, the British and French governments continued funding it even though they knew the aircraft would not have any economic benefit. They argued that they had invested too much to give up. 

 

Behavioural economists suggest the following psychological reasons for this irrationality: 

  1. Loss Aversion: People prefer avoiding losses to acquiring equivalent gains. For eg. Most people avoid bets where they can win 1000 rupees because they could also lose 1000 rupees. It’s because we are more likely to avoid losses than seek out gains with equal risk involved. 
  2. The desire not to appear wasteful: Withdrawing from a decision is admitting that whatever resources we invested in it was wasteful, and being wasteful is certainly not a desirable quality. This is why some finish food even when they feel full or don’t think it’s particularly tasty. 
  3. Emotional attachment: Many people are emotionally attached to whatever they invest their money and time into, whether it be a relationship or a business venture. This attachment makes it difficult to withdraw, even when it’s rational to do so. 
  4. Optimism bias: People have the tendency to overestimate the chances that our efforts will yield desirable results at the end, causing us to ignore any red flags.Thus, it compels us to invest more of our time, money and resources into it. 

In Nepal, talking about the general public, most people are seen continuing to pursue a degree or career path they are no longer invested in or don’t see their future potential in, simply because they’ve already invested too much of their money, time and resources in that path. The most prominent examples are of students who persist to complete an engineering degree despite having lost interest midway through, just because they don’t want their past spendings to go in vain. Likewise, farmers in Nepal often persist with inefficient and traditional methods and crops despite poor returns and continuous loss for many seasons. They do this because of the considerable commitment of time made in learning these methods and investment of funds into fertilisers, seeds and traditional equipment that they don’t want to abandon. Furthermore, the real estate industry of Nepal often falls prey to this phenomenon. People continue to renovate or improve their existing property despite economic factors clearly indicating that it may not yield good returns. This is more evident in rural parts of Nepal where people build bigger houses than necessary, motivated by the fact that a huge sum of capital has already been invested in it and stopping would mean all of that possession going to waste. 


Looking at the larger spectrum, ‘The Nijgadh International Airport’ is another prominent instance. This ambitious initiative was supposed to be Nepal’s biggest airport which would boost tourism, trade and significantly reduce the growing air traffic issues in Nepal. However, there have been several environmental concerns raised, followed by legal battles and significant delays but the government continues to pour resources and capital into this project. This continued spending is driven by the substantial amount already invested even though it’s highly unlikely the initiative will deliver expected outcomes. Moving forward, the brick kiln industry in Nepal is another huge industry which has suffered because of this fallacy. Many of the companies involved in producing bricks continue to invest in environmentally harmful and outdated technologies because they’ve heavily invested in those traditional infrastructures. As a result, production has been way less efficient than it can potentially be and results in large scale pollution that could easily be avoided through logical decision making. The Hydropower industry of Nepal is no stranger to this phenomenon either. According to ICRA Nepal, ‘The Upper Tamakoshi Hydropower Project’ was initially budgeted to cost around NPR 35 billion. However, due to continuous labour strikes, technical difficulties and unexpected natural calamities, the expense has escalated to around NPR 90 billion. Nonetheless, due to the heavy former commitments, investment continues to pour into the project despite it lacking confidence to pay back the capital and meet the initial expectations. 

 

There are innumerable such instances in every field and at every level. However, knowing about this phenomenon can assist you in identifying it the next time you come across this and make a reasonable judgement. Despite identifying, overcoming the sunk cost fallacy can be challenging, but simple steps can help you achieve this. Firstly, pay attention to your reasoning. Are you prioritizing future expenses and benefits, or are you held back by your previous expenses, even when it no longer yields the best outcome? Secondly, consider the opportunity cost. What are you missing out on by continuing to invest in your past endeavours? Are there other paths that could potentially be more beneficial? Thirdly, avoid being too sentimentally  attached to your investments because that is when the sunk cost fallacy will take effect and you’ll go down the rabbit hole. In this situation, seeking advice from people who aren’t emotionally invested in your venture can give you a better insight of what to do and what not to do. Ask yourself these questions while drawing conclusions, and you’ll most likely make more objective, strategic and rational decisions that will be more beneficial, in all aspects of life and business.