Failures of Megaproject Management, or Why Are the Olympics so Unprofitable?

The Olympics are massively unprofitable for host cities, so why do they compete for the privilege of losing money?

To find answers, we’ll go on a meandering tour of how megaprojects go wrong.

Winner’s Curse?

To determine a host, each competing city submits a proposal, then active members of the IOC cast a vote, and the winner is chosen. Assuming more lavish proposals improve your odds of winning, this process is auction-like, and winners will tend to overpay.

That explains some degree of cost overrun, but what we see in practice is really tremendous. Baade and Matheson’s The Economics of the Olympics puts the London 2012 Olympics at a cost of $11.4 billion, with revenue at just $3.3 billion. Even if winners have a tendency to overpay due to the underlying mechanism, we’re still positing a situation where London makes an estimate, determines hosting is profitable, and then ends up being off by $8.1 billion. That seems like a fairly large error.

Indirect Benefits?

Okay, so direct revenue is low, but what about follow-on tourism, improved image, and so forth? In a section titled “The Long-Run Benefits of Hosting the Olympics”, Baade and Matheson examine the ongoing benefits of facilities, investment in general infrastructure, and future tourism, but ultimately conclude:

When bidding countries are appropriately compared with countries that are otherwise similar but did not bid for the Games using propensity matching techniques, the significant Olympic effects on trade, consumption, investment, and income all disappear. Again, the long-run benefits of hosting the Games prove to be elusive.

Although there may be some more ephemeral benefits, it seems unlikely that these sorts of indirect and long-run benefits make up for the immense direct financial losses.

Cities Don’t Compete?

In the past, my question would have had more force. In 2012, eight other countries competed with London to host the Olympics games. But these days, there seems to be less interest. For the latest round of selections, Brisbase was chosen “without a rival bid”. Perhaps cities are rationally responding to the profitability of the Olympics, and have ceased to express a serious interest in hosting.

Except that’s not quite the entire story. The AP reports that although Brisbase was the only city considered, it was not the only city interested. Doha and Budapest were both working on formal bids, as were cities in China, Germany, India, Indonesia and Russia. But all were excluded before they could complete the process, due to a last minute rules change.

So while it’s true that the number of cities issuing formal bids has decreased in recent years, there still appears to be widespread interest.

Cost Overruns?

Bent Flyvbjerg, author of The Oxford Handbook of Megaproject Management describes the Iron Law of Megaprojects: “Nine out of ten such projects have cost overruns. Overruns of up to 50 percent in real terms are common.” This bears out empirically for the Olympic games. According to one analysis, estimated costs are dramatically lower than actual, with Athens and Sochi seeing overruns of 400%!

This is certainly a piece of the puzzle, but it’s not the whole thing. Host cities have access to the same historical data. They know that their estimates are not going to be accurate, that the true costs will be higher, and can at least attempt to reason accordingly.

Maybe this is an extreme failure of inside-view thinking over reference class forecasting, or of extreme arrogance (“everyone else sucks at planning, but my estimates are better”), but that still feels insufficient. Lots of people have those problems in reasoning, they don’t go on to exceed budgets by 400% when tens of billions of dollars are at stake.

Intentional Underestimates?

The economist Albert O. Hirschman (of Exit, Voice, and Loyalty fame), also coined the principle of the Hiding Hand: if people knew the true cost of projects up front, they would never fund it. So insofar as our aim is to get anything done, some degree of ignorance is our friend. This bears out anecdotally, as when San Francisco mayor Willie Brown famously said

News that the Transbay Terminal is something like $300 million over budget should not come as a shock to anyone. We always knew the initial estimate was way under the real cost… the first budget is really just a down payment. If people knew the real cost from the start, nothing would ever be approved. The idea is to get going. Start digging a hole and make it so big, there’s no alternative to coming up with the money to fill it in.

It sounds crazy, but can be justified by appeal to rational irrationality. As Hirschman explains: “since we necessarily underestimate our creativity it is desirable that we underestimate to a roughly similar extent the difficulties of the tasks”.

Though Hirschman meant to celebrate the principle, Flyvbjerg and Cass Sunstein refute its glory, instead coining the “Malevolent Hiding Hand”. They note that empirically, underestimates of difficulty in fact greatly exceed underestimates of our abilities, leading to “unexpectedly high costs but also to unexpectedly low net benefits.”

Incentives?

If these overruns are not a case of rational irrationality, but rather of plain-old irrational irrationality, the question remains of how such important and financially impactful decisions end up being made by such incompetant actors.

The standard libertarian critique here is that there’s simply no market. It’s a top-down, centralized and bureaucratic decision, and therefore bound to fail. If the planners are wrong, there’s no way to “short” their position and correct the price, no mechanism that would improve a bad situation. As Yudwkosky describes an even more severe policy failure:

The Bank of Japan is just one committee, and it’s not possible for anyone else to step up and make a billion dollars in the course of correcting their error… to the extent the Bank of Japan has poor incentives or some other systematic dysfunction, their mistake can persist… Standard economic theory, generalized beyond the markets to other facets of society, did not seem to me to predict that the Bank of Japan must act wisely for the good of Japan. It would be no surprise if they were competent, but also not much of a surprise if they were incompetent.

Of course, you might hope that there are at least some personal drawbacks to losing $8.1 billion, but that doesn’t seem to be the case. Sebastian Coe, who masterminded London’s winning bid and chaired the London Organising Committee of the Olympic and Paralympic Games, seems to be doing alright for himself. Post-olympics, he was appointed Chairman of the British Olympic Association, presented with a lifetime achievement award from BBC Sport, and elected a member of the IOC.

So yes, incentives seem to play a role here, but we’re still not done. Given basic historical data, the reasonable thing for cities is to run away screaming as the prospects of becoming an Olympic host. It should never even get to the stage of an incompetant or poorly incentivized bureaucrat making a poor analysis.

Glory?

From Baade and Matheson again:

economic concerns may only play a small role in a country’s decision whether or not to stage the Olympics. The desire to host the Games may be driven by the egos of a country’s leaders or as a demonstration of a country’s political and economic power.

This seems to bear out for megaprojects in general. In Flyvbjerg’s model, decision making is blinded by four “sublimes”, boons of a nearly spiritual nature that distract from more sober cost-benefit analysis. They are:

• Technological Sublime: “the rapture engineers and technologists get from building large and innovative projects”
• Political Sublime: “the rapture politicians get from building monuments to themselves and their causes”
• Economic Sublime: “the delight business people and trade unions get from making lots of money and jobs”
• Aesthetic Sublime: the pleasure designers “get from building, using, and looking at something very large that is also iconically beautiful”

The Olympics are surrounded in so much mystique and hype that we can easily imagine an aggravating effect. You are not merely building a monument to yourself, you are building it to human glory. The whole world will come to see what you’ve designed. And so forth.

The effect can further be accentuated by a sense of historical importance or sense of inadequacy. As Brazil’s president described his desire to host the Olympics, “We’re not this tiny country people thought.” Or as Sepp Blatter, one of the IOC members said following the president’s speech: “I honestly think it is Brazil’s turn… It is South America’s bid. This is a continent that has never held the Games. It is time to address this imbalance.”

Conclusion

There are many reasons mega projects go wrong… but the astute reader will notice one cause conspicuously missing from this entire discussion.

I do have a follow-up post planned, but in the meantime, it’s left as an exercise to the reader. To win internet points, you’re welcome to email me or share your bad take on Twitter.