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Wednesday, 31 August 2016

University and the Sunk Cost Fallacy

Even though their links seem to be terribly broken these days and I am generally feeling too busy to do anything about following up on interesting article titles, I was recently (ten or so minutes ago) rewarded with a gem from Minding the Campus, i.e. "How to win at college, according to economics."

This talks about three main ideas (some of which I have discussed myself on this blog):
  • Opportunity Cost (e.g. of writing blogs, which in this particular case is either sleep or readings for an essay due in two days)
  • The Sunk Cost Fallacy
  • Inter-Temporal Choice
Of these, the Sunk Cost Fallacy is the most interesting one, when we combine it with the first point. There are varying ways to think about debt. From a rational perspective, you are better off not paying off (some of) your student loan if offered $10,000 and instead putting that in a bank to earn interest (or investing it directly yourself). The basic idea here is the time value of money (a dollar today, is worth more than a dollar tomorrow) and this morphs into the concept of net present value (NPV). However, we should consider student loans (especially in the American model) as a form of investment, i.e. there is a return we want and risk.

What is the risk attached to a student loan? Well, basically, that you won't earn a great enough return to pay-off the loan/accumulated debt. This sounds a bit abstract and we'll just assume that it is the same as saying "not graduating". However, I contend that when you graduate matters too. For example, maybe an employer (although I am given to understand they don't care so much about grades, which implies this doesn't matter to them) will treat someone who graduated in three years (standard here) differently to someone who took four. What is a more interesting angle to take is the opportunity presented by finishing at one time versus another (or set of other times).

One of my friends decided, sometime prior to 2012, that it would be a good idea to jump straight from year twelve to university. A large part of the reason for this was entering the workforce earlier. I'm not sure why, but last I heard, he has changed his mind regarding the wisdom of this. This is one way in which finishing sooner can be thought to present an opportunity. After all, if we assume that entering the workforce at 20 rather than 21 translates to one more year of full-time employment we're talking about a difference of tens of thousands of dollars.  Surely that matters? I mean, if only because getting the money earlier means you can have it working for you earlier. But there are other, less quantifiable, opportunities presented here.

Fatigue seems to be a major theme when I talk to my friends these days. For most of them that came up with me, this is their final semester and the sense is definitely of "I'm glad I am finished". I've still got a year to go (different programme), but I don't feel so weary (bogged down, yeah, sure)... but another friend of mine who has two years left is looking forward to its finishing. While we don't know what the value here is (and may, in fact, never be able to do find it), the value of not studying that extra-year definitely does exist, and should theoretically be incorporated in decision making. One might extend this discussion by arguing for some kind of Lewis Turning Point... except, instead of running out of costless labour, we run out of costless time units of study, and therefore after the Turning Point, additional study is associated with increasing, unknown, costs. In other words, if you finish your undergrad sooner, then you are likely to not reach Turning Point during it, i.e. you are more able to pursue further qualifications. There are some issues with this idea (such as assuming that the last year of school doesn't contribute differently to weariness compared with uni) but I think the principle is soundly established.

This is where the sunk cost fallacy comes in. Basically, the sunk cost fallacy is the idea that you will keep doing something you shouldn't because of what you've already invested (i.e. your sunk costs). If this sounds weird, imagine that you've spent $1000 already on whatever and that it will require $2000 to complete. Under the Sunk Cost Fallacy, you continue to pursue whatever it was because you've already spent $1000, even though there is a better use of the $2000. This is not some abstract concept: it pops up all the time in all sorts of contexts.

What I am proposing is that the Sunk Cost Fallacy may appear to exist in pursuing a particular path, but once you factor in the time costs associated with switching, then maybe it becomes the case that it isn't fallacious. For example, while you may not be particularly keen on what you're studying (an indicator you should do something else), if you keep going with it, you get to do something you'd really like to do sooner, and that the value attached to sooner outweighs the gain from doing some alternative and more enjoyable pathway.

Naturally, depending on where and what you're studying, those switching costs are going to vary. It was pretty painless to switch from maths to stats within my BA/BCom, in large part because I didn't have to backtrack to do any further pre-reqs before jumping into Stage II. If I had, for instance, switched to psychology, that wouldn't have been the case. Not switching from a BA/BCom to a straight BA, before I had the stats idea, may have been a case of the Sunk Cost Fallacy.. I was definitely strongly motivated by a desire for the five papers I'd already done in the BCom to matter rather than have just slowed me down.

Now, while this discussion has been interesting, I don't dispute the advice given in the article. The only alteration I would make is that you do need to be conscious of the costs of switching and of failure, and that these are a restriction on one's ability to dabble... but that these things aren't necessarily the same for different universities and different programmes. In fact, if I majored in Information Management instead of economics they'd be higher because that major is more structured than any of the ones I do pursue (this lack of structure is why, assuming I don't fail any papers, I am confident that I could, with the will, find a timetable that would let me finish by semester one next year, rather than second semester).

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