The cost-benefit principle and investing in AI technology

In the first week of my ECONS102 class, we talk about rational behaviour as a useful starting point (or optimum) for considering decision-making. There are three characteristics of rational behaviour:

1. People (and firms, and government) have objectives (goals);
2. People choose the correct way to achieve their objectives (i.e. they compare benefits and costs, and they learn from past mistakes); and
3. People respond to the incentives they face (people’s behaviour may change if the costs and/or benefits of the alternatives change).

The second of those characteristics of rational behaviour relates to the cost-benefit principle: A rational decision-maker will take an action if, and only if, the incremental (extra) benefits from taking the action are at least as great as the incremental (extra) costs. Now, not everyone is rational in all decisions and at all times. But, deviations from rationality invariably make decision-makers worse off. Consider the cost-benefit principle. If a decision-maker takes an action where the incremental costs exceed the incremental benefits, they are making themselves worse off (because they would be better off by doing nothing at all instead).

So, that brings me to this article in The Conversation today by Evan Shellshear and Len Coote (both University of Queensland), which looks at the decision about whether to invest in some artificial intelligence (AI) application. The example they use is a farmer investing in an AI application that offers cost savings through reducing crop inputs. Shellshear and Coote offer some clear advice, deriving directly from the cost-benefit principle:

Invest if the extra profit is greater than the “opportunity cost” – the benefit you can gain from spending your money another way, or by not spending the money.

And Shellshear and Coote offer a simple flowchart for decision-makers to follow:

Peddlers of AI are great at selling the technological benefits of AI. However, that doesn't mean that AI should be adopted everywhere and for all purposes. A rational decision-maker must recognise that AI must pass the cost-benefit test. Applying Shellshear and Coote's simple flowchart, if you can't quantify the benefits (or gains), or you can't quantify the costs, or having quantified the benefits and costs you find that the costs outweigh the benefits, you should not adopt the AI. As they conclude:

Using an economic framework of worth, rather than an engineering claim of possibility, is the first step to make better decisions. Doing so reduces the prospect of another AI winter, and increases the chance of real gains contributing to a more prosperous and sustainable world.