<p>Under the original question there are comments which imply a model or reasoning process stated as follows: markets validate investment decisions (e.g., bridge building) by rewarding the investors with profits. If this logic is used as the &quot;yardstick&quot; for measuring economic efficiency then it is clear that future spending decisions either validate or do not validate the actual cost outlays of capital spending projects.</p>
<p>The Austrian Business Cycle Theory (ABCT) describes malinvestment as the cause of economic business cycles and argues that the central bank is the proximate cause of malinvestment. This 12 page paper outlines the argument:</p>
<p><a href="https://cdn.mises.org/qjae9_4_4.pdf" rel="nofollow noreferrer">https://cdn.mises.org/qjae9_4_4.pdf</a></p>
<p>Hyman Minsky argues in the short paper below that uncertainty and financial relations are a feedback from the past into present spending decisions under the institutions of a particular capitalist economy:</p>
<p><a href="https://digitalcommons.bard.edu/cgi/viewcontent.cgi?article=1023&amp;context=hm_archive" rel="nofollow noreferrer">https://digitalcommons.bard.edu/cgi/viewcontent.cgi?article=1023&amp;context=hm_archive</a></p>
<p>These types of economic theory seem to argue that we do not know which projects will be validated before, during, or after construction, but if cash flows validate past debt structures and pay profits then in retrospect some economic observers argue that those investments were the more efficient.</p>

CC BY-SA 4.0
2020-10-13T04:13:18.120Z
I appreciate the thoughtful answer. In a certain sense though -- perhaps profits can be the only yardstick? If you accept the premise that prices are an epistemological "interface" which express the supply/demand dynamics of different resources ...then by definition market-based exchange ratios (i.e. "prices") would be the only conceivable yardstick. However, don't jump on me too much for that logic lol -- I just wrote that off the top of my head. Simply trying to poke + prod your argument.
David
CC BY-SA 4.0
2020-10-13T04:16:02.330Z
As an aside, I like your name -- I am a big fan of Systems Theory/Thinking as well. But I won't be on Econ Stack Exchange in the future for a variety of reasons. I'd love to debate more/hear more of your thoughts. You obviously know the topic well. I'm obviously using my real name, so you should reach out on LinkedIn / email.
David
CC BY-SA 4.0
2020-10-13T17:45:25.883Z
Maybe I will reach out. The problem with the model where profits either validate or do not validate past investment projects has been investigated by (defunct) economist Hyman Minsky. If we consider one investment project in isolation then profits are the "democratic vote" which validates this use of assets (it is efficient because customers pay for service). But in the whole economy the debt finance of new investments is generating cash flow to validate prior investments. If debt and money markets crash then many investments are no longer validated by present cash flows.
SystemTheory
CC BY-SA 4.0
2020-10-13T18:16:45.000Z
Umm, I see what you're/Minsky is saying -- but that seems to be a very theoretical/edge-case objection. He's just saying: If the economy completely crashes, then it (arbitrarily) invalidates past investments? Two philosophical objections: 1) I think credit markets would dislocate BECAUSE of malinvestment. It's not like credit markets just happen to "freeze" one day arbitrarily...  2) I would think the bigger barometer of success isn't cash flow vis-a-vis debt financing. I would think the bigger determinant is increased cash flow vis-a-vis an increase in productivity.
David
CC BY-SA 4.0
2020-10-13T18:20:44.900Z
I.e. I don't think an increase in debt (created by whom, btw?) is necessary to justify an earlier investment. I think of money as a veil over the real resources in the economy. I.e. it is neutral in the medium run. So I don't see an increase (or decrease) in M0, M1, etc as being terribly important to the question of: "Why does the pricing system allocate resources efficiently, and what does that even mean practically speaking?"
David
CC BY-SA 4.0
2020-10-13T18:33:54.413Z
I am no expert on the history of economic theory, however, I think this topic is the subject of historic disagreements between J.M. Keynes (and now the Post-Keynesian school) of economics and the classical theory. One school argues that money and financial relations dominate outcomes and the other school thinks finance is a veil which cannot influence and disrupt the price systems operating in the real economy. In a modern money market crisis the "run" on liquid funds forces a fire sale of financial assets which reduces credit for new projects which reduces spending in the whole economy.
SystemTheory
CC BY-SA 4.0
2020-10-13T19:28:30.550Z
I think economic "efficiency" has multiple meanings. In one context it means society operating inside the production possibility frontier. The modern term for this is called "the output gap." Debates over ISLM models and financial feedback into the real economy are efforts to close the output gap via public policies rather than massive bankruptcies with loss of output relative to some past trend. If one defines efficiency as the validation of investments via the flow of profit then the goal is to tune policy to get financial and/or govt "distortions" out of the free market voting mechanism.
SystemTheory
CC BY-SA 4.0
2020-10-12T16:47:01.173Z
2020-10-12T16:47:01.173Z
SystemTheory
<p>A short answer is that in case of provision of public goods in real-life we can never be completely sure if they are provided in optimal quantity due sheer difficulty of quantifying all costs and benefits, measurement problems when it comes to underlaying utility, due to uncertainties involved and many other factors.</p>
<p>However, this does not mean that no evaluation of public projects can be done. Most developed countries will have some dedicated analytic unit. In the Netherlands where I live that would be <a href="https://www.cpb.nl/en/node" rel="nofollow noreferrer">Centraal Planbureau</a> [Bureau for Economic Policy Analysis] (CPB)  in the US it is <a href="https://www.cbo.gov/" rel="nofollow noreferrer">Congressional Budget Office</a> (CBO).</p>
<p>These units routinely engage in cost-benefit analyses of public projects and then make recommendations based on whether the projects net present value is positive. The net present value would be given as:</p>
<p><span class="math-container">$$ NPV = B_0 - C_0 + \frac{B_1-C_1}{1+r} + \frac{B_2-C_2}{(1+r)^2} + ... + \frac{B_T-C_T}{(1+r)^T} $$</span></p>
<p>Where <span class="math-container">$B$</span> are benefits of the project, <span class="math-container">$C$</span> are costs and <span class="math-container">$r$</span> is discount rate or you can interpret it as a required rate of return.</p>
<p>The benefits and cost try to capture actually underlaying changes in utility. They will be usually estimated using hedonic pricing or various discrete choice models that can tell us something about peoples preferences and utilities based on observing their actions. For example, from the way how housing prices vary in cities with high congestion we can estimate how much people value time lost in traffic. The required discount rate is usually set to be equal to interest rate on government/municipality bonds or rate that government could obtain if it had invested the money into wealth fund. Of course, the way how these parameters are estimated or assumed is always a point of contention as this can't be done with infinite precision and complete certainty (this holds even in cases when we do ex-post cost-benefit analysis as most benefits and costs are virtually never directly observable and have to be estimated).</p>
<p>The above is, of course, just a short overview as providing an exhaustive review of how public cost benefit analysis is done is unfortunately beyond scope of SE. A good and highly cited example of public cost-benefit analysis is: <a href="https://www.aeaweb.org/articles?id=10.1257/jep.20.4.157" rel="nofollow noreferrer">Leape, J. (2006). The London congestion charge. Journal of Economic Perspectives, 20(4), 157-176.</a></p>
<p>Furthermore, just because project passes cost-benefit analysis it does not necessary means that the outcome is pareto efficient or even that it maximizes utility. However, it is reasonably good guard against completely frivolous spending.  This being said, advice given is not advice taken and such analyses are often ignored by politicians, as pointed out by Giskard public officials are not necessarily benevolent.</p>

CC BY-SA 4.0
2020-10-07T01:48:38.947Z
Thanks for the answer, this looks good. Out of curiosity, do you know of any govt projects that were closed because of insufficient benefits vis-a-vis costs? It seems like we could only guarantee a project/building is "efficient," insofar as it has to cease to exist if it's not...
David
CC BY-SA 4.0
2020-10-07T08:33:55.187Z
@DavisClute Yes I was actually working at the above mentioned CPB as RA. I was working in sector 1 public finance and partially sector 2 macro economics on forecasting inflation, but one of my classmates from public econ MSc was working in infrastructure unit  and I know that in the case of project he was working on which was cost-benefit analysis for a bypass route in some city (I think it was Den Haag but cant remember) they decided not to construct the bypass - but cba's are usually done before municipality goes public with the project so usually cancelations don't get press-releases
1muflon1
CC BY-SA 4.0
2020-10-07T08:47:12.757Z
@DavisClute I talked to my friend and he said that this CPB report in the box  on pp 37 called: The influence of the benefit–cost balance on decision-making provides short review of literature on how much government listens to the outcomes of the CBA's and that the literature cited therein has some concrete examples so if you are interested have at it: https://www.cpb.nl/sites/default/files/publicaties/download/cba-guidance.pdf
1muflon1
CC BY-SA 4.0
2020-10-12T14:22:06.703Z
Whether or not the unit planning a capital investment project is the government or the private sector (markets) note very carefully that the cost benefit equation is subject to several modes of uncertainty associated with (1) the subjective utility of the community now and in the future; (2) projected cash flows; and (3) future changes in the discount rate. So one is comparing two or more alternatives in the present without knowledge of what will happen in the future. If a public project "fails" we have another political argument over government waste. Private failures resolved via bankruptcy.
SystemTheory
CC BY-SA 4.0
2020-10-12T14:32:20.330Z
@SystemTheory I agree hence the reason why the first paragraph of my answer says what it says.
1muflon1
CC BY-SA 4.0
2020-10-12T14:42:31.317Z
@1mflon1 Yes you describe the general uncertainty in a public context. In reality all capital investment projects can fail whether the decision to use resources in a particular way is made via a public (joint decision) or private (independent autonomous decision) process. The Austrian economists argue that malinvestment causes the business cycle and that central or democratic planning increases malinvestment. Hyman Minsky argues that future cash flow patterns are uncertain in part because future investment spending generates cash flow to validate capital asset prices of past investments.
SystemTheory
CC BY-SA 4.0
2020-10-12T14:55:58.357Z
Correction in the logic of the last sentence of my comment. In general it should not be controversial to argue or assert that future income streams are caused by future spending decisions. So discounted cash flows are speculations about future public and private spending decisions. Hyman Minsky argues capital assets are financed with long term debt. This means future prices of output goods cannot fall significantly, to adjust supply and demand, without causing debt default and a downward adjustment of capital asset valuations. So if profit is the measure of efficiency it is a rubber yardstick.
SystemTheory
CC BY-SA 4.0
2020-10-12T14:57:38.470Z
@SystemTheory this answer is about public projects and it does not advocate use of profit as a yardstick or even argues that profits are used about as the yardstick
1muflon1
CC BY-SA 4.0
2020-10-12T15:11:02.753Z
Under the question @David Clute comments "I'm just trying to figure out how we know if resources are allocated efficiently or not." He also comments "If it were a private company building the bridge, the profit-loss system would tell us (I think?) whether or not it was efficient vis-a-vis the alternatives at hand. If it weren't "Pareto Efficient," then theoretically it would go out of business & its inputs would be bid away by other producers who can use it more efficiently." Comments about validating private investments are here since you mention uncertainty of cost-benefit cash flow models.
SystemTheory
CC BY-SA 4.0
2020-10-13T11:48:04.560Z
In the UK this process is detailed in the Green Book: https://www.gov.uk/government/publications/the-green-book-appraisal-and-evaluation-in-central-governent
Dan
CC BY-SA 4.0
2020-10-06T18:58:46.943Z
2020-10-08T15:53:09.480Z
2020-10-08T15:53:09.480Z
1muflon1
<p>I would assume the &quot;goal&quot; of any economic activity is to make the largest amount of people the &quot;happiest&quot; -- i.e. Pareto Efficiency or sum-total 'utility.'</p>
<p>How do we know if this occurs? Either before, during, or after construction?</p>

CC BY-SA 4.0
2020-10-06T17:34:23.303Z
At the moment we don't. To know that we'd need more context on the government in question and the country, the market etc etc etc. As it stands your question needs more details
Maarten Punt
CC BY-SA 4.0
2020-10-06T17:36:43.157Z
Are you asking from purely theoretical perspective or from practical one? Practically measuring utility even for an individual is difficult and can be done only indirectly through revealed preferences. At societal level empirically measuring if a construction of single piece of infrastructure is pareto optimal is practically impossible.
1muflon1
CC BY-SA 4.0
2020-10-06T17:43:33.747Z
Woah, woah, woah! Are you saying the government *may* not be omniscient and benevolent?
Giskard
CC BY-SA 4.0
2020-10-06T17:43:44.680Z
Both practically + theoretically. If it were a private company building the bridge, the profit-loss system would tell us (I think?) whether or not it was efficient vis-a-vis the alternatives at hand. If it weren't "Pareto Efficient," then theoretically it would go out of business & its inputs would be bid away by other producers who can use it more efficiently.
David
CC BY-SA 4.0
2020-10-06T17:44:45.337Z
Also, note that "Pareto-efficiency" and maximized sum total utility are not the same thing, see "monotonic transformation".
Giskard
CC BY-SA 4.0
2020-10-06T17:45:02.170Z
@Giskard that made me laugh out loud. Also, fair enough if they're not the same thing. But I was just using terms loosely. I don't think it changes the thrust of my question. I'm just trying to figure out how we know if resources are allocated efficiently or not.
David
CC BY-SA 4.0
2020-10-06T17:50:10.673Z
@DavisClute actually it’s more complicated - markets lead to optimal outcomes only when they are perfect in the case of bridge depending on the circumstances it might be considered public/semi-public good in such situation free market might not lead to optimal outcomes and having some public provision of the bridge might. Theoretically in highly stylized model we can calculate optimum government provision of public goods but practically that’s impossible if you just want to see an example of such model I am happy to write one down but then the question should be adjusted
1muflon1
CC BY-SA 4.0
2020-10-06T17:55:04.710Z
@1muflon1 But that just begs the question of: "How do we measure a public good?" By that logic, if the govt turned downtown Manhattan into a wildlife preserve -- is that efficient or inefficient? If I was being argumentative, I would say that saving the planet is more important than anything. The mental health benefits of nature outweigh anything else, blah blah blah. We can't just axiomatically claim something is a "public good," and is thus immune to comparative analysis of its alternatives...
David
CC BY-SA 4.0
2020-10-06T17:59:36.423Z
@DavisClute we measure public good by looking whether good is excludable and rivalrous. Excludable and rivalrous goods are private, non-excludable and non-rivalrous are public goods. Also these things can be considered on spectrum but based on the above criteria you can  decide what is public good and what not in most cases. Also just because something is public good that does not mean it’s immune to comparative analysis as different public goods projects compete for the same scarce public funds
1muflon1
CC BY-SA 4.0
2020-10-06T18:04:10.267Z
A bridge is definitely excludable (toll booths), and probably rivalrous (it doesn't have infinite capacity). Anyways, I didn't mean for this to be a thread of comments. It sounds like we don't know if it's an efficient usage of resources? I'm just curious if there's a litmus test. Just logically there has to be, otherwise economics as an entire field would be useless...
David
CC BY-SA 4.0
2020-10-06T18:09:20.100Z
@DavisClute that’s why I said that it can be considered public good/ semi-public good or more specifically quasi-public good depending on situation. If in some area congestion is low bridge will be non-rivalrous making it already quasi public, and if there is not large enough customer base to support toll it becomes non-excludable. In real life a sort of litmus test for public project is whether their return would be higher than publicly decided required rate of return - that is not the same as being Pareto optimal or completely efficient but it’s common method applied to public infrastructure
1muflon1
CC BY-SA 4.0
2020-10-06T18:19:55.913Z
Let us [continue this discussion in chat](https://chat.stackexchange.com/rooms/113796/discussion-between-davis-clute-and-1muflon1).
David
CC BY-SA 4.0
2020-10-07T11:26:31.323Z
@Giskard nobody here said it *was* omniscient and benevolent so I don't know why you bring it up.
Criticize SE actions means ban
CC BY-SA 4.0
2020-10-07T11:48:58.967Z
@user253751 It is unfathomable! And who are the people upvoting that comment??
Giskard
CC BY-SA 4.0
2020-10-08T19:51:46.413Z
This has to be said: Your assumption on the goal of economic activity is wrong. There are many theories of what a good goal could look like, e.g. utilitarian, Rawlsian, etc. It is not clear that one is better than the other. That is a normative question. Different frameworks may yield different results.
BB King
<macroeconomics><pareto-efficiency>
If the government builds a bridge, how do we know it's the best possible usage of real resources (i.e. steel, labor, etc) at the time?
David
# If the government builds a bridge, how do we know it's the best possible usage of real resources (i.e. steel, labor, etc) at the time?

(Asked by: username_0 on 2020-10-06)

I would assume the "goal" of any economic activity is to make the largest amount of people the "happiest" -- i.e. Pareto Efficiency or sum-total 'utility.'

How do we know if this occurs? Either before, during, or after construction?

**Tags:** macroeconomics, pareto-efficiency

> **Comments:**
> **username_1**: At the moment we don't. To know that we'd need more context on the government in question and the country, the market etc etc etc. As it stands your question needs more details  
> **username_2**: Are you asking from purely theoretical perspective or from practical one? Practically measuring utility even for an individual is difficult and can be done only indirectly through revealed preferences. At societal level empirically measuring if a construction of single piece of infrastructure is pareto optimal is practically impossible.  
> **username_3**: Woah, woah, woah! Are you saying the government *may* not be omniscient and benevolent?  
> **username_0**: Both practically + theoretically. If it were a private company building the bridge, the profit-loss system would tell us (I think?) whether or not it was efficient vis-a-vis the alternatives at hand. If it weren't "Pareto Efficient," then theoretically it would go out of business & its inputs would be bid away by other producers who can use it more efficiently.  
> **username_3**: Also, note that "Pareto-efficiency" and maximized sum total utility are not the same thing, see "monotonic transformation".  
> **username_0**: @username_3 that made me laugh out loud. Also, fair enough if they're not the same thing. But I was just using terms loosely. I don't think it changes the thrust of my question. I'm just trying to figure out how we know if resources are allocated efficiently or not.  
> **username_2**: @DavisClute actually it’s more complicated - markets lead to optimal outcomes only when they are perfect in the case of bridge depending on the circumstances it might be considered public/semi-public good in such situation free market might not lead to optimal outcomes and having some public provision of the bridge might. Theoretically in highly stylized model we can calculate optimum government provision of public goods but practically that’s impossible if you just want to see an example of such model I am happy to write one down but then the question should be adjusted  
> **username_0**: @username_2 But that just begs the question of: "How do we measure a public good?" By that logic, if the govt turned downtown Manhattan into a wildlife preserve -- is that efficient or inefficient? If I was being argumentative, I would say that saving the planet is more important than anything. The mental health benefits of nature outweigh anything else, blah blah blah. We can't just axiomatically claim something is a "public good," and is thus immune to comparative analysis of its alternatives...  
> **username_2**: @DavisClute we measure public good by looking whether good is excludable and rivalrous. Excludable and rivalrous goods are private, non-excludable and non-rivalrous are public goods. Also these things can be considered on spectrum but based on the above criteria you can  decide what is public good and what not in most cases. Also just because something is public good that does not mean it’s immune to comparative analysis as different public goods projects compete for the same scarce public funds  
> **username_0**: A bridge is definitely excludable (toll booths), and probably rivalrous (it doesn't have infinite capacity). Anyways, I didn't mean for this to be a thread of comments. It sounds like we don't know if it's an efficient usage of resources? I'm just curious if there's a litmus test. Just logically there has to be, otherwise economics as an entire field would be useless...  
> **username_2**: @DavisClute that’s why I said that it can be considered public good/ semi-public good or more specifically quasi-public good depending on situation. If in some area congestion is low bridge will be non-rivalrous making it already quasi public, and if there is not large enough customer base to support toll it becomes non-excludable. In real life a sort of litmus test for public project is whether their return would be higher than publicly decided required rate of return - that is not the same as being Pareto optimal or completely efficient but it’s common method applied to public infrastructure  
> **username_0**: Let us [continue this discussion in chat](https://chat.stackexchange.com/rooms/113796/discussion-between-davis-clute-and-username_2).  
> **username_4**: @username_3 nobody here said it *was* omniscient and benevolent so I don't know why you bring it up.  
> **username_3**: @user253751 It is unfathomable! And who are the people upvoting that comment??  
> **username_5**: This has to be said: Your assumption on the goal of economic activity is wrong. There are many theories of what a good goal could look like, e.g. utilitarian, Rawlsian, etc. It is not clear that one is better than the other. That is a normative question. Different frameworks may yield different results.  

---

## 2 answers

### Answer by username_2 on 2020-10-06. Score: 4 | Accepted answer

A short answer is that in case of provision of public goods in real-life we can never be completely sure if they are provided in optimal quantity due sheer difficulty of quantifying all costs and benefits, measurement problems when it comes to underlaying utility, due to uncertainties involved and many other factors.

However, this does not mean that no evaluation of public projects can be done. Most developed countries will have some dedicated analytic unit. In the Netherlands where I live that would be [Centraal Planbureau](https://www.cpb.nl/en/node) [Bureau for Economic Policy Analysis] (CPB) in the US it is [Congressional Budget Office](https://www.cbo.gov/) (CBO).

These units routinely engage in cost-benefit analyses of public projects and then make recommendations based on whether the projects net present value is positive. The net present value would be given as:

$$ NPV = B\_0 - C\_0 + \frac{B\_1-C\_1}{1+r} + \frac{B\_2-C\_2}{(1+r)^2} + ... + \frac{B\_T-C\_T}{(1+r)^T} $$

Where $B$ are benefits of the project, $C$ are costs and $r$ is discount rate or you can interpret it as a required rate of return.

The benefits and cost try to capture actually underlaying changes in utility. They will be usually estimated using hedonic pricing or various discrete choice models that can tell us something about peoples preferences and utilities based on observing their actions. For example, from the way how housing prices vary in cities with high congestion we can estimate how much people value time lost in traffic. The required discount rate is usually set to be equal to interest rate on government/municipality bonds or rate that government could obtain if it had invested the money into wealth fund. Of course, the way how these parameters are estimated or assumed is always a point of contention as this can't be done with infinite precision and complete certainty (this holds even in cases when we do ex-post cost-benefit analysis as most benefits and costs are virtually never directly observable and have to be estimated).

The above is, of course, just a short overview as providing an exhaustive review of how public cost benefit analysis is done is unfortunately beyond scope of SE. A good and highly cited example of public cost-benefit analysis is: [Leape, J. (2006). The London congestion charge. Journal of Economic Perspectives, 20(4), 157-176.](https://www.aeaweb.org/articles?id=10.1257/jep.20.4.157)

Furthermore, just because project passes cost-benefit analysis it does not necessary means that the outcome is pareto efficient or even that it maximizes utility. However, it is reasonably good guard against completely frivolous spending. This being said, advice given is not advice taken and such analyses are often ignored by politicians, as pointed out by username_3 public officials are not necessarily benevolent.

> **Comments:**
> **username_0**: Thanks for the answer, this looks good. Out of curiosity, do you know of any govt projects that were closed because of insufficient benefits vis-a-vis costs? It seems like we could only guarantee a project/building is "efficient," insofar as it has to cease to exist if it's not...  
> **username_2**: @DavisClute Yes I was actually working at the above mentioned CPB as RA. I was working in sector 1 public finance and partially sector 2 macro economics on forecasting inflation, but one of my classmates from public econ MSc was working in infrastructure unit  and I know that in the case of project he was working on which was cost-benefit analysis for a bypass route in some city (I think it was Den Haag but cant remember) they decided not to construct the bypass - but cba's are usually done before municipality goes public with the project so usually cancelations don't get press-releases  
> **username_2**: @DavisClute I talked to my friend and he said that this CPB report in the box  on pp 37 called: The influence of the benefit–cost balance on decision-making provides short review of literature on how much government listens to the outcomes of the CBA's and that the literature cited therein has some concrete examples so if you are interested have at it: https://www.cpb.nl/sites/default/files/publicaties/download/cba-guidance.pdf  
> **username_6**: Whether or not the unit planning a capital investment project is the government or the private sector (markets) note very carefully that the cost benefit equation is subject to several modes of uncertainty associated with (1) the subjective utility of the community now and in the future; (2) projected cash flows; and (3) future changes in the discount rate. So one is comparing two or more alternatives in the present without knowledge of what will happen in the future. If a public project "fails" we have another political argument over government waste. Private failures resolved via bankruptcy.  
> **username_2**: @username_6 I agree hence the reason why the first paragraph of my answer says what it says.  
> **username_6**: @1mflon1 Yes you describe the general uncertainty in a public context. In reality all capital investment projects can fail whether the decision to use resources in a particular way is made via a public (joint decision) or private (independent autonomous decision) process. The Austrian economists argue that malinvestment causes the business cycle and that central or democratic planning increases malinvestment. Hyman Minsky argues that future cash flow patterns are uncertain in part because future investment spending generates cash flow to validate capital asset prices of past investments.  
> **username_6**: Correction in the logic of the last sentence of my comment. In general it should not be controversial to argue or assert that future income streams are caused by future spending decisions. So discounted cash flows are speculations about future public and private spending decisions. Hyman Minsky argues capital assets are financed with long term debt. This means future prices of output goods cannot fall significantly, to adjust supply and demand, without causing debt default and a downward adjustment of capital asset valuations. So if profit is the measure of efficiency it is a rubber yardstick.  
> **username_2**: @username_6 this answer is about public projects and it does not advocate use of profit as a yardstick or even argues that profits are used about as the yardstick  
> **username_6**: Under the question @username_0 Clute comments "I'm just trying to figure out how we know if resources are allocated efficiently or not." He also comments "If it were a private company building the bridge, the profit-loss system would tell us (I think?) whether or not it was efficient vis-a-vis the alternatives at hand. If it weren't "Pareto Efficient," then theoretically it would go out of business & its inputs would be bid away by other producers who can use it more efficiently." Comments about validating private investments are here since you mention uncertainty of cost-benefit cash flow models.  
> **username_7**: In the UK this process is detailed in the Green Book: https://www.gov.uk/government/publications/the-green-book-appraisal-and-evaluation-in-central-governent  

---

### Answer by username_6 on 2020-10-12. Score: 1

Under the original question there are comments which imply a model or reasoning process stated as follows: markets validate investment decisions (e.g., bridge building) by rewarding the investors with profits. If this logic is used as the "yardstick" for measuring economic efficiency then it is clear that future spending decisions either validate or do not validate the actual cost outlays of capital spending projects.

The Austrian Business Cycle Theory (ABCT) describes malinvestment as the cause of economic business cycles and argues that the central bank is the proximate cause of malinvestment. This 12 page paper outlines the argument:

<https://cdn.mises.org/qjae9_4_4.pdf>

Hyman Minsky argues in the short paper below that uncertainty and financial relations are a feedback from the past into present spending decisions under the institutions of a particular capitalist economy:

<https://digitalcommons.bard.edu/cgi/viewcontent.cgi?article=1023&context=hm_archive>

These types of economic theory seem to argue that we do not know which projects will be validated before, during, or after construction, but if cash flows validate past debt structures and pay profits then in retrospect some economic observers argue that those investments were the more efficient.

> **Comments:**
> **username_0**: I appreciate the thoughtful answer. In a certain sense though -- perhaps profits can be the only yardstick? If you accept the premise that prices are an epistemological "interface" which express the supply/demand dynamics of different resources ...then by definition market-based exchange ratios (i.e. "prices") would be the only conceivable yardstick. However, don't jump on me too much for that logic lol -- I just wrote that off the top of my head. Simply trying to poke + prod your argument.  
> **username_0**: As an aside, I like your name -- I am a big fan of Systems Theory/Thinking as well. But I won't be on Econ Stack Exchange in the future for a variety of reasons. I'd love to debate more/hear more of your thoughts. You obviously know the topic well. I'm obviously using my real name, so you should reach out on LinkedIn / email.  
> **username_6**: Maybe I will reach out. The problem with the model where profits either validate or do not validate past investment projects has been investigated by (defunct) economist Hyman Minsky. If we consider one investment project in isolation then profits are the "democratic vote" which validates this use of assets (it is efficient because customers pay for service). But in the whole economy the debt finance of new investments is generating cash flow to validate prior investments. If debt and money markets crash then many investments are no longer validated by present cash flows.  
> **username_0**: Umm, I see what you're/Minsky is saying -- but that seems to be a very theoretical/edge-case objection. He's just saying: If the economy completely crashes, then it (arbitrarily) invalidates past investments? Two philosophical objections: 1) I think credit markets would dislocate BECAUSE of malinvestment. It's not like credit markets just happen to "freeze" one day arbitrarily...  2) I would think the bigger barometer of success isn't cash flow vis-a-vis debt financing. I would think the bigger determinant is increased cash flow vis-a-vis an increase in productivity.  
> **username_0**: I.e. I don't think an increase in debt (created by whom, btw?) is necessary to justify an earlier investment. I think of money as a veil over the real resources in the economy. I.e. it is neutral in the medium run. So I don't see an increase (or decrease) in M0, M1, etc as being terribly important to the question of: "Why does the pricing system allocate resources efficiently, and what does that even mean practically speaking?"  
> **username_6**: I am no expert on the history of economic theory, however, I think this topic is the subject of historic disagreements between J.M. Keynes (and now the Post-Keynesian school) of economics and the classical theory. One school argues that money and financial relations dominate outcomes and the other school thinks finance is a veil which cannot influence and disrupt the price systems operating in the real economy. In a modern money market crisis the "run" on liquid funds forces a fire sale of financial assets which reduces credit for new projects which reduces spending in the whole economy.  
> **username_6**: I think economic "efficiency" has multiple meanings. In one context it means society operating inside the production possibility frontier. The modern term for this is called "the output gap." Debates over ISLM models and financial feedback into the real economy are efforts to close the output gap via public policies rather than massive bankruptcies with loss of output relative to some past trend. If one defines efficiency as the validation of investments via the flow of profit then the goal is to tune policy to get financial and/or govt "distortions" out of the free market voting mechanism.  

---

