TCS Daily

Casino Battle Royale

By Benedikt Koehler - October 26, 2004 12:00 AM

Casinos once upon a time were a staple film setting where action heroes proved they moved at ease with wealth, glamour and risk. But gambling nowadays has moved beyond the portals guarded by liveried doormen and permeates the culture of leisure pursuits of all classes and age groups. From bingo, to lotteries, to betting on the next Wimbledon winner, anything goes.

Small wonder in Britain the government would like to overhaul gambling laws and pave the way for mega-casinos. Blinking lights, Las Vegas style, would bring overseas investment to blighted communities and generate tax receipts from a growth industry. It seems a win/win proposition. Yet the reform is highly controversial and opposition is making front-page headlines.

Proponents of the brave new world of gambling think their critics are a blast from the past. They point out that the terms of the new regime propose closing down many gambling opportunities accessible to minors. In come high-tech fruit machines, out go the penny drops on seaside piers. It's time for the industry to grow up, and keep kids safe. Critics are staid sticks in the mud, blocking progress and job creation.

Moral concerns explain only part of the objections. Not only has the gambling industry matured, so has consumers' awareness of how markets work and whether producers offer consumers value for money. This is why supporters of the Gambling Bill still have some explaining to do.

Governments began using lotteries as a means to raise revenue in the 18th century. Back then it became common practice to issue bonds, with payoff schemes offering supernormal returns to bond holders chosen at random. Charles de Talleyrand in 1789 wrote a treatise Des loteries arguing lottery bonds were fundamentally flawed. Lottery bonds, he said, were bought mainly by the poorer sections of society, who thus bore a disproportional burden of taxation. Lotteries were inherently iniquitous. Talleyrand might have used different terminology, but the point he was making was that lotteries are effectively a form of regressive tax. Even today many still subscribe to this view. (With the benefit of hindsight, one might have pointed out to Talleyrand that many French aristocrats by 1789 were mired so deeply in debt, buying lottery bonds might have been a perfectly rational strategy to salvage their fortunes.)

In fact, Talleyrand got it partly wrong and partly right. Lotteries, like taxes, may be a means for governments to raise revenue, but that's where the similarity ends. Taxes are compulsory, lotteries are not. If the terms of a lottery look a bad deal, hang on to your cash and spend it on something else.

On the other hand, Talleyrand was right to assert that lotteries are a mug's game. They recycle money from the pockets of one set of punters into the pockets of another set of punters, minus a surplus which the sponsor creams off. Running a lottery is a risk free business. That explains why so many countries keep lotteries in the public sector or channel their surplus to charities. Britain's National Lottery in only ten years has raised £16 billion for good causes.

Betting has proliferated. Forecasting has become more complex. Operators have become more sophisticated. When it comes to forecasting the next Booker Prize winner, the odds offered by bookies have been beating literary critics hands down. Yet then and now, the underlying process is still the same. Betting operators cannot influence outcomes.

In Talleyrand's day, members of Brooks's Club in London on rainy days would sit by the bay window and bide their time placing sizeable bets on which raindrop would win the race to the bottom. Today, placing sums on future outcomes is a mainstay of financial markets. It is commonplace to compare markets for financial futures with betting shops. The comparison cuts both ways. The Business School at the University of Iowa some years ago started a futures markets where users buy and sell contracts on future events, for example on election outcomes, or first day takings of Hollywood blockbusters.

This is where fruit machines and one-arm bandits are fundamentally different. Like lotteries, they recycle money from the pockets of one set of punters to another set of punters, minus a commission. Understandably, when casinos fix pay out rates they err on the side of the caution. Or has anyone heard of a casino that went out of business? The mechanics of a casino business are down to statisticians equipped with appropriate software. Casinos can adjust pay out rates at the push of a button.

Given that investing in a casino is a one-way bet, what is the appropriate structure for the industry? The instinctive animosity of casino critics against gambling behemoths which crowd out competition is perfectly legitimate. There is a genuine challenge for public policy and for regulators: who determines pay out rates and profitability.

The crux with licensing casinos is to ensure consumer protection by means of transparency and competition. Proponents of casinos should make it plain the rules of competition will not be rigged. For example, put pay out rates in the public domain and let consumers rank casinos. Moreover, ensure there are no barriers to entry for competitors. No casino will retain an excess share of takings, knowing new entrants are waiting in the wings. Third, ensure that casinos face competition along the entire value chain, from slot machines to restaurants to overnight accommodation. The best regulator are market forces. And, finally, for goodness sake keep those penny drops. They do no more harm to Britain's youth than chips with vinegar.


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