TCS Daily

Drug Testing and the Market for Lemons

By Stephen Bainbridge - June 6, 2005 12:00 AM

Senator John McCain recently introduced the Clean Sports Act of 2005, which he explains:

        ... is designed to strengthen the testing procedures and toughen penalties 
        for the use of performance-enhancing drugs in the four major American 
        sports: Major League Baseball, the National Football League, the National 
        Basketball Association and the National Hockey League. The Clean Sports Act 
        establishes strict, uniform standards for the prohibition of performance
        -enhancing drugs including steroids and amphetamines.

If you're like me, your initial reaction will be to ask whether the federal government doesn't have bigger problems to solve. Like, say, Social Security? Yet, upon reflection, I decided a case can be made for the bill.

Begin with the proposition that a market failure is an essential precondition for government intervention. Is there a market failure in professional sports when it comes to performance-enhancing drugs?

Congressman Henry Waxman claims that: "There is an absolute correlation between the culture of steroids in the major league clubhouse and the culture of steroids in high school gyms. If we can remove steroids from the clubhouse, we will fix the problems in school locker rooms." In other words, he's claiming there is a negative externality here -- i.e., drug use by adult sports stars has a spillover effect on children. The argument is self-evidently spurious. If every bad act by an adult role model is going to be defined as a negative externality justifying government intervention, Big Brother truly has arrived; indeed, we might just as well ban adulthood.

Instead, at least as I see it, the only plausible market failure story in this context is based on Nobel economics laureate George Akerloff's famous "market for lemons." Akerloff focused on the impact asymmetric information as between buyers and sellers has on the market for used cars. Some would be sellers' used cars are in good shape; call these cherries. Others have hidden defects that are known to the seller but hard for the buyer to discover; hence, the problem of asymmetric information; call these lemons. Because buyers don't know and can't cheaply distinguish lemons from cherries, rational buyers will assume that all cars are lemons. In other words, the price buyers are willing to offer for a used car is discounted on the assumption that the car has hidden defects. This effect drives down the prices of all cars, including the cherries. In turn, it results in a crowding out phenomenon -- similar to Gresham's Law -- in that sellers of cherries become less inclined to sell their cars, because they will be unable to get a fair price, which means the market comes to be dominated by lemons, which reinforces the perception of buyers that they need to discount the price they're willing to pay, and so the vicious cycle continues.

Assume fans prefer clean sports in which no player uses performance-enhancing drugs. I concede I'm not sure that assumption is valid, but consider the impact of performance-enhancing drugs on baseball. Much of baseball's appeal grows out of its welter of statistics and historical records, all of which is negated when some athletes setting records or leading the league are doing so not because of their God-given talents but because they are willing to inject themselves with various drugs.

Assume therefore that fans would be willing to pay more for clean sports. They'd go to games where clean players starred. They'd buy more jerseys of clean players. They'd use the products endorsed by clean players. And so on.

Unfortunately, fans can't easily tell the difference between cherries (clean players) and lemons (drug users). There's that problem of asymmetric information again. So fans discount the price they're willing to pay. They stop paying attention to baseball home run records, because they suspect the records are tainted by steroid use.

It is thus in the interests of both owners and players to convince fans that their games are clean. Unfortunately, it's going to be difficult for owners and players to credibly bond against using performance-enhancing drugs. An unscrupulous player who knows that hitting a ton of home runs will lead to higher salaries, provided he's perceived as being drug-free will try to maximize his income by pretending to be clean while secretly using performance-enhancing drugs. Likewise, owners will be tempted to put butts in the seats by offering home run-hitting players who purport to be clean but in reality are juiced up.

Fans will be aware of this phenomenon, but the problem of asymmetric information makes it impossible for them to distinguish between honest and dishonest players and owners. Certainly, such fans would have no reason to trust a private drug screening system controlled by players or owners. In contrast, a legal prohibition of performance-enhancing drugs, effectively enforced by a regulated testing agency, and backed up by law enforcement, would be necessary to prevent the vicious cycle that otherwise causes the market to be dominated by drug users.

Note that this analysis would hold even if there are a substantial number of fans who don't care whether players use performance-enhancing drugs or not. As long as most fans fall into the former category, a prohibition of such drugs would be Kaldor-Hicks efficient. (A transaction is Kaldor-Hicks efficient if it makes at least one person better off and that person could compensate anyone who is made worse off. If the first group of fans could compensate the second for any losses a prohibition causes the latter, and still be better off, the prohibition is Kaldor-Hicks efficient.)

A mandatory prohibition also may be Kaldor-Hicks efficient when viewed from the players and owners perspective. Assume there are two groups of owners and players: one wishes to promise to refrain from using performance-enhancing drugs and to provide a credible bond for that promise; the other does not. A mandatory prohibition of such drugs backed up by public enforcement and the threat of both criminal and civil sanctions makes the latter group worse off, but makes the former group better off by making their bond much more credible. Again, so long as aggregate gains to the first group are large enough that they could compensate the second and still be better off, the prohibition would be Kaldor-Hicks efficient.

And so we are left with an empirical question: do fans care about performance-enhancing drugs? I've followed the hearings Senator McCain has been holding on this issue and they've been concerned more with the Congressional version of the perp walk than finding out what fans really want. It would behoove Senator McCain to go back and make sure he's really dealing with a bunch of lemons before trying to make lemonade.


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