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Keith Rankin - Socially Responsible Gambling

Keith Rankin's Thursday Column
Socially Responsible Gambling
27 April 2000

We tend to regard gambling as a vice, but risk-taking as a virtue. Indeed, risk-taking is a virtue. If nobody had ever taken a risk, then no economic development would have taken place.

We could define entrepreneurial risk-taking as making 'investments' in which the present value of the expected return exceeds the outlay, where the expected return is an appropriately weighted average of all possible returns. On the other hand, we can define gambling as an 'investment' in which the expected return is less than the outlay. Thus, on the surface, gambling is irrational to individual gamblers, but may be profitable to the suppliers of gambling services, and to governments who generate tax revenue from gambling.

Last week, we were reminded once again, that investment in the sharemarket or any other financial market, is a 'game' of uncertain returns for a given outlay. All too often sharemarket punters are irresponsible gamblers who fancy themselves as far-sighted entrepreneurs. While income saved and invested in shares may or may not give a net return, the investments that promise large returns carry high risk. In practice, playing the markets is gambling, because the chance of losing money is high.

When rich people gamble, there is a high outlay, a high probability of a net return, and a not-insignificant likelihood of a major loss. The rule of engagement is that you do not accept risk using money that you cannot afford to lose. Risk-taking with large individual outlays is really only an option for persons who have access to a separate stable income source - eg partners' wages. The corollary of that is that you do not borrow money in order to make risky investments.

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Is it irrational for poor people to gamble?

When poor people gamble, there is a low outlay, a low probability of a return, and, given the low outlay, no chance of a major loss. Non-trivial losses occur only as an accumulation of small losses; eg addiction to pokies. There is a small but real chance of a very large gain.

When poor people do not gamble there is no chance of their raising sufficient capital to escape from their low income status. Compound interest on small savings never did add up to much. Nowadays small savings lodged in a bank actually incur losses, thanks to taxes and bank fees. Gambling is therefore a rational strategy for low income people, because conventional saving is not rational for them. So long as the outlays are strictly managed - eg a maximum of $5 per week - the losses are frequent but trivial, while the gains are infrequent but substantial. Gambling is rational for low income people, even though the expected value of the return falls short of the outlay.

Two interesting examples of gambling in our history are 'terminating building societies' and 'bonus bonds'. Terminating building societies were a means devised in the nineteenth century by which groups of 'working men' could collectively raise enough capital for them to build houses in turn. The order in which members would get access to the capital of the group was determined by ballot. The society terminated once every member was housed. In the case of bonus bonds, the money allocated as interest on all bonds was paid instead as large sums to a few bondholders, again on the basis of random selection.

Building societies in particular represented a socially responsible way in which low income members pulled themselves out of the low income 'poverty trap'. Bonus bonds were a bit of a con, though, because the 'interest' fund was too small. The government was the main beneficiary.

How can gambling products such as lotto be structured so as to incur maximum benefits to society and participating individuals, while minimising the risk that people will overcommit themselves, and while ensuring that such gambling games are not simply a mechanism by which rich capitalists draw income from low income workers and beneficiaries?

Gambling is beneficial to individuals only if the prizes are big enough to direct a significant amount of capital into the hands of the winners, but not so big as to destroy the social fabric of winners' lives (as so often happens; eg by attracting undue attention from fair-weather friends). If prizes are properly structured, and there is no opportunity for corruption (as there is in betting on sports like one-day cricket internationals), then gambling is an excellent way of mobilising capital within low income communities.

However, given that in games like Lotto up to 50% of the money invested is not returned to punters, gambling can still represent a collective drain on the poor. Indeed, if the profits of gambling are taken by national or local governments as a substitute for income tax, the real beneficiaries are the high income people who are paying less income tax than they otherwise would.

For gambling to be beneficial for low income communities, therefore, three conditions must apply: (i) no corruption (which means, among other things, no excessive salaries paid to people who provide gambling services), (ii) prizes structured to be high but not too high, (iii) profits should be returned, in the main, to the communities from which the invested money is drawn.

Lotto could be run on such a basis.

If Lotto were to be operated with just one division and no jackpotting, it could create more prizes set at the optimum amount which I estimate to be between $100,000 and $300,000. My suggestion is that 7 numbered balls out of 40 would be drawn, as at present, and a winning ticket line would have 6 of those 7 numbers. Ticket lines would be made up, as at present, with six numbers per line. A $5 'lucky-dip' ticket would contain 10 lines, meaning 10 winning chances.

Each line of 6 numbers on a Lotto ticket would have 7 chances in 3,838,380 of winning. If we assume that 50% of the ticket money is returned to Lotto players, then 4 million 50-cent entries would create a prize pool of $1 million. On average, there would be 7.29 winners per million dollars of prize money. In the vast majority of cases, there would be between 5 and 10 winners per million dollars. The average prize would be $137,000, and a winner would be virtually guaranteed of a prize between $100,000 and $200,000. (If 75% of the money was retained for prizes, then prices would range in value from $150,000 to $300,000.)

Games like Lotto, when structured responsibly, can concentrate useful capital sums in the hands of many more low income people than who gain at present. At the same time, the profits can also be recycled by supporting the voluntary sectors in the communities in which Lotto punters live.

The biggest danger with gambling - which can be economically rational for individuals, even if the expected return on money invested is less than the outlay - is the temptation governments have to use it as an easy source of general government revenue. Australian states rely heavily on gambling taxes.

It is wrong to assume, paternalistically, that gambling is an irrational vice of the poor that necessarily perpetuates poverty. On the contrary, it is a means through which low-income communities can create capital, enabling randomly selected participants to better their circumstances from the combined resources of the whole community or nation. But, on the downside, gambling is also a means by which low income communities can be drained of their capital, through addiction to poorly designed games, through corruption, through big-business profiteering, or through taxation.

Socially responsible gambling is not an alternative to social welfare. But it can help to make communities prosper by creating capital, thereby enabling some people in low-income communities to acquire businesses and become capitalist employers.

© 2000 Keith Rankin

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