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Legalized Gambling

Privatization and Other Strategic Issues Concerning the Regulation of Gambling
One of the more interesting developments in state-sponsored gambling has been the subcontracting of lottery games to private corporations such as G-Tech and Scientific Games. When states subcontract--also termed privatize--states permit a private firm to conduct the lottery, and the state merely takes a certain percentage (usually 2 to 4 percent) of either the gross amount in the betting pool (as in pari-mutuel betting) or a certain percentage of net revenue (varying from 5 to 8 percent). The first state to privatize its lottery was South Dakota.

When three states recently ( Georgia, Nebraska, and Texas) began legalized gambling, they auctioned off the right to run their lottery to either G-Tech or Scientific Games. Since these firms manufacture most of the instant game tickets, which is the game of preference for new lotteries, given the Massachusetts experience, it makes sense to let these firms operate a state's initial lottery offerings. These states, then, proceeded to set up "gambling commissions," which have the task of overseeing the operations of the lottery, racing (all forms), and nonprofit gaming such as bingo. Until this trend started, lotteries had been set up and solely operated by state agencies. Hence, the questions that this chapter addresses are: 1. What are the motives behind the privatization of gambling by government?
2. What are the possible consequences of this privatization of gambling by the states?

To provide answers to these questions, a framework will be provided to evaluate the privatization process, and then this framework will be used to determine the possible positive and negative consequences of a privatization of state-sponsored gambling.

A FRAMEWORK FOR EVALUATING PRIVATIZATION
A government's policy decision to privatize a firm that has been traditionally nationalized is usually evaluated in terms of whether or not economic efficiency has been increased in either the short run or the long run. If the privatization has increased economic efficiency, then it is proclaimed a success ( Vickers and Yarrow, 1988). In the case of privatizing state gambling operations, efficiency would seem to imply that the state would increase its revenue by handing over the operations of the lottery rather than continuing to operate the lottery by itself.

But in the case of privatization of legalized gambling, this preoccupation with economic efficiency fails to measure the political consequences that any decision to privatize might have ( Savas, 1987, p. 233). To deal with this deficiency, Pint ( 1990, pp. 267-270) has proposed using a "rational-choice" framework that is "based on the view that interest group members and politicians act as rational decision-makers." It is essentially a cost-benefit analysis that measures both the economic and political consequences for every interest group or stakeholder that will be affected by a proposed privatization. Hence, the real question becomes how to develop a calculus that would enable a researcher to calculate the economic and political consequences of a proposed privatization for every interested group.

This would seem to be a daunting task. For even if there could be agreement on what constituted the costs and benefits of any privatization for every stakeholder, these calculations could only be determined for short-run costs and benefits and would be nearly impossible to estimate for the long run. However, this distinction between short-run and long-run costs and benefits provides an opportunity to develop a framework that utilizes both Vicker and Yarrow's emphasis on efficiency and Pint's observation that political consequences must be taken into account in determining the success of any privatization policy by government ( McAllister and Studlar, 1989, table 8). This measurement of economic and political consequences was one that policy makers had to make when they initially started a lottery, and now it seems they will have to continue this evaluation as they decide whether or not it is in a state's best interest to turn over the control of a lottery to a private concern.

The Framework
The purpose of this framework (shown in Figure 7.1 ) is to provide the reader with a four-step process by which a privatization of legalized gambling (or any privatization of a traditional service provided by the state such as water, sewerage, etc.) can be evaluated. The rest of this section will be used to explain how this process works. Our discussion will begin with an examination of the short-run economic and political criteria that will be employed in this framework.

Cell 1 of the framework or matrix is concerned with the efficiency that the newly privatized firm displays in the period immediately after privatization. The questions that need to be asked are: Has privatization enabled the firm to develop business strategies that lead to increases in market share and/or profits? (It should be noted here that the business strategy of the firm might be to sacrifice short-term profits in order to obtain increases in market share that hopefully will lead to increases in long-term profitability. Hence, the goal of a newly privatized firm could be either to achieve increases in market share or to increase profitability, although obviously these two goals do not have to be mutually exclusive.) Is the newly privatized firm better able to achieve operating economies and to reduce its overall cost structure? It is this cell that has been the primary focus of economists such as Vicker and Yarrow. The reason for this is obvious: If privatization is not successful in economic terms in the short run, then it can have little hope of being successful in the long run either economically or politically. This cell is also by far the easiest to measure using available data. Hence, it is the one most evaluators of a privatization process have utilized.

But it is rather naive to postulate that economic efficiency is the only short-run goal to be analyzed during the privatization process. There is also a need for political efficiency in the short run, which is represented by cell 2. While many political processes are represented as zero-sum games, the privatization process is certainly not one of them. As Pint ( 1990, p. 268) has pointed out, the privatization process is quite inefficient if the process does not benefit most of the stakeholders who take part in the process, since this could lead to a situation where the privatization process is too easily reversed. Hence, to ensure that the privatization process is efficient, the majority of stakeholders in the privatization process must benefit directly from any privatization. Government must obtain more revenue (or cut its losses in terms of reduced subsidies) from the newly privatized firm. Customers must benefit either by receiving a better-quality product/service or by paying less for the goods/services that the firm provides. Finally, other interested stakeholders, such as public interest groups and local government, must be satisfied that their interests will not be discounted when short-term policy decisions are being made for the newly privatized firm.

Cell 3 represents the long-run economic interests of privatization and has as its goal the development of a corporate strategy that will ensure the continued profitability of the newly created privatized firm. The development of this corporate strategy demands that the privatization process provides the firm with new options in planning its future strategies. Can the firm pursue a diversification strategy so that the firm is no longer dependent on just one source of revenue? Has privatization enabled the firm to compete in new markets outside those traditionally present? Should the newly privatized firm become vertically integrated either forward or backward? Also, the type of management that is needed to make decisions of this type is not usually found in nationalized or highly regulated firms. This is particularly true in the case of gambling. It would also seem that in order for the privatized firm to engage in this sort of long-term corporate strategy thinking, new managers as well as a new corporate culture would have to be developed.

Obviously, if the privatized firm is going to choose any of these corporate strategies, then it must be given the freedom by government to do so. The amount of freedom that the government can give to a privatized enterprise is precisely the issue that cell 4 has as its chief concern. Just as the privatized firm needed to have options in order to establish a basis for long-term economic efficiency, the other stakeholders, which were mentioned in the previous discussion about short-term political efficiency, also need to retain some measure of power/influence over the future course of any previously nationalized firm. For if the privatization process is to be politically viable in the long run, then government must decide the amount of power it will exercise in order to satisfy all of the constituencies to which the firm is responsible.

In summary, this framework for evaluating the privatization process requires the evaluator to ask a series of questions about the economic and political effects that the privatization of a firm will have both in the short run and in the long run. In the short run, the newly privatized firm not only has to be a modest success economically but also needs to satisfy the vast majority of stakeholders, who must perceive that privatization has worked for their betterment. The criterion for the long-run success of a privatization is the development of various options for all of the stakeholders in the process. For the firm, this involves having the ability to implement a new corporate strategy for itself. Meanwhile, government as well as other stakeholders must maintain a measure of influence over how goals will be set by the privatized firm. The unique feature of this framework is that it recognizes not only the trade-offs that the evaluator must make between the short- and long-run objectives of privatization but, most important, the trade-offs between the economic and political goals of privatization. For some observers, nationalization represents the subjugation of economic objectives to political objectives, while privatization can be perceived as the triumph of the economic goal of efficiency over political concerns of equality. What this framework is trying to point out is that a privatization cannot be evaluated correctly unless proper attention is paid to both the economic and political compromises that must be made if the privatization is to take place successfully.

The rest of this chapter will be spent examining a very controversial but unique privatization process: the privatization of statesponsored gambling.

EVALUATING THE PRIVATIZATION OF STATE-SPONSORED GAMBLING
Cell 1
This is the cell that emphasizes economic efficiency in the short run. A success in this cell is measured by how fast a private firm can increase revenue for the state from gaming operations. But why would a privatized lottery be in a better position to increase revenue than one operated by the state? To increase revenue, a privatized gambling concern would need either to increase sales or to cut costs in comparison to the state-operated lottery. How would this privatized lottery achieve either or both of these goals in order to increase overall revenue?

To increase sales, a privatized lottery would be able to advertise in a much more aggressive manner than state-controlled lotteries normally are permitted. For example, the Massachusetts state lottery advertising budget was limited to $2 million a year. In many other states, the amount of advertising permitted is limited to some percentage of net revenue, usually 2 to 3 percent. However, a privatized gambling firm would not have to limit its advertising budget. The other advantage that would accrue to a privatized gambling concern would be lack of a limit on the type of advertising that could be employed. To avoid controversy, most state lotteries use fairly "tame," general advertising, trying to show how "fun" it is to play a lottery game. A privatized lottery could be much more aggressive in advertising. Rather than generalized advertising, advertising could be used to target certain niche markets as well as displaying the "dream" of winning lottery millions in much more graphic terms.

Besides more aggressive advertising, a privatized lottery could also employ a much more aggressive sales force. Presently, most state lottery salespersons are salaried employees. A privatized firm would be much more inclined to employ commissions as the basis for its sales force. Another area where a privatized firm could expand sales opportunities is making additional outlets available for lottery tickets available. Perhaps a privatized lottery could also increase the prizes (presently 1 percent) given to vendors as a reward for aggressively "hawking" lottery tickets.

One area where a privatized firm would have a distinct advantage over the state-controlled lottery games is in the area of cutting costs. Since state employees are protected by civil service regulations as well as having more costly fringe benefits, the cost of operating a private lottery ought to be substantially lower than a state-operated lottery. Another cost "benefit" derived from privatizing lottery operations would be the more liberal use of part-time employees as opposed to unionized state employees. These arguments are generally used in support of any privatization process; that is, a private concern ought to be able to provide the good or service at a cheaper (more efficient) rate than a state-controlled operation.

The case for privatizing state-sponsored legalized gambling rests on the ability of the private concern to expand the lottery's markets as well as to reduce the costs of operating the lottery. In the next cell, the political ramifications of privatization will be analyzed.

Cell 2
The short-run political consequences of privatizing lottery operations are centered around the issue of whether or not this privatization is considered "fair." Trying to define what one means by fair is, of course, a daunting and thankless task. However, in the context of privatization, it is generally centered around the issue of whether the majority of stakeholders (groups interested in an issue) are "better off." The four major stakeholders in the gambling arena are government, customers, unions, and antigambling interest groups. Hence, the emphasis in this cell is no longer on economic or revenue issues but rather on how the political process deals with the interests of groups that are concerned with gambling.

Government officials, whether they are from the executive or the legislative branches of government, have borne criticism from many antigambling groups. As we have seen, this criticism is centered around two issues: (1) The state should not be in a business that is potentially addictive; (2) the payoff of lottery games is not fair--that is, a greater percentage ought to be given back to the bettors. By privatizing a lottery, state officials avoid both of these criticisms. Government officials simply point out to these groups that they are no longer in the gambling business, and they have no wish to "legislate morality." However, the government will take its portion of the profits at absolutely no risk to government. It allows government officials to broadcast their belief in an individual's ability to "choose" while showing voters how efficient government can be. It cerainly appears that the privatization of lottery games is an ideal short-run solution for elected officials.

Meanwhile, the customers of lottery games potentially benefit from privatizing lottery games in two ways. First, a private firm is much more likely to provide a broader array of games. Second, a private lottery firm would be much more likely to increase the percentage of winners for lottery games. Currently, these percentages are fixed by lottery commissions. But a private lottery firm could use increases in payoffs to generate more interest in playing games since its costs would be lower than those of a state-controlled lottery. The role of the lottery commission would be to ensure the public that the games are fair (in this context, no fraud). Hence, the customers could potentially enjoy greater variety and better payoffs under a privatized lottery.

The unions that represent state lottery workers are in a "nowin" situation. Obviously, they would like to oppose the privatization of the lottery since it will most likely result in the loss of union jobs. However, the amount of sympathy that state lottery workers could mobilize does not appear to be overwhelming. Certainly, the firm that is initiating the privatization of a lottery will offer to keep current lottery workers but without state benefits. Also, the current trend toward the privatization of state services will not help these workers, given the fact that the lottery does not provide a necessary good or service. The argument could also be made, since the lottery is a form of entertainment, why should the workers providing this entertainment be protected from the forces of the marketplace. Interest groups that are leading antigambling campaigns are also in a rather curious political position. Certainly, a common complaint among these groups is that the state ought not to be in the gambling business. So one would think that these groups would be rejoicing over the privatization of gambling since it removes the state from the gambling business. However, these groups realize that they would have a much greater influence over a state lottery commission than they would over a private firm operating lottery games for the state. The amount of political pressure that could be applied to a successful private firm is minimal as long as the gambling activity has been sanctioned by the state. This is not the case with a state-controlled lottery, which has to answer directly to legislative committees that are much more susceptible to public pressures and negative news accounts of gambling activities. For these antigambling interest groups, privatization can be claimed as a victory insofar that it removes the state as the chief sponsor of gambling activities, but in reality, it actually weakens the influence that these groups have over the future course of gambling activities.

Cell 3
One of the key assumptions that supporters make about gambling is its long-term viability as a revenue source for government. In Chapter 4, we saw that the only lottery game that seemed capable of providing long-term growth in revenues was the instant game. However, the rate of growth did not even begin to satisfy the ever-increasing demands by government officials for more revenue. Even Massachusetts, which has used instant games to their maximum advantage, seems willing to sacrifice this success to venture into new gambling arenas. Hence, it certainly appears that the goal of many state governments is to increase gambling revenue, and the strategy that most states are willing to undertake to achieve this goal is diversification, that is, legalize many more forms of gambling. So the question becomes: What is the best "structure" to implement this new gambling strategy? Alfred Chandler's famous dictum "Structure follows strategy" seems to apply to this situation ( Chandler, 1962). As states expand gambling opportunities to their constituents, it would certainly appear that a new structure to oversee these gambling enterprises is needed. The lottery commissions that are operating lottery games contain neither enough staff nor the expertise to simultaneously operate keno, OTB, video poker, and casino gambling operations. To make sure that these new gambling ventures bring in the maximum amount of revenue to the state, gambling operations must be coordinated.

There are two possible solutions. The state could set up an overall gaming agency that would operate all forms of gambling in the state. Obviously, this solution would require the state to hire many more employees, to buy gaming equipment, to build video poker locations as well as casinos, and to maintain these machines and casino sites. To choose this solution, the state needs to make a fairly heavy capital investment.

The other answer to this structure question is, of course, to privatize these new gambling operations. This solution offers many advantages to the state. First, the cost of buying and maintaining new gaming equipment would be borne by the private operators. Second, the risk of failure also rests solely with the private operators. Finally, the state gets its cut of the funds at absolutely no risk to the state. In many ways, the privatization of other forms of gambling would resemble pari-mutuel betting on horse racing. In states where pari-mutuel betting is permitted, these states set up a state racing commission whose salaries are paid by the individual owners of the track. The state takes a certain percentage of the bettingpool and is assured of revenue. Obviously, if private operators run video poker parlors and full-scale casinos, a similar regulatory setup could, and probably would, take place.

In summary, by pursuing gambling as a source of revenue, the state is implicitly sanctioning a long-run strategy of diversification, that is, legalizing various forms of gambling. But for the state to involve itself in these operations, it would need to make a huge investment in both equipment and buildings as well as personnel. So it would appear that privatization of gambling is the state's best chance of fulfilling the dream of risk-free revenue from its constituents.

Cell 4
Politically, the privatization of gambling in the long run offers both the executive and legislative branches many advantages. Obviously, the governor can request, and the legislature can approve (or as is the case in many states, the legislature approves over the governor's veto), whatever additional gambling is thought appropriate. But privatization also has another political advantage: By taking the operations of gambling out of various state commissions, it also puts to rest "infighting" over who controls the funds as well as the operations that come from gambling activities. In Chapter 6, we witnessed how this infighting was precisely the central issue that the Massachusetts legislature had to deal with as it decided how much it was going to expand its gambling opportunities in the state.

Another long-run stakeholder in the privatization of gambling is the customer. Privatization offers the customer two advantages in the long run. First, by removing the state from its monopoly position in the gambling arena, the customer should benefit from the competition that will develop to entice gamblers into their various games. One can foresee alliances made between hotel owners and restaurants to attract gamblers to their establishments. Gambling will become another element in an entertainment package.

The other stakeholders in the long-run privatization of gambling are antigambling groups such as Gamblers Anonymous as well as various church and civic organizations. By removing the state as the only beneficiary of gambling activity, these groups will now be able to dismiss the '"good" cause that lotteries and other gambling can be said to support. The fight against legalized gambling will be moved to the legislative committees and the governor's office. It is easy to imagine that these groups will probably move to have gambling profits taxed at a higher rate than other corporate profits or to have a set percentage of their profits set aside for programs that deal with individuals who are addicted to gambling. In many ways, the privatization of gambling clarifies who the "enemy" is, and this is quite important for groups that wish to renew the public's interest in an issue such as gambling.

CONCLUSION
Privatization of state-operated lottery games at first sounds like an unlikely idea. After all, why should the state share its gambling revenue with a private corporation or firm? However, as the state seeks to expand its gambling horizon, the amount of money invested and risk taken increase substantially. Politically, the number of stakeholders who could benefit potentially from the privatization of gambling also increases dramatically.

As we saw earlier, gambling as a form of entertainment must be tolerated. By privatizing gambling activities, it appears that this tolerance level is increased. Gambling appears to be a prime example of what ethicists term the "slippery slope" argument--that is, if one permits even the smallest opening, then the floodgates are eventually opened. In many ways, the privatization of gambling is the logical conclusion to the ethical dilemma that gambling poses. Once a state-sponsored lottery (the small opening) is permitted to support a good cause, it does seem only a matter of time until there will be calls for legalizing all types of gambling in the private sector (floodgate) in order to support all kinds of state activities. Indeed, the privatization of gambling does appear to be the future of gambling in this country. However, the final chapter examines the other possible solutions to the gambling crisis.