The Theory – Practice Gap

This is an example of why libertarians get thulped for being impractical:

If betting was legal, and as a punter you could choose from a) an HDFC subsidiary offering betting facilities, b) a Taj Group company and c) some shady outlet like the ones you can choose from now, you’d obviously choose one of the more legit ones. Being public companies, and part of bigger brands, they would be far less prone to fix matches. That would reduce bookie-led match-fixing.

It will work, in theory. Also, in theory, banks and NBFCs will drive loansharks out of business. The problem is that theory requires that there are no barriers to customers. Real life will have barriers in plenty.

Let’s look at the real real world first. Suppose we do get an enlightened government which legalises betting. Even so, the Income Tax Department and the Prevention of Money Laundering Act are going to play spoilsport. The IT Department is going to monitor all transactions made with legitimate bookies. Punters will be required to submit their PAN details with every bet they make.

This is not an issue for a software sarariman who is going to put a thousand rupees down. But if you’re a big-time punter betting ten megarupees of black money then a legitimate bookie is out of bounds for you. The big money will continue to be placed with underworld bookies, and because it’s big money, the underworld will continue to fix matches.

This is where my own inner libertarian pops up and says, bah, get rid of the regulation and the problem is solved. Money being laundered is actually a good thing as it will then find its way into legitimate uses.

Unfortunately, even in an idealised real world with no regulation or monitoring, there will still be barriers to customers, especially if the bookmaker is an HDFC subsidiary that is accountable to shareholders and can’t take too many chances. Just as HDFC won’t give anybody a loan beyond a certain limit, HDFC’s bookmaking subsidiary won’t allow anybody to place a bet beyond a certain limit. The bigtime punters will still be excluded, not by regulation but by the bookmakers’ own risk appetite. And so the biggest bets will still remain underground, and the incentive for the mafia to fix matches will still remain.

Two points before I end this post:

  1. Even so, betting should still be legalised, if only for the benefit of the small ticket punters who’re betting a day’s worth of salary. And once legit bookies are successful enough with small time punters, they’ll be able to create risk management systems robust enough to deal with the big betters.
  2. I’m sure Skimpy will respond to this by saying something to the effect that hedge funds will have enough risk appetite to serve big punters and so I’m worrying needlessly. I actually hope he does.

0 Responses to The Theory – Practice Gap

  1. amit varma says:

    Aadisht, firstly, my point has consistently been that legalising betting will be an improvement, not a panacea. You seem to agree with this towards the end of your post, in the first of those two points.

    Secondly, your inner liberarian is right. And there is so much money in betting that players will certainly emerge who’ll develop the complex risk management systems required to deal with this. They have in the UK. You don’t trust markets to take care of that once the opportunity is there? Hmm…

  2. Let’s say I trust them over a very long timespan where cleaning up betting is concerned. Twenty or thirty years.

  3. amit varma says:

    Cool. Let’s leave it to the mafia then.

  4. vatsan says:

    if betting is legalised, im sure the underworld will form betting companies and run their current underground operation overground. They have the first mover advantage, and will create entry barriers to keep out organised firms like HDFC etc. None of what amit says will happen. Underworld controls the entire racket, its a vertically integrated operation therefore they have the power to raise entry barriers. Dont throw the alcohol example. there they werent vertically integrated operations.

  5. vatsan says:

    im my example, i can say the underworld will be the legal bookies will accept both black and white money because they are willing to flout laws.

  6. Actually I am as optimistic as Amit that if betting is legalised then legitimate bookies will not have any underworld involvement. He is right that the ordinary punter will prefer an HDFC to a shady goon. And I don’t think that the mafia can erect very substantial entry barriers if betting is legalised.

    What I am pessimistic about is the mafia being wiped out altogether. HDFC has been around for thirty years and real estate is still fuelled by black money. Now that we have REITs and REMFs to take care of bigger ticket spenders it will gradually get cleaner, but very gradually. That’s why I don’t trust markets to deliver immediately to clean up sports betting.

  7. amit varma says:

    Vatsan, what entry barriers can the underworld create? Heh.

    AAdisht, another point is that I think you overestimate the amount of black money that goes into betting. I know loads of people who bet on cricket, and they’d all be perfectly happy to bet white money. The reason they bet is for the thrill of gambling, and it would hardly matter to them whether the money is black or white. Thus, the real estate analogy doesn’t work.

  8. Nandu says:

    I’ve been following your blog for a while, but the trail to this one was different! Got here from reading Amit’s Mint article, his follow-up post, and this one….V interesting, but I just wanted to understand your views a little more clearly –

    1. So legalising gambling will increase transparency in a HDFC v the mob situation – completely agree. But this will make prices fall and the mob is overcharging people today?? Really, the mob is actually many small mobs, and its not necessarily very oligopolistic (definitely not in the longer term). Prices are driven by fairly simple demand-supply economics, else they would not make sense.

    2. From a HDFC v mafia’s ability to take on sizeable bets, wouldn’t you think that the ability of a legalised financial institution to accept really large bets also exists? They seem to have the financial scale to pull it off where required. For eg, like writing SuperCat insurance policies, which Reinsurance companies are now beginning to specialise in.

    I don’t see what advantages the mob would enjoy over legal betting businesses, just due to the relatively large size of the bet (except where money laundering and ilicitly held cash wealth is a part of the economy – as it is in India).

    3. Transparency increases with legalising betting, but to come back to my first point, this may not necessarily result in betting becoming cheaper for the average punter. More importantly, with the exception of investors in a legalised gambling business, the transparency may not bring anyone any specific advantages.

    4. Last and most important, so if a gambling business is legal, it would NEVER stoop to fixing matches?? I hardly think so. Companies have committed crimes in the past, and will continue to do at times in the future. The mere legitimisation of a business can hardly be seen as a guarantee that something like match-fixing will not occur. If it occurs today, it will occur tomorrow, irrespective of the legality of the parties pulling the strings. That’s just the economics of the way it works.

    I’d be very interested in seeing your views on these issues, thanks!! Oh, and excellent post!

  9. vatsan says:

    amit, isnt it simple? they can always use force and coerce interested entrepreneurs not to operate. this is what they will do to guard their turf.

  10. amit varma says:

    Vatsan, the mafia’s going to “coerce” HDFC and Reliance not to operate in an industry if they want to enter it? Heh.

    Nandu, the reason it costs more for the consumers if it is illegal is because of all the hidden costs that come from being an illegal business: the bribes inevitably given to law enforcement officers, the cost of the risk that comes from operating illegally, and so on. That is why even drugs cost much more for a consumer in countries where they are illegal as compared to countries where they are legal.

    And regarding your fourth point, of course people will always try to game the system, but there are far more disincentives for a legit company to do hera-pheri than for the mafia, more ways for consumers to scrutinise their behaviour, as well as greater choice. So it is less likely. Not impossible. Just less likely.

    I keep stressing that legalising betting is not a panacea but an improvement, so capitalising that ‘never” is needless!

  11. Nilu says:

    Yay!!!!

    I now want to bet on when Amit will stop taking his own crap seriously enough to defend it. Rs. 1000 on 6 months.

  12. Nandu,

    1. If The Mob is actually a collection of little mobs, then legitimsation and consolidation should lead to fairer pricing as the risk pool deepens.

    2. Okay, I did not even think about the possibility of rebookmakers emerging to handle big ticket risks. That’s actually a wonderful concept. But how soon will institutions with this sort of risk appetite emerge? It’ll surely depend on a lot more than just legalising betting- investor enthusiasm, technology, market demand and so forth. And it still won’t solve the problem of punters who want to bet big with black money.

    3. Back to point 1. And what Amit said above.

    4. Yeah, this is an interesting point. After all banks have to worry about reputational risk but we still see rogue traders emerging every now and then. On the other hand rogue traders are the exception and not the rule.

  13. Nandu says:

    Amit, don’t know if I agree with “the reason it costs more for the consumers if it is illegal is because of all the hidden costs that come from being an illegal business: the bribes inevitably given to law enforcement officers, the cost of the risk that comes from operating illegally, and so on” argument. The biggest cost differential in running a business legally v illegally today probably lies in taxes. Given current direct tax rates of around 30%, running a business illegally (in terms of cost of risk or bribery related costs) makes economic sense when your ‘illegality-related’ expenses are lesser than the taxes you would pay to run the business legally. Setting aside any ‘moral arguments’ for a minute, this really should boil down to the economics, should it not? Or am I missing something here? Oh, and apologies for the capitals, was merely trying to stress the point!

    Aadisht, rebookmakers to cover big ticket risk already exist. Dunno if you’ve heard of GeneralRe (the Berkshire Hathaway-owned reinsurance company run by Ajit Jain), who are pretty much out on the market, willing to insure against ANY liability, and the bigger the better. They currently specialise in insuring against ‘super-catastrophes’ (hurricanes and the ilk, which cost billions in damages and many insurance companies find very iffy to cover).

    Also, “If The Mob is actually a collection of little mobs, then legitimsation and consolidation should lead to fairer pricing as the risk pool deepens.” And why should that be? Assuming you mean ‘cheaper’ when you say ‘fairer’, consolidation leading to better pricing as an outcome seems to fly in the face of market economics (competition drives prices down until equilibrium is reached). In re legitimisation helping pricing, as I mentioned above, I’m wondering about the relative cost of bribes v. taxes.

  14. Nilu says:

    OK Nandu, you are the winner.

  15. amit varma says:

    Given current direct tax rates of around 30%, running a business illegally (in terms of cost of risk or bribery related costs) makes economic sense when your ‘illegality-related’ expenses are lesser than the taxes you would pay to run the business legally.

    Nandu, good point. So why does cannabis cost more in the US than in the Netherlands?

  16. Nandu says:

    Amit, valid point too! To be honest, can think of only one potential defense – there’s lesser cannabis grown in the US (relative to demand, that is) than in the Netherlands. Which is perfectly possible, given that its illegal to grow the stuff in the US. Consequently, demand-supply meeting point on the curve shifts….. Wonder if there are any studies out there on how the relative costs of running a business legally v. illegally.

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