I pay attention to horse racing twice most years, and three times at most. I find out the winner of the Kentucky Derby (though usually not by watching the actual race) and then, when the Preakness rolls around, I check to see if the same horse has won both races.
If so, I pay just enough attention to learn if that horse also wins the Belmont Stakes, taking racing’s prestigious Triple Crown. The last time a horse actually won all three races was in 1978, so since then my excitement over the Belmont Stakes has been pretty limited.
In spite of all that, I thought I knew at least one thing about the gambling world: The house always wins. But it turns out that’s not the case when New York City or New York State takes the bets.
In early December, after about 40 years in business, New York City’s Off-Track Betting Corporation (OTB) closed its doors when it failed to receive a hoped-for legislative reprieve. In its last full fiscal year, ending March 31, the state-controlled corporation operated at a loss of $37.2 million after handing over the money it was required to give to the state, local governments, and race tracks. At the time of its closing, OTB had also racked up a pension bill that, together with health benefits promised to retirees, could be greater than $600 million.
This is a pretty astonishing feat considering that OTB’s business consisted of taking money from people and then giving some of it back to them. This is a business which was previously handled by neighborhood bookies, who never seemed to have a problem making money at it. To be fair, the bookies probably had a less generous pension plan.
Yet both New York City and New York State managed to fail to make money in the business of taking money for nothing. The city finally gave up in 2008, when it handed its mess over to the state.
Officials have tried to blame OTB’s collapse on decreased interest in horse racing. Speaking with The New York Times, John D. Sabini, chairman of the State Racing and Wagering Board, referred to off-track betting as “an industry that’s having a tough time…in a tough economy.” But while decreased demand is a fine excuse for not making much money, a gambling outfit should still be able to avoid losing money. All you have to do is reduce expenses to match revenues.
OTB could have easily closed down many or all of its betting parlors and relied on a small staff to manage Internet and phone traffic. For some businesses, atmosphere is everything, but OTB considered it a major upgrade in “customer amenities” when it installed restrooms and seating in 1993. It seems safe to say then that, while some may have enjoyed a sense of camaraderie in the storefront parlors, most people didn’t turn to off-track betting for the luxurious environment. With the cost savings from closing physical locations, OTB could have done some advertising to try to boost demand. That is what any rational manager would have done.
Unfortunately, instead of having rational managers, OTB had New York City and then New York State.
OTB was designed to function as a public benefit corporation, an entity that operates like a private business but turns over its profits to the state. However, everyone knew that OTB, being affiliated with New York City, was almost certain to become a bastion of patronage, if not corruption, and probably would never admit to having any profits to give back to the government. So lawmakers decided to have the corporation pay the city, and later also the state, a portion of its gross revenue, rather than its net profits. As Assemblyman J. Gary Pretlow of Mount Vernon succinctly explained: “If they’re allowed to pay on the net there would be nothing left over.”
This structure meant that the state was sure of getting some money, but it also meant the government had little reason to encourage OTB to cut costs. Meanwhile OTB had no assurance that it would have enough money after paying the state and the city to actually cover its operating costs, let alone reinvest in its business. The result was inevitable. Now that inevitability has come to pass.
It may take some skill to lose money collecting bets, but it’s the kind of skill New York has in spades. When it comes to the sport of mismanagement, there’s no doubt about it: The people who run the Empire State are thoroughbreds.
For more articles on financial, business, and other topics, view the Palisades Hudson newsletter, Sentinel, or subscribe to my daily opinion column, Current Commentary.
Business cycles and the essence of long-run economic growth are distinct issues. Preventing recessions is not the key to growth, as these are regrettable but unavoidable companions to an economy directed by a capital allocation process that is susceptible to systematic failure. Preventing the last failure is pretty irrelevant, because the next systematic failure will be different. Last I checked, only the US government is offering low-down payment loans, and no one offers no-documentation loans, so our government is not really helping here. As for creating growth via something new, if centralized governments could do that, the Soviet Union would still be around.
That decentralized, self-interested, people can collectively make such large errors seems irrational or corrupt to many, but they should remember that growing economies require people to be making things better, which means, new ways of doing things. New ideas are often wrong. Economics has gone onto intellectual cul-de-sacs many times (socialism, Keynesian macro models, input-output models, Hilbert spaces in finance, Arbitrage Pricing Theory, Kalman-filter macroeconomic models, etc.). Other scientific disciplines have their own mistakes, and political mistakes--stupid wars--are also common. These are rarely conspiracies, but rather, smart people making mistakes because the ideas that are true, important, and new, are really hard to discern, and tempting ones are alluring when lots of other seemingly successful people are doing it.
My Batesian Mimicry Theory posits that recessions happen because certain activities become full of mimics, entrepreneurs without any real alpha who got money from investors looking in their rear-view window of what worked and focusing on correlated but insufficient statistics. For example, people assumed a nationally diversified housing prices would not fall significantly in nominal terms, because they had not for generations; people assumed anything related to the internet would make them rich in the internet bubble, conglomerates would be robust to recession in 1970, that the 'nifty fifty' top US companies had Galbraithian power to withstand recessions in 1973, that cotton prices would not fall in 1837, etc.
As in ecological niches, there is no stable equilibrium with when mimics arise to gain the advantages of those with a real, unique and costly, comparative advantage. Every so often there are too many mimic Viceroy butterflies, not enough real poisonous Monarch ones, and a massive cataclysm occurs as predators ignore the unpleasant after-effects and start chomping on all of them. The Viceroy population grows until this devastating event occurs, a species recession. Next time, it won't happen in butterflies, but rather, among frogs or snakes. They key is, some ecological niche is always heading towards its own Mayan collapse (distinct from the 2012 Mayan apocolypse).
The key to wealth creation is doing less with more--destroying jobs at the micro level and creating jobs at the macro level by reallocating capital and labor to more valuable pursuits. The computer got rid of things from typesetters, secretaries, to engineers working with slide-rules, but these people didn't stay unemployed, they did something else, making the economic pie bigger. This is antithetical to government and unions who think creating a permanent 'job' creates productivity--stability at the micro level and stagnation at the macro level. Wealth is created by having decentralized decision-makers focused on simple goal of making money, which means, they oversee transactions where revenues collected are greater than expenses paid. If externalities are properly priced (I know, most liberal think this never happens), this implies value is created. The continual improvements in method (ie, productivity, wealth creation) merely maintain profits in a competitive environment; to do nothing would see their profits eaten away by competitors would could easily copy what they did and just undercut their prices.
The key to this is having managers who keep their workers focused. A good example is a story I heard second-hand about a football player for Minnesota Vikings in the 1970s. Coach Bud Grant called this marginal player into a meeting, and said, 'Here's what I need you to do...'. The player, an articulate fellow quite confident in himself, interrupted with an explanation of why he wasn't doing better and suggestions about how to correct it, mainly focused what others were doing wrong. Grant cut him off: 'You don't understand. This isn't a negotiation. Do what I'm telling you, and you have a role here. Otherwise, you don't.' Hierarchies only work well when people have clearly defined goals, and managers who manage their direct reports singlemindedly.
Private firms can do this much more quickly and often than government, and are rewarded with investment and retained earnings to the degree they do it well. When the government wants to do something, like build a light-rail system, it instead satisfies all its stakeholders who have no financial downside, only veto power, and so the cost/benefit calculus is almost irrelevant. The probability that benefits will outweigh costs when not prioritized is negligible, as highlighted by the fact that companies have to work very hard to make this positive when all those other considerations are ignored.
Thus, Minneapolis's light rail, at the cost of $1.1B for 12 miles of track, takes me longer to go downtown than a car because it stops 19 times at places no one wants to go because these 'hubs' were then sold as development opportunities, and an unusual number of ex-city councilmen are part owners of coffee shops and stores near these stops. Ridership does not even cover their marginal costs. It could have worked if they had an express train that went non-stop from end to end, but doesn't because it was not designed with the goal of making money, only the hope.
Good companies like Facebook, Apple and Google, have this sense of really understanding their users. Lots of simple things that making going to their sites and getting what you want. Their inferior competitors are relatively ugly, cluttered, and clunky. These generally weren't genius ideas like the ideas needed to create the first transistor, or Cantor's diagonal argument, in that there competitors had similar raw competence in these field, but it did take people looking to do things better than others, and decisive people who could empathize with their customers created really great things.
Robin Hanson had a neat article about the Myth of Creativity, where he criticizes Richard Florida's vision of bohemian lead productivity:
This is a Star Wars vision of innovation: "Feel the force, Luke; let go of your conscious self and act on instinct." And it is just as much a fantasy as that celluloid serial. Innovation is no more about releasing your inner bohemian than it is about holding hands, singing Kumbaya, and believing in innovation.
In truth, we don't need more suggestion boxes or more street mimes to fill people with a spirit of creativity. We instead need to better manage the flood of ideas we already have and to reward managers for actually executing them.
Sure, it's good to punish fraudsters, and be wary of the stupid ideas that were passed off as brilliant in the prior cycle (eg, Angelo Mozilo winning the American Banker's Lifetime Achievement Award in 2006, celebrated by politicians on the right and left, prized by Fannie Mae, and Harvard, is now an example of the 'unregulated predatory private sector'). But this is like learning not to put one's hand on a hot stove--good to know, but old news to most. Our priority at the top level should be to get out of the way, and so government should focus on its essential but limited perennial tasks as opposed to creating some new engine of growth. Leave that for the millions of people making sure millions of small changes are constantly made to daily procedures. Such changes do not require vision from politicians, subsidies, or tax breaks, but are rather the natural by product of people trying to make a buck. It's the standard Hayek/Friedman view of macroeconomics, and it's still the best description of how the complex adaptive system of our economy works.
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