Institute for Research in Economic and Fiscal issues

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The political economy of state-owned lotteries

IREF Working Paper No. 201704: Alexander Fink

In many countries around the world, lottery services are provided by government-owned firms that are equipped with (regional) monopoly privileges. The official argument for lottery monopolies by state-owned firms as, for instance, in Germany regularly point to the protection of lottery players in general and (potential) lottery addicts in particular. Applying an incomplete contracts approach, Alexander Fink argues that even if the government is assumed to be perfectly benevolent and the addictive potential of lotteries is acknowledged, lottery services are more efficiently provided by privately owned firms than by state-owned enterprises. He further maintains that the persistence of state-owned lottery enterprises in Germany can be better understood by the self-interests of the state governments and other current players in the lottery industry than by assuming the state governments to be perfectly benevolent.

Managers of state-owned enterprises face different incentives than owners of private enterprises. If complete contracts were feasible this difference would not matter when a government decides whether to have lottery services provided by a state-owned or by privately owned firms. The government could ex ante regulate the actions of the providers in all contingencies. Only aspects that cannot be considered by regulation matter for the relative attractiveness of state-owned and private enterprises. As the future is inherently uncertain and not all future states of the world can contractually be accounted for, it matters if lotteries are provided by state-owned or privately owned enterprises. As private firms have residual claimants that benefit from an increase in profits, they have a stronger incentive to increase quality and decrease cost.

Most aspects that speak to the protection of regular and (potentially) addicted lottery players can be accounted for by individual contracts or general regulation, which renders them irrelevant for the question of whether state-owned or private enterprises should be preferred. Therefore, a benevolent government should opt for lotteries that are provided by regulated (and taxed) private enterprises to allow the customers to benefit from the strong incentives of private providers to engage in both quality-increasing and cost-reducing innovations in situations that are not covered by regulation.

To explain the persistence of state-owned lottery enterprises in Germany although the government could pursue the goals of raising revenue and protecting lottery players by allowing for the more efficient provision of lottery services by private enterprises, Fink drops the assumption that the German state governments are perfectly benevolent. He argues that the state governments’ interests in influencing hiring decisions and the use of funds of the state-owned lottery enterprises, the interests of the current employees of the state-owned firms, and the interests of private vendors of lottery tickets who currently contract with the state-owned lottery enterprises help to explain the persistence of state-owned lottery enterprises in Germany.

IREF Working Paper No. 201704: Alexander Fink

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