Streetwise Professor

John Cassidy’s book, When Markets Fail was incredibly annoying.  Coase obviously didn’t make a real dent on his consciousness.  How is that possible, in this day and age?

Cassidy writes for the New Yorker, and yesterday he turned his penetrating analytical abilities to criticize Romney by hyping government support for Olympic athletes:

In the past fifteen years, government spending on sports facilities and sports-training programs has steadily increased to a point where the British Olympic team now receives about a hundred and twenty-five million pounds (about two hundred million dollars) in annual funding. And guess what? The team’s performances have improved greatly. Four years ago in Beijing, the British team won nineteen golds and forty-seven medals over-all, putting them in fourth place behind China, the United States, and Russia. This year, Team G.B. leapfrogged Russia in golds.

“You do not get excellence on the cheap nor do you get all the virtuous outcomes that come from that without long term and predictable levels of funding,” Lord Coe, the great middle-distance runner who headed up the London Organizing Committee, said over the weekend. “That’s what we witnessed in Beijing, that’s what we witnessed here and if we want to maintain our position in Olympic sport then that’s what you will need to do.” Many of the British heroes from this year’s Games echoed Coe’s sentiments. “I was at Atlanta in 1996 when G.B. finished thirty-sixth in medal table,” said Ben Ainslie, a sailor who just won his fourth gold medal. “So to see where we are now in third place at London 2012 demonstrates just how successful this strategic investment has been.”

I haven’t seen Romney or Ryan asked about the financing of the Olympics. Their response would probably be that Team U.S.A. did splendidly without much government backing, and that’s true. The United States Olympic Committee, unlike its British counterpart, relies on individual donations and corporate sponsorship for funding. Such a system can produce great athletes, especially when it is combined with supportive parents and outstanding college programs. But government-financed initiatives can work, too: the British showed that.

In fact, the entire London Games was a testament to the productive role that governments can play.

Really?  Bad economics is seldom persuasive, and the above is chock-full of it.

To start with, straw man arguments are unpersuasive.  Nobody claims that additional government spending should not lead to improved performance.  So, it’s hardly a surprise that, all else equal, the UK’s medal tally increases if it spends tens of millions supporting Olympic athletes.

The questions are whether this is a good investment, and whether-as Cassidy clearly believes-that Britain’s subsidies should be imitated by other nations.

The answer to both questions is definitely No!  And you would think that a guy that finds a market failure lurking behind every blade of grass would understand that, for the logic is pretty straightforward.

Even without government subsidies, the superstar syndrome (eloquently analyzed by one of my intellectual idols, and thesis advisor, the lamentably late Sherwin Rosen) induces overinvestment in athletic achievement.  The big winners earn rents, and due to the nature of tournaments and the superstar system, virtually all of the rents go to the top performer in a few sports, e.g., Michael Phelps, Usain Bolt.  This induces competition to be the superstar.  This competition dissipates the rents.  The more popular the sport, the bigger the platform (e.g., the Olympics), the greater the endorsement potential, the more rents, and the greater the waste.  (This is actually an argument for old-style amateurism.)

Government subsidies only make things worse, and arguably far worse, because of the non-cooperative nature of the interaction.  Government X gets utility out of sports achievement.  It subsidizes sport.  But government Y also gets utility out of sports achievement.  Given the nature of sports competition, this sets up a very wasteful competition between X and Y.

This is most easily seen when the pools of talent and the effectiveness of the subsidized training in the two countries is equal.  (The argument can be extended to cases where there are asymmetries.)  Tournament competition is winner take all, and for the most part, the margin of victory doesn’t matter in determining the utility of winning.  This means that if X outspends Y by a dollar, X’s athletes win, and it gets 100 percent of the benefits of victory: 50 percent of expenditure generates 1oo percent of the gains.  This gives Y an incentive to see that dollar, and raise X a dollar.  The trivial increase in Y’s expenditure leads the gains of victory to shift entirely from X to Y.

But X won’t stand for that.  For a mere $2 more, it can get all of the benefits of victory.

Note the discontinuity.  A small change in expenditure leads to a discontinuous change in the fruits of victory, from 0 to 100 percent.

And so it goes.  In equilibrium, both sides overspend.  Indeed, all of the spending is overspending.  In equilibrium, X and Y spend the same positive amount, and the outcome is random, with each nation’s athletes having an even chance of winning.  If they had  spent nothing, the outcome would be random, with each nation’s athletes having an even chance of winning.  In other words, the outcomes (the probability that X’s or Y’s athletes win) doesn’t change if the countries subsidize: in that sense, the entire expenditures of X and Y are a pure waste.

You might argue that the absolute level of performance would improve, and that has some value.  Maybe.  But the main thing is who gets the gold, not the time they do it in (in track or swimming), or the distance they jump, or the height they clear, or the score (in shooting, say), or the dominance in the ring or on the mat.  In the Olympics, it is the medal count that countries tout-and which Cassidy emphasizes in his piece. So on that dimension-the dimension of the number of wins/medals-it is unambiguous that the subsidy is a waste.  Expenditures of resources affect nothing.  All pain, no gain.

Moreover, the waste tends to get worse, the larger the number of competing countries.

This isn’t rocket science.  It is non-cooperative game theory 101.  The problem is that when resources aren’t allocated by price, but are allocated in a winner take all race, there is wasteful competition for rents-as anyone who claims to be an expert about market failures (like Cassidy) should know.

In market settings, the Coasean logic operates: such waste will be mitigated by the incentive to craft efficiency enhancing arrangements (where efficiency takes transactions costs into account). With governments, not so much.  Or, to put it differently, the transactions costs incurred to reduce government waste are quite high.

The bottom line is pretty simple: government subsidization athletic performance is incredibly wasteful.  A government failure. But Cassidy lauds these subsidies.

That tells you all you need to know about how much attention you should pay to him.