Small ticket with a big impact

A CONFESSION: for the second time since it started, I put a pound into the lottery. Bit stupid really, but at least I was in good company; and I suppose it is good to know we are all subject to the same irrational economic forces.

But what would have happened to that pound had it not gone into the lottery? Maybe I would have saved it. Perhaps I would have spent it on some "low ticket" item, such as an extra Sunday newspaper. What, in short, are the economic effects of the lottery? It is a fascinating question of practical economics, and it is one to which it is beginning to become possible to supply some (rather surprising) answers.

The best starting point is to look at the amount we are spending on gambling in general, and the impact of the lottery on that. Here the crude impact is very clear, for as shown in the left-hand graph, spending on gambling has leapt upwards in the last year, reversing a 20-year downward trend. But anyone concerned about the effect on our national morals might care to note that figures unearthed by Kleinwort Benson show gambling expenditure is still lower as a proportion both of consumption and of GDP than it was in the early 1970s, and that the late 1960s surge in gambling was duly reversed.

At some stage in the future, gambling will presumably go out of style again, though that day may be a long way off.

Meanwhile the lottery is undoubtedly distorting our pattern of spending. The annual total spent on gambling is now running at pounds 7bn, up from pounds 3.5bn. Most of that, not all, is coming out of other purchases. David Mackie, an analyst at Morgan Stanley, notes that while overall consumption in the first three quarters of last year rose by 2.4 per cent in volume terms, spending on confectionery fell 2.4 per cent, spending on other forms of entertainment 5.3 per cent, video hiring was down 3.1 per cent, and purchases of newspapers and magazines down 0.9 per cent.

That surely feels right. The lottery is a form of entertainment, and other forms of entertainment are just the sort of spending you would expect to be displaced by sales of lottery tickets. This looks like one of the none-too-frequent instances where a common-sense expectation of people's behaviour is supported by the figures. Other forms of gambling seem to have suffered a bit, but not by as much as one might expect.

This switch of spending into the lottery means that retail sales are rising more slowly than they would have done otherwise. This is charted on the right-hand graph, which adds the payments into the lottery on top of the slower rise in retail sales. JP Morgan reckons that about one third of the slowdown in the growth of retail sales last year is attributable to the lottery.

The effect on tax revenues, on the other hand, is none too marked. Sure, the Government gets revenue from its share of the proceeds, but it is losing out on VAT on other areas and - with less spending on drink and tobacco - it may be losing on excise duties too. But there is a cash-flow advantage for the Government: it not only receives its tax take but also sits on the funds until they are disbursed to charities and other beneficiaries. Were it not for that, the public sector borrowing requirement would be perhaps pounds 1bn higher than it currently is.

Now turn to the spending side. The money goes out in three ways: in administration costs, in prizes, and in payments for the various good works. The first is pretty small in relation to the economy as a whole and whatever one's views about the deal that the organisers struck, is not a significant economic factor. Prizes? Well, we really don't know much about the spending habits of the winners. Obviously the bulk of the big wins are saved and invested, and the bulk of the small ones are spent. But we do not know the balance between the two: maybe it is 50/50.

On the good causes, all spending is supposed to be on capital projects rather than running costs. There may be a little displacement - money set aside for a capital project becoming available for other expenditure - but a decent working assumption is that the whole lot goes on capital and most of that on construction.

Put all this together and what do you get? I can discern at least five effects.

The most obvious is that gambling has increased relative to other forms of entertainment and to sales of things such as sweets.

The second follows from that: retail sales understate the rise taking place in consumption.

Third, investment in the economy will rise relative to consumption. There will be a greater supply of investment funds from the big winners and more spending on investment projects by recipients of the funds.

Fourth, part of the pause in economic growth last year may be attributable to this switch: it takes a while for the money taken out of circulation to be disbursed, and a further period before it is actually spent. Expect maybe some injection of demand into the economy at the back end of this year.

Finally, the Government's own finances have been flattered by the lottery simply by its cash-flow effect: the PSBR would be declining even more slowly had the Government not had the interest-free loan it currently receives from the punters.

What happens next? As the months roll by, the initial impact of the lottery will fade and it will become a perfectly normal part of our personal and public finances. Expect the spending on gambling as a proportion of national income to level off, perhaps close to the level of the early 1970s at about 1 per cent of GDP. That surge shown in the left-hand graph is not sustainable for long, and other forms of entertainment will start to fight back more effectively. We do not know what technical developments are around the corner to capture more of our cash, but TV, phone and electronics companies are itching to sell us wonderful new goodies. As they do, the state lottery may come to seem slightly old hat.

We are also going, after a while, to reach the limits of what needs to be spent on "heritage" projects. There is a finite limit to the number of sports stadia and opera houses that we need. Because we seem to have underinvested in these projects in recent years there is a clear backlog. But pounds 1.5bn a year is a lot of money, even in these days of devalued sterling. Once the facilities are built, they have to be run and that costs money, too. The worst thing to happen would be a repeat of the 1960s when we over-invested in inappropriate state housing, which now is having to be replaced. It is very easy to waste money on grand projects that cost too much to run. After a while, expect pressure for lottery funds to be re- allocated to more pressing needs.

Finally, expect us all to feel more comfortable with the lottery. We will see the money being spent on things society would not otherwise have. It will, in the main, be money that otherwise would have been spent on small-ticket items, that do not have any lasting impact on the way we live - at least most of them don't. Please keep buying Sunday newspapers.