Daniel Sutter: An economics lesson from daily fantasy sports

New York Attorney General Eric Schneiderman announced last week that daily fantasy sports (DFS) sites Fan Duel and Draft Kings will stop paid contests in the state, because DFS amounts to illegal sports betting. Accusations last fall of “insider trading” against the sites, which seem to have precipitated legal action, offer a lesson on the discovery function of economies.

First some background. Fantasy sports players choose pro players for their team, with game stats counting for the fantasy team. People generally play in season-long leagues with friends; fantasy football originated in the 1960s and Rotisserie league baseball in the 1980s. DFS involves one day (or week in the NFL) games, which particularly appeals to fans not interested in managing a fantasy team for an entire season. Large DFS tournaments draw thousands of entries and offer prizes over $1 million. Whether DFS constitutes gambling depends on the details of state law and is not my concern here. Massachusetts’ Attorney General just last week decided DFS sites could continue to operate, subject to regulation. States laws clearly differ on this question.

The insider trading allegations involved employees playing on other DFS websites, which could provide an unfair advantage. A contrarian lineup offers the best hope of winning a large prize in a contest with thousands of entrants. A team with the best, most popular players might be more likely to win, but lots of players will split the prize. Really big wins require teams of less frequently selected players who have great games. Employees could use selection patterns in tournaments on their site to craft contrarian teams to field on other sites. Such information offers an advantage, but not the guaranteed profit of true insider trading.

Discovery in economies was first highlighted by economist Friedrich Hayek and refers to the knowledge we gain through the operation of the economy. Most of our economic knowledge emerged from economic action. We know now that the corporation is an efficient business organization and that oil has hundreds of economic uses. But we did not know these things before economic activity. Oil deposits became a valuable resource only when people learned how to drill for and refine oil.

Competition in sports offers a parallel. We discover the best college football teams each year through the season’s contests. Unexpected Heisman Trophy candidates and national championship contending teams can emerge. These surprises personify discovery, and demonstrate that we must play the games to learn the best teams and players.

Economic discovery means that we constantly learn new things and must always be ready to adjust our plans accordingly. Any business which gets too wedded to the old ways of doing things runs the risk of obsolescence. We cannot know what we will learn during the operation of the economy.

Consider now the evaluation of the DFS insider trading charges. Draft Kings and Fan Duel already did not let their employees play on their own sites – they recognized the potential conflict of interest. But neither recognized the potential use of selection patterns by employees on other sites for unfair advantage. Both Fan Duel and Draft Kings banned their employees from playing for money on other DFS sites after the recognizing the problem, and for good reason. Customers will play less if they thought that DFS contests were unfair. In a world with discovery, this is part of the learning process.

Someone who does not recognize the role of discovery is more likely to see nefarious activity. If DFS knew everything when they began operations, the choice to let their employees play on other sites looks calculated. Hindsight is usually 20/20, and if we ignore discovery, we might also believe that foresight is 20/20.

Unfortunately too many policymakers and even economists ignore the role of discovery. This may not be an accident. For policymakers seeking to run the economy, discovery is a subversive concept. Would-be government planners want us to believe that they know how to solve all of our problems. Economic discovery explains why would-be planners cannot know everything needed to run society.

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Daniel Sutter is the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University and host of Econversations on TrojanVision.