OPINION 

Why the World Cup matters

Chris Dillow

Chris Dillow

The start of the World Cup this week is an event not just of sporting significance, but of economic importance, too. Researchers increasingly believe that football can shed light upon our economic decision making.

One way in which this is true is simply that the World Cup matters for share prices. The MIT's Alex Edmans and colleagues have shown than when a country is knocked out of the tournament, its stock market subsequently falls. This confirms that share prices depend not just upon 'fundamentals' such as profits and interest rates, but also upon sentiment.

Guy Kaplanski and Haim Levi, two Israeli economists, believe investors might be able to profit from this effect even if they cannot predict the outcome of games. Their reasoning is cunning. As investors get depressed by their team's failure, they say, they'll sell not just their domestic stocks but some US ones too. And because 31 of the 32 national teams will lose at some stage, the overall effect upon the US market will be negative. Sure enough, they show that, on average, US share prices do significantly worse during World Cups than they do at other times. They estimate that the US stock market underperformed cash during 12 of the 15 World Cup tournaments between 1950 and 2006. Although their paper was written before the 2010 World Cup, that one fitted their pattern, as the S&P 500 fell slightly during it. In this sense, going short of the S&P 500 during the World Cup might make money.

There's another lesson from football. Researchers across Europe have shown that when teams change manager, performance does not, on average, improve. The England team conforms to this pattern. Over the last 40 years we've tried old and young managers, foreign and home grown, but with little change in fortune. This is because even talented and well-qualified individuals are often powerless against powerful cultural and organisational forces which generate mediocrity.

What's true of football is also true of companies. As Warren Buffett said: "When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is usually the reputation of the business that remains intact." Investors hoping that a change of CEO at Tesco (to take just one example) will transform the company's fate should take note.

A new book by Ignacio Palacios-Huerta at the London School of Economics shows some other ways in which football illuminates economic life.

One, he says, is that the team that takes the first kick in a penalty shoot out has a big advantage; they win 60 per cent of the time. This is because the team going second are usually behind and so are under greater pressure.

It's not just in football that a desire to get even leads to worse performance. One common error investors make is to hold onto losing stocks in the hope of breaking even, thus causing them to become victims rather than beneficiaries of momentum effects. And gamblers often take reckless risks when they've lost money, thus worsening their plight; this is how rogue traders start.

Professor Palacios-Huerta points to another footballing curiosity - that in Spain referees add on more injury time if the home team is a goal down than if it is a goal up, with the bias being greater if the crowd is big. 'Fergie time' is not confined to Old Trafford.

This shows that even apparently neutral people can be swayed in their behaviour by those around them. And again, the same is true in conventional economic life. There's now abundant evidence that peer pressures influence our decisions about how much to spend, what to study at college and whether to commit crime or not. They also influence our investment decisions. Hans Hvide at the University of Aberdeen and Per Ostberg at the University of Zurich have shown that investors are more likely to buy particular shares if their work colleagues do. This wouldn't be a bad thing if these were good shares - but, they show, the opposite is the case. Investors, like Spanish refs, are prone to make mistakes because of the subconscious influence of others.

There's something else. Professor Palacios-Huerta looked at what happened when teams were awarded three rather than two points for winning a game. The move was intended to encourage attacking play, by increasing the reward for a victory. But, says Professor Palacios-Huerta, this wasn't the only thing that happened. He shows that when teams went a goal up under the new system, they became less attacking. They "parked the bus" because conceding a goal meant the loss not of one point but of two.

The lesson here is that incentive systems can backfire; changing incentives can have unpleasant and unintended effects. The now-classic example of this comes from the experience of kindergartens in Haifa. They wanted to stop parents being late in picking up their children, so they introduced a small fine for late-comers. And they found that parents turned up even later, because they regarded the fine as a reasonable price to pay for extra child-care.

What's true of children is also true of investment bankers. There's now quite abundant evidence that big bonuses can have adverse effects by encouraging risk-taking or criminal behaviour, in part because they crowd out intrinsic motives such as self-respect in doing a decent job.

In all these senses, football can illuminate less important matters, such as how we invest and financial crises. Perhaps we can learn more from watching the World Cup than we can from listening to the pompous empty suits who prognosticate on the economy.

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