Chapter 9

1. The Economics of Sports FIFTH EDITION Chapter 9 Labor Market Imperfections Michael A. Leeds | Peter von Allmen

2. Introduction • While salaries grew rapidly in all the major North American team sports, they grew more rapidly in some than others • The faster growth of salaries in baseball than in football is surprising since revenues in football have risen faster and baseball is exempt from antitrust laws • Baseball has a relatively stronger players’ association

3. Learning Objectives • Understand how leagues exert monopsony power on players and the impact of monopsony on salaries • Describe how unions act as a countervailing force on teams’ monopsony power and how the player associations have increased player income • Describe how the most recently negotiated agreements in the NFL and NBA have changed the economic relationship between players and owners

4. 9.1 The Monopsony Power of Sports Leagues • No major sports league has a competitive labor market • In this section, we take a closer look at • The reserve clause • The advent of free agency in professional sports • The impact of monopsony power on players who are not free agents

5. Monopsony • Monopsony is a market structure with a single buyer • In a monopsony labor market, workers can sell their services only to the monopsony employer • The impact of monopsony power is the mirror image of monopoly power • A monopsonist uses its market power to drive down the prices it pays producers

6. The Monopsony Model ME • It is an upside down monopoly (Figure 9.1) • Pays lower wages, wm • Employs fewer workers, Lm • Causes a deadweight loss • The supply curve is the market supply curve • Marginal Expenditure (ME) is the added expenditure from hiring one more player if all are paid the same wage • Profit is maximized when ME = MB $ S wc wm D L Lc Lm

7. Figure 9.1

8. The Reserve Clause • Baseball set the pattern • Until the mid-1870s, players controlled the sport • The National Association of Professional Base Ball Players (NAPBBP) set the rules • Financial backers provided the money • The NAPBBP had a crucial weakness • It could not keep players from jumping contracts • The Pittsburgh Piratesgot their name because they “pirated” players from other teams

9. The Origins of the Reserve Clause • William Hulbert was many things • A financial backer of the Chicago White Stockings • A brazen thief • An unwitting founder of modern baseball • In 1875, he signed 5 players • They were still under contract with other clubs • After signing them he called for a new system to end such practices • The new system allowed teams to “reserve” players – a gentlemen’s agreement

10. The Reserve Clause • The text of the reserves clause is quite vague • [I]f, prior to March 1, . . . the player and the club have not agreed upon the terms of such contract [for the next playing season], then on or before ten days after said March 1, the club shall have the right to renew this contract … except that the amount payable to the player shall be such as the club shall fix in said notice • Its interpretation was unambiguous • It bound players to teams in perpetuity • This gave the clubs the right to set wages

11. The Clause Seemed Innocent • By 1889 the reserve clause became a part of all players’ contracts • It bound players for a limited time • The length of their contract plus one year • This became a perpetual tie • Owners did not let players play without a contract • All parties eventually assumed the clause was a lifetime contract • Other sports leagues copied it

12. Impact on Wages • With no competition for players, teams reduced salaries to levels that just kept their players in the sport • Roger Maris worked as a beer distributor in the offseason after breaking Babe Ruth’s record in 1961 • Players had little countervailing power • Major League Baseball Players Association was formed in 1953 • It had no collective bargaining agreement until 1968

13. 9.2 Unions in Professional Sports • Unions have been representing a declining portion of the civilian labor force • In the 1950s, about one third was unionized • By 2011, this had fallen to about 12% • Globalization, technological advances, and demographic changes of the workforce have reduced the importance of unions • In contrast, all major league players belong to professional sports unions

14. Introduction to Unions • Craft unions descended from medieval guilds • They are organized along skill lines • To keep prices high, they prevent non-members from practicing the same craft • Modern craft unions consist of workers who share a common skill • Example: Screen Actors Guild • Industrial unions originated in 19th century • Industrial revolution led to the rise of large firms • Unions sought to offset the power of large employers • Example: United Auto Workers

15. How Craft Unions Affect Pay • Some restrict access to skills • Some restrict access to jobs • They raise pay by restricting labor supply to Su in Figure 9.2a

16. How Industrial Unions Affect Pay • Workers act like a monopoly • See Figure 9.2b • They push wages up via collective bargaining and the threat of a strike • They reduce employment in the industry

17. Figure 9.2a

18. Figure 9.2b

19. Strikes and Lockouts • A strike occurs when workers act together to remove the labor input from the production process • A lockout occurs when the management of the firm does not permit the labor input to operate

20. Are Unions Inefficient? • Monopolies drive price up and quantity down • Have unions hurt sports? • Unions can justify higher pay if • Employers find ways to increase the MRPL • Providing a voice to workers decreases worker discontent, thus increasing MRPL

21. Monopsony Unions v. Monopoly Employers • Owners retain monopsony power • Only a few teams employ players • They drive down pay • Players now have monopoly power • Unions negotiate with owners • They drive up pay • The result is bilateral monopoly • Pay is now in an indeterminate range between the high monopoly price and the low monopsony price • See Figure 9.3 • Pay depends on each side’s bargaining power • This was analyzed by Nobel Laureate John Nash • A key is each side’s threat point – the well-being of each side if there is never a settlement

22. Sports Unions • Unions in professional sports are a hybrid • They represents players with special skills like craft unions • Because players work for a particular employer, unions bargain like industrial unions • They are sometimes unlike any union • They do not bargain over specific pay but for a framework within which individuals bargain • They sometimes advocate positions that are unlike those of other unions or firms • Example: During the 1998–1999 NBA lockout, the players advocate a free market for labor

23. Advent of Free Agency • Because, at first, it applied to only five players, being reserved meant that a player was regarded as a star • When players recognized the impact of the reserve clause, they sought to improved its terms • Eventually, they sought to overturn it • No major sport now has a reserve clause • Players now have a path to free agency • They can sell their services to the highest bidder

24. Football and Free Agency • The NFL was the first to get free agency • In 1957, Radovich v. NFL ruled that football is interstate commerce • A gentlemen’s agreement not to sign free agents quickly broke down • Commissioner Pete Rozelle imposed the Rozelle rule

25. The Rozelle Rule • Teams had to compensate each other when signing a free agent • The rule turned signing a free agent into a trade • Free agency was not restored until 1992 • The NFLPA disbanded • This allowed individual players to sue the NFL on antitrust grounds

26. Hockey and Free Agency • The World Hockey Association (WHA) was formed as a rival league in 1972 • It sued the NHL on antitrust grounds • In an attempt to sign away players • Courts declared players could become free agents

27. Figure 9.3

28. Basketball and Free Agency • The American Basketball Association (ABA) and NBA sought to merge in the mid-1970s • The NBA players blocked the merger • They did not want the “salary war” to end • The union brought an antitrust lawsuit • The ABA and NBA did not have a limited exemption allowing them to merge • They got the union to drop its suit by granting the players free agency

29. Baseball’s Path to Free Agency • MLB players could not use the courts • MLB was exempt from antitrust laws • The legacy of the Federal Baseball ruling • Free agency came first to MLB thanks to one man: Marvin Miller • He made unions a force in sports • Named Director of the Major League Baseball Players Association in 1966 • He was the MLBPA’s first full-time director

30. The Brilliance of Marvin Miller • He outsmarted the owners & commissioner • He got them to form an arbitration panel • The panel had three members • One each appointed by owners and the union • One mutually agreed upon • Previously the commissioner handled all appeals • In 1976, Andy Messersmith played a year without a contract • His appeal went to the panel • The panel voted 2-1 to declare him a free agent

31. Forms of Free Agency • All leagues now have free agency • This is the right of a player to sign with any team that offers him a contract • Each league has its own restrictions on when and how to achieve it • There are two forms of free agency

32. Unrestricted Agency • Player can sign with any team • Eligibility • MLB: After 6 years • NBA: After 4 years for first-round draft picks • No restriction on other players • NFL: After 4 years if his contract has expired • NHL has a complex formula • 27 or 7 rule allows free agency for 27-year olds or players with 7 years of experience • Can vary with position and the number of games played

33. Restricted Free Agency • Player’s original team has the right of first refusal • It can retain the player by matching another team’s offer • Rules for restricted free agency vary • MLB does not have restricted free agency • NBA: After 3 years for 1st round draft picks • It does not apply to other players • NFL: After 3 years if his contract has expired • NHL: Again has complex set of rules

34. Salary Arbitration • Arbitrators play the judge in disputes • Unlike mediators who act as middlemen • Arbitration comes in two forms • Binding: both sides pre-commit to judgment • This is often used with municipal unions • Non-binding: both sides face indirect pressure to accept • NHL and MLB have binding arbitration

35. Salary Arbitration in NHL • Team and player submit proposals to panel • The panel may choose either offer or impose its own ruling • The panel has 48 hours to make its ruling • A recent study shows that the rulings closely track what econometric studies say the players are worth

36. Salary Arbitration in MLB • MLB uses Final Offer Arbitration (FOA) • FOA is designed to prevent addiction to arbitration

37. Addiction to Arbitration • Arbitrators like their jobs • They don’t want to offend either side • They are pressured to choose middle ground • Labor and firm have no incentive to compromise • Moderating one’s offer just shifts the middle ground • This makes arbitration addictive Firm Labor Arbitrator

38. Final Offer Arbitration (FOA) • Each side makes one offer • Arbitrator must choose one • Arbitrator cannot impose or propose an independent solution • FOA restores the incentive to compromise • Of 34 players who initially filed for FOA in 2011, only 3 actually went to arbitration

39. The Impact of FOA • Players have lost more than half the arbitration cases • Arbitration still has had a huge impact on salaries • 78 players filed for FOA in 2010-2011 • Only 6 went to arbitration • The average salary of the 78 players more than doubled

40. Measuring Monopsony Power • Krautmann, von Allmen, and Berri (2009) compare 3 major sports leagues • Players who are not eligible for arbitration or are restricted free agents • Are paid 66% of their MRP in the NBA • Are paid 50% of their MRP in the NFL • Are paid 19% of their MRP in MLB • When they are eligible • They receive 77% of their MRP in the NFL • They receive 86% of their MRP in MLB

41. Salary Caps • The collective bargaining process is typically a matter of compromise • Three of the four major sports leagues—the NHL, NBA, and NFL—now have salary caps • We introduced salary caps in Chapter 5 • Here we examine their impact on team payrolls

42. Salary Caps in the NBA • Payrolls are now limited to 49-51% of basketball related income (BRI) • The individual salary scale is based on experience • The NBA levies an escrow tax on all salaries • 10% of all salaries are held in escrow by the NBA • The tax applies if total salaries exceed the cap • It holds regardless of exceptions and exemptions • Income in escrow goes to the NBA until salaries fit below the cap

43. Salary Caps in the NHL • Payrolls are set at 57% of qualifying revenue • No individual can receive over 20% of the team’s allowable payroll • Players put 13.5% in an escrow account similar to the NBA’s • The current lockout is about how what percentage of revenue goes to the players

44. Figure 9.4

45. Salary Caps in the NFL (Hard Cap) • Players different shares of different sources • 55% of national media revenue • 45% of NFL ventures revenue • 40% of aggregate local revenue • The NFL has no individual limits • Bonuses are a complicating factor

46. Bonuses in the NFL • A bonus counts against the cap if it is easy to obtain • Example: signing bonuses • They are prorated over the life of the contract • The do not count if not easily earned • Example: leading the league in sacks

47. The Impact of Salary Caps • Caps have significantly reduced payrolls • Caps have significantly leveled payrolls • See Figure 9.5

48. Figure 9.5

49. Figure 9.6

50. Luxury Taxes • In MLB • Teams with payrolls above a threshold must pay a tax • The threshold will rise from $178 million to $189 million in 2014 • The tax is 17.5% of overpayment for first-time offenders and can rise to 50% • In the NBA • Teams pay 150% tax for first $5 million over the cap • This rises to 325% for teams $15 million over