The Reserve Clause and the Failure of the Free Market

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Richard Hershberger

Richard Hershberger is a paralegal working in Maryland. When he isn't doing whatever it is that paralegals do, or taking his daughters to Girl Scouts, he is dedicated to the collection and analysis of useless and unremunerative information.

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24 Responses

  1. Avatar Kazzy
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    says:

    “Organized baseball could not function without the reserve, or something like it.”

    But other sports lack a reserve and manage to function. Unless you consider drafts themselves to be “something like” a reserve. In the NBA and NFL (I don’t know much about the NHL), you sign your rookie contract (with more restrictions set forth by the former league than the latter) and upon completing that, you are a free agent. There are opportunities in the NBA during the rookie deal for the player and club to mutually agree to extend it through a couple different means, but if the player is so inclined, they can become a free agent after three (2nd round pick) or four (1st round pick) years. The NFL system is a little trickier because of the non-guaranteed nature of the contracts and the franchise and transition tag system.Report

    • Avatar Richard Hershberger in reply to Kazzy
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      says:

      The amateur draft is a particularly peculiar institution, but yes: if a player is restricted from offering his services to whomever he chooses, then this is a version of the reserve system.Report

  2. Avatar CJColucci
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    says:

    So freely-negotiated contracts are “something like” the reserve system because they bind the player to the team for the duration of the contract? Even annual contracts, which forbid the player from moving during the season whenever he thinks he can get a better deal from another team? You really don’t see a difference between a club having the sole right to a player in perpetuity and a club having the sole right to a player for a time based on arms-length negotiations?Report

    • Avatar Kazzy in reply to CJColucci
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      says:

      @cjcolucci

      The issue is that the players have zero say over who their initial team is and imposed limitations on the nature of that contract.

      For several years, MLB players go through the arbitration process wherein they make a bid for a salary and an arbiter determines whether their bid or the team’s bid will be their pay for the coming years.Report

    • Avatar Richard Hershberger in reply to CJColucci
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      says:

      Are we still talking about baseball here? This was discussed in the antepenultimate paragraph.Report

  3. Avatar Brandon Berg
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    says:

    This was much better than I expected from a post with the phrase “and the failure of the free market” used unironically in the title.

    And despite what some people might assume based on my political orientation, I’m not particularly opposed to the idea of salary caps in baseball, if the league decides to impose them. I don’t watch sports myself, but I gather that sports leagues are different from most other industries, in that much of the customers’ utility comes from seeing competition between evenly matched teams. It’s good for consumers if a firm develops a car or telephone or medication that’s dramatically better than the competitors’, but it’s not at all clear to me that that’s true in baseball.

    All that said, I’m not convinced you’re correct. Ticket prices, like everything else, are a function of supply and demand. Technically the local baseball team has a monopoly on baseball tickets, but for all but the most hardcore fans there are many substitutes (other forms of entertainment), so it’s not clear how much monopoly pricing power they have. Also, even monopolists have their pricing constrained by demand.

    Anyway, raising ticket prices results in fewer sales. So that puts limits on ticket prices, no matter how high player salary goes. It’s also not clear to me how much higher ticket prices would go even with pure free agency. Owners are presumably charging profit-maximizing prices anyway. Since player salaries are a fixed cost (in the sense that they don’t increase with the number of tickets sold like, say, the cost of hiring cleaning staff and security guards), I don’t think salaries should affect the profit-maximizing ticket cost much, if at all.

    All of which is to say, my suspicion is that ticket prices are already about as high as they can go, and the primary financial beneficiaries of any cost savings from salary controls are the owners. This is aside from any additional consumer surplus fans might get from having more balanced teams.

    As you’ve probably inferred from the hedged language, I’m not 100% confident in this analysis. I bet there’s economic literature on this topic, or at least something close enough that reasonable inferences could be drawn about baseball.Report

    • Avatar Brandon Berg in reply to Brandon Berg
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      says:

      Forgot to add: This has some empirical support in the form of other industries with superstar economics. Movie tickets haven’t gone into an inflationary death spiral. Nor have concert tickets. Music has actually gotten cheaper, though that’s probably because of competition from piracy.Report

    • Avatar Brandon Berg in reply to Brandon Berg
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      says:

      Couldn’t find anything on Google Scholar, but the first page of regular Google results is full of economists saying that high ticket prices lead to high player salaries and not the other way around.Report

      • Avatar Kazzy in reply to Brandon Berg
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        says:

        @brandon-berg

        I’m pretty sure you’re right. They sell tickets based on what the market will bear. They used to do tiers (e.g., When the Yankees came to town, tickets were $40 but when the Mets came to town, tickets were $20). And the introduction of dynamic pricing over the last few years shows just how market driven ticket prices are.

        But prices are a relatively small drop in the bucket. Broadcast money is what drives things. See: the upcoming jump in the NBA salary cap which is directly related to a new TV deal and the players getting a set percentage of that dough. I believe over the next four years, the cap will go up 70%, which means teams are flush with cash and are going to spend it (in addition to a cap, the NBA has a salary floor).

        Don’t blame player salaries on high prices. If you (proverbial you… not you, BB) object to what players make (and, really, what business is it of yours?), then blame yourself and fans for make the leagues multi-billion dollar industries who can pay top talent top rates.Report

    • Avatar Richard Hershberger in reply to Brandon Berg
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      says:

      I confess to having given the piece a provocative title, what with the “failure of the free market” bit. Inasmuch as this is about market economics (as opposed to baseball history and governance) the point is that there are some areas where the free market simply doesn’t work. I have known people who reject this proposition as ideologically unacceptable.

      Ticket prices are largely beside the point. This is why I barely touched on revenue. My argument is that, in a totally free market, player salaries will always outstrip revenue. What this revenue is doesn’t matter. The discussion about the direction of causation of higher salaries and higher ticket prices actually confirms (or at least is consistent with) this.

      The argument is that owners, being rational economic actors, set ticket prices as high as the market will bear. OK, stipulating to this, how does this lead to higher player salaries? Higher ticket prices change neither the supply of players nor the demand for it. Were player salaries determined by supply and demand, ticket prices would be irrelevant.

      The explanation is that the modern modified reserve/free agency system is a mixed system. The reserve side provides a mechanism to keep salaries down, while the free agency side tends to inflate salaries. The former keeps things from getting entirely out of hand. Where higher revenue comes in is that it moves upward what constitutes “entirely out of hand.”Report

      • Avatar Brandon Berg in reply to Richard Hershberger
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        says:

        Of course higher ticket prices lead to higher demand for players. Demand is a function of willingness to pay, and willingness to pay is constrained by the difference between revenues minus other expenses and profits the owners require (which may be negative in the case of owners who are willing to sustain losses indefinitely just because they really like owning a baseball team).

        The constraint on payroll is that team owners are neither willing nor able to sustain infinite losses. Some aren’t even willing to sustain any losses indefinitely. They all want to hire the best players, but there’s a limit to how much they’re willing to pay to do so.

        Now, maybe it turns out that there are enough billionaires willing to sustain huge losses just to own a baseball team that owning a baseball team ceases to become a viable business and just becomes a rich man’s hobby. I don’t really see that as a problem. And even in that case, salaries are still constrained by the fact that they’re only willing to lose so much.

        Ultimately, in every bidding war, there comes a time when every participant but the winner says, “Fish it, I’m out,” either because he’s trying to earn a profit, or because he’s just not willing to lose that much. That’s what constrains prices, even if the thing being bid on is the best there is.Report

  4. Avatar Joe Sal
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    says:

    If subjective value is maintained, yet return on investment and/or profit is removed from exchanges, each individual agent is basically exchanging “at cost” services and products in a free market. IMO when financialization distorts a market it is no longer free. It is a financialized distorted market.Report

  5. Avatar Michael Cain
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    says:

    Shouldn’t any discussion of market distortions in MLB start with “Ownership is a limited, closed group”? You and I can’t take our billion dollars, make a deal with a stadium, hire coaches and players, and demand that the other teams schedule us in for the next season. No, we have to use a billion dollars to try to buy a membership in the club, subject to approval by the other members. Under those conditions, I’m in favor of giving the players every negotiating advantage that you can think of.

    The “don’t have to field a competitive team” is the giveaway. Adopt something like the English Premier League has. Plenty of room for someone to start a team one notch below the top, and every year teams with enough history of not being competitive are demoted and the best of the next league down are promoted.Report

    • Avatar Richard Hershberger in reply to Michael Cain
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      says:

      Start with it? No. The phenomenon I discuss, of inflationary player salaries and no free market mechanism to contain them, predates the phenomenon you discuss, of closed leagues. Players were paid under the table since 1860 or so, and openly since 1869. The complaints about outrageous salaries came simultaneously with this. The first closed league, the National League, was founded in 1876. The closed league system is but one of many peculiarities of sports economics.Report

  6. Avatar Mark Thompson
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    says:

    I’m late to this, but just wanted to say this was an unbelievable post. Seriously, one if the best things I’ve read round here in years, if not ever.Report

  7. Avatar Slade the Leveller
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    says:

    In John Helyar’s Lords of the Realm Charlie Finley is quoted as advocating making all players free agents. This was at the end of the reserve system as baseball had known it for a century. Since it was Charlie Finley, the advice was roundly ignored by his fellow owners.

    As it turned out, the modified reserve system created the worst of both worlds for owners. A limited supply of free agents, which drove salaries sky high, and a reserved bunch of players who were just biding their time until free agency. The truly good ones were, and are, as good as free agents, as clubs fall all over themselves to reward them early in order to avoid losing them to free agency.

    Helyar painted the owners as a bunch of egotistical stumblebums, and it’s not hard to agree with him given the post-Messersmith/McNally era of baseball economics.Report

    • As it turned out, the modified reserve system created the worst of both worlds for owners. A limited supply of free agents, which drove salaries sky high, and a reserved bunch of players who were just biding their time until free agency.

      And the reserved players get binding arbitration halfway through their reserved period, so the high free-agent salaries drive their salaries up too.Report

    • Avatar Richard Hershberger in reply to Slade the Leveller
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      says:

      You are the second person to present this argument, though the other (in private communication) ascribed it to Marvin Miller, who feared rather than advocated pure free agency.

      If I understand the argument (and I am not at all sure that I do), it is that the clubs collectively have a pool of money available for salaries. In a pure free agency system this money would be spread among the pool of all the players, but under the hybrid system the players still under reserve are removed from the pool of players, taking only a small portion of the pool of money with them. This leaves more money per capita for the players who are free agents, leading to hire salaries which then set the bar higher all around. In a pure free agency system, on the other hand, the money pool would be divided among the entire player pool, therefore spread more thinly and therefore setting the bar lower for everyone.

      I don’t buy it. My argument is that under pure free agency, salaries will naturally tend to outstrip club revenue, with wackiness ensuing. The Finley/Miller argument seems to agree. If, after all, the money pool for salaries was constant, or tied only to external factors such as club revenue, then the difference between the two systems would merely be how the money gets divided among the players. The Finley/Miller argument is that the hybrid system accelerates salary inflation. My take is that there might some such effect by making for a higher initial price point, but in the long run this difference would be minor.

      My argument is that the hybrid system keeps salary inflation in check by giving clubs a way to opt out. It is possible to construct a competitive team around players under reserve. Case in point: the Houston Astros (no longer a bad joke) have the second highest winning percentage in the AL right now, with the second to lowest payroll in MLB. Since it is possible to win without breaking the bank, it is possible to balance profit and winning. This isn’t to say that calmer heads will prevail in every club, but if a handful of super-rich owners get in a bidding war for aging superstars, this doesn’t force everyone else to do the same.Report

      • Avatar Slade the Leveller in reply to Richard Hershberger
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        says:

        @richard-hershberger I think you’re misreading the Finley position. If the entire labor pool of MLB players were free agents this would tend to depress wages. Probably not as much as in the real world where the labor pool is immensely larger, but depressed they would still be. Thus, you have a probably washed up Melky Cabrera earning 26x the salary of Avisail Garcia, a good, young White Sox. Cabrera, or a more egregious example from recent White Sox rosters, Adam Dunn, can wring crazy pay out of a usually sane Jerry Reinsdorf because the pool of home run hitters has been artificially limited by the reserve system.

        I can’t think of a single team sport that’s tried pure free agency, so we may never know how it might work. Does anyone here have an example?

        And, why would Marvin Miller not be in favor of salary inflation?Report

        • Avatar Richard Hershberger in reply to Slade the Leveller
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          says:

          “I think you’re misreading the Finley position.”

          Entirely possible. Probable, even.

          “If the entire labor pool of MLB players were free agents this would tend to depress wages.”

          This is the conclusion, but I’m not persuaded about the path to getting there. I agree that the distribution of wages would be different. Money that in the hybrid system goes to the past-his-prime home run hitter would in a pure free agency system go to the up-and-coming slugger. I just don’t think that the total money devoted to salaries would be lower in a pure free agency system.

          “I can’t think of a single team sport that’s tried pure free agency, so we may never know how it might work. Does anyone here have an example?”

          Sure: baseball. It didn’t work well–at least not for the owners. That’s why they abandoned it.

          Most of what interests me in sports history is how and why we got where we are, be it playing rules or governance or what have you. Some of these aspects are very path specific. There are directions the rules could have taken that would have led to a game different from what he have today. Other aspects seem pretty inherent in sports. One of the latter is how player movement and salary works. Pure free agency has never been shown to work. Why this is, and the alternative strategies that have been tried is just the sort of thing that interests me a great deal.Report

  8. Avatar Barry
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    says:

    “This doesn’t work in professional team sports. There are two reasons: owner incentives are complicated and inconsistent; and that labor market model using plumbers contains simplifying assumptions that are invalid for professionals sports.”

    Bull. Complicated incentives and simplifying assumptions are the norm in the real world, not the exception.Report

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