chapter 9 labor market imperfections fifth edition the economics of sports michael a. leeds | peter...

Chapter 9

Labor Market Imperfections

FIFTH EDITION

The Economics of Sports

MICHAEL A. LEEDS | PETER VON ALLMEN

Copyright ©2014 Pearson Education, Inc. All rights reserved. 9-2

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


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


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


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


The Monopsony Model

• 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

$

ME

S

D

L

wc

wm

Lm Lc


Figure 9.1


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 Pirates got their name because they

“pirated” players from other teams


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


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


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


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


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


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


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


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


Figure 9.2a


Figure 9.2b


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


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


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


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


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


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


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


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


Figure 9.3


Basketball and Free Agency

The American Basketball Association (ABA) and NBA sought to merge in the mid-1970s

The NBA players blocked the mergerThey did not want the “salary war” to endThe 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


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


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


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


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


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


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


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


Salary Arbitration in MLB

• MLB uses Final Offer Arbitration (FOA)• FOA is designed to prevent addiction to

arbitration


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

Labor Firm

Arbitrator


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


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


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


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


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


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


Figure 9.4


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


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


The Impact of Salary Caps

• Caps have significantly reduced payrolls• Caps have significantly leveled payrolls• See Figure 9.5


Figure 9.5


Figure 9.6


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


The Impact of Rival Leagues

• Entry undermines monopsony power• Salaries rise with serious challenges

– NFL salaries doubled between 1982 and 1986 because of the USFL

– Between 1970 and 1976 salaries in the NHL more than tripled because of the WHA

– See Figure 9.7


Figure 9.7


9.3 Labor Conflict and Compromise

• Labor relations in professional sports have been particularly contentious

• Table 9.1 shows that each of the four major North American sports has experienced a work stoppage since 1980

• The NBA’s lockout shortened the regular season from 82 to 66 games in 2011

• The NFL lost preseason games 2011• The NHL is on the verge of losing its 2012-13 season


Rationality and Conflict

• Economics presumes rational behavior– Rational people do not needlessly impose costs on

themselves

• Strikes and lockouts seem willfully to waste resources• In the NHL, both team owners and players would have

been better off if they had agreed to implement a salary cap at the beginning of the season and avoided the loss of income that resulted from the 2004-5 lockout


Economic Theory and Labor Conflict

• Economists reconcile strikes with rational behavior by acknowledging that uncertainty affects negotiations

• If one side is overly pessimistic, it may settle for a less favorable agreement than it could have reached

• If one side is too optimistic—overstating its own bargaining power or understating its opposition’s power—conflict may result


Settlement in Contact Zone

• If both labor and management know exactly how far they can push the other side, they can typically reach a settlement without conflict – Figure 9.8 illustrates how this might occur– They both settle in the contract zone

• The contract zone is the range of wages or salaries that is acceptable both sides


Illustrating Conflict (Figure 9.8)

Firm willing to accept

Union willing to accept

Contract Zone

Both union and firm are willing to settle within the contract zone

Low Wage High Wage


Conflict

• The threat point for labor is the minimum acceptable wage

• The threat point for management is the maximum offer

• Conflict occurs if one side or the other misjudges this point and stays outside of the contract zone

• This is illustrated in Figure 9.9c


Illustrating Conflict (Figure 9.9c)

Firm willing to accept

Union willing to accept

Union’s Perceived Contract Zone

If the union underestimates the firm, it will refuse offers in the actualcontract zone

Low Wage High Wage


Labor Conflict in Professional Sports

• Unions in sports bargain over bigger issues than most unions

• Most unions do not bargain over basic entrepreneurial decisions

• But issues like revenue sharing and league expansion or contraction are often at the heart of negotiations in professional sports


Conflict in the MLB

• MLB owners were often divided – Large market v. small market

• They could not present a coherent stance– This caused uncertainty by players over what owners

wanted and mistrust of the owners– The players also knew that big-market owners wanted

to settle and would eventually prevail over the small-market owners


Conflict in the NHL

• Alan Eagelson has left a legacy of ill-will– As executive director of the NHLPA (1967-92) he

engaged in massive conflicts of interest– He was also an agent for many players– He had business dealings with NHL owners

• As director of a foundation that oversaw international hockey exhibitions, he told players that revenues would benefit their pensions

• But he told the owners to keep the revenues

– Eagleson went to prison • Players lost faith in the owners


Comparing 2011 NBA and NFL Negotiations

• The NFL lockout marked its first work stoppage since 1987

• The NBA followed four months later• The circumstances were very different

– The NFL was hugely profitable– The NBA was in some distress


The 2011 NFL Lockout

• Both sides had so much to lose that conflict seemed illogical

• But the key was uncertainty and mistrust– Both the NFL and the NFLPA had relatively new

leadership that had not previously negotiated a CBA – Each side mistrusted the other’s actions

• The NFL negotiated a TV contract that would pay $4 billion even if it played no games

• The NFLPA filed to decertify, opening the way for another antitrust lawsuit


The NFL Agreement

• Owners got– A 7 percentage-point reduction in labor’s share of

revenues– A rookie salary cap– Credit in revenue for stadium investment (reducing

amount shared with players)• Players got

– Commitment that teams would be at or close to the cap– Added funding for retirees and safety research– Restriction on preseason practices– No expansion of the season to 18 games


The 2011 NBA Lockout

• The NBA sought significant, basic changes– Lower percentage of revenue to players– A harder salary cap

• Players threatened to play in Europe


The NBA Agreement

• The agreement is unusually long – 10 years• Owners got

– The desired reduction in labor share– A much harder cap thanks to the escrow tax noted

earlier

• Players got relatively little– A promise that teams would come close to the

maximum payroll established by the cap


Professional Tennis Associations

• In 1968, the first year of “open” tennis, the prize for winning the men’s singles at Wimbledon was only £2,000– Both professionals and amateurs compete in an open

tournament• By 2012, the prize rose to £1,150,000

– This is an increase of 57,400 percent• The prize for women went from £750 to £1,150,000• The tennis associations helped


Professional Tennis Associations (cont.)

• Men and women have separate unions– The men’s Association of Tennis Professionals was

formed in 1972 (ATP)– Sony Ericsson Women’s Tennis Association was

formed in 1973 (WTA)

• Both associations resemble craft unions– They restrict supply by defining who qualifies– They provide labor to tournaments


A Different Kind of Union

• The ATP and WTA do not specify how much tournaments pay specific players

• They establish the reward structure of the tournaments

• They also negotiate all aspects of the “working conditions”

– Example: Bathroom facilities in locker rooms

• ATP and WTA do not engage in negotiations with a single management group but with tour sponsors

chapter 9 labor market imperfections fifth edition the economics of sports michael a. leeds | peter...

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