Player salaries, MRPL, and exploitation (revised 13 Nov. 2008)

News flash: MLB players are highly paid Average MLB salary = $3.2 M (April 2008) –More than 2 times as high as in 1998 –More than 10 times as high as in 1983 –Less than NBA ($5.4 M in 2007) –More than NHL (~$2 M in 2007) and NFL ($1.4 M in 2006) Median MLB salary = $1 M in 2006, 2007, and 2008 –Highest ever; previous peak was $975,000 in 2000 –85 players made $10 M or more in 2008 Up from 66 in 2007

marginal revenue product of labor (MRPL) = the amount of revenue that an employee generates for his employer standard economic answer to “How much is that employee worth?” can be measured in yearly terms (salary), or in hourly terms (hourly wage) marginal product of labor (MPL) = how much OUTPUT an employee produces

MRP theory & player pay First, note that athletes are not the only very highly- paid people in U.S. society Also, free-agent contracts are examples of VOLUNTARY EXCHANGE (market transactions agreed upon by buyer and seller) –Nobody forces the owners to pay such high salaries. Rodney Fort: “talent is hired to produce [wins] in the long run.” –perhaps more than just wins... –Mark McGwire, 1998: extra MRPL of $15M?

A labor market under perfect competition: Assumptions Many buyers, many sellers –> nobody has market power No restrictions on pay or employment No cartels among employers or workers Diminishing returns --> downward-sloping demand curve for labor Upward-sloping supply curve for labor

Notation (for diagram drawn on board): L = # of workers ( = Q L = quantity of labor) w = wage ( = P L = price of labor) S L = supply of labor D L = demand for labor MRPL = marginal revenue product of labor –MRPL = the amount of revenue that an additional worker generates for the firm

Economic exploitation MONOPSONY: a labor market with just one buyer ECONOMIC EXPLOITATION = difference between a worker’s marginal revenue product and his wage = MRPL - w In a monopsonistic labor market: w < MRPL w < w* (competitive wage)

When the baseball players’ labor market was a monopsony Until 1976, when all players were under the reserve clause. RESERVE CLAUSE: a provision in baseball’s rules that allowed owners to renew a player’s contract automatically for one year. –Players either re-signed with their teams after each season or retired (or were traded or released). –No free agency; no competitive bidding for players. –Held salaries down; average salary = $25,000 in 1969.

Independence Day July 1976: new Basic Agreement gives all players free agency after 6 years of service. –Salaries surged after 1976; up 42% in –Can use monopsony diagram to illustrate [See link on course website, “MLB’s Labor Economic History, Present,” for details on the Messersmith-McNally case that ended the reserve clause and brought free agency to MLB.]

Baseball’s current system

Baseball’s salary explosion, 1976-present “Freedom and prosperity” Shift from monopsony to competitive bidding was less sudden than it seems –Over time, more and more teams played the FA market –Collusion against FA’s held salaries down in mid-1980s Salary arbitration (1973-) allowed 3rd-to-6th-year players to piggyback on FA salary scale MLB revenues surged -- attendance rose, TV revenues soared, stadium revenues soared,...

Comparison of performance (MRPL) and salaries First, how to measure MRPL for baseball players? The standard, simplified way is a two-step process: –(1) Using player statistics, estimate each player’s contribution to team wins; –(2) Estimate the contribution of more wins to team revenues.

For hitters, the one statistic that has the highest correlation with team winning percentages is...

“OPS” = On-base percentage (OBP) + Slugging percentage (SLG) OPS * (player’s plate appearances as % of team’s) = what Zimbalist and Bradbury use to measure hitters’ productivity, in computing MRPL’s

For pitchers Earned run average (ERA) is the standard measure –Bradbury prefers “Defense-Independent Pitching Statistics” (DIPS), which is like ERA minus the contributions of the team’s fielders Includes walks, strikeouts, and home runs allowed –Then compare a pitcher’s DIPS with the league average, and multiply by his innings pitched as a % of his team’s total.

Next steps toward estimating MRPL Estimate the player’s contribution to team winning percentage, based on wins as a function of OPS or ERA/DIPS Estimate contribution of additional wins to team revenues

Comparison of performance (MRPL) and salaries: Exploitation = MRPL – salary Zimbalist (1992): –Younger players tend to be exploited (pay<MRPL) –Veteran players (6+ years in majors) tend to be “overpaid” (pay>MRPL) MRPL calculations by Bill Felber (The Book on the Book, 2005) echo Zimbalist’s conclusion. MRPL calculations by Bradbury (p. 195) find pay<MRPL (i.e., “exploitation”) but a much smaller gap for veterans. –But Bradbury doesn’t “think this is exploitive” if you take development costs into account.

MRPL - salary, by service category

How do we explain those systematically “overpaid”* veterans? (* overpaid by Zimbalist’s and Felber’s estimates, not Bradbury’s) Nature of the (seniority) system –Most free agents are past their prime (age 30+), which reduces their MRPL, but as free agents they’re in a position to earn the most money –Limited supply of free agent players –Many free-agent contracts are long term (less risky for player) --> Reduced incentive to work hard? Statistical MRPL measure (based on stats and wins) may be too narrow –Doesn’t count leadership, experience, consistency, marquee value –Also doesn’t count expected value of playoff or World Series success, or of extra offseason ticket sales due to a free-agent signing. Back to supply and demand –Limited supply of free agents, high demand for players who can help a team –Concept of value above replacement – A player’s value is not just relative to the rest of the league, but also to his team’s next best option. Ex.: A team that has no MLB-caliber catcher in its organization may be rational to “overpay” for a catcher.

Salary arbitration A mechanism for players with 3 to 5 years of service to avoid being underpaid relative to their peers Established in 1973, implemented in 1974 How it works: –If a player and his team cannot agree on his salary for the next season, then, separately: The player submits a salary figure The team submits a salary figure An arbitrator decides which figure is more reasonable and awards it. –“Final offer” arbitration: The arbitrator must pick one figure or the other, cannot split the difference. –The player and team, however, can always settle on a compromise figure before the arbitration hearing. –The vast majority of arbitration-eligible players reach an agreement with their team before filing for arbitration or going to arbitration. »Salary arbitration is an acrimonious, risky process that players and teams generally seek to avoid.

Effects of salary arbitration system Higher salaries (for players with 3-5 years of MLB service) –“I was going to be rich or richer” –Salary arbitration and free agency a potent combination –Ironically, this is true even though owners have won the majority of salary arbitration cases. More multi-year contracts for young players –Multi-year contracts are a way to avoid arbitration and yearly salary spiral.