1. The Economics of Sports Labor Market Imperfections
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)$ ME S D L wc wm Lm Lc
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

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 Pirates got 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
Labor
Firm
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
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

51. 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

52. Figure 9.7

53. 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 season

54. 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 lockout

55. 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

56. 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

57. Illustrating Conflict (Figure 9.8)
Union willing to accept
Firm willing to accept
Low Wage
High Wage
Contract
Zone
Both union and firm are willing to settle within the contract zone

58. 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

59. Illustrating Conflict (Figure 9.9c)
Union willing to accept
Firm willing to accept
High Wage
Low Wage
Union’s Perceived Contract Zone
If the union underestimates the firm, it will refuse offers in the actual
contract zone

60. 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

61. 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

62. Conflict in the NHL Alan Eagelson has left a legacy of ill-will
As executive director of the NHLPA ( ) 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

63. 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

64. 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

65. 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

66. 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

67. 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

68. 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

69. 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

70. 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