Covering All the Economic Bases of Troubled Major League Baseball

The economics of sports has been big news recently. Last week, the National Football League reached an agreement with the football players union that grants players effective free agency for the first time.

Starting this winter, players with at least five years in the league will be free to shop themselves around to other teams when their existing contracts expire. Before this, players were effectively tied to the team that originally drafted them out of college as long as that team wanted them.

Baseball, by contrast, has had free agency for years, and some people wondered whether teams could survive the competition for players that had developed.

The issue was recently dramatized when Barry Bonds changed teams, in the process receiving a $43-million contract for the next six seasons. Not long after, a long-awaited study of the baseball business, by a committee commissioned by the players and owners, made some constructive suggestions for increased revenue sharing among teams and earlier free agency for players, but waffled on the big issue of baseball’s economic well-being. Some owners apparently see financial calamity ahead, a forecast the players view skeptically.

The likelihood of a showdown that would interrupt or cancel the 1993 season has been reduced by a procedural change adopted by the owners. But a showdown may still occur, if not next year, then the year after, when the current contract between teams and players runs out.

All this fascinates the public because baseball is a national treasure and finance is a great spectator sport. To an economist, there is the added attraction that a major sport league is unlike any other industry, so its economics are a challenge to think about.

If baseball were a competitive industry, it would be relatively uninteresting, because then market forces could be counted on to get things about right without any special rules or regulations. But it is hardly competitive since, unlike other merchants, a team has nothing to sell if the other teams do not play with it, and new teams can enter only if the existing team owners allow them to and if they pay the existing teams a large entry fee.

If it were simply a monopoly, that too would be a case right out of the textbooks. But it is not. Owners control the product market, just like pure monopolists, but they compete with each other for players, all of whom have highly unusual skills and some of whom have skills that are virtually unique. In this situation, how the pie is divided between the teams and the players they hire depends on the league rules governing the contractual relations between them.

In 1932, Babe Ruth explained “I had a better year” to justify earning more than the president of the United States. Today, the average ballplayer earns four times as much as the president. This change in fortunes mainly reflects the changes in the contracts binding players and their teams.

In Ruth’s day, players could be traded or dropped by their team. But if they wanted to play baseball, they had no option but to accept the salary offered by the team that owned their contract. Legal challenges and the formation of a players union have made the journeyman better off than Babe Ruth ever was, mainly by introducing free agency. Now some owners argue that the pendulum has swung too far and they seem determined to change the rules more in their favor.

Judging from the sports pages I read, many pundits believe that baseball salaries have gotten too high “for the good of the game” and assert that the average fan is fed up with overpriced ballplayers.

Bonds’ new contract, which is sometimes dramatized to $45,000 per game, has been called an affront to the fan who makes that or less in a year. And Bond’s annual salary is not much different than that of other superstars. Ryne Sandberg, Cal Ripken, Kirby Puckett, Ken Griffey Jr., and Joe Carter all make over $6 million a year, and many others are close behind. But whether fan resentment of such high salaries will hurt the game is questionable. Fans resent a high-priced flop, but most seem to be enthralled by high-priced stars who deliver.

Whether high salaries are jeopardizing baseball economically is another matter, and one which was not settled by the study committee.

Major league baseball teams collectively earned more than $200 million in 1989, their best year, with earnings declining to around $100 million in 1991. But experience varied widely across teams, with some losing money. Those operating in large markets generally did better than those operating in small markets, as one would expect. But with average salaries still rising, and with revenue from baseball’s national TV contract widely expected to decline when the present contract expires, the club owners and many outside observers believe profits will be smaller and losses larger in coming years, putting baseball in serious financial trouble.

Plausible as such projections appear, they seem to be contradicted by the value placed on teams when they are bought and sold. There have been several such transactions in recent years, at prices ranging between $80 million and $130 million.

How can these high and stable asset prices be squared with the prospect of vanishing profits? One could simply assume the buyers were foolish. But it is more realistic to recognize that any baseball fan would like to own a team and a few very wealthy ones are willing to pay a lot to do so.

In a supplementary statement to the study committee report, Henry Aaron, one of its four outside members and no relation to the slugger, makes this point and emphasizes the importance of considering the prices willingly paid for a baseball franchise when assessing the economic health of baseball.

Owners, Aaron notes, own teams for a range of reasons beyond the narrow profit motive associated with typical investments. These include pleasures such as civic prestige, the challenge of competing, or just the fun attached to the game. So the profitability of baseball is not a decisive indicator of its economic health, as it would be with a conventional investment.

What then of the incredible salaries? Recall that they reflect how the available pie is divided between clubs and players, where the size of the pie to be divided is not limited to accounting income because of the willingness of owners to accept losses in pursuit of the pleasures of ownership and competition. How the pie is divided, and therefore how much players earn, depends mainly on the freedom players have to move from one team to another. Baseball salaries are high because baseball players have a great deal of freedom.

This freedom has not damaged the game in any way that is measurable. Baseball has its problems, including an unruly and ungovernable collection of owners and a wide imbalance in the revenue now available to different teams. But the ability to bid for free-agent players has not magnified the differences in on-field performance between big-market and small-market teams. Competitive balance, by any measure one can think of--win-loss records, league championships over the years, and so on--has not deteriorated.

This counter-intuitive result is actually predicted by economic theory. After all, teams could always buy players from other teams--the Yankees bought Ruth from the Red Sox. So theory predicted that free agency would not alter the relative performance of teams, but would give the player his true value, instead of keeping part of it, perhaps most of it, with his old team.

Which brings us back to football, where NFL players have had almost no freedom. Individual owners could increase their chances of winning by spending more on scouting, coaching and facilities and on players made available in the very limited free agency that existed the past few years, or on players occasionally available from the breakup of an attempted new league.

But none of this did anything for most players salaries. Their contractual commitment to their team was best described as bondage and their salaries reflected it.

Very recently, under the threat of a court decision that could free players to shop their services to other teams--the threat that led to the just-completed free agency agreement--a few star players have gotten large, long-term contracts. Even so, a star quarterback still gets less than half of the top baseball salaries.

The greater freedom just obtained by NFL players will now give them a bigger slice of the financial pie, although the agreement puts a cap on how large that slice may become. But if theory is again borne out, it will not alter the on-field competitive balance among NFL teams, which, incidentally, has been much more lopsided in the tightly controlled NFL than in the financially free-wheeling major leagues of baseball. The Cowboys, Redskins and 49ers are likely to continue winning most of the Superbowls, just as they have before free agency.