Labor Market Twist

Posted by on Saturday, February 23, 2019 in Major League Baseball.

Part 2 of Interview with CNBC; Sequel to “The Baseball Way.” Source: Sportsman Leagues.

The Going Rate. Harper and Machado Present Value Contracts both $200 million.

  1. What kind of revenue sharing does major league baseball need to have to make more teams competitive and as a result make more teams bid more on free agents? Why does it not have a revenue sharing model like that today?

Optimal revenue sharing is an empirical question because it ultimately depends on the supply-side objectives of club owners throughout the league. Owners range from being profit maximizers who are only in it for the money to sportsmen gamers who are only in it to win it. The complicating factor is that MLB is a natural cartel where any team’s game production and bottom line jointly depend on the performance of an on-field competitor.

If MLB owners are pure profit maximizers subject to the same proportional formula, then revenue sharing would have no impact on competitive balance. According to this “invariance proposition”, revenue sharing could actually reduce competitive balance because cooperative sharing is a form of progressive cartelization that makes the winning of large-market teams more important to the league as a cartel (because the large market revenue is shared).

The unfortunate aspect of revenue sharing in a pure profit league is that increased revenue sharing also drives down the incentive to win and reduces the portion of revenues that goes to the players. According to this revenue sharing paradox, the rate of player salary exploitation is equal to the percent of revenue that is shared and at the pure syndicate limit, the league ironically becomes even less balanced than without sharing.

If all of the revenue is shared the 30-team league becomes a perfectly syndicated cartel that maximizes total revenue and minimizes player salaries.

If owners are instead high-flying sportsmen who spend all of their revenue on talent in order to win, then intuition defeats the paradox, and revenue sharing leads toward optimal competitive balance for the fans, maximum compensation player and zero profit for the sportsmen owners.

MLB is currently a $10 billion league that shares roughly 50 percent of its revenue. Gate and venue revenue are each about 30 percent and local and national media are each about 20 percent of total revenue. All of national media revenue is shared equally and 34 percent of all local revenue including media, gate and venue is shared after deductions for new stadium expenses. The MLB players’ share of league revenue has been relatively stable around 50 percent over the last decade.

This leads to the conclusion that increased revenue sharing could move MLB relative talent (competitive balance) toward the league-cartel max profits and optimal fan welfare, but exploitation of talent would remain a significant problem, especially in the lower tiers (<6 years of service) of the segmented MLB players’ labor market.

The problem with the revenue sharing solution is that the sportsman owners would reject the opportunism of small market profit-max owners pocketing the revenue sharing payment and taking a free ride on the rest of the league cartel. Eg. Florida Marlins payroll has been less than the League’s revenue sharing payment. The recent 2017 CBA addresses free rider opportunism:

“CBA (5a). Accordingly, each Club shall use its revenue sharing receipts (including any distributions from the Commissioner’s Discretionary Fund) in an effort to improve its performance on the field.”

  1. What do you think are the best ideas for changes to MLB revenue sharing model? Why have they not been tried out already?

The good news about the current MLB revenue sharing model is that there are very few deductions from the revenue sharing base, because all local and national revenue is subject to the revenue sharing “tax” formula except stadium construction expenses. Exceptions from the revenue sharing base are like tax shelters that redirect spending objectives toward tax exempt revenue sources.

This stadium cost exception encourages MLB clubs to spend private league money on their venues rather than extorting public funds. The stadium-cost loophole allows individual clubs to shift their stadium cost to the rest of the league in the same proportion that the league benefits (rather than local taxpayers.)

The bad news is that the stadium cost “loophole” allows larger market clubs to avoid the revenue sharing tax. The stadium exemption allows clubs to shelter major revenue from sharing (Yankees) and some large market clubs (Phillies) can actually become a net revenue sharing recipient rather than payer. The good and bad news about the revenue sharing tax loophole is that it probably improves stadium cost equity for the home market at the expense of competitive balance across the league.

If the MLB revenue sharing tax base is symmetrical across revenue sources (all revenue is taxed the same), then the best competitive balance solution would probably be to increase the tax rate from 34 percent to the NFL’s 40 percent rate, or make the revenue-sharing tax structure more progressive. (Similar to the progressive competitive balance tax (luxury tax) rates that have been ineffect since 2017.)

The problem with the demand side revenue sharing solutions implemented alone is that they fail to address the labor market twist (see previous interview) of player salary exploitation based on the monopsony power of MLB in the “protected” lower talent development tiers (<6 yrs of service) and sudden shift to the monopoly power of the artificially limited free agents in Tier 3.

Resistance to change to increased revenue sharing comes from the surprising bargaining coalition of the two major MLB forces that stand to lose the most from the reduction of the segmentation process that creates the labor market twist: the veteran free agent eligible players in Tier 3 and large market sportsman owners.

In order for demand-side revenue sharing to be effective, the supply-side labor market must be free of inefficient segmentation. The current internalization of player development and simultaneous avoidance of inefficient external talent acquisition in Tier 3 that are spreading throughout MLB are natural remedies for the inefficiencies of the labor market twist.

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