The Economics of Sports (6th Edition) PDF

The Economics of Sports 6TH EDITION Michael E. Leeds, Peter Von Allman, and Victor A. Matheson CHAPTER 9 Labor Markets in...

The Economics of Sports 6TH EDITION Michael E. Leeds, Peter Von Allman, and Victor A. Matheson CHAPTER 9 Labor Markets in Professional Sports 1 IN THIS CHAPTER Understand the basic model of wage determination in labor markets and see how athletes’ investment in skills affects their pay. Grasp why the rewards to professional athletes are often highly skewed, with a few superstars making huge sums while most others make much less. Learn how providing incentives to exert effort can sometimes backfire. © 2021 Taylor & Francis®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 2 9.1 An Overview of Labor Supply and Labor Demand In general, the salaries paid to professional athletes were not always as high as they are now. Over the last 25 years, the average salary of a MLB player has more than quintupled from about $850,000 in 1991 to about $4.2 million in 2019. The average MLB salary was approximately 36 times per capita GDP in 1991. By 2019, it was almost 75 times per capita GDP. Salaries in the other major team sports in the North America show similar growth. Average Barcelona player earns 300x average income in Spain. 3 9.1 An Overview of Labor Supply and Labor Demand Labor Supply In labor markets, the quantity axis refers to the hours of work that a person is willing to provide, and the vertical axis is the price per unit of time, usually the wage. In professional sports, cannot use hours as the unit of labor because almost all athletes contract for a fixed amount of time. Figure (b) measures the quantity of fights a boxer has over the course of his career, and the vertical axis measures the boxer’s earnings per fight. In team sports, the quantity of labor provided by a player is typically set for a given season, and the price variable is the amount paid per season, or salary. An upward-sloping labor supply curve indicates that a worker responds to higher wages by offering to work more hours (we move from A to B). 4 9.1 An Overview of Labor Supply and Labor Demand Labor Supply People choose how much to work based on the benefits and costs of an hour of leisure, and the opportunity cost of one more hour of leisure is one hour’s worth of earnings, the wage rate. As wages increase, workers experience an income effect and a substitution effect. The substitution effect captures the increased cost of leisure as wages rise: workers sacrifice higher earnings when they “purchase” leisure. As wages rise, the substitution effect leads workers to work more. The income effect reflects the increased purchasing power that comes from higher wages. If leisure is a normal good, then workers buy more leisure—and work less—as their income rises. Generally, the labor supply curve slopes upward (substitution effect stronger than income effect). When non-labor income and the value of one’s assets fall, the demand for all normal goods and services, including leisure time, falls. A decline in the demand for leisure is equivalent to an increase in the supply of labor (rightward shift of the supply curve). 5 Labor vs. Leisure tradeoff Substitution effect typically dominates income effect until very high wages. In 2009, Tiger Woods led the PGA in winnings with $10.5 million (or about $618K per start). He played in 17 events, tied for 3rd fewest among top 100. © 2023 Taylor & Francis®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 6 9.1 An Overview of Labor Supply and Labor Demand Labor Demand There are many complaints about overpaid athletes, but understanding the factors underlying the demand for labor shows that many highly paid professional athletes are underpaid. Assume that firms produce a single output using two inputs, capital (K) and labor (L). Also assume that the firm is operating in the short run, so capital is fixed, and the firm can alter output (Q) only by changing the labor input. Assume that all markets are perfectly competitive, so firms cannot affect the market price of their output. Firms then maximize profit by choosing L to maximize the difference between revenue and cost. This occurs where the marginal revenue from employing one more worker equals the marginal cost of employing that worker. 7 9.1 An Overview of Labor Supply and Labor Demand Labor Demand Ignoring all employment costs except for a worker’s pay, the marginal cost of one more hour of labor is the worker’s wage, w. The benefit of adding a worker is the extra revenue that worker generates, the marginal revenue product of labor (MRPL). Since marginal revenue equals price in a competitive market, MRPL is the price per unit of output times the additional output produced: ∆𝑄 𝑀𝑅𝑃𝐿 = 𝑀𝑅 ∗ 𝑀𝑃𝐿 = 𝑝 ∗ ∆𝐿 For example, if adding a worker increases output 20 units per hour, which can be sold for $5 each, the value of that worker to the firm is $100 per hour. 8 9.1 An Overview of Labor Supply and Labor Demand Labor Demand Relabeling the graph so that the wage is on the vertical axis gives the demand for labor (*graph should say DL, not SL). The marginal product of labor falls as the labor input rises (due to diminishing returns), so the demand curve is downward-sloping. A competitive firm buys labor until wages exceed the value produced by the worker. As teams hire more talent, they generate more revenue. Teams should hire talent until cost of additional talent exceeds additional revenue generated by the talent. 9 9.1 An Overview of Labor Supply and Labor Demand Labor Demand: Measuring a Player’s Performance Determining what a player is worth can be very complex, in part because players do not operate in a vacuum. The interdependence of players on one another helps to explain why some standard metrics of performance are surprisingly unstable. In the NHL, save percentage and goals-against average seem obvious ways to evaluate a goalie. The correlation of these measures across the 2017-18 and 2018-19 seasons are only 0.04. An excellent goalie may have a high save percentage but may not win as much as a weaker player who plays behind a stronger team. The attempt to separate a player’s performance from the conditions under which he plays, new video technology, and “big data” analyses have led to sports analytics, the development and use of advanced statistics to measure a player’s “true” performance. 10 9.1 An Overview of Labor Supply and Labor Demand Labor Market Equilibrium Market demand (supply) is the horizontal sum of all individual demand (supply) curves. The equilibrium levels of pay and employment in a labor market are set by the intersection of the market labor supply and labor demand curves. An increase in the demand for labor increases both the wage and the amount of labor hired. 11 9.1 An Overview of Labor Supply and Labor Demand Labor Market Equilibrium When basketball became much more popular in the 1980s (Magic Johnson, Larry Bird, Michael Jordan), the demand to see NBA games both in person and on TV rose. This increased the value of each player’s contribution, and the marginal revenue product of all NBA players rose, due to the rise in marginal revenue. Thus labor demand increased, and salaries rose. Declining economic conditions in 2008 reduced the demand for tickets to NBA games. This, in turn, caused the MRP of players in the NBA to decline, and salaries in the NBA for the 2009– 2010 season fell slightly. COVID-19 pandemic in 2020: A forced shut down of the NBA season reduced the number of games played by about ten games, from the usual 82 to approximately 72. MLB shortened its season to just 60 games instead of the usual 162 resulted in a dramatic decrease in the demand for labor. As a result, MLB players lost more than 60 percent of their pay. 12 9.1 An Overview of Labor Supply and Labor Demand Labor Market Equilibrium The number of jobs available is also determined partly by roster size. Roster limits are negotiated by team owners and the players’ associations or set by competition organizers. In the figure, the equilibrium employment level is Le, but there is a binding roster limit, shown by the vertical line at Lr. The limit reduces total employment and increases salaries. 13 9.1 An Overview of Labor Supply and Labor Demand Human Capital and Player Compensation: General and Specific Skills Workers can increase their MRP and their pay by investing in their stock of skills (through training and education) = human capital. Although an athlete’s physical abilities wear out, or depreciate, with age, many skills may increase throughout his or her career. An important difference between human and physical capital is that a firm can generally transfer physical capital to another firm by selling the asset. Human capital, however, is embodied in the individual, who cannot sell his skills to another player. Human capital theory divides investment into general and specific training. General training increases the worker’s productivity regardless of the setting, such as learning the rules of the game of hockey, how to pass or shoot the puck accurately, etc. Specific training increases a worker’s MRP in a particular context, possibly only to the firm who provides the training, such as learning a specific team’s playbook. Training often provides a mix of both general and specific skills. The type of training a worker receives determines who pays for it. 14 9.2 Rank-Order Tournaments and Superstar Effects Sometimes small differences in performance translate into huge differences in compensation. Typical of individual sports, such as tennis, golf, bowling, etc. Roger Federer won the 2017 Men’s Singles Championship at the Australian Open in a very tight match, which brought Federer $3.7 million, while his opponent, Rafael Nadal, received only a little over half that amount ($1.9 million). The difference in prize money seems even more drastic considering that a player who was eliminated in the second round earned just $30,000 more than a player who was eliminated in the first round. In such cases, relative productivity, winning, rather than absolute productivity matters. Roger Federer would have received the same prize regardless of his margin of victory. Winning is all that counts. Since the order of finish is the only performance criterion, such contests are known as rank-order tournaments. Organizers of the tournament want to provide an exciting contest at which all players try hard. Ideally they, like any employer, would base a player’s reward on their MRP. It can be very difficult and expensive to measure MRP in many cases. Particularly true in sports, as performance can depend many factors that have nothing to do with individual ability (surface, weather, opponent quality). A prize structure in which the increase in reward grows as a player moves up the leaderboard gives athletes a powerful incentive to do their best. The highly uneven distribution of the purse appeals to the most basic of economic tenets: self- interest. 16 Active Learning: CEO pay In 2022 the average Fortune 500 CEO earned $16.7 million (272x the median worker pay). How can this level of pay be justified economically? The CEO could be increasing company profits by $16.7 million compared to another leader. (MRP) The prospect of a huge payoff if a worker can rise to CEO results in high productivity for all workers at the firm. (Rank-order tournament) © 2023 Taylor & Francis®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 17 9.2 Rank-Order Tournaments and Superstar Effects Tournaments and Effort Assume that contestants maximize the difference between the benefit of winning prize money and the cost of effort. Organizers of the tournament want to provide an exciting contest at which all players try hard. If effort is costly and rises with the degree of effort, then the marginal cost curve is positive and upward-sloping. If increasing effort adds more to costs at higher levels of effort, the marginal cost curve becomes steeper at greater levels of effort. For example, moving from E0 to E1 adds little to the cost of effort, but moving from E2 to E3 adds a great deal. If organizers want competitors to play hard, they must make set prizes that increase steeply as players move to the top of the rankings. 18 9.2 Rank-Order Tournaments and Superstar Effects The Economics of Superstars Superstar effects refer to differences in income that are disproportionate to differences in performance. Sports earnings are wildly skewed. Strong desire by consumers to the “the best.” At 2023 Women’s World Cup, the best tickets for the 3rd place match had a face value of $40. The best tickets for the final had a face value of $120. As in Figure 9.9, a small change in quality causes a large change in demand and much higher prices Sports and entertainment are particularly prone to superstar effects, especially now that media makes it possible for all to be able to see the best players or entertainers. 20 9.2 Rank-Order Tournaments and Superstar Effects Tournaments, Superstars, and the Distribution of Income The distribution of income is much more unequal in sports than most other industries. Serena Williams earned more during her career than the bottom 80% of professional women’s tennis players combined. In MLB, just 40 players earned one-quarter of salaries in 2023. Lorenz curve of MLB vs. Holy Cross faculty salaries. 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 0% 20% 40% 60% 80% 100% MLB Holy Cross Perfect equality 21 9.2 Rank-Order Tournaments and Superstar Effects Tournaments, Superstars, and the Distribution of Income While many athletes benefit from superstar effects, others benefit even more. Forbes top paid athletes in 2024 22 9.3 The Danger of Tournaments and Superstar Effects A large spread in rewards can have negative effects on athletes’ behavior in both individual and team sports. When teammates compete for individual rewards, the result can be selfish play, which undermines the cooperation that teams need to succeed. The negative impact of pursuing individual goals on team performance has led economists to question the value of wide spreads in salaries among teammates. Several studies of MLB teams find that, all else equal, teams with higher salary spreads have worse records. Interestingly, a study of baseball in Japan, a country where incomes are much more equal than in the U.S., by Takuma Kamada and Hajime Katayama finds that higher spreads improve team performance. In extreme cases, a tournament can lead to outright sabotage. The most famous such case might be that of Tonya Harding, a former national champion figure skater who admitted her involvement in the plot to injure fellow skater Nancy Kerrigan prior to the 1994 Winter Olympics. Harding’s ex-husband and an accomplice confessed to attacking Kerrigan at the US Figure Skating Championships prior to the 1994 Winter Olympics and claimed that Harding herself was involved in planning it. The motivation for the attack was to remove Kerrigan as the preeminent U.S. woman figure skater, providing Harding with a “ticket to fame and fortune.” 23 Incentives and Risk Event 1st place 2nd place 3rd place Ratio Boston Marathon $150,000 $75,000 $40,000 3.75:1 Wimbledon £2,350,000 £1,175,000 £600,000 3.92:1 The Masters $3,200,000 $1,900,000 $1,200,000 2.67:1 Daytona 500 (2015) $1,581,453 $1,157,470 $857,245 1.84:1 While golf, tennis, and running provide large incentives to promote exciting (and risky) play, auto racing does not want to encourage the same level of risk-taking. © 2023 Taylor & Francis®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 24  9.3 The Danger of Tournaments and Superstar Effects Pay Disparity and Externalities: The Case of NASCAR Although car racing satisfies the basic conditions for a rank-order tournament, the per- race reward structure is nearly horizontal. Are NASCAR’s incentives large enough to influence driver effort? Why are NASCAR’s payouts so different from other sports? In racing, drivers all compete on the same track at the same time, so tournament-style wages that lead to highly aggressive driving may have catastrophic results. In golf, the only risk of aggressive play is hitting the ball into the water. In addition, because race cars are covered with advertisements, being on the track – and on camera – for a long time becomes very important to race sponsors. NASCAR has developed complex payoffs that include payments from sponsors, year-end prize money, and a wide variety of bonuses that drivers can win during races. Season championship points also give drivers a powerful incentive to remain on the track for the entire race rather than risk crashing in an attempt to earn points that may lead to a large end-of-season prize. NASCAR officials seem to have set these payouts at levels that create exciting racing while being mindful of potential risks. 25 Incentives and Corruption Poorly designed incentives can lead to poor performance. Do players’ performances decline under guaranteed contracts? Poorly designed incentives can lead to corruption. Steven Levitt (of Freakonomics) uncovered clear corruption in sumo wrestling. Because prizes were discontinuous between 7th and 8th win in a tournament, wrestlers would throw matches to allow an 8th win. © 2023 Taylor & Francis®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 26 9.3 The Danger of Tournaments and Superstar Effects The Danger of Trying Too Hard Disproportionate rewards that accompany even small differences in performance sometimes induce coaches, trainers, and athletes to push themselves and others too hard. Imagine a country in which selected children are put to work full-time. School, friends, a normal childhood are all denied them as they perform hours of backbreaking work, and some are subjected to physical, emotional abuse at the hands of their overseers, or even their own parents. By the time they reach adulthood, some of them are physically or emotionally broken by the arduous demands of their supervisors. The country is the United States, and the children are the ones we cheer on at events such as the Olympics, Wimbledon, and NCAA championships. These youths are victims of a reward system in which first place counts for everything and second place for next-to-nothing. A gold medalist gets huge rewards, but hardly anyone will remember a fourth-place finisher. The result is children who work extremely long hours, often suffer through severe injuries that may or may not be treated, and often develop eating disorders or other psychological problems. Example of US gymnast Simone Biles 27 The difference between gold and silver at men’s single scull rowing at 2016 Olympics (2000m race): 28 9.3 The Danger of Tournaments and Superstar Effects Performance-Enhancing Drugs After finding evidence of widespread doping that involved Russian Olympic and government officials, the International Olympic Committee banned 118 Russian athletes from the 2016 Summer Olympics. The investigation eventually implicated roughly 1000 Russian athletes in 30 sports. Russian athletes could participate only under the acronym “OAR” (Olympic Athlete from Russia) at the 2018 Pyeongchang Winter Games and “ROC” (Russian Olympic Committee) at the 2021 Tokyo Summer Games and 2022 Winter Games in Beijing. The use and danger of performance-enhancing drugs (PEDs) is not new. The first documented doping-related fatality came during a bicycle race in 1879. At first, doping was strictly an individual decision. As sport became increasingly politicized, doping became a state policy. During the Cold War, athletic contests became propaganda campaigns in which the Soviet bloc and Western democracies used Olympic medal counts to demonstrate the superiority of their economic and political systems. In the shadow of West Germany’s economic growth and success in international football, East Germany used Olympic sports as a public relations tool. 29 30 9.3 The Danger of Tournaments and Superstar Effects Performance-Enhancing Drugs The fall of the Berlin Wall in 1989 and the resulting publication of state secrets showed the high cost of East German Olympic success. Physical disabilities, birth defects, even a change in sexual identity were all attributed to the “vitamins” that unsuspecting East German girls were given as part of their training regimen. In the United States, some estimates show that as many as one million high school students have used anabolic steroids, a popular PED. Researchers claim that the use of steroids causes heart and liver damage, violent mood swings (“roid rage”), and psychological dependency. Steroids are often a gateway to other drugs and risky behaviors. While some regard PEDs as just another way to seek an edge, most fans and all international sports organizations view PEDs as qualitatively different from other ways of improving one’s performance (e.g. specially designed swimsuits or new material to lighten the bicycle). The dangers of PEDs have not deterred athletes from using them. 31 9.3 The Danger of Tournaments and Superstar Effects Performance-Enhancing Drugs A survey of 200 elite athletes asked the following question: You are offered a banned performance-enhancing substance that comes with two guarantees: 1. You will not be caught. 2. You will win every competition you enter for the next five years, and then you will die from the side effects of the substances. More than half the athletes surveyed said they would accept such an offer. Such attitudes among athletes have led economists to model PED use as a prisoner’s dilemma. Assume that we have only two athletes, Mark and Sam, each of whom chooses to use PEDs or not use them. Using PEDs improves performance and gives each player an advantage if the other does not use them. Consistent with the above survey, Mark and Sam are willing to risk their health if they can dominate their sport. 32 9.3 The Danger of Tournaments and Superstar Effects Performance-Enhancing Drugs The payoffs (expressed as units of happiness) in the upper left entry occur when neither athlete takes PEDs, while the payoffs in the lower right occur when both do. In both situations, neither Sam nor Mark has an advantage over the other; the only difference is that both athletes risk their health if they take PEDs. As a result, the payoffs in the upper left square are superior to the outcomes in the lower right square. In the off-diagonal cells, the athlete taking PEDs wins (by setting a world record, winning the title, or becoming world champion) and the other loses. Given the preferences described above, taking PEDs is a dominant strategy. The result is a prisoner’s dilemma in which Mark and Sam risk their health but gain no advantage. 33 9.3 The Danger of Tournaments and Superstar Effects Performance-Enhancing Drugs No other sport has been as severely damaged by PEDs as bicycling. Famously, in an interview with Oprah Winfrey, Lance Armstrong admitted using PEDs and blood transfusions over a period of at least ten years when he won a record breaking seven Tour de France races. As testing and surveillance have improved, some professional cyclists have even turned to mechanical doping – hiding small electric motors in their bikes. In 2016, Femke Van den Driessche was found to have a motor concealed in her bicycle at the under-23 Cyclocross World Championships. Despite her denials, she was issued a six-year ban. From 1996 through 2010, only one winner of the Tour de France, the world’s premier bicycle race, did not use PEDs. Tests implicated no Tour de France winner since 2011, but Team Sky, the team of 4-time champion Chris Froome, has been implicated in a doping scandal. The sport continues to be tarnished by its association with PEDs. Cyclists now be “doping” their bikes; CBS News has reported that twelve riders in the 2015 Tour de France used bicycles with hidden motors. 34  End of chapter questions 1) Are winner-take-all (or winner-take-most) contests a good reward mechanism? Would you want to take part in them at your workplace? 2) Suppose that the market demand for basketball players is perfectly inelastic (vertical) at 360 players. If the market supply increases due to an increase in the number of available international players, show using a graph how wages will change as a result. 3) Use a labor supply and labor demand graph to show why salaries in the NBA went down during the COVID-19 lockdown in 2020. Explain why the curves moved the way they did. 4) Use a graph to show the effect on MLS player salaries of: a. An increase in the number of teams due to greater popularity of football (soccer) b. A decrease in television revenues due to fan preferences for drama shows c. A minimum salary set above the equilibrium level. d. A decrease in roster sizes in the European leagues. 5) Show what would have happened to the Lorenz curve for the whole ATP season if Novak Đoković, Rafa Nadal, and Roger Federer had all lost in the first round of Wimbledon in 2019. 6) Use supply and demand curves to explain how the development of the interstate highway system, which allowed fans to travel much greater distances to watch ballgames, increased pay disparities between major league and minor league baseball players. 7) Show how the Prisoner’s Dilemma led to massive doping in international athletics. What can authorities do to prevent doping from becoming a dominant strategy? 8) Use the supply and demand model to explain why top athletes are often paid less than top celebrities in the showbusiness. 35