July 17, 2000

Out of Whack

Financial Solutions That Don't Work

by Keith Law

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On Friday, Major League Baseball's Blue Ribbon Panel of Certified Outside Experts released its report on competitive balance in baseball, issuing a list of recommendations on how to prevent the gap between extremely-rich teams and less-extremely-rich teams from getting bigger.

The four-man group, which had access to all of the sport's financial data, didn't say the sport needs a salary cap and didn't recommend changes to free agency or salary arbitration. Instead, the economic study committee urged baseball to impose a 50 percent luxury tax on payrolls above $84 million; proposed sharing 40 to 50 percent of local revenues after ballpark expenses; and recommended that new national broadcasting, licensing and Internet revenue be distributed unequally to assist low-revenue clubs, provided that they meet a minimum payroll of $40 million.

The Players' Association's initial responses were worded cautiously, but boiled down to giddy statements that a hard salary cap is off the table, leaving them to soften the luxury tax (since the proposed incarnation is merely a fungible salary cap by another name) at the negotiating table.

However, what the panel--which featured onetime Fed Chief Paul Volcker, slayer of the stagflation of the late 1970s--recommended goes beyond laughable to be simply dangerous. It provides more opportunities for well-run teams to fleece the Orioles and Brewers, more opportunities for an insolent owner to hold his breath for a new stadium and more opportunities for overrated veterans to win guaranteed contracts.

The main flaw in the panel's report is the group's decision to ignore the federal government's experience with massive subsidy programs like pre-1996 welfare (Aid for Families with Dependent Children). These programs distort recipient incentives (e.g., have more kids to get more money) and often do little to achieve their basic goals (such as reduce poverty, which didn't happen until after AFDC was altered in 1996). The panel's plan would give money to the worst-off teams when, in fact, the worst-off teams are often worst-off for a reason: they make bad decisions.

Although the relationship isn't perfect, teams tend to find themselves moving up the revenue ranks when they do well on the field. When they make bad decisions on players--for example, trading for a 30-year-old Marquis Grissom with four years and $20 million left on his contract--they do worse on the field, at the gate, in merchandise sales and in TV/radio negotiations. Thus, the current system, which penalizes teams who can't compete financially for some talent, provides teams with a strong incentive to make smarter decisions on who to sign and who to play. The Oakland A's are the best example of this, and the Cincinnati Reds and Florida Marlins have exhibited some understanding of it as well.

Giving more money to the worst-off teams will exacerbate the disparity between the smart and the dumb. Giving the Brewers another $10 million a year will simply encourage them to bring in more high-priced veterans like Grissom, when in fact the team would do well to develop its own talent and make better use of the waiver wire. This will lead to a general inflation in the salaries of free agents, since the panel proposed no changes to the current system of salary arbitration and salaries for pre-arbitration players, meaning that the worst-run teams will have more opportunities to shoot themselves in the foot by signing players to ill-advised contracts.

At the same time, the plan reduces the incentives for smart teams to run themselves well. Why chase a dollar of extra revenue when fifty cents of it will go to fund your competitor? Industrial planning of this sort has never worked in any industry or any country, and it led to the economic implosion of the Soviet Union, of several Asian countries in 1997 and, most recently, Japan.

The proposal for a "competitive balance draft," in which the worst eight teams would each get to select a player off the 40-man roster from one of the eight teams to make the playoffs the previous year, is similarly boneheaded. In addition to duplicating the intent of the Rule 5 draft, the new draft would merely further encourage the best teams to create package-deal trades, where teams upgrade their 40-man rosters by dealing players outside that designation. Weaker teams already have opportunities to raid other organizations via the Rule 5 draft and minor-league free agency, but when Roberto Petagine can't get a major-league job, it's obvious that weak teams are weak due to their own inability to tell a ballplayer from Homer Bush.

The panel's recommendation did well by opposing the idea of reducing the number of major-league teams--as blatant a ploy for more stadium bucks as you'll find--and by recommending that baseball allow some teams to move. But by buying into the broader contention that baseball is running amok simply because the Yankees are winning World Series, the panel jumped to conclusions unwarranted by the current state of the game and issued a set of proposals likely to do much more harm than good.

Keith Law can be reached at klaw@baseballprospectus.com.