The Coase Theorem Meets Moneyball
Milton Friedman Essay Contest Winner
Adam Jeff Yu
Issue date: 4/14/05 Section: Perspectives
The Coase Theorem may be one of the most debated and misread theories in existence; modeling a world without transaction costs seems decidedly unfeasible. Thus, in such impractical instances, concluding that the assignment of property rights is inconsequential rings somewhat hollow. But the crux of the argument, that transaction costs do matter, as does the assignment of property rights is ever true but lost in translation.
Interestingly enough, the economics of baseball offers a lucid backdrop from which to glean the insights of the Coase Theorem. Prior to the inception of free agency in 1976, the property rights of players were solely assigned to the team. This policy, known as the reserve clause, meant that barring a trade or sale of player rights, individuals could only play for their drafted team. With the advent of free agency, players who had acquired a requisite amount of service time were free to the highest bidder. Free agency thereby signified the transfer of property rights from teams (owners) to players. Owners vehemently resisted free agency, fearing the disproportionate flow of premium talent towards the larger baseball markets. According to Coase however, free agency's transfer of property rights would leave the allocation of players unaffected. Even under the reserve clause then, it was argued that the better players from smaller market clubs were peddled to the larger market clubs anyway. Most infamously, the Boston Red Sox sold Babe Ruth to the New York Yankees in 1920. And the New York Yankees and Los Angeles Dodgers were seemingly always competing for the World Series and chock full of All-star talent even before free agency. Ironically, competitive balance and the distribution of major league talent, while seemingly entwined, are nonetheless distinct.
The reserve clause was not completely abolished, as it surfaced in two key areas: players that had yet to earn their free agent rights and those entering from the amateur draft. The reserve clause is still essentially binding for the players' first six years prior to free agency. Small-market teams compete via the limited reserve clause. When property rights remain with the team, premium talent is underpaid. Players in free agency earn several times more than those that have yet to earn the right, even controlling for ability. Free agency drives up salaries because teams bid against one another for players. Under the reserve clause, there is only one buyer. Wages are more or less set, and then accepted. Thus, before the advent of free agency, small-market teams could not only retain their talent, but player salaries were controlled. In the decade of competition prior to free agency, the dominant baseball teams were located in Oakland, Kansas City, Cincinnati and Pittsburgh. Today, these four teams are considered part of the lower class in the financial caste of baseball.
Interestingly enough, the economics of baseball offers a lucid backdrop from which to glean the insights of the Coase Theorem. Prior to the inception of free agency in 1976, the property rights of players were solely assigned to the team. This policy, known as the reserve clause, meant that barring a trade or sale of player rights, individuals could only play for their drafted team. With the advent of free agency, players who had acquired a requisite amount of service time were free to the highest bidder. Free agency thereby signified the transfer of property rights from teams (owners) to players. Owners vehemently resisted free agency, fearing the disproportionate flow of premium talent towards the larger baseball markets. According to Coase however, free agency's transfer of property rights would leave the allocation of players unaffected. Even under the reserve clause then, it was argued that the better players from smaller market clubs were peddled to the larger market clubs anyway. Most infamously, the Boston Red Sox sold Babe Ruth to the New York Yankees in 1920. And the New York Yankees and Los Angeles Dodgers were seemingly always competing for the World Series and chock full of All-star talent even before free agency. Ironically, competitive balance and the distribution of major league talent, while seemingly entwined, are nonetheless distinct.
The reserve clause was not completely abolished, as it surfaced in two key areas: players that had yet to earn their free agent rights and those entering from the amateur draft. The reserve clause is still essentially binding for the players' first six years prior to free agency. Small-market teams compete via the limited reserve clause. When property rights remain with the team, premium talent is underpaid. Players in free agency earn several times more than those that have yet to earn the right, even controlling for ability. Free agency drives up salaries because teams bid against one another for players. Under the reserve clause, there is only one buyer. Wages are more or less set, and then accepted. Thus, before the advent of free agency, small-market teams could not only retain their talent, but player salaries were controlled. In the decade of competition prior to free agency, the dominant baseball teams were located in Oakland, Kansas City, Cincinnati and Pittsburgh. Today, these four teams are considered part of the lower class in the financial caste of baseball.