Arbitration and Salary Gaps in Major League Baseball
Gustafson, Elizabeth, Hadley, Lawrence, Quarterly Journal of Business and Economics
Prior to 1973 the labor market for major league baseball players was dominated by the reserve clause. This clause restricted a player's labor market activity to the team holding his contract in the previous season. Because major league teams were not permitted to compete for each other's players, they enjoyed the advantage of a pure monopsonist in dealing with their own players. Economic theory predicts that profit-maximizing monopsonists will exploit workers by paying a wage rate below marginal revenue product. This prediction is based upon the standard textbook analysis of monopsonists who face marginal resource cost functions rising above their labor supply functions. Scully (1974) uses a recursive econometric model to estimate the magnitude of this exploitation. He finds the losses of the baseball players to be considerable.
Since 1973 there have been two dramatic changes in this labor market. First, in 1973 players and owners voluntarily agreed to use binding final offer arbitration to settle salary disputes. At the time, this appeared to be a harmless concession from the owners' viewpoint. The Curt Flood lawsuit challenging the reserve clause recently had been decided in the owners' favor and had been upheld by the Supreme Court.(1) The clause seemed solidly entrenched as a permanent part of baseball's labor market. The owners had every reason to expect that arbitrators would observe only salaries suppressed by the existing labor market and that these salaries would set the boundaries of their awards.
Second, grievance arbitration overturned the reserve clause in 1975, and major league baseball entered the free agent era. Players currently become eligible for arbitration just before reaching three years of major league service(2) and become eligible for free agency after six years of service.(3)
The combination of free agency and binding salary arbitration has proven to be advantageous for veteran players, as indicated by the upward explosion in their salaries over the past 15 years. Our research has documented a large one time salary increment at the time that players become eligible for arbitration. This salary jump suggests that arbitrators have succeeded in making salary awards that are at least commensurate with those of free agents (Hadley and Gustafson, 1991). The result of this market structure is a salary gap between the players who are eligible for arbitration and those who are ineligible, suggesting that ineligible players may continue to suffer from monopsonistic exploitation.
While the salaries of players eligible for arbitration are definitely higher than the salaries of ineligible players, it could be argued that the difference is due at least partly to improved performance of experienced players and seniority effects rather than exploitation. To isolate the portion of the salary difference that is due to a different reward structure rather than due to different performance, this paper presents a gap analysis for hitters and for pitchers. The portion of the gap between earnings of average eligible and ineligible players explained by their performance and their years of service in the major leagues is justifiable in the context of a competitive labor market. In contrast, the remaining unexplained portion of the gap is interpreted as a measure of exploitation of the arbitration-ineligible players. It should be recognized that important variables omitted from the earnings equations also will contribute to this portion of the gap.
Scoville (1974) hypothesizes that star players will be less exploited than average players because the supply of star players is inelastic. Hill (1985) finds evidence that stars are more exploited than are average players. To pursue this open question we have done a gap analysis for certain groups of above average players.
One may expect an increase in earnings when players become eligible for free agency after six years of service rather than when they become eligible for arbitration at about three years of service. …