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Arduous Arbitration

It's getting to be arbitration time in baseball. Each year a set of players and teams negotiate under the threat that a third party (a panel of three arbitrators) will render a decision on the player's salary if a negotiated settlement cannot be reached. Even though a given case is not likely to make it all the way to the arbitration panel, the threat of arbitration drives a given player and his team, when they negotiate, to consider what the panel may decide.

Arbitration, first offered to the players by the teams back in the early 1970's as a way of appeasing the union in its calls for free agency, has never been popular with teams. This article by Fred Claire at partly explains why.

One reason it is unpopular is because of the nature of the hearing process. For the players, they try to maximize their value to their team in the eyes of the arbitration panel: a sort of "how great I art" argument. For the teams, they try to minimize the player's value: basically arguing "how great thou aren't." This is contentious.

Another reason is that simply by becoming eligible for arbitration, players see a jump in their salaries and teams are bound to accept these salaries.

Here's what Bud Selig (in 1992 PM) had to say when asked by the New York Times about the economics of baseball: "In the last 15 to 18 months, talking to every club, asking 'What do you hate most about the system?' The bottom line is if they had their choice, without a doubt, it's salary arbitration. Free agency at least you can elect to do, but in salary arbitration you're somewhat of a prisoner of what other people have done."

Claire points to the tie between the arbitration system and free agency as one of the problems.

Baseball's labor market consists of three tiers of players: 1. reserved players who have less than three years of service* are, basically, the property of their teams; 2. arbitration-eligibles - players who have at least three years of service are also the property of their teams. But they can have their salaries determined through arbitration; 3. free agents, players who are not the property of their teams and are free to sign with whoever wants to sign them.

The collective bargaining agreement (CBA) restricts what arbitration panels can consider when rendering decisions (Article VI, Section F). Among those considerations are what comparable baseball players have earned as salaries. Because some free agents are comparable to arbitration-eligibles, their salaries, somewhat filtered down and averaged out, become part of the consideration (Dan Marburger's 2004 Economic Inquiry paper on arbitrator compromise provides econometric evidence of this). That's one reason why players see a jump in their salaries when they first become eligible.

But reading the article, the rhetoric and one-sidedness reminded me that this article comes from, the official site of MLB and, therefore, a mouthpiece of the teams. So Claire doesn't discuss another reason for why the average player sees a nice raise just for becoming eligible: reserved players are in a monopsonistic labor market and, thus, earn salaries below their marginal values to their respective teams.

You can argue that part of the difference between salaries and marginal value can be considered a return on investment in minor league training. You can also argue that part of the difference goes to pure monopsony rent. The point is that reserved players are paid less than their marginal value and arbitrated players are paid closer to their marginal value because arbitration mimics, albeit imperfectly, a competitive labor market. Thus the jump in salaries by becoming eligible.

*A set of players with two years of service are also eligible for arbitration.