Wednesday, 11 February 2015

Are Top Sports Stars Actually Overpaid Or Not?

This is one of the longer Blog posts I've written (at just under 3500 words) - but if you are the sort of person who a) reads my stuff regularly, or b) is interested in this particular subject, then you hopefully won't mind its lengthier nature.

I've just read that Sky and BT Sport have paid a record £ 5.1 billion for live Premier League TV rights, which amounts to a 70% increase on the current £3 billion deal. It's a good time, then, to ask the question: Are top sports stars like the highest earning footballers overpaid? I think they are, but not for the reason you might imagine. In actual fact, the standard reason given for why the top footballers are said to be overpaid is, I think, misjudged. The usual argument is that it is obscene to reward footballers with the same money in a week that a heart surgeon gets in a year, or a soldier defending his or her country gets in several years. The odds are some of you reading this now probably hold that view. Here's why that view needs redressing. What people earn is not an issue of moral probity, it is an outcome of market forces related to supply and demand. If a footballer or actor can generate millions of pounds per year more than a nurse or a soldier we are not seeing immorality, we are seeing what people are prepared to pay for a certain skill or service they value. Of course you'll respond by saying that we 'ought' to value a nurse or soldier more than a footballer, musician or actor, but market processes give clear demonstration that we do not.

Quite a few people can be nurses, but only one person can be Jim Carrey or Meryl Streep. And preferences are made up of a collection of the individuals in society, so there is no logical argument that says it's unethical if more people value multi-millionaire Meryl Streep than an individual nurse on £25,000 per year. There is no way to judge the 'fair' pay of a film star, a nurse, a bookmaker, a chemist, a taxi driver or a bouncer except by the demand for what they do and how much those skills and services can generate through market processes. It's not my fault that a soldier gets paid less than a top footballer, and nor is it yours, but it is ours, where 'ours' means everyone in society.

In a supermarket customers pay for the goods the supermarket produces because they value those products. The market rewards of Tesco and Sainsbury's depend, very directly, on the value that their products deliver to society as a whole. Similarly, football wages reflect the scarcity and skill of the players.

Hang on, I hear you object - this is true, but doesn't it miss one key point? The English Premier Football League contains many clubs that are paying players beyond their means, resulting in huge losses which are maintained by benevolent owners who subsidise the shortfalls with earnings from other investments. Doesn't this suggest not that they confer value to justify their earnings, but rather that some people (like Roman Abramovich) have so much money that they've lost touch with the marginal revenue productivity of wages?

I understand the objection, but it isn't a valid one - after all, unless you or I have never paid a little over the odds for something we really wanted, who are we to speak? If an owner wants to pay millions to see his or her team win silverware, that simply reflects their desire to spend their money as they wish.  It is no different from you or I paying over the odds for something we desperately want. Of course, I'd much rather Roman Abramovich gave millions to Water Aid instead of using it to buy egotistical prima donna footballers, but unless we want to live in a world in which people aren't free to spend their money as they wish, we have little to say in the matter.

Given the foregoing, how, then can I maintain that sports stars are, in fact overpaid, as the title of this blog suggests? I'll explain, but to do so it'd be good to start with a basic assessment of value. For many people this is thought to be an entirely subjective issue, contingent on the personal value you place on sport and its performers. But economics usually has a way of answering these questions – and this one is pretty standard textbook stuff.

Assessing value
How do you know if you are of value to your employer? Easy – your value can be measured by what’s called the marginal revenue productivity of wages, which is basically the benefits your employer earns from employing you. If your wages are more than your marginal revenue productivity then you earn more than the sum total of value you bring to your company. The question is, do footballers, tennis players and the like earn more than the sum total of value they bring to their sport or the person paying their wages?

If you tried to answer that question purely on grounds of marginal revenue productivity then it gets tricky, because some sports stars do have such a star status that they have a positive effect on their employer’s revenue. Research done by economists Jerry Hausman and Gregory Leonard showed that star players such as Michael Jordan, Magic Johnson and Larry Bird “raised television ratings by around 30%, in addition to their effect on paid attendance.”

Knowing a bit about English football, I know that some of the big-spending teams (like Chelsea and Manchester City) regularly make losses by spending over the odds on big name players. In most businesses such high sums would not be paid out when the result constitutes such a deficit on the marginal revenue productivity. But with clubs like Chelsea and Manchester City their owners are not too bothered – they see their clubs as hobbies, and they are willing to make financial losses to attain wins on the field.

In the case of the biggest sports stars, wages are often higher than the marginal revenue productivity of labour – but equally the supply of those extraordinarily talented players is very small, which leads to the spectacularly high wages they receive each week (to give an example: Gareth Bale – one of the world’s best footballers earns in one week what Prime Minister David Cameron earns in two years).

Or take Lionel Messi - perhaps the greatest player the game has ever seen. Messi has been blessed with an immense footballing talent, which is a combination of background, natural ability and hard work. The market system that sees Messi being paid millions of Euros per year to play for Barcelona FC and a Sainsbury's shelf stacker or the CEO of Sainsbury's being paid nothing to play for Barcelona FC is a market that's delivering a better outcome than if Messi was shelf-stacking and Joe the shelf-stacker was a striker for Barcelona FC, even if Messi is earning more than we'd like, and the shelf-stacker less.

But our desires aside, this is the epitome of a supply and demand market - its analogue occurs in price theory, which says that if a product is highly sought by hitting a target then its price will go up when it is in short supply. In football Lionel Messis are in short supply, and in supermarket retail CEOs are in shorter supply than shelf-stackers, with shelf stackers being in more regular supply than top footballers and chief executives. Despite much dissonance, no one should want it any other way, because if there was a mechanism that prevented popular products making inventors rich, and rare skills making CEOs and top footballers sought after, then not only would that be terribly bad for acquiring skills, it would be terribly bad for consumers too, because without consumer prices, suppliers cannot know how much value people place on things.

Adam Smith explained it famously by drawing our attention to a paradox:

"The things which have the greatest value in use have frequently little or no value in exchange; on the contrary, those which have the greatest value in exchange have frequently little or no value in use. Nothing is more useful than water: but it will purchase scarcely anything; scarcely anything can be had in exchange for it. A diamond, on the contrary, has scarcely any use-value; but a very great quantity of other goods may frequently be had in exchange for it."

If I offered you a choice between a diamond ring and a glass of water you'd choose the diamond ring. The reason why is obvious; you can easily get a glass of water from the tap any time you like, but you'd have to work hard and save up to buy a diamond ring. But paradoxically if I said you have to give up one thing for the rest of your life - diamonds or water, you'd give up diamonds, because while you could live without diamonds, without water you'd die. That's a little like how it is with Lionel Messi (a diamond) and a shelf stacker (water). If you had to have one less shelf-stacker or one less Lionel Messi you'd choose to have one less shelf stacker, because Lionel Messis are much rarer and much more uniquely talented. But if you had to choose to live in a world with no shelf stackers or no footballers you'd probably prefer to keep shelf stackers, lest the food buying industry runs amok (replace shelf stackers in this equation with policemen or car mechanics and the point holds even more so)

So how is it that top sports stars are overpaid then?
I explained that wages are governed by supply and demand, but I hinted earlier that some people (sports stars etc) may actually be overpaid in a market that is pre-dominated by benefactors with big money (like Abramovich, etc). The key question is, how do we measure quantity to find what is excessive and what isn't?  The way we do it is by assigning value using an economic template.

In sport relatively small numbers of participants earn disproportionately vast sums of money compared to the majority of other participants with less talent. But are the differences in talent significant enough to justify the translation into such large differences in wages? I seriously doubt it, which is the best argument for their being overpaid. For example, in football the best premier league players can earn ten times more than the best players from the championship league below, but I doubt they are ten times better in ability. The difference in earnings between a top footballer and a second-tier footballer is not based just on marginal productivity but instead on the financial power of benefactors pumping money into the clubs and the economic power of the media. This applies in all sorts of areas too. People only allocate a limited amount of time to movie watching and cookery books, which means a Brad Pitt film and a Nigella Lawson cookbook each has a higher probability of big sales despite probably only being marginally better than competing films and books.

It's tempting to ask; if sport gives people great pleasure, and people wilfully follow it at some personal cost, who is anyone to say the money could be better spent elsewhere? But that is the wrong question.  The right question would be - if the vast sums of money associated with sport were diminished and put into more worthwhile uses, would the diminution that greatly compromises the quality of sport be worth it against the gains obtained from the increased resources in other uses?  Let's say the benefactors and businessmen behind sport and its media outlets got together and agreed to charitably take 50% of the crazy money out of sport and invest it in projects that helped the needy (Oxfam, Water-Aid, Save The Children, etc). You'd find that the quality of sport would decrease, but not by as much as you'd fear, and not by enough to drastically reduce your pleasure, because the enjoyment levels would soon equilibrate again. Whereas, on the other hand, thanks to the money given to the charities, the quality of life for those in need would increase greatly. 

That is the essential point - sport involves huge sums of money that generates rewards that would not be greatly diminished with much of the crazy money taken out. Good charities that invest their money well ensure that the recipients of that money greatly benefit from as much money as they can get. In the global sense, where we are measuring quality of life and well-being, sport (and many other things, of course) sucks up a lot of money and provides relatively little in return.

Once again, that is not a wild speculation - it is based on the economic principle that market economies quite naturally shape rewards, contribution and demands commensurably.  With a small degree of flexibility, the price of a bunch of bananas, or a mobile phone, or a lawnmower, or a scarf, or the fees of bricklayers, plumbers and removal men reflects the demand and willingness to pay a particular sum for those goods or services.  That is why (save for anomalies) the market generally isn't over-saturated or in great scarcity of the products consumers buy and the services people need. Sport doesn't have this Smithian 'invisible hand' to regulate its dispensations - it can extend globally and amount to a huge over investment which robs us of a great many resources and denies the more valuable and worthwhile alternative uses.  Because of this, irregularity in the market economy doesn't provide the optimum number of sports stars as it does goods, supplies, bricklayers, plumbers and removal men. 

I first came to this realisation while I was watching a Wimbledon tennis match a few years ago: the realisation that we could shave off the top 10% of quality tennis players and not significantly diminish the overall quality of tennis, retaining pretty much the same enjoyment or appreciation as before. That is to say, if the top 10% of tennis players suddenly disappeared, then once we'd adapted I think we’d still have more or less the same enjoyment of tennis with the remaining 90% (I would actually say the same for all sports - which is probably why I'm not very interested in sport generally). A friend of mine had the following objection:

"Ah but how would the world benefit by getting Andy Murray to do something else like play the harp? There's no evidence he would be any good and the net result would just be lower standard of tennis being played and no improvement in world harp playing standards."

That's true if he ends up doing something that he's no good at (like playing the harp). But he won't end up doing something he's no good at, because that won't be sufficient to pay his bills. If tennis suffers no major diminution by Murray's absence, then anything else he does will benefit the society as a whole, so long as what he does earns him a living. The main indication that someone is benefitting society in a vocation is if someone else is willing to pay them for what they're doing. If Murray had no aptitude for the harp then no one will pay him for it. If someone pays him to be a baker or a carpenter or a painter then society is the better for it.

Conversely, I think if the top 10% of contributors to popular music and literature suddenly disappeared I don’t think once we’d adapted we’d still have more or less the same enjoyment of music or literature with the remaining 90%. To paint a picture, and I know this is subjective, but in popular music you'd have to envisage that shaving off the top 10% would leave you with a world in which there were no Beatles, Stones, Dylan, Led Zeppelin, Pink Floyd, Bowie, Neil Young, Jimi Hendrix, and so on. In literature you'd have to envisage that shaving off the top 10% would leave you with a world absent of Dickens, Tolstoy, Austen, the Bronte sisters, Eliot, Dostoyevsky, Greene, Lawrence, Joyce, Woolf, Hardy, and so on.

This is part of a general piece of wisdom that says the world benefits on the whole when great talents go on to employ those talents. I want the future Einsteins to be studying physics at Oxford or Cambridge rather than bumming out and working at Tesco. I want the future Mozarts to be involved in music rather than working in factories or driving in cabs.

A novelist like Dan Brown or JK Rowling has rewards that are easy to demarcate – each book sold is a unit of income. But Roger Federer or Wayne Rooney do not have easily measurable units of income, because their pay cheques are based on relative performance not absolute performance. Tennis tournaments offer huge incentives for effort because under tournament conditions relative performance is primary over absolute achievement. All the winner has to do is play better than his opponents. In absolute terms he may play better the year after he won it and lose because his opponents played even better still. This, of course, is what motivates other players to improve – it is the allure of the big pay cheque, even though the ratio of winners to losers is miniscule. A similar logic applies to the marketplace in general. The salaries of the high earners above us aren’t just high to reflect the skill set of the Chief Exec – for as we know, often the performance of a company is down to factors outside of the Chief Exec’s control. But a higher salary for Chief Execs, managers, supervisors, etc doesn’t just motivate them, it motivates those underneath them. A workplace full of staff wanting to climb the ladder is going to be a stronger workforce than a workplace full of staff with no tangible aspirations, and that probably is one of the hidden benefits of paying your Chief Execs and managers high salaries.    

Another interesting difference between say literature and tennis (as per my examples above) is that if the top 10 % of tennis players weren't playing tennis for a living they'd be doing other things and making perhaps equally good contributions to society overall. Conversely, I think it may be argued that if the top 10% of literary contributors had not written novels but done something else instead their contributions to society overall would not be equally good. This is perhaps heightened by the fact that one only needs to write each book once, and its legacy can endure for any future time.

Do you add any value to tennis by becoming a tennis player?  A tiny bit, but negligible.  If you make bread (and make a living), the world has more bread.  If you become a plumber (and make a living) the world has someone else to fix people's plumbing.  If you become a tennis player or gymnast and win a medal then the world won't have one more winner, it will just have you instead of someone else. 

Follow that pattern.  So, if you reduce tennis players by 10% - the world will have n quality instead of n+1, but that's very slight, particularly when you are none the wiser about those 10% once they've gone.  So virtually no change in tennis. But as far as the world goes, those 10% are now free to do something else.  If they all become plumbers or builders or taxi drivers the world has more of these services, so it's a social gain.  In sport, top performers merely capture lots of income that would have gone elsewhere in the sport, so 10% reduction is not a social cost it's a transfer of wealth. Incidentally, a lawyer largely transfers wealth too - the defendant's gain is the plaintiff's loss (and vice-versa).  They do act as deterrents to unproductive behaviour, but also to productive behaviour and activity too.

Put it this way, if all other tennis players had spent their 15 years playing professional tennis, and Andy Murray had spent those 15 years baking bread, the world of tennis would be just about as good, and the world have 15 years' worth of additional bread. Of course a baker can replace another baker, but the key difference is that another baker can go and do something else, whereas a losing tennis player still spends 15 years playing tennis and losing in tournaments. If one tennis player is a baker instead of competing, the tennis tournaments are almost as exciting, and we would have 15 years' worth of baked goods. It' a valid question to ask how we know the value of the baker's output exceeds the value of say 100 million people's enjoyment of Andy Murray - but what they'd be missing is that those 100 million people would still be enjoying some other tennis player just as much.

The standards to enter the market are different too. A baker who performs 85% as well as the average baker can expect to receive about 85% of the average baker's income, whereas a tennis player who plays 85% as well as the average tennis player probably wouldn't even make it to professional status.

The market has produced good outcomes when it delivers rewards that match the social contribution of the participants. Most sport fails this standard*. The point is, when other inventions fail that standard they are weeded out because demand for them is too scarce to justify their existence. This doesn't happen in sport like it would, say, if Cadbury brought a new combination of flavours in a chocolate bar (called Bananpeach) that almost no one liked. The value of an activity socially is the aggregate of all benefits to everyone, where benefits amount to how much people are willing to pay. If no one is willing to buy the Bananpeach, it will not be manufactured for long. On the other hand, in sport people's willingness to pay is retained due to them not realising that the top earners don't add all that much to how much they'd enjoy the sport if they were absent. In other words, in the chocolate market, the superiority of the Twix, Kit-Kat, Dairy Milk and Mars Bar over Bananpeach makes the Bananpeach unable to compete any more, whereas the superiority of the semi-finalists at Wimbledon no longer makes the first round losers unable to compete anymore.

Does all this mean people should give up their love of sport?  Not necessarily - it gives them pleasure, and the crazy sums of money involved aren't going to change for the better anyway.  Compounding this is the fact that money isn't the same as wealth - money buys you the things you want and need, but it is the assets that money buys that gives quality of life.  You don't create wealth just by giving someone millions of pounds. You create wealth when you start a company that fulfils the demands of the consumer with the supply of a particular product that adds quality or well-being to people's lives. You create wealth when you streamline a company of its extraneous staff. You create wealth every time you close down an entity that sucks up more resources than it provides. You create wealth when you invent new things, or synthesise multiple concepts in innovation, or construct new theories that generate prosperity when actioned. That is why the crazy money in sport is doing much less good than that crazy money could do elsewhere.

*Obviously I'm only talking about professional sport. People who partake in sport in their leisure time are doing so for their own pleasure, so it's unlikely it will provide rewards below their contribution.