July 7, 2020
Digitalization, Superstar-Economics, and Major League Baseball, by Morgan Wack and Nicolas Wittstock
The economy and labor markets across the US are changing dramatically.
Big technology companies powered primarily by intangible assets are creating enormous value. Those who can take advantage of the emerging knowledge economy often reap huge rewards, while the returns to the second-best options dwindle or stagnate. Similarly, the returns to the right kind of education have grown considerably. Many search for new tools to manoeuvre this economy.
Income pooling agreements can give more people exposure to the upsides of the digital economy, by letting them share in the wins and giving them access to professional networks.
The Fourth Industrial Revolution is the continued digitization of the economy–including advertising, entertainment, research, education, and retailing–coupled with the ascendance of machine learning and AI. Many researchers argue that it is creating winner-take-all markets across industries. The most innovative and shrewd suppliers and producers may reap outsized profits, leaving their competitors to fight over crumbs.
Why? The digital economy has created globally integrated markets that were hitherto more localized, spreading and duplicating information at scale and at virtually no cost and providing 24-7 access to products and highly valued services to anyone in the world. People in remote areas were previously held captive by local monopolies. Yet the sole grocery store serving a small town must now contend with Amazon, which offers access to an amazing selection of products at competitive prices. And while in a growing number of markets only one digital platform or one dominant firm has captured the entire market, it often gives its product away for free.
Therefore, digitalization has benefited consumers by ensuring they never have to settle for inferior products and it has made almost everything more affordable. Frictionless comparison shopping has enabled them to more easily screen out both lemons and unremarkable substitutes. Billions of global consumers have access to the best educators through online education, the best entertainment through cheap apps, and ever cheaper products.
This phenomenon has also brought tremendous wealth to entrepreneurs like Jeff Bezos, Elon Musk, and Mark Zuckerberg, as well as their financiers on Wall Street or venture capitalists and Angel investors around Silicon Valley. Until recently, performing a task almost as well as the top performer in a field yielded a similar return. Because (virtual) access is now so easy, however, why would anyone bother with second-best alternatives?
What do we make of this? On the one hand, this is obviously glorious. Who would we not want everybody to have access to Harvard Professors, the best doctors, and the best lawyers? On the other hand, what happens to everyone else? The 95 to 99% who are not the top performers in their respective fields?
In the sports world, a winner takes all dynamic has also taken hold. The interesting thing about sports, however, is that clever contract innovation between potential competitors may address the downsides of superstar economics.
Consider Major League Baseball. Like most wages within the modern economy, the minimum salary of minor league baseball players has stagnated, failing to best increases in US inflation since the mid-1970s. At the same time, just as superstar industry wages have soared, the comparable salaries of players in baseball’s top professional league rose from an average of $20,000 in 1970 to over $4 million by 2020 (prior to Covid-19 based salary pro-rating). After factoring in inflation and taxes, this constitutes tremendous exponential growth in take home pay for ballplayers.
Though draft position can help predict promotion and long-term earnings, the career success of each player is characterized by great uncertainty. Even for the top prospects selected in the first round of each year’s draft, the expected remuneration over any one player’s career exhibits extreme variation, with fifty percent likely to make over $90 million dollars while the other fifty percent expected to make less than $1 million.
For players taken in the later rounds of the draft, the likelihood of major league success declines precipitously. In spite of these odds, even a slim chance of a major league call-up (and paycheck) has kept upwards of 7,000 players in the minor leagues each year, hoping against hope that they will make the majors one day. While the allure of these benefits and the nontransferable nature of baseball talent has kept demand for high caliber athletes among professional squads high, the uncertainty of each player’s long-term gains has led some players in search of innovative strategies for reducing risk.
Enter the formation of shared risk arrangements known to economists as income pools. Baseball players have begun to work with specialized companies to develop contracts that enable them to share the sport’s potential rewards and safeguard against risk by pooling future gains. The players are themselves responsible for recruiting the members of their own “pooled” cohorts; these groups enable players of similar talent, with similar odds of making it to the majors, to greatly expand their expected returns without sacrificing the opportunity for personal riches.
To ensure that the successful players from each pool receive the lion’s share of their gains, a cap is placed on total payments and a minimum number of professional experiences is required under most contracts. Though these pools are relatively new to baseball, early success has seen companies such as San Francisco-based Pando Pooling expand their income-pooling services to players in other major American sports and, most intriguing, to the students of America’s top business schools.
Does Major League Baseball portend the future? Why not band together with like-minded peers subject to similar risks and share in the potential upside of one of you (talented, but perhaps lucky) making it big? There are obvious limitations to expanding this model outside of baseball. Free-riding issues might complicate contract design. Also, the introduction of advanced sabermetrics in the late 1990s and early 2000s has made baseball unarguably more meritocratic. This contrasts with the perceived reality at least in other sectors: Americans have become increasingly less likely to believe that hard work is the strongest determinant of professional success and to view labor market rewards as determined by circumstances outside of their control. Yet there are surely many potential competitors –- like grad school cohorts and start-up founders — who might be willing to sign contracts that will let them share in their peers’ future financial returns, should they exceed a predetermined threshold.
The same digitization of the economy that has created superstar economics might also hold the key to reducing its downsides: these risk-sharing pools might be easier to organize and execute on digital platforms that reduce transaction costs and collective action costs. In the near future, joining one of these collectives might be as easy as downloading an app onto a smartphone.
