The Coase theorem is back in the saddle

by on November 26, 2011 at 7:09 am in Sports | Permalink

On nearly every count, the deal favors the owners, who had sought all along to overhaul the system. The players made significant concessions, including a reduction of up to $300 million year in salaries, $3 billion over the life of the agreement.

It seems there will be an NBA season.  The details of the deal have not yet been released, and on minor issues are still being negotiated, but the exact revenue split will depend on revenue projections.  Henry Abbott discusses winners and losers.

1 matt November 26, 2011 at 8:14 am

It seems to me that the loss of a season has significantly higher non-monetary costs for players, than owners and administrators. As a player, I might get 10 or even 15 seasons at the highest level if I’m lucky. As an owner, I have many more seasons in which to achieve my goals (championships, glory, ???).

2 Careless November 26, 2011 at 11:09 am

Compare that to the money side, where the average player just lost almost 4% of his lifetime basketball income from missing just those 15 games

3 Dan Cole November 26, 2011 at 8:28 am

The agreement is a nice example of successful bargaining despite the existence of significant transaction costs. It does not in any way, shape, or form, put the Coase Theorem “back in the saddle.” To do that, we would have to assume counterfactually that the owners and players were negotiating in the complete absence of transaction costs – something that could never happy in the real world, according to Coase. He could hardly have been clearer about this. It was far past time for economists and legal scholars to stop misconstruing Coase.

4 Chris November 26, 2011 at 9:54 am

Deal gets done after players get a look at Boies’ first bill?

5 acpigou November 26, 2011 at 10:07 am

Dan, even I think you’re off on this one. First, you’re off on your facts. The transaction costs with respect to bargaining are low here. Allocation of resources ends up the same irrespective of prior assignment of property rights. Second, you’re off on your interpretation. Even under conditions of positive transaction costs, the question is still one of net benefits…specifically, which party’s are higher, even when assignment of property rights means that one party or the other must recoup the marginal damages plus transaction costs. So, Dan, let us now go forth and study the world of positive transactions costs. Fear not, Tyler gets it.

6 Dan Cole November 26, 2011 at 11:12 pm

Whether the transaction costs were high or low here (a debatable point) is irrelevant with respect to the Coase Theorem, which assumes circumstances of zero transaction costs. Any situation that involves positive transaction costs is, by definition, outside of the world of the Coase Theorem. That doesn’t mean, of course, that there are no gains from trade; only that transaction costs may sometimes impede otherwise efficient transacting. That they did not do so here hardly means that the Coase theorem applied. It did not and could not have.

As for the chap, below, who claims a distinction between transacting and bargaining, I have no idea what he’s talking about.

Dan

7 John Whitehead November 26, 2011 at 10:26 am

But wasn’t Coase mostly concerned with externality (or did I miss something?)? The NBA situation seems like more of a negotiation over private property for which the market failure isn’t externality, with an assignment of property rights solution, but market power.

8 Dan Cole November 26, 2011 at 11:18 pm

Coase was concerned, in “The Problem of Social Cost” (1960) to correct Pigovian misconceptions about the nature of so-called externalities (i.e., that they are created bilaterally rather than unilaterally). You have to go back to his 1937 paper on “The Nature of the Firm” for his analysis of transaction costs (to explain why firms exist in addition to markets). Transaction costs also figure in “The Problem of Social Cost” paper, of course, because in a world with zero transaction costs, Coase argues, all “externalities” would be efficiently distributed (in other words, all social-cost problems would be efficient averted or resolved) by costless contracting in markets. It is the existence of positive transaction costs in the real world that gives rise to persistent social-cost problems and requires costly non-market mechanisms such as courts to resolve disputes.

9 Enrique November 26, 2011 at 11:37 am

The more apt analogy is not Coase but rather Schelling. In the “strategy of conflict,” he refers to two dynamite trucks heading towards each other on a one lane road — which driver backs up and cedes to the other ? This scenario is much like the “brinksmanship” that occurred during the NBA labor negotiations

10 Chris November 26, 2011 at 12:02 pm

The problem with all American sports CBAs is the looming spectre of a legal regime where no one really knows what the law is. It hangs over every negotiation.

11 juan November 26, 2011 at 12:07 pm

I was looking forward to the continuing labor chaos.
I’ve enjoyed following the negotiations more than I enjoy an actual NBA season. The regular season is worthless.

An NBA regular season is like turn of the century wrestling contests. The contestants would barn-storm around the country fighting in each town. And they quickly realized they’d make more money the more towns they could fight in — which meant not getting injured was the #1 priority.

The NBA regular season is just an exhibition, a step up from a scrimmage.

There’s no point watching until the semi-finals.

12 enrique November 26, 2011 at 1:49 pm

Juan, I agree with you wholeheartedly, though the same logic also applies to baseball. What I especially hate about basketball is the time-outs and foul calls, both of which slow the tempo of the game so much that a chess match is faster in comparison. I am especially bothered by so many foul calls — physical contact is inevitable in a game like basketball, so only flagrant or hard fouls should be called.

13 chuck martel November 26, 2011 at 4:32 pm

Check the box scores. The team that shoots the most free throws almost always wins. Pretty exciting, watching guys shoot free throws.

14 theakinet November 26, 2011 at 6:29 pm

@juan I read last week that the playoffs are so much more lucrative than the regular season that the NBA could cut the regular season down to 30-40 games and make nearly as much money as they make with an 82 game regular season. Just look at the 30-35 game college season before the single elimination playoffs.

My Alternative Basketball Association would replace regular season/post season with short tournements where teams earn points. Teams are put into 8 team groups. Arenas/cities bid to host 1-2 week long double elimination tournements per group. You get points based on your finish (bonus points if you go undefeated). Every groups bottom 4 teams go to the Relegation Tournement, while the top 4 go to the Championship Tournement.

15 Mike Huben November 26, 2011 at 12:51 pm

Isn’t losing 16 games of a season a huge transaction cost for both players and owners? If so, I don’t see how the Coase Theorem, which assumes no transaction costs, could come close to applying.

I don’t expect Tyler will explain.

16 enrique November 26, 2011 at 1:53 pm

Tyler may not explain, but Coase’s transaction cost (TC) analysis applies in the following way: imagine if all 30 owners had to negotiate with all 400+ players to reach a deal — this would be a paradigmatic high TC situation; in contrast, imagine if only David Stern and Derek Fisher were authorized to negotiate on behalf of the owners and players, respectively — this, in theory, would be a low TC situation. But what happens when the actual labor negotiations fell somewhere inbetween ( a small group of reps on both sides); this is where TC analysis is pretty much useless for predicting the outcome.

17 k November 26, 2011 at 3:24 pm

That’s not quite true. Positive transaction costs arise from something about the transaction.

I don’t see a transaction here, I see a bargaining situation.

Costly bargaining arises from costly transactions. But because a bargain is costly doesn’t mean there was a costly transaction behind it.

Actually you’re totally correct – TC analysis is useless for predicting the outcome because it doesn’t apply at all. But that is like saying spoons are useless when you need to chop vegetables.

18 Mike Huben November 26, 2011 at 4:59 pm

The Coase Theorem is not the same as transaction cost analysis. I presume Tyler ought to get that straight.

19 Bill November 26, 2011 at 5:23 pm

Agreed. See below. This is an example of allocation of ownership of an asset by two contending parties and strategies that can be undertaken to prevent deadlock by allocating a property interest to the other party.

20 k November 26, 2011 at 3:18 pm

The Coase theorem *is* the saddle!

21 Bill November 26, 2011 at 3:20 pm

Actually, the Coase theorem is llustrated above in the development and allocation of property rights in the team.

Just as in the original Coase theorem examples of farmers/railroads and sparks, what you have here are two opposing bargaining parties, with each, in effect, bargaining over the “Value” of the team. You basically have a bilateral monopoly situation with indeterminate outcomes. One of the ways that the potential deadlocks of bilateral monopoly is resolved is by giving one of the parties an ownership interest in the other party, as was done here, where the players ended up with an increased ownership from 49% to 51% of the enterprise value. In this way, since the players share in the value of the team, they have less incentives to hold it up in a deadlock.

Roger Noll, a really good I/O and sports economist, hypothesized some time back that team ownership would devolve to be owned partially by the players. That makes sense: they, not the owners, create the value, and therefore, the ownership residual value would devolve to them, just as in Coase theorem examples of where “ownership”, initially allocated randomly, devolves to those who create the most value from the asset. What has slowed down the devolution of team sports into this model is restricted entry–new teams cannot be made–and city exclusive franchises where the owners also have partial ownership of sport facilities, further consolidating their market power on team side.

22 Bill November 26, 2011 at 5:26 pm

The other issue in this negotiation game–a bilateral monopoloy negotiation game–is that the negotiation is not over present rewards, but the allocation of future rewards WHERE THE PARTIES have negotiated a new framework for future bargaining. In other words, what the team owners did was not only negotiate the terms of this deal, BUT ALSO the positions and rules for the next negotiation. Look carefully at the article and you will observe that the playing field in the next negotiation favors the team owners.

23 Dan Cole November 26, 2011 at 11:21 pm

The “Coase theorem” is “illustrated” by nothing about the NBA settlement. No real world transactions illustrate or exemplify the Coase theorem because that theorem, as specified by Coase and named (for Coase) by Stigler, presumes absolutely costless transacting, which cannot occur in the real world. From the very start of the negotiations, the players and owners were not the world of the Coase theorem, but in the real Coasian world of positive transaction costs. The good news is that, in this case, the transaction costs were not so great as to derail a socially efficient outcome.

24 Bill November 27, 2011 at 8:37 am

Dan,

You might want to do some more reading. I suggest the Theory of the Firm.

Without getting out some books and articles, let me quote Wiki:

“Coase developed his theorem when considering the regulation of radio frequencies. Competing radio stations could use the same frequencies and would therefore interfere with each others’ broadcasts. The problem faced by regulators was how to eliminate interference and allocate frequencies to radio stations efficiently. What Coase proposed in 1959 was that as long as property rights in these frequencies were well defined, it ultimately did not matter if adjacent radio stations interfered with each other by broadcasting in the same frequency band. Furthermore, it did not matter to whom the property rights were granted. His reasoning was that the station able to reap the higher economic gain from broadcasting would have an incentive to pay the other station not to interfere. In the absence of transaction costs, both stations would strike a mutually advantageous deal. It would not matter which station had the initial right to broadcast; eventually, the right to broadcast would end up with the party that was able to put it to the most highly valued use. Of course, the parties themselves would care who was granted the rights initially because this allocation would impact their wealth, but the end result of who broadcasts would not change because the parties would trade to the outcome that was overall most efficient. This counterintuitive insight—that the initial imposition of legal entitlement is irrelevant because the parties will eventually reach the same result—is Coase’s invariance thesis.”

You might also want to do some reading on bargaining and negotiation, and look up Coase in the index, say, on Law and Economics.

25 Dan Cole November 27, 2011 at 9:06 am

Bill:

I think it is you who should go back and re-read what Coase actually wrote in 1937, 1959, and 1960. For one thing, the title of his 1937 article is not “The Theory of the Firm,” but “The Nature of the Firm.” His 1959 article on “The FCC” was his first effort to bring his transaction-cost analysis to social-cost problems, as your otherwise inapposite quote from Wiki suggests, but he first used transaction-cost analysis in 1937, not 1959.

The reason your quote from Wiki is generally inapposite is that it focuses only on the conditions in which the “Coase theorem” holds. It is certainly true that, under those unrealistic conditions (which were really nothing more than Coase’s characterization of the standard assumptions of neoclassical economic theory), the initial allocation of property rights cannot matter because parties will costlessly bargain their way to a socially efficient allocation. Once the assumption of costless bargaining is relaxed, the situation in which Coase was most interested and to which he devoted the lion’s share of “The Problem of Social Cost,” the initial allocation of property rights often matters a great deal because of positive transaction costs that might impede efficiency-enhancing reallocations. In other words, the law matters to economic outcomes because of transaction costs.

However you slice it, there is no situation in the real world in which the costs of transacting are zero. Hence, the Coase theorem (named by Stigler, but intended by Coase merely as a pedagogical device for understanding why transaction costs really are important in the real world) is, by its own terms, inapplicable. What we are left with are situations of lower or higher transaction costs in which efficiency-enhancing reallocations of entitlements often occur, but are sometimes obstructed.

Dan

26 Bill November 27, 2011 at 9:28 am

Dan,

You seem to be only disagreeing with my recollection of title of the book, but not my comment, which are opposite your own earlier comment.

If what it takes for you to agree with me and disagree with yourself is simply putting a memory, or other trivial, error in the blog comment, Im (notice the absence of apostrophe) all for it.

27 Richard Scott November 27, 2011 at 5:38 pm

I’m with Dan – the only way to understand Coase is to read Coase – he’s one of the most widely misconstrued economists. If you read the original Problem of Social Cost article fully, his ‘theorem’ was only intended as a strawman to lead into the discussion of the impact of transaction costs (which include bargaining costs and uncertainty, inter alia) – and his point was that you can’t understand the real world from a theoretical example that assumes away transaction costs. This aligns with his work on firms, which posits that the firm evolved because of the need to minimise transaction costs. There are several later short articles by Coase where he tries to put the ‘theorem’ that Stigler ascribed to him back into it’s contextual box. (The Coase Theorem and the Empty Core: A Comment. 1981). McLoskey is also entertainingly illuminating on this point (The so-called Coase Theorem (1998).

28 Bill November 27, 2011 at 5:55 pm

Oh, I’ve read Coase. Too much of him. It’s just that others incorporate him in their work, and I read that as well.

29 theakinet November 26, 2011 at 6:14 pm

What I’ll never understand is why the players cancelled the proposed world tour a few weeks before it would’ve started. They were guaranteed money, and didn’t have to bother with day-to-day logistics. That could’ve been the springboard for a player owned league like the ATP/WTA (which led to tennis players making more money in the long-run).

Another party who botched the lockout was arena owners. Most NBA teams are renters. The NBA has cancelled games in 2 seasons, the related NHL teams cancelled a whole season (and may lockout its players next year). So if you’re AEG, why let these guys get away with this? Arena owners keep 100% of arena revenue, players get everything else. Win-win. Cut out the middle man…And let anyone get a team. No franchise fees. Promotion and relegation.

30 Bill November 26, 2011 at 7:39 pm

A duopoly does not make as much as a monopoly. So, had the players created their own team, and other players remained in the franchise system, you would have lower net profits. And, some players could leave the player team to make their own team, creating even more competition.. What may be the barrier to entry is exclusive rights to, or ownership interests in, arenas.

Perhaps the players or their union should invest in arenas and squeeze the owners from both ends, and have a stronger position of possible threatened, but unexercized, entry.

31 Peter November 27, 2011 at 10:22 am

Dan is correct about Coase and the Coase Theorem. Those who doubt it should not only re-read Coase’s famous papers but also read what Coase has to say about the Coase Theorem in “Notes on the Problem of Social Cost,” Chapter 6 of The Firm, The Market, and the Law.

32 Bill November 27, 2011 at 11:38 am

Peter, You might want to reread chapter 5, and also read: Law and Economics by Cooter and Ulen pp 82-87 re Coase theory and bargaining and Raiffa, The Art and Science of Negotiation at 107. You can begin by asking yourself: What is the Team, who owns it, and what is the value created by the owners and the team players and go from there.

33 Bill November 27, 2011 at 12:31 pm

Peter, I would also add: http://encyclo.findlaw.com/0730book.pdf pp. 851-855 for the application of Coase in the non-cooperative bargaining context where there is a threat of extortion.

I am not a big fan of the Coase theorem in all applications. As you point out, transaction costs matter. But, it is a framework to look at the allocation of interests in THE TEAM as between the owners and the players. The owners realize that if they can bargain as a group, own the venue (arena’s), and can engage in various exclusivity relationships, they can thwart potential entry by other teams, including those created by players.

34 Dan Cole November 27, 2011 at 4:04 pm

Bill:

“The Nature of the Firm” was not a book, but an article. And I was expressly and strongly disagreeing with your assertions, which strike me as displaying absolutely no understanding of what Coase was after in specifying the conditions that Stigler termed the “Coase theorem.” You can cite plenty of economists (and legal scholars) who, according to Coase himself, have misunderstood Coase (in all kinds of weird ways) since (at least) 1960. But one point cannot be denied: either we are in a world of zero transaction costs or positive transaction costs. If the later, then the Coase theorem is simply inapplicable because Coase’s theorem specifies zero transaction costs as a critical assumption.

Dan

Dan

35 Bill November 27, 2011 at 4:34 pm

Dan, People use the Coase theorem in all sorts of situations, including bargaining, as a prediction of or justification of, the end result of a bargain. Rail against them, not me. I gave you the citations of where people have used the Coase theorem for their argument in negotiation and bargaining situations. I am not a purist in this. If, as the protector of the vestigal purity of Coase theorem, you object, so be it. But, you might want to open yourself up to reading how others–Raiffa, Cooter, et. al.–use or incorporate the Coase theorem in negotiations and how a final allocation is achieved.

Frankly, when I saw Tyler’s use of Coase I thought it was a little stretched, but I could see the argument. Personally, I looked at it as a situation of bilateral monopoly–a team owners monopoly and a players monopoly–fighting over the spoils. If you look at this in the broader framework of bilateral monopoly, and not just a Coasian allocation based on relative efficiencies, then you also understand that whomever has the most money to begin with (the owners with deep pockets) and whomever has less resources (the players), you would recognize that at the end of the day, the owners would be in a better position, although they would lose the most money. You also understand that there may not be areas of mutual gain as well under conditions of bilateral monopoly.

As to Coase and sports, and team ownership and player negotiations, you would really enjoy reading some works by Roger Noll at Stanford. He has talked about the devolution of team ownership towards players in a Coasian framework.

36 Bill November 27, 2011 at 4:43 pm

Dan, To aid in your reading, I am linking to an review on Sports Economics by Roger Noll. Note the use of Coasian analysis and the critique. http://books.google.com/books?hl=en&lr=&id=6rD8EP9FGosC&oi=fnd&pg=PA17&dq=roger+noll+and+coase+and+sports&ots=WDDegNue1o&sig=BN6UE1wgSwKlH0XnfwmjJIW8YoE#v=onepage&q=roger%20noll%20and%20coase%20and%20sports&f=false

37 Bill November 27, 2011 at 4:49 pm

For the link above, you want to link to the article by Noll entitled Sports Economics After 50 Years, and look for the discussion beginning on p. 25.

38 Bill November 27, 2011 at 6:50 pm

Oh, and Dan, regarding the book: mine is The Firm, the Market and the Law, which is a collection of his essays.

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