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Restricted Free Agency

Major League Baseball features a bizarre system for determining player salaries. A player goes through three phases in their MLB career:
  1. Glorified indentured servitude - For three years a player must take whatever the team gives them. Most teams offer the league minimum, unsurprisingly.
  2. Arbitration - For three years a player can go to arbitration to increase their pay. The stated intention of arbitration in the collective bargaining agreement is to gradually increase a player's salary up to their anticipated open market value in free agency. The general rule of thumb is that a player earns 40% of what they are worth the first year, 60% the next year, and 80% in their final year.
  3. Free agency - This is where players finally go on a completely open market.
No other sport has a salary system like this. MLB's became this way largely thanks to a history filled with rampant, overt collusion that got challenged by an aggressive players union back in the late 1960s though the 1970s. It used to be that players had to take whatever the team handed them forever (in other words, phase 1 was the only phase for a player in their career). That changed when the reserve clause got challenged in court, and reinterpreted as binding a player to their team for only one year, instead of forever.

The reinterpretation forced the MLB and MLBPA to the bargaining table, as neither side really wanted all MLB players hitting the open market. Interestingly, MLBPA leader Marvin Miller was the one that suggested the modern system. He realized that limiting the free agent pool would create a more competitive open market, and figured MLB owners' desire for top free agents would trump their seemingly innate habit to collude and keep prices down. Miller turned out to be right, and I think even he would be surprised at the massive contracts doled out these days.

The current system, as odd as it is, more or less served its purpose for a long time. However, over the past decade, there are obvious signs that its time has come and gone. It's time to update the system again.

Teams willingly hand out money to players these days, and have started to do things in the past 10 years that were unimaginable when Marvin Miller proposed the modern salary system. Every year, young players who haven't even hit arbitration receive multi-year, multi-million dollar deals. The latest is 23-year-old southpaw Martin Perez, who signed a 4-year deal worth $12.5 million guaranteed that also includes 3 team-option years. This kind of deal, where an MLB team willingly offers something beyond the bare minimum when it's not forced to, was unthinkable in Marvin Miller's time. Now, it's become a bit of a norm, because it makes sense. A team offers some guaranteed money up front to a young player in return for keeping the player well under their expected market value several years into the future.

The only reason deals like Martin Perez's happen is because the system intentionally inhibits the earning potential of inexperienced players. Back in the day, the reality was that the arbitration-to-free agency system didn't inhibit income in practice. Most players weren't getting much beyond the minimum anyway. However, in the modern game, where efficiency is a higher priority than collusion, long-term deals with promising young players are all the rage. The fact that they keep happening suggests that there is an inefficiency being exploited over and over by teams.

On top of that, the explosion of wealth in baseball has resulted in skyrocketing player salaries. However, because the free agent market is so restricted in the current system, the money gets funneled to an elite few. The result is some stunning inequality, even though every player in baseball is making good money.

There are 750 players active in baseball at any given time (25 players on 30 rosters, and 25 x 30 = 750).  I used USA Today's database of MLB player salaries to analyze the income distribution in Major League Baseball. I simply looked at what percentage of all MLB income the top 10% of baseball players earn. In a perfectly equal distribution, the top 10% would earn exactly 10% of all income. It turns out that 41.03% of all money spent on MLB players in 2013 went to the top 10% of earners.

Here's a fun thought experiment I guarantee you won't see on any other baseball blog. Have you ever wondered how baseball's economic system compares to other nations? I have, and for your convenience, I'm about to provide the results of my research.

If Major League Baseball were a nation, the percent of income their top 10% earns makes them comparable to nations like Panama (40.08%), Swaziland (40.12%), Cape Verde (40.64%), Paraguay (41.11%), Honduras (42.4%), and Chile (42.77%).

For reference, the top 10% of the United States earn 29.85% of the nation's income, and many are worked up over the income gaps in this nation. In Mexico, the top 10% earn 38.68% of all income, and border-hopping happens in part because the poor are so much poorer than the wealthy. Brazil, with obvious and rampant corruption at the top, checks in with the top 10% earning 42.93% of all income.

So the 41.03% that MLB rocks right now is a stunning number. It's the kind of number that suggests a system is failing, corrupt, or at the very least could be improved. It is clear that Major League Baseball is limiting the income of less experienced players, which artificially creates cheap talent that would be less cheap otherwise. The system has always suppressed the value of inexperienced players, but what's new is that owners no longer collude and pocket the money themselves. The savings are passed on to the elite through free agency.

The consequences aren't dire in baseball (where "poor" means earning $500,000), but the gap is still worth worrying about. Income gaps are a breeding ground for protest, discontent, and upheaval, particularly when the poor feel they are getting robbed of something that's rightfully theirs. Furthermore, the gap will only widen in baseball as media contracts explode with the free agent pool staying the same size.

It doesn't seem like MLB has hit its breaking point yet, and maybe all the money in the game is so crazy that it doesn't really matter. There is no such thing as real poverty in baseball, and usually large income gaps equate to painful poverty. Still, I'd have to think at some point that young players will realize what kind of sham the system is.

I'd like to see Major League Baseball make a simple change that could go a long way: get rid of arbitration and replace it with restricted free agency. This simple move could reduce the current price of unrestricted free agents by a whopping 30% and I don't think the MLBPA would complain. It's simple supply and demand.

Time for more numbers!

Last year, by my count, 97 players signed MLB free agent contracts. Those players accounted for 129.3 WAR the previous season, and were given $506.3 million in total salaries to play in 2013. That pencils out to paying about $3.92 million for every 1 WAR.

Last year, again by my count, 160 players were eligible for arbitration. Few went to arbitration, but the threat of arbitration motivated contract negotiations. Those 160 players accounted for 228.1 WAR the previous season, and were given $472.81 million in total salaries to play in 2013. That pencils out to paying about $2.07 million for every 1 WAR.

Clearly, players in arbitration earn much less than players in free agency. That makes sense, since arbitration is designed to slowly ramp up a player to their open market value. The discrepancy is a sign that system is working as designed.

Here's how restricted free agency would work in my theory: Arbitration ceases to exist. Players eligible for arbitration become restricted free agents, meaning they hit the open market but their current team can retain them as long as they match whatever other offer a team gives. Additionally, a team would be given a compensatory draft pick (in a compensatory round) if they lose a restricted free agent that they made some sort of qualifying offer on. I'd make the qualifying offer fairly low - maybe something like $4-5 million, or whatever works out to about 4 or 5 times the suggested slot bonus amount in the compensatory round*.

*Based on the idea that maybe 20-25% of compensatory draft picks become MLB players, which I'll admit is completely unfounded. The qualifying offer price should be tied to how valuable that compensatory pick is though.

Teams wouldn't have more money to play with, but the way it gets allocated would change. The arbitration and free agent pools would become one big pool. That means, at least last year, $979 million to spend on 357.4, which comes to paying an average of $2.74 million for every 1 WAR. This is about 70% of the price per WAR in free agency last year, which is where I come up with the 30% reduction.

So how might this system look in practice? Let's look at the Mariners. They only have two players hitting arbitration this offseason, Justin Smoak and Michael Saunders. In the new system, they would both be restricted free agents. MLB Trade Rumors projects that Smoak will earn $2.8 million and Saunders $2 million, both as first-time eligible players. In theory those numbers represent about 40% of their open-market value, meaning they are actually worth about $7 million and $5 million, respectively. However, remember that restricted free agency lowers open market prices an estimated 30%. So, with that reduction added, Smoak would project to make $4.9 million, and Saunders $3.5 million.

If I were the Mariners, I'd extend offers to both players, but look for an upgrade at first base. There are 214 arbitration-eligible players this year, including guys like Mark Trumbo, Brandon Moss, Brandon Belt, Logan Morrison, Ike Davis, Lucas Duda, Chris Davis, Kyle Blanks, John Mayberry, Garrett Jones, Mike Carp, and others that might be able to play first base. It's unlikely all these players would hit the open market (I'm guessing teams would sign many more players before they hit the market), but it's easy to imagine more options than in the current system. More importantly, the M's have a projected $50 million or so to spend this offseason, but with so few restricted free agents of their own, they would benefit. Their $50 million would play more like $70 million in the current system.

There's a lot to like. Owners should like that premium salaries get dampened. The MLBPA shouldn't mind because their players ultimately get the same amount of money as before, just allocated differently. There are reasons to believe this change would appeal to a broad enough base for approval.

This is Major League Baseball though, where change is but whispered on occasion. It's hard to say baseball's system is broke, but I'd argue it is easy to say it could be better. So why not introduce restricted free agency?