Archive for November, 2009

Trade(s) Is (Are) Mutually Beneficial

Continuing with my extended explanations of hot stove myths, today I discuss why trades tend to be win-win instead of win-lose.

Rarely will you meet an economist who doesn’t like trade. And if you are a student of James Buchanan—as I am—you really like trade, because Buchanan stresses to all his students that economists should begin by studying markets and exchange (catallactics or katallactics) rather than resources allocation. Adam Smith, and later David Ricardo, demonstrated how specialization and trade can produce optimal output. But, this is not the only reason to like voluntary exchange. If the parties involved in the exchange are both rational, self-interested, and acting of their own volition, then they will only engage in exchange when they are made better off. This must be the case for both parties, thus trade is mutually beneficial. This logic applies to the exchange of baseball players, as well. This generates the following myth:

Every trade has a winner and a loser — Swapping resources only takes place if both parties are made better off. Therefore, when we observe trades taking place, it’s likely that both parties are doing so because they expect to improve their teams (see the weak axiom of revealed preference, or as I call it: “the useful WARP“). Mistakes happen, but as a general rule, all parties to trades are winners. Who says economists aren’t touchy-feely?

Now, what people mean by winning and losing may differ. Some commentators like to argue that we should look backwards to evaluate a trade to see what ultimately happened. I disagree; the future is difficult to project, and I believe that trades should be evaluated according to what the parties knew at the time of the trade. In the long run, every trade will likely turn out to be better for one party or another. Who cares? Just because someone wins the lottery doesn’t mean that the winner should be praised for his/her investment acumen. It’s wrong to punish a GM for not having information that no one else had either—was it really possible to predict what would happen to Ken Griffey in Cincinnati?

At this point, I defer to the fundamental theorem of exchange: rational and self-interested parties will only voluntarily trade when both parties expect to be made better off by the exchange. Players change teams only because both GMs sees the new player as superior to the old. And this doesn’t necessarily mean playing quality: salary requirements, service time, age, and contract length also play important roles. In some cases, player skill-sets just fit better on different teams.

Commentators often begin their analysis of a trade by asking “who won?” This is the wrong place to start, because trade is not a zero-sum game. Rather than trying to identify winners and losers, I try to understand why the trade happened. Sometimes, I don’t get the deal; and, in this case, it’s OK to say “this GM got fleeced.” But, I rarely find myself saying this. Most times I find that deals make sense for both sides, as economic theory predicts.

The Failure of Development Planning

There’s nothing like a high-profile example of things going wrong in a predictable manner. From WSJ:

Now, four years after that decision gave Susette Kelo’s land to private developers for a project including a hotel and offices intended to enhance Pfizer Inc.’s nearby corporate facility, the pharmaceutical giant has announced it will close its research and development headquarters in New London, Connecticut.

The aftermath of Kelo is the latest example of the futility of using eminent domain as corporate welfare. While Ms. Kelo and her neighbors lost their homes, the city and the state spent some $78 million to bulldoze private property for high-end condos and other “desirable” elements. Instead, the wrecked and condemned neighborhood still stands vacant, without any of the touted tax benefits or job creation.

That’s especially galling because the five Supreme Court Justices cited the development plan as a major factor in rationalizing their Kelo decision. Justice Anthony Kennedy called the plan “comprehensive,” while Justice John Paul Stevens insisted that “The city has carefully formulated a development plan that it believes will provide appreciable benefits to the community, including, but not limited to, new jobs and increased tax revenue.” So much for that.

The lesson learned? Let the private market handle economic development, because it’s much better at doing so than the government. What we see in sports stadiums applies to other projects as well.

Thanks to Craig Calcaterra (via Facebook) for the pointer.

Testing Moneyball

Pizza Cutter posts an interesting bit of analysis on shifts in the labor market chronicled in Moneyball at The Hardball Times.

Did Moneyball really have an effect outside of Oakland and the handful of teams that embraced Sabermetrics in the following years? Were the lessons of Moneyball taken to heart league-wide? The surprising answer is “Yes, and in a much more powerful way than you might expect.” The way to tell whether a man believes something is if he’s willing to “put his money where his mouth is.” In baseball, that’s rather literal. Teams buy the service of players in a (mostly) open market. How much money they are willing to commit to a player tells a lot about what they think of him. And what drives those salaries tells a lot about what the market as a whole thinks about what makes a player valuable.

Cutter then examines the correlations of OBP, home runs, and RBI with player salaries for five years before and five years after Moneyball‘s publication. He finds that the OBP correlation increases around the time the book was released, and the correlations decline for home runs and RBI.

Cutter’s findings fit with the findings of two studies by Jahn Hakes and Skip Sauer (The Sports Economist), both excellent economists and fans of baseball and sabermetrics. Their first paper (working version), published in Journal of Economic Perspectives looks at the baseball market from 1999 — 2004. They used multiple-regression analysis to examine the valuation of on-base percentage relative to slugging average and found OBP was undervalued but the “undervaluation of a batter’s ability to get on base, appears to have been substantially if not completely eroded by the time the book was published.”

In a follow-up study (working version) published in International Journal of Sport Finance, Hakes and Sauer expand the sample before and after Moneyball from 1986 — 2006 and examine specific skills (i.e., walking and power) to see how they were valued over time. Again, the findings mirror Cutter’s results: “we find that the pricing anomaly extends well before the period described in Moneyball, and that with some important caveats, the market correction in the post-Moneyball period persists.” That the inefficiency extends well into the past is an interesting finding.

It’s been said that the plural of anecdote is data. Well, Michael Lewis gave us an enjoyable anecdote, and there appears to be strong evidence in data that the anomaly discussed in the book was real. On-base ability was undervalued, but the market quickly adjusted to correct for the inefficiency.

Are General Managers Myopic?

I continue my discussion of hot stove myths by focusing on the competence of general managers. Today, I explain why selling high and buying low are not reliable strategies.

GMs can buy low and sell high — So, let me get this straight: you think you know when a player is playing above or below his true ability—usually due to a small sample or by using a SGT-approved metric instead of a mainstream statistic—but guys who make a living in baseball completely miss it. For this to work, the GM on the other team has to be a colossal moron. GMs have made mistakes in the past and will make mistakes again, but they’re not dumb enough to act on a meaningless hot/cold streak. You can’t sell high or buy low and profit financially because all GMs understand these things. You don’t have to wait for a guy to get hot to sell him, nor dump him before he gets cold. In addition, the key knowledge of when the peak or trough is doesn’t exist, except in the mind of message board posters. Fluctuations in performance create uncertainty, which affect the price that GMs are willing to pay.

Several responses include historical examples of bad decisions by general managers as evidence that this is not a myth. My contention is not that GMs are infallible, just that we should not expect them predictably to make mistakes that are obvious to everyone but one sucker GM. Suckers are born every minute, and some GMs are better than others; but, sucker GMs are rare. Several years ago, I asked Oakland A’s Director of Baseball Operations Farhan Zaidi his thoughts on the issue.

Are there any GMs on other teams that are just plain suckers?

Absolutely not. Working in baseball has given me a newfound respect for GM’s in baseball. It takes a lot to rise through the ranks of the industry to one of those 30 positions. Fans and media like to deride some GM’s as being clueless, but from what I’ve seen, being a clueless GM is an oxymoron of the highest order.

Zaidi is no lifetime insider. I conducted this interview a few months after the A’s hired him out of Cal’s economics doctoral program, and his advisor was a world-renowned behavioral economist (Matthew Rabin). In the interview, he did acknowledge that GMs were subject to some types of biases that affect all humans, but that’s not the type of mistake we’re talking about here. Remember, message board posters are getting this right, while GMs make mistakes.

The type of statement I’m rebutting can be seen right now among Braves fans discussing Kelly Johnson. Before last season, Johnson had put up respectable numbers and looked to be growing into an above-average second basemen. His 2009 was awful, and Martin Prado rose to the occasion and took his starting job. Now the Braves are in search of an outfield bat, and trading Johnson as part of a package to get one is being discussed. This is when I see a statement like the following, “We can’t trade Johnson now, that would be selling low. He’s a better player than last year, the Braves should hold onto him and move him when his numbers rebound.” Or, “We should move Prado instead. There’s no way he’s an .800 OPS players. Dump him now while his value is high and get more in return than we could for Kelly.”

The assumption that underlies these statements is that the commenter can see the true Johnson and Prado, but a GM and his many close advisors can’t. I don’t care how much you liked Moneyball (I liked it, too), but no GM is this stupid. When scouting departments project players, they understand that performance is volitile. They see Johnson’s batting average was well below his historical norm, and understand that on-base percentage and power are more stable than average—in fact, I’m probably being too simplistic here. This will allow the Braves to get more for him than the typical hitter coming off a sub-.700 OPS season. There is no need to play him to get his value up.

Still, his value will be affected by his poor performance, because it raised some uncertainty about what Johnson is. The Braves might know more than other GMs because of their access to inside information about work habits and injuries; however, that he might not be that good is an uncertainty that the Braves face as well. What if they gamble on him getting better and it turns out that he’s just lost it (see Marcus Giles)?

Humans make mistakes, and general managers are human; therefore, general managers make mistakes. But, I don’t think such obvious mistakes can be so easily exploited. Teams are constantly looking for errors and do take advantage of them when they find them; however, selling/buying high/low isn’t one of those areas where inefficiencies persist unless GMs are colossal morons. I don’t think they are, and I think the proper incentives are in place from allowing incompetent individuals to rise to the GM position and stay there.

This doesn’t mean that GMs are above criticism, either. GMs can and should be criticized when we see bad moves, but I think they should always be given then benefit of the doubt.

The Size of the Free Agent Pool and Competition

So, it seems that my post last week on hot stove myths created a bit of a stir. Since this is the case, I’ll devote a post to each of my contentions over the next few days. I’ll begin with the myth that is generating the strongest objections.

The number of free agents at a position affects the price of free agents at a position — It seems logical that more free agents at a position will mean more options for teams. Players act as substitutes and thus a team can pit the players against one another to keep salaries down. The problem with this is that the free agents have come from somewhere. A high number of players looking for new teams means that there is a corresponding number of openings that teams need to fill. For example, it there are four good shortstops on the market this means that there are also four openings on team. The increased supply of players is canceled out by the increased demand by teams needing replacements.

The chief argument against this being a myth is that teams who lose players to free agency do not have to replace them with free agents. Instead, teams can use in-house replacements—from the minors or shuffling the major-league roster—thus, removing available landing spots for free agents on the market. This is certainly true, but it has nothing to do with the number of free agents on the market.

Imagine two free agent markets for shortstops: one with five free agents and one with a single free agent. Let’s further assume that in each market one team replaces its departing shortstop internally. In the former market, there are five players looking to fill four holes. Someone will be left out of the mix, and thus players compete against one bidding down their wages. In the latter market, the free agent has the market all to himself, but no place to go. In a world where the number of free agents is the only factor that affects bargaining power, he should have a monopoly and extract maximum surplus from his employer. Instead, he’ll take the league minimum just to find a bench slot to stay in the league. The five-player market actually provides more bargaining power for players than the single-player market. We could play around with the assumptions all day—fill in all five slots, leave a single slot open in the single-free-agent market—but, the exercise reveals the number of free agents is not important here.

There are two sides to this market and they cannot be viewed separately. Every free agent on the market generates an opening on a major-league team—it has to. And though not every opening must be filled by a free agent, more openings certainly help free agents. If you were to ask a player-agent which market he would prefer to hit, one with a few or one with many suitors, I think the instinctive response would be the one with many openings, because teams would compete for his clients. But, the openings have the side effect of creating competition for his client. In the end, it doesn’t matter. The sides of the market are linked, and this link is rarely mentioned. Alone, the number of free agents or number of teams looking for a free agent seem to tell us something about the competitiveness of the market, when they really don’t.

This leads to my second point: prices for free agents are affected by scarcity in the entire baseball labor market, not just free agents, which is what is important for generating expectations about player salaries. For example, last season had one of the more-plentiful free-agent classes of top starting pitchers in recent years. In any given year C.C. Sabathia, Derek Lowe, or Adam Burnett could have been the top starter on the market, but they all happened to hit free agency at once—Burnett actually opted into the market. If you followed this market you know that the pitchers faced competition not just from each other, but from non-free agents. The Atlanta Braves wanted two of the three and went hard after Burnett and Lowe, landing only Lowe. But this wasn’t the Braves’ only outlet: they tried hard to acquire Jake Peavy and eventually landed Javier Vazquez through a trade. Though Peavy and Vazquez were not free agents, they were available substitutes that were just as important as C.C. Sabathia as competition. And so were many other starting pitchers who were discussed behind closed doors but never switched teams.

What is important for competitive effects on free-agent contracts is the overall scarcity of major-league talent. The free agent market does not exist on its own, rather it is one sector of the labor market where teams purchase their services from among many available substitutes. Top prospects and controlled veterans are just as relevant—though maybe less liquid—to the wages free agents can command as the number competitors offering their services through free agency. An offseason with many similar free agents will not yield lower wages any more than a market with one free agent will yield high wages.

Hardy for Gomez

The Brewers just completed a swap of J.J. Hardy for Carlos Gomez with the Twins. I initially liked this deal for the Twins, but after finishing the post I see why this deal makes sense for the Brewers.

Hardy really had a bad year, last year. And the Brewers had the guts to send him to the minors—to work on his game and delay his free agency. It’s possible he’ll go all Marcus Giles and never hit again, but I doubt it. Combined with his above-average defense at shortstop, even if he just pulls it together to hit a mid-.700s OPS, he should continue to be worth his salary. Last season, he earned $4.65 million. He’s got two more years of arbitration, and he might get a pay cut instead of a raise. I’ve got him valued at about $6.5 million based on a three-year average. But if he’s somewhere in his 2007-2008 range, he’ll be an $8-9 million player.

Gomez is a nice defender at a premium position, but he couldn’t hit in the minors any more than he can hit in the majors. But, his defense is the only thing that keeps him valuable. His 2008, when he had a +29 Plus/Minus, was worth just around $8 million; but I think that’s the high end of his production and that he’s more of a $7 million player. I believe he’s got one more year of purely-reserved service before beginning arbitration, so he is cheap and controlled for several more years. The down side is that one injury, and this kid is toast. He can’t move over to a corner. You’ve just got to hope he learns how to hit (unlikely) or stays healthy.

I tried real hard to pick a winner on this one, but I don’t think that I can.

More Shortfalls in Stadium Revenue

The Gwinnett Stadium continues to “pay for itself from day one” as promised. How about a $168,000 shortfall?

Patrick Fox writing in the AJC.

The county, which had predicted $200,000 in revenue from parking proceeds this year, received a check for $9,188 to cover parking from May-September. The Braves had paid the county $22,342 for parking in April, the first month of the Gwinnett Braves season.

Wow, what a shocker. Fox ends the story with “More to come,” so check back at the AJC link for more updates.

Breaking Down the Hermida Deal

Yesterday, the Red Sox acquired Marietta’s own Jeremy Hermida (his mayor is named Thunder, too) from the Marlins for Jose Alvarez and Hunter Jones .

Hermida is one of those guys from whom everyone expected great things; but, aside from a good 2007, he hasn’t lived up to expectations. He probably could have used some more time in the minors, but it’s too late for that now. My guess is that the Red Sox will use him as a part-time player who can play himself into a starting role. His variance in performance makes him a bit difficult to value, but I’d argue that he should be viewed like a younger Mark Teahen, valued between $3.5 — $5 million per season. He made $2.25 million in arbitration last season, and has two more years of arbitration remaining. Given his performance last season he’ll likely get a small raise to between $3 — $4 million. That’s about what I estimate he’s worth.

The prospects the Red Sox gave up are decent, but unspectacular. Their value is entirely probabilistic, with an expected value of major-league peanuts (a few million here or there). It’s interesting, because that’s probably how Hermida should be viewed. If he is what he is, then he’s worth his salary, and not much more. Improvement will make him worth a good bit more, but he’ll get big arbitration raises as well. If the prospects the Marlins received succeed, they each have three years of league minimum salaries to look forward to, as well as arbitration years. This is a trade of a higher-risk big payoff for a lower-risk small payoff. And given that the Marlins rely on a low-payroll strategy, they’re probably just happy to have Hermida’s salary off the books.

Do I have to say it? The trade makes sense for both teams.

Valuing Bobby Abreu

Yesterday, Bobby Abreu signed a two-year $19 million deal to remain with the Los Angeles Angels of Anaheim. Abreu is a good player and still has value as a hitter, good enough to make up for his an atrocious defense. The contract calls for two guaranteed years at $9 million a piece, with an option for a third year that vests after 550 plate appearances in 2011 or 1,200 total plate appearances in 2010 and 2011. If the option doesn’t vest, Abreu gets $1 million.

My model predicts that Abreu will be worth $23 million to the Angels over the next two seasons. This value includes his specific contribution to a team of the Angels caliber, where wins are more valuable—wins on good teams are worth more than wins on bad teams. Accounting for aging at the late stage of players careers gets tricky, but even after factoring in his decline he’s still good enough to justify the deal. If his option vests, then he’ll likely be worth the third year. That’s a nice feature of the option: if he’s not worth it, almost certainly the Angels won’t have to pay it.

Overall, it seems like a good deal for both parties. It may also foretell a good market for all free agents.

Hot Stove Myths

Let me debunk a few common myths about baseball’s labor market as baseball’s second season begins.

GMs can buy low and sell high — So, let me get this straight: you think you know when a player is playing above or below his true ability—usually due to a small sample or by using a SGT-approved metric instead of a mainstream statistic—but guys who make a living in baseball completely miss it. For this to work, the GM on the other team has to be a colossal moron. GMs have made mistakes in the past and will make mistakes again, but they’re not dumb enough to act on a meaningless hot/cold streak. You can’t sell high or buy low and profit financially because all GMs understand these things. You don’t have to wait for a guy to get hot to sell him, nor dump him before he gets cold. In addition, the key knowledge of when the peak or trough is doesn’t exist, except in the mind of message board posters. Fluctuations in performance create uncertainty, which affect the price that GMs are willing to pay.

The number of free agents at a position affects the price of free agents at a position — It seems logical that more free agents at a position will mean more options for teams. Players act as substitutes and thus a team can pit the players against one another to keep salaries down. The problem with this is that the free agents have come from somewhere. A high number of players looking for new teams means that there is a corresponding number of openings that teams need to fill. For example, it there are four good shortstops on the market this means that there are also four openings on team. The increased supply of players is canceled out by the increased demand by teams needing replacements.


Every trade has a winner and a loser
— Swapping resources only takes place if both parties are made better off. Therefore, when we observe trades taking place, it’s likely that both parties are doing so because they expect to improve their teams (see the weak axiom of revealed preference, or as I call it: “the useful WARP“). Mistakes happen, but as a general rule, all parties to trades are winners. Who says economists aren’t touchy-feely?

Players peak at 27 and old players are worthlessPlayers peak at 29 — 30. And just because a guy is past his peak doesn’t mean he’s not valuable. The aging process is gradual, more like the Minneapolis Metrodome than an Egyptian pyramid. If a guy was good last year, even if he’s in his mid-30s, he’ll probably be good next year. Now, the older he gets the more dangerous long-run contracts get, but one- and two-year deals are fine.