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The economic answer behind superstar salaries

The economic answer behind superstar salaries

Rugby Union’s Premiership season is underway again.

This is yet another professional sport which operates on the principles of socialism: the money all ends up in the pockets of what we might call the “workers”.

In a sport which was allegedly only played by amateurs until the mid-1990s, earnings have boomed. The average salary in the Premiership is over £200,000, and the stars are paid around the one million mark.

As a result of such payments, most of the Premiership clubs are only kept afloat by huge loans from their owners. Their accounts for 2016/17 were released at the end of August. Bruce Craig has put £18m into Bath since 2010. Bristol owe more than £20m. Wasps have liabilities approaching £50m.

But the players’ earnings are mere shadows of those of the top American sports stars. According to Forbes magazine, in the year to June 2018, the 100 best-paid athletes made $3.8bn between them. The boxer Floyd Mayweather topped the list with $285m.

Stars of popular culture pull in similarly staggering amounts. George Clooney earned $239m and Dwayne Johnson was the second highest among male actors at a mere $119m.

These vast sums appear to pose a challenge to economic theory. These players and actors are very good, but they are not so stupendously better than others who get paid very much less. How can this be explained?

The answer was provided in a brilliant article by the American economist Sherwin Rosen as long ago as 1981, entitled “The economics of superstars”.

Rosen based his theory on the fact that activities such as watching a sport or going to a film involve what economists call “joint consumption”.

If I am watching Arsenal, say, on the television, it does not matter how many other people are viewing at the same time. The game is still available for me to watch. In contrast, if I book a table at a popular restaurant or a particular seat on a flight, no one else can use it.

In 1880, if you wanted to hear a particular singer, you had to go to a live performance. Perhaps a thousand people could enjoy the joint consumption of the product. In 1980, tens of millions could watch on television.

Rosen, writing well before the internet, argued that advances in communications technology such as radio and television increased enormously the potential size of markets involving joint consumption. As he put it so succinctly, “the possibility for talented persons to command both very large markets and very large incomes is apparent”.

For example, the football played in England’s Premier League is in general better than that in the Scottish Premiership. But the English league rakes in well over £1bn a year in television rights, and Scotland less than £20m.

It is the combination of the joint consumption nature of these services and advances in communications which mean that a relatively small number of sellers can in principle service the entire market.

The more talented they are, the fewer still are needed. And that’s how they are able to earn so much.

Paul Ormerod 

As published in City AM Wednesday 12th September 2018

Image: Twickenham Stadium by David Iliff licensed under CC-BY-SA 3.0
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From supply and demand to game theory, football is full of economics lessons

From supply and demand to game theory, football is full of economics lessons

The football transfer window closes tomorrow, and the opening days of August have seen the usual flurry of activity at all levels.

The window in the rest of Europe stays open until the end of the month. Do we detect here the hands of Monsieur Barnier, in another dastardly European Commission plot to do us down?

Sadly, the reality is more prosaic. The Premier League clubs themselves voted this year to bring the official Fifa deadline forward. They were concerned about the negative impact of transfer uncertainty and speculation on their players.

Obviously, clubs buy players to try to strengthen their team. And there is no doubt that money talks. The more you can offer in wages, the better the quality of the player who will be interested in playing for you. The more cash you have, the more you can afford to buy them.

The correlation between spend and success is not perfect. But as a rule of thumb, teams in the top six of the Premier League spend on players’ wages at least twice the average amount of the bottom six.

Both the wages paid to an individual player and the amount paid in a transfer fee contain implications for economic theory.

In a modern economy, very few markets operate in complete conformity with the standard supply and demand model of the textbooks. The football market is no different.

All scientific theories have to make assumptions. One of the assumptions in this basic model is that the commodity being traded is homogeneous. In other words, each individual product which is bought and sold in the market is identical to every other one in the same market.

In this idealised world, price is determined by the balance between supply and demand. But products can differ in many subtle ways.

If they differ too much, they are no longer operating in the same market. The journeymen players in Leagues One and Two – the bottom two – are not competing in any way with the likes of Harry Maguire of Leicester and the England team, who is the subject of strong speculation of a bid from Manchester United.

Within the same market, supply and demand get you to a benchmark region, but not to the final price.

Ben Gibson, who has been in the England squad but has not yet played for the national side, has just been bought by Burnley from Middlesbrough. Burnley wanted a good defender. Middlesbrough, which narrowly failed to return to the Premier League last season, needed the cash. So supply and demand played a part in the transaction.

But why was the fee £15m? Middleborough could not have realistically asked for £50m. You get a world-class defender for that amount. Burnley could not have offered £5m. They would have been shown the door.

Supply and demand feature in setting a fairly broad range for the price. But within this band, it was indeterminate. Game theory is needed to understand the process which led precisely to the £15m figure.

Increasingly, a lot of modern economic theory is about bargaining, rather than the basic supply and demand curve. It makes it much more difficult for students, but more realistic.

As published in City AM Wednesday 8th August 2018

Image: Premier League Football Pixaby is licensed under CC0 1.0 Universal
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Never mind who wins, the World Cup is a treasure trove for curious economists

Never mind who wins, the World Cup is a treasure trove for curious economists

Our boys make progress – and I don’t mean on Brexit.

On a visit to Glasgow last Thursday, a popular Scottish newspaper had a mock-up photo of Harry Kane lifting the cup. In massive type, the headline shrieked “This Would Be the End of the World”. Yes, it would rather put the Highland Clearances into perspective.

There is a general perception this year that the football has been more entertaining than usual. This is reflected in the fact that the average number of goals per game – 3.18 – is the highest since the 1958 finals.

The qualifiers for the last 16 generally followed the form book, with only three of them – Russia, Denmark, and Sweden – edging out teams placed above them in the FIFA rankings before the tournament started.

But the patterns in the results show once again how close many of the teams are in ability. One team has to win, though it is not obvious which one.

Germany’s own qualifying group illustrates the point. A key concept in economic theory is that of transitivity. It essentially means that preferences should be well-structured.

If I prefer product A to product B and product B to product C, the assumption is that I prefer A to C.

If we carry this over into team sports, it seems logical that if A beats B and B beats C, then A should beat C.

None of these “transitive triples”, as the jargon puts it, were observed in Group F. Mexico beat Germany, who beat Sweden. But Sweden beat Mexico. Sweden also beat South Korea, who beat Germany.

The conclusion is that the teams in this group were very evenly matched. It was largely a matter of chance rather than superior ability that Mexico and Sweden qualified.

In the round of 16, three of the eight games ended in draws and the result was by penalty shoot-out. Two of the others were decided by goals deep into injury time. And one of the quarter finals was won on penalties.

Again, the implication is that there is a great deal of randomness in the outcome. Even in England’s famous victory over Colombia, the opposition goalkeeper got his hand to the final penalty shot but could not prevent the ball entering the net. Move his hand by just a few centimetres, and he saves it.

To round off this football economics analysis, finally and frivolously, is winning the World Cup good for the economy? I looked at the eight years from 1974 when European countries won.

As a control group, I examined the US and Australia, two western economies where soccer is a minor sport. Growth in a World Cup year was higher than in the previous year seven times, and lower nine times. Growth was higher in the year after the World Cup nine times and lower seven. So the pattern here looks completely random.

In the countries which won, growth was higher in the World Cup year than the previous on four occasions, and lower on four. But in contrast to the control group, growth in the year after victory fell six times out of the eight.

Winning the World Cup is bad – or so the statistics say!

As published in City AM Wednesday 11th July 2018

Image: World Cup 2018 by RonnyK is licensed under CC-BY-0.0
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Anyone for England? The World Cup and business stardom are both games of luck

Anyone for England? The World Cup and business stardom are both games of luck

The 2018 World Cup in Russia kicks off tomorrow.

This time, at least, there is little feeling that our boys will emerge victorious.

And yet. There is a great deal more randomness in the outcome of soccer games than is generally appreciated.

A striking feature of games in the World Cup is that they are low-scoring affairs. Leaving aside the penalty shoot-outs, the average number of goals per game in the 2014 finals was just 2.75 – and this includes the memorable semi-final in which Germany overwhelmed Brazil 7-1.

In the 2010 finals, the average number of goals per game was even lower, at 2.25. This range, between 2.25 and 2.75, has been the experience of all finals since 1962.

Clearly, in low-scoring games, chance has a great potential to influence the outcome.

No fewer than 45 per cent of all games in the 2014 finals were decided by a single goal. A further 21 per cent ended in a draw.

We might expect greater disparities in the qualifying phases of the World Cup, where the skill levels of the teams may differ much more.

True, in the European qualifiers, only half of all games ended in a draw or victory by a single goal, compared to two thirds in the 2014 finals. But countries such as Gibraltar, Lichtenstein, Andorra, and San Marino were involved.

In the African qualifying rounds, where there are less obvious disparities between the countries, again two thirds of all games were either drawn or won by just one goal.

Football reflects the broader world. It is not always the fittest, to put it in Darwinian terms, which come out best in any given situation. There is more pure chance involved in success than many would care to admit.

A classic example of the impact of chance is Windows. The first two versions, way back in the mid-1980s, struggled to gain acceptance with consumers. Marlin Ellers was Microsoft’s lead developer for graphics on Windows, and he gives a fascinating account of the times in his 1998 book, Barbarians Led By Bill Gates.

Before Windows 3 was released, Microsoft announced that it would carry out no further development of the system. The operating system of the future, it believed, would be something else called OS2, being developed in partnership with IBM.

To everyone’s surprise, Windows 3 sold two million copies in six months. The rest is history. Had the company given up one iteration earlier, Windows might never have taken off.

All this said, quality or skill is not completely squeezed out. In all the World Cup finals since 1930, 77 teams have participated, but only 12 have ever made it to the actual final game, and a mere eight countries have won. Just three – Brazil, Italy, and Germany – have won 13 out of the 20 tournaments between them.

Amazon and Google, Brazil and Germany, all develop a tradition of excellence, which is hard for others to overcome.

Hard but not impossible. In any process which involves innovation, whether evolution itself, business or team sports, the potential is always there for an outsider to triumph. Anyone for England?

As published in City AM Wednesday 14th June 2018

Image: FIFA World Cup by By Isak Aronsson is licensed under CC2.0
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Money talks in football, but all incumbents are displaced eventually

Money talks in football, but all incumbents are displaced eventually

The Premier League season opens on Friday against a background of stratospheric transfer deals, with Paris Saint Germain capturing the Barcelona striker Neymar for a world record €222m.

With the exception of Cristiano Ronaldo’s transfer from Manchester United to Real Madrid in 2009, all the top 10 most expensive player deals ever have taken place in the past four years.

No fewer than 33 of the top 100 of all time have happened in 2016 and 2017. Only one of the top 100 dates from the twentieth century: the €49.5m transfer of Christian Vieri from Lazio to Inter Milan, in 1999.

The stupendous flow of money into the game at the top level has created a self-reinforcing system. The rich clubs get richer. They can afford to buy the best players, which means they are even stronger on the field. And as a result, they attract even more money.

Yet this very process makes the competition more boring for spectators, in the sense that the outcomes at the end of the season become more predictable.

Arsenal have finished in the top five for each of the past 20 seasons. Manchester United have been in the top five – indeed the top three – in no fewer than 18 of these. Chelsea have occupied one of the top three places in 12 out the previous 14 seasons.

Manchester City were taken over by the Abu Dhabi United Group at the start of 2008/09, and in subsequent seasons have always been in the top five.

La Liga, the Spanish equivalent, has become dominated by just two clubs, Barcelona and Real Madrid. We have to go back to 2001/02 for a season in which one of them was not in the top two. In the past decade, they have won the league nine times between then, and also finished second nine times.

Money talks in sport. Celtic swept aside all opposition in the humbler setting of Scottish football last season, being unbeaten in all competitions. Their wage bill exceeded the total spent by the next six teams in the league combined.

But to put it into perspective, Celtic only paid out 80 per cent of the salaries at Burnley, which was easily the lowest spending team in last year’s Premier League.

Little wonder that Scottish teams struggle in European club football. Last season’s second and third, Aberdeen and Rangers, have already been eliminated in the 2017/18 preliminary rounds of the less glamorous competitions by teams from Cyprus and Luxembourg.

These massive inequalities seem to be characteristic of popular culture in the twenty-first century. Think of the current dominance in their respective spheres of Google, Facebook and Amazon.

We know that evolutionary forces are still at work in all of these markets. Myspace was the largest social networking site in the world until 2008, when it was overtaken, and then totally eclipsed, by Facebook.

It is always hard to imagine how the top incumbents can ever be displaced from their dominant position, but they inevitably are – eventually. Maybe Burnley and Bournemouth will be the teams of the 2030s.

As published in City AM Wednesday 9th August 2017

Image: Neymar by Alex Gau is licensed under CC by 2.0
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