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The Power of Competition

Posted By Russ Roberts On May 1, 2007 @ 12:43 pm In Competition | Comments Disabled

In a number of recent posts, there have been comments questioning whether "the market will solve all problems," or whether competition works as advertised. In my post on the myth of clutch hitting, K. Williams wrote:

All these baseball people, who spend all of their lives presumably
thinking about the game and about ways to improve their own performance
and the performance of their players and (if they’re in management)
about what creates real value on the field, and they all have an
essentially false view of something as fundamental as clutch hitting.

Why is it, again, that we’re supposed to believe that competition ensures that people will make optimal decisions?

A similar complaint has been made about the insights of Billy Beane, the GM of the Oakland A’s who discovered that players who walk a lot, all other things held equal, are undervalued in the market for baseball talent. How could this insight go undiscovered for so long? Why do some teams still ignore on-base percentage?

My claim is that baseball, while competitive (in the everyday sense of the word), is not a very good testing ground for the power of competition as economists use the term. It’s not a very good measure of how competition works in markets even though there is a "market" for baseball players in the everyday sense of the word.

The biggest problem with generalizing from baseball to the rest of the economy is that if you do a lousy job in baseball, you still make a lot of money. That is hard to do in most markets. In most markets, if you fail to keep up with your competitors, if you use outdated technology, if you fail to please the customer, you don’t just make less money than your competitors. You go out of business.

In baseball, you can have an inept owner who hires an inept general manager, who signs inept players (or who doesn’t  bother signing ept ones), who fails to spend sufficient money on the fundamental assets necessary to excel, who signs players who do the little things and the big things badly, who neglects the team’s farm system. You can perform poorly, year after year and you can not only survive, you can thrive.

Since 1998, the Kansas City Royals have been horrible [1]. They have won more games than they’ve lost only once in that span. The other years, they’ve been dreadful. They’ve lost 100 games or more four times since 1998. Yet according to Forbes [2], the value of the franchise doubled between 1998 and 2005.

Even though the Royals are terrible, the Yankees can’t drop them from their schedule. Despite fielding a mediocre team, when the Yankees or the Red Sox come to town, the Royals draw a nice crowd. Even though the Royals are terrible, the owner keeps the team. Can a different owner buy him out the way he would if another asset weren’t used to its full potential? It’s possible but it’s not easy. There are only 30 baseball teams. If an owner sells he can’t just buy another one. So the non-monetary thrills of owning a team can’t be easily replaced. As long as an owner gets sufficient non-monetary thrills from being an owner, he will rationally turn down lucrative offers.

The other owners would prefer a more profitable franchise in Kansas City, but not too profitable. They would prefer better attendance when the Royals come to their parks but they are happy that the Royals are not a threat to win the pennant. So there is little incentive for the other owners to force out the owner in Kansas City for performing so badly. The owners almost never force out a mediocre owner who doesn’t try very hard. Having a few of those is tolerable.

So while baseball has competition in the sense that teams play each other and keep score and while baseball keeps precise measures of relative performance (called the standings), baseball is not competitive in the traditional economic sense. There is no free entry or exit. Excellence is rewarded (as long as it is relative excellence) but mediocrity is not punished.

In such a world, it is not surprising that the best strategic ideas can take a while to be adopted by baseball teams. It is not surprising that racism can persist for years in the explicit form of a color line and it is not surprising that even after Jackie Robinson, teams can be slow to sign African-Americans.

In the competitive world of sports, you can indulge your preferences for hiring a pleasant fellow as a general manager rather than a smart one. You can indulge your preference for hiring someone with your skin color. And you can indulge your preference for hiring someone who is not much of a risk-taker. In fact, a risk-taker is a bit scary.

After a while, if enough of the other teams start signing African-Americans or using better decision-making heuristics or starting a baseball academy in the Dominican Republic, the costs of your inadequate strategies might get so costly that you join the new ways of doing things.

But I don’t think you want to argue that because baseball teams forgo profit by using crummy heuristics for what makes a good player or a good team or a successful strategy, that markets don’t work very well.

Contrast the market for baseball players or baseball strategies with the market for restaurants. Consider the following insight from a former student of mine, Steve Daley. Every town in America over a certain size (50,000, maybe) has a Chinese restaurant. There’s no Chinese Restaurant Czar to allocate Chinese talent to towns and cities all over America. The profit motive is sufficient. A town with more than 50,000 people but no Chinese restaurant is a forgone profit opportunity. Somehow, word gets around. And a town of 150,000 people with only one Chinese restaurant or attracts others. If a Chinese restaurant is badly run, it usually goes out of business and another one opens that does a better job. And in bigger cities, the standard for what is badly run is more demanding because there are even more competitors both in the Chinese niche but also outside of it, competing with the Chinese restaurants.

Finally, consider my local grocery store in a prosperous Maryland suburb outside of DC. I went in there the other day and the shelves in the soft drink section were half empty. It’s not the first time I’ve noticed this. You’re out of root beer I told the cashier. Oh, she replied, we can’t do anything about that. They just show up when they show up, she explained. I suggested that she might want to tell the manager to ask them to show up more often. She shrugged.

There’s are only two grocery stores in my neighborhood (both owned by Giant) and both are run poorly relative to other grocery stores in my experience. A failure of markets to serve customers? My guess is that it’s a lot harder to open a new grocery in my neighborhood compared to other neighborhoods—a combination of various zoning regulations [3]

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[1] the Kansas City Royals have been horrible: http://www.baseball-reference.com/teams/KCR/

[2] according to Forbes: http://www.forbes.com/2005/04/06/05mlbland.html

[3] various zoning regulations: http://cafehayek.com/2004/11/smart_growth_as.html

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