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Steve Aschbruner

Renowned economist Murphy lends smarts to NBPA's cause

Posted Oct 27 2011 10:17AM's Labor Central

CHICAGO -- The emails come with increasing frequency, frustrated and sarcastic, quick to comment on the "geniuses" at work whenever the NBA owners and players meet for their latest round of collective bargaining negotiations. In the case of economist Kevin Murphy, though, no quote marks are needed.

Never mind the card-carrying variety -- Murphy, working with the NBA players union during this lockout, is a check-cashing genius. That's the very best kind, as bestowed by the MacArthur Foundation "genius grant" -- $500,000, no strings attached -- he received in 2005 for his research on "seeming intractable economic questions." Back in 1997, he received the John Bates Clark medal awarded to the most promising economist under the age of 40.

He is a professor of economics at the University of Chicago, he's been commuting to the labor talks in New York and, with all due respect to NBA commissioner David Stern, union director Billy Hunter and the others hashing out the league's finances and future, he truly might be the smartest guy in the room.

NBPA economist Kevin Murphy
Courtesy of The University of Chicago

"Kevin is far and away the smartest guy in the field," Freakonomics author and Chicago colleague Steven Levitt said in a 2006 profile of Murphy. "Not only is he widely regarded as the smartest economist on Earth, but he can also fix your refrigerator."

Murphy has analyzed the economics of health and medical research, of addictions and national drug policy and of inequality and labor markets. He was brought in to assist Microsoft during its antitrust battles with the Justice Department a decade ago. He and his former professor at UCLA, Ben Klein, worked with the NFL during the formulation of its Plan B free agency system. He teaches an advanced microeconomics class this term, is known to be a mean woodworker and is mired in his second go-round of NBA negotiations.

"A colleague of mine here, John Huizinga, was the agent for Yao Ming," said Murphy, a sturdy, non-tweedy type of academic known for his trademark ball cap (he reportedly wore one even when he testified before Congress). "I guess Billy asked him, well, do you know any economists who would be good to help. John recommended me. I talked to Billy and started working for them in '05."

Murphy spoke at length with Tuesday evening from his office at the Gleacher Center, the school's downtown campus. By morning, he would be on a flight back to Manhattan for another small-group bargaining session -- the first since talks emotionally broke off last week -- in hopes of ending the nearly 4-month-old lockout.

"I was very pessimistic last week after the Thursday blow-up but I'm beginning to come around and think we've got a shot," Murphy said. "If there's a deal here, it's going to be a deal that nobody likes. That's what deals are. Nobody walks out feeling like they got a complete victory. That's initially. But then you get back to playing and you realize, geez, I can live with this."

Murphy is a transplanted Californian; in fact, he grew up so close to The Forum in Inglewood that he could see it from his house. Working his way through school at grocery stores, Murphy dazzled the economics faculty at UCLA, then enrolled in graduate school in Chicago in 1981. Thanks to geography, the eventual influence of his kids and hitting the Michael Jordan era just right, he shifted his allegiance from the Lakers to the Bulls.

The NBA has its own set of economists, who predictably and respectfully differ with some of Murphy's views on the current labor strife. But in terms of the quality of his advice -- and his role in shaping the union's give-and-take at the table -- NBA players could hardly do better than this superstar of supply-and-demand. People are familiar with a lot of the names and faces in the negotiations -- David Stern, Billy Hunter, Derek Fisher -- but you're largely unknown to fans and the media. Tell us what you do in the room.

Kevin Murphy: My role is to try to really understand the various positions put forward by the sides and how they'll ultimately play out. You talk changes to the luxury tax system or changes to free agency, changes to just about anything, that all has pretty wide-ranging effects on length of contracts, guarantees, salaries, just about everything that matters to the players and to the owners. They're all interconnected, which makes it tough. This is your second time dealing with NBA labor talks, right?

KM: I did this in '05 and tried to build predictions about what was going to happen based on the changes in that deal. Obviously the guys in the NBA office have more experience because they deal with it on a daily basis. They have a team of people who routinely forecast league finances and outcomes, administer the salary cap. I kind of come and go at negotiations. Does each side's economist try to discredit the other's viewpoint?

KM: I don't think it pays to try to pull the wool over the other side's eyes. When it comes to economic analysis, I try to be as honest as I can with the people on the other side.

It doesn't do you any good to try to fool 'em. They're not dumb. You're not going to succeed and then they're not going to trust you. Is economic analysis open to interpretation or do the numbers generate one "truth?"

KM: In certain cases, it's relatively straightforward. In cases like this, there's more room for disagreement. All those moving parts, people can put them together in different ways. Everybody has their own vested numbers, so everybody shapes their numbers in their own direction. If they think 'it' could be between 6 and 12 and 6 is good for them and 12 is good for us, they'll say 7. That's not like making stuff up, that's just saying, 'I'm going to be cautious.' I usually try to say, 'I can't tell you for sure, but it's going to be between 6 and 12.' What's the consequence if it's 6? What's the consequence if it's 12?

Sometimes I see things differently that maybe they haven't thought about. Hopefully that will help move the needle and help move their position a little bit. But my biggest role is to keep my side informed and tell them, 'If you agree to this, here's what's going to happen.' Given the numbers that are out there now -- the owners offering 50 percent of basketball-related income (BRI), the players seeking 52.5 -- it seems like a small gap to close.

KM: Saying that and getting one are two different things. You can sit there and say, 'We're only X apart.' But the other guy can say, 'Well, it's only X, why don't you move?' And you say, 'It's only X, why don't you move?' You can "cut the baby in half."

KM: Sometimes. But people will say, I already cut it in half to get to here. That's certainly our view of the world. We started from where we were. We didn't stretch our position in order to give it up. They started from what objectively -- I think they would agree -- was a massive change in the system and have "given" from there. But if you start 100 miles away and move 50 miles, you can still be outside the range of reasonable. Had they gotten their initial offer, that would have been the most one-sided deal in the history of sports negotiations -- by, I think, a fair stretch. It was an enormous ask on their part. Many people understand that NBA players as a select group of specialized, highly skilled workers. Are there many many instances, though, in which labor commands more than 50 percent of an industry's costs?

KM: In certain sectors, there's a ton. You go to a law firm, most of its cost is labor. You've got to remember, labor is 60-something percent of the economy. In the service sector, it can be much higher than that. And these people really define the product. These are the ones people come to see.

What separates the NBA from a different basketball league? Well, it's the players. The basketball's' the same, the court's the same, it's the players who really are the distinguishing feature. That's not to say that the league doesn't have value. But the defining characteristic and the scarce resource, if you think about it from an economic point of view, is the talent. It's not unlike Hollywood, the music business or any of the other ones where the thing that distinguishes one person from another is the talent. Why do you think it's more so in basketball than other sports?

KM: The difference between being an NBA Finals team and being an also-ran is a couple of guys -- maybe one guy. It's only five guys and you can give the same guy the ball every time you come down if you want to. ... And the players are very visible. It's more of a player-driven sport than [the others], and the advent of the Internet has made it even more so.

It's also changed the game in that people aren't as parochial as they used to be. At one time, people followed their team because they read the local paper and watched the local news. But now I can be a fan of the Lakers and live in ... Seattle. I've got all the Internet access, I've got NBA TV, I've got a zillion ways to be a fan long-distance. That plays right into the structure issues the owners have. They want Milwaukee fans, for example, to not only root for the Bucks but to have most seasons with hope that their team can compete with bigger-revenue markets.

KM: There's an element of that. But also, be careful what you wish for. When you get a Sacramento-Charlotte NBA Finals, guys will be crying over the TV ratings. We know that even with baseball -- it's an exciting World Series but the ratings aren't there because it's the Texas Rangers and St. Louis [Cardinals]. Basketball is even more star-driven. You get to an NBA Finals that doesn't have one of the premier players in the league in it, it becomes a lot less interesting. And with 30 teams, not everybody is going to have one of the premier players. There are fewer franchise players than there are franchises.

KM: For sure. Especially not created equal. You have a relatively small number of true franchise players. Then you have kind of wannabe franchise players. But there aren't 30 Kobe Bryants, LeBron James or Dwyane Wades -- wherever you want to draw the line, but there aren't 30 of them. So do you buy the competitive balance concerns?

KM: You don't want a system where almost nobody has a chance. Then again, the optimal league doesn't look like a crap shoot at the beginning of the years. First of all, there is a lot more interest in some teams than others. The league has done very well that way. When the Bulls were great, that wasn't a bad league. When it was the Lakers and Boston ... there have been a number of years like that. You grew up in Inglewood as a Lakers fan, spanning the time from Wilt Chamberlain and Jerry West to Kareem Abdul-Jabbar and Magic Johnson's arrival. In the 1970s, eight different franchises won the 10 titles.

KM: That was not the greatest time for the league. This complete egalitarian world is unlikely to be the best league. One effect of equalizing payrolls is you incentivize good players to go where the money is available. But another might be paying good money to players who might not deserve it, just because more franchises have to spend on ... somebody.

KM: That's a problem. The other thing is, there is some relationship between pay and success but it's not nearly as strong as people think it is. Even if you were to completely equalize pay across teams, there still would be an enormous variation in strength of teams. In a statistical sense, the level of payroll of a team explains somewhere like 5 percent to 10 percent in the variation in outcomes. That's all?

KM: That's it. I did a little experiment. All you have to do is take the overall distribution of win-loss percentages. Let them tell you what they think the relationship between salaries and wins is. They tell you 'This much spending is worth this many wins.' So then you take everybody's salary down to the mean or up to the mean. Then if you tell me you get an extra win for every $3 million you spend, I'm going to give everyone I'm moving up an extra win for each $3 million. Everybody I move down, I'm going to give one fewer win for each $3 million. And?

KM: The relationship between salaries and the number of wins in a season is positive, but it's pretty weak. It certainly is not going to have a dramatic change in the distribution of outcomes. It might change who the winners are and who the losers are, but you're still going to have some teams that are much better than others. Because some people spend their money much more wisely than others do. That's what the owners say they want: A chance for good management to make a difference.

KM: That's a different issue. The problem is, just about for every [owner] who spent a lot and they won a lot, so you're moving them closer to the average, there's some [owner] who spent a lot and didn't win a lot and you're moving them in the other direction. Even at this late date, from interviews given by Hunter, Fisher and others on the players' side, there seems to be skepticism of the league's financial numbers, as if the audited figures aren't to be believed.

KM: I would say the primary disagreement is not over the accounting numbers. It's what you include and how you interpret the numbers. For example, the accounting picture of the NBA isn't very different from what it was five years ago or 10 years ago in terms of ratio of revenues to costs and all the rest -- it's changed very little. Which immediately tells you, wait a minute, if the underlying financial picture is similar today to what it was five years ago or 10 years ago, and people are paying $400 million or whatever for franchises, and you're telling me that these things lose money every year, something's missing, right? These people aren't stupid, right? These guys are worth billions of dollars. So why did they pay all this money for franchises that, it looks like, lose money?

Well, the answer is pretty clear. There are a couple of things that are really attractive. One is, historically, you've seen franchises appreciate in value and that appreciation has more than outstripped any cash-flow losses that you've had. And if you're in the right tax position, it's actually pretty good because you've got a tax loss annually on your operating and you've got a capital gain at the end that you accumulate untaxed until you sell it and then pay at a lower rate. So you get a deferred tax treatment on the gains and an immediate tax treatment on the losses, that's not a bad deal.

Let's say the NBA is a $4 billion revenue business -- that's not exactly right but it's close enough. Then let's say you lose $200 million. That's 5 percent. OK, my franchises are worth -- let's make it simple, 2 times revenue, which is well below Forbes [valuations] -- that's $10 billion. Now let's say it's appreciating at 4 percent a year. I'm getting $400 million in appreciation even though I only have $200 million in losses. I'm getting better tax treatment on the $400 million that I'm making, and I deduct at a higher rate the $200 million that I'm losing. Suddenly this picture doesn't look so crazy any more.

Secondly, it's a lot of fun to own an NBA franchise... The "psychic benefits" Malcolm Gladwell touts.

KM: The psychic benefits are not trivial. Third, there are benefits outside basketball. Like who got a casino? Who got a land deal? Who got real estate? You start looking around, you say, 'There's a lot of benefits to being an NBA owner." You put all those pieces together, it explains why those people spent all that money for those franchises.

What I keep coming back to as an economist is, "Look, you tell me this is a lousy investment. The No. 1 way to tell if something's a lousy investment, it ain't worth anything." There are a lot of firms that are losing money and are going to go bankrupt, look at what their stock is worth -- it's not worth nothin'. But when you tell me these things aren't worth a lot of money and they don't make money, you immediately hold onto your wallet. You say, "There's a disconnect here. Smart guys, a lot of money -- well, why are you buying it? Why are you buying something that loses money every year?" The owners will say there's been a franchise bubble not unlike the housing bubble. A number of them bought high and don't think they'll see the equity growth.

KM: The fact is, guys have not done well over the last few years as asset prices generally have gone down. I don't doubt that. But to say that you lost money in the worst asset crash in memory -- and franchises haven't gone down nearly as much as many assets have gone down -- that's not telling you you need concessions going forward.

If you go back before the last 3-5 years, these guys did incredibly well. Their franchises weren't going up by 4 or 5 percent, they were going up by 8 or 9 percent a year. They were making money hand over fist. Should [the players] get credit for that? Should we get that money back? Now those are different people in some cases. They need to go get their money from the guys they bought the franchises from. That's the guy who has all your money. Not us.

But who bought anything in '07 that they're happy with the price they paid? If you bought a house in '07, if you bought stocks in '07, if you bought bonds in '07 -- I don't care what you bought, you're not happy with the price you paid. When you buy at the top, you don't make your money. That's not unique to the NBA, that's everywhere in life. But by and large, NBA franchise ownership has been a good investment. You can't base long-run projections on how you did in the biggest financial downturn of the last 50 years. On that basis, there are no good investments out there. But we know that's not true. Management cites rising costs in marketing, ticket sales and other areas.

KM: Ask them to show you how much their costs have gone up as a percentage of BRI. Our moving from 57 to 52.5 covers more than 100 percent of any cost increase they've had. How does it make sense economically to hold out for a small percentage that's much less, in sheer dollars, than what the players are losing by missing games? A gap of 2.5 percent is worth $100 million annually, but a missed month of paychecks is $400 million.

KM: Part of it on our side is an investment in the future. If you give up a lot today, you're not just giving it up today, you start the next contract from that much lower. So you're talking about the long-term impact of that kind of concession.

You can say the same thing for the owners. They're losing money every week. The answer is, both sides are losing in this. It's a shame we can't get a deal. But I'm not going to make it sound easier than it is. It's always easy to say, "Well, one of you guys should give in." But tell me who? And when someone says, 'Just compromise,' at least recently, that hasn't been happening. Maybe it will. Some cynics think the owners wanted to get to this point to squeeze the players via lost paychecks.

KM: I think there's an element of that, a desire to see how far they could push the players to see when the players would crumble. Given that there was not a great cost ... it's almost too bad that it isn't more costly to lose the start of the season. If it had been, they wouldn't have done it. The idea that I can get this, like, almost-free test of the other side's resolve is tempting, right? So maybe they need to set the expiration date of the CBA right before the playoffs to raise the stakes.

KM: That would make a difference. That's the old increase-the-cost way to get a deal. That's true of negotiations in general. It takes the threat of fire to get people to move. When do the rosy growth projections of 4 percent used by both sides take a hit from fans' backlash to this lockout?

KM: If we get a deal here soon, I think the long-term consequences will be minimal. The longer it goes, the more substantial the risk. I think everybody's taken a hit to some extent. It might not show up in the financial numbers right away, but I don't think this has been good for either side. Both sides have looked not so good at times, comical at other times.

I've tried to stay out of it. This is the first interview I've done. I don't think it does any good to throw crap around, spin everything that comes out -- and there's been a lot of that going on. It wears thin on me, I'm sure it wears thin on fans too. Leverage plays a role in economics?

KM: Absolutely. It ultimately is the determinant of what deal you're going to get. Call it what it is. Neither side wants to take a bad deal from its perspective, which makes it tough. Both sides have this mixed constituency, who aren't all on the same page, which makes it doubly hard. It's a shame. I feel bad for the fans, I feel bad for the people who are waiting.

Hopefully we'll be able to get in a room, reach across the table and shake each other enough to get us to a deal. Where do you see this landing?

KM: Ultimately what it comes down to is, you get what you can negotiate. It's not what you deserve, what's "right," that ends up carrying the day. But then they ought to be straight up. They ought to say, "We've got the ability to negotiate. We'll hold your feet to the fire and get what we can."

The one thing I don't want to see happen: I don't want to see any lingering bad blood between the two sides. That's not good either. You run the risk that, if it gets too personal, that creates its own set of frictions going forward. I think people on both sides are cognizant of that.

Steve Aschburner has written about the NBA for 25 years. You can e-mail him here and follow him on twitter.

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