The New Economics of the NBA: Part 2

Thomas Arnold, Hoopism fan and Economics student at William & Mary, has written a great article about the new player/team dynamic from an economic stand point. We really enjoyed it and hope you do to. The article is in two parts, be sure to read part 1. You can follow Tom on Twitter @tomrannosaurus.

Part 2: New NBA Econ 101: Salary Caps and the Demise of Small Market Teams

While LeBron is the first player to fully realize the ‘new’ economics of the NBA, he is not the first player to maximize his utility; he is simply the first to do so while leaving his hometown team. The issue is not with LeBron, or Carmelo, Deron, Dwight or Durant, but with the NBA’s terrible player pay rules. For the past 27 years, the NBA has had a salary cap. Fans of small market teams generally favor the cap as it is supposed to level the playing field for their teams. The NBA has, for 27 years, agreed with this view. This year the annual cap is $20,315,400, and it stands to reason that $20 Million in Milwaukee is the same as $20 Million in New York, right? No. The salary cap is going to disadvantage small market teams in the NBA in the future.

Simple logic would suggest that star players will want more to play in Salt Lake City than they would to play in Washington D.C. However, under the salary cap, the Jazz can’t offer a dime more than the Wizards, even with their small market disadvantage. There is no provision in the current CBA that would let a small market team offer a player more income, than a large market team, even if the player can make millions more in the large market from external sources. So small market teams are out of luck in free agency. What about the draft? If a small market team is lucky enough to draft a player that deserves a max contract after their rookie contract expires, they will most likely not be able to offer the player enough money to stay, rather than leave for a large market or for a team with a better chance of winning a title. The Bird exception does offer some wiggle room, but simply put, the extra money allotted by the Bird exemption is not enough to compensate for players desire for a championship, and not nearly enough to make up for lost external income available in a large market. Small market teams will lose their star draftees to free agency. The cap, meant to level the field, is essentially useless. The cap is broken.

The current breadth of players deserving of max contracts is larger than at any time in NBA history (if all those who receive max contracts deserve them is another issue). At the same time, the cap is still set at a level that assumes that there are only a few players worth maximum money. Teams must then fight for max contract players not based on the money they can offer but on externalities, the chance of a title or large endorsement deals. Essentially the NBA cap as it is currently designed will foster stratification of NBA teams into three categories: Large market teams that offer a max contract player external income, teams that offer a player a shot at a championship, and small market teams that offer neither.

Take, for example, the Knicks. The Knicks are a large market team with little hope for a title within the next two years, yet they have landed two max contract players. It is clear that Amare and Carmelo stand to make millions from playing in New York through secondary contracts that they could not make in Phoenix or Denver. Carmelo and Amare maximized their utility by taking a max contract and external income. The Heat, on the other hand, offer the tantalizing prospect of an NBA title. LeBron and Bosh each maximized their utility by signing with Miami, forgoing some income for an increased chance of a title.

Where does this leave small market teams? Essentially small market teams will be forced to compete under an entirely different set of rules than those teams that can attract max contract players. The Spurs are the perfect example of this. The Spurs currently have no player individually deserving of a maximum contract, and as such are not in jeopardy of losing their team to free agency. Additionally, they have legitimate title hopes and therefore can be expected to remain cohesive. The Spurs accomplished this almost exclusively thought prudent drafting and shrewd trades. The Spurs are the role models for small market NBA teams, while Miami is the prototype for large market NBA teams.

All of this analysis leads to a few clear predictions: small market teams will be forced to draft players from the middle of the pack in hopes that they can mold them into premier players, think Manu Ginóbili and Tony Parker, even if they have the opportunity to draft a future star player. Small market teams will be forced to give up their stars for players that can be offered more money to stay, unlike max-contract players who can be offered the maximum and still choose to go elsewhere, think Carmelo. Large market teams will attract talent because of the external income opportunities. These teams will then be able to attract more talent with their existing talent and the promise of a championship that comes with the concentration of talent.

Baring a drastic change in the CBA, this is the new NBA. Small market teams will become talent mills for large market teams. Dynasties will be formed, Boston, L.A., New York, Miami will compete each year for the title while the Clippers and Golden State incubate talent that they will lose to a team with title hopes. That is, unless the CBA changes the player pay structure. Enjoy the 2010-2011 San Antonio Spurs, because such a masterpiece of mid-level contracts may not appear again for many years to come.