Mention the words "reserve clause" in a crowded sports bar and within seconds the noise level will exceed 100 decibels as 12 guys try to tell you free agency is the root of all that's wrong with baseball while another 15 will say it's a man's right to earn his wages and sell his wares to the most willing buyer. The debate is endless (and often times, scrutinized to the point of inanity), but there's no doubting that the reserve clause is one of the most argued points in all of Major League Baseball history.
Beginnings
When the first organized baseball leagues were forming in America, there were little profits to be made: owners had to stick it out for the long-term, and to do this meant cutting costs whenever and wherever possible. By far the most expensive aspect of operations was player salaries: supply and demand ensured the owners with the most money would have the best talent, thereby dominating the league and generating more attendance, leading to a spiraling economic gap in the league.
To prevent this, in 1879 owners in the National League agreed to reserve 5 players on each of their teams. No other team would be allowed to sign or attempt to sign a reserved player. The agreement was kept secret at first, but soon its inner workings were revealed and it was added to the National League's Constitution. Players didn't complain at all - being made one of the five reserves was a badge of honor and worth. It is important to note that almost all of the talent within the league was local talent; it was rare to see more than one or two trades throughout the year.
Grumblings
In 1883, the American Association and National League formed a coalition, and the number of reserved players increased to 11. In 1887, it was raised again to 14. Since the roster was limited to 21, this meant 2 out of 3 players could not leave their current team. Many players began to complain that they weren't being paid what they thought they were worth. John Mongtomery Ward, a first baseman for the Baltimore team, complained: "Like a fugitive slave law, the reserve rule denies him a harbor or a livelihood, and carries him back, bound and shackled, to the club from which he attempted to escape."
When players began quitting to join other upstart leagues (most notably the Players' League, formed in 1890), the owners tried to invoke the reserve clauses, but court after court upheld the player's right, one of them even citing the Thirteenth Amendment, which barred involuntary servitude, as grounds for its decision. Yet no one ever took the case to the Supreme Court, and the reserve clause remained a standard part of many players' contracts.
Dissent
When Curt Flood was traded from the St. Louis Cardinals to the Philadelphia Phillies in 1970, he refused to report, instead suing Major League Baseball for antitrust violations. Flood's case went all the way to the Supreme Court, and although he lost, the owners made it clear that they felt this issue should be handled via arbitration and collective bargaining. This would be the beginning of the end of any practical application of the reserve clause.
In 1975, Andy Messersmith and Dave McNally both pitched without signing contracts, and then claimed they were free agents, since the reserve clause did not apply to them. Major League Baseball's arbitration panel, headed by Peter Seitz, oversaw the proceedings and ruled in favor of the players: they were free to sign with whoever they want. Suddenly a bidding war emerged for Messersmith (he eventually signed with the Atlanta Braves for a $1 million "lifetime" contract). A new agreement was signed between the owners and the players in 1976 which allowed players with 6 years of major league experience to declare free agency and seek arbitration. Free agency blossomed, and today, many players peddle their wares to all teams, which occasionally lead to some very interesting bidding wars and contracts.
Summary
Of course, it is easy to argue that the balance of power shifted heavily from the owners to the players. Some say this has ruined the game because players are greedy and don't care about the game as they used to; others say that since the owners are running a business, they wouldn't pay the players what they do if they didn't feel it was a good business decision. Whatever the case may be, the reserve clause's role in the financial history of Major League Baseball can't be denied.
A minor interesting side note is that the National Hockey League also used a reserve clause until 1972, when it switched over to the option clause favored by the National Football League and the National Basketball Association (which binds a player to his team for one more year after his contract expires).