Noncompete Contracts Can Help Both Workers and Firms

Noncompete Contracts Can Help Both Workers and Firms

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Non-compete clauses, contractual provisions that prevent employees from taking jobs with rival businesses or starting competing firms for a period of time after they leave, serve beneficial purposes for both workers and companies. It would be better to regulate them than ban them entirely, as the US Federal Trade Commission has proposed.

The value of non-compete clauses is easy to illustrate. Say you run a hedge fund. Many members of your commercial team will have partial access to your firm’s trade secrets, and if they leave, they may take those secrets with them. In the absence of non-compete agreements, firms would be more likely to “internalize” information—becoming less efficient and less able to pay higher wages.

Non-disclosure agreements for workers in such positions are common, but they are difficult to enforce – making non-compete agreements all the more important. How exactly can you find out if another newly created hedge fund is using your trading algorithms?

Or say you’re a sales company with a list of clients, or a non-profit organization with a list of donors. An employee who sees those lists may use that information to start a competing business or obtain that information from competitors. It seems reasonable to limit the ability of employees to “jump ship” in such cases.

If non-competition is completely banned, to reiterate, the effect will be less information sharing within the company. Young workers in particular, who have not demonstrated their long-term loyalty, will find it difficult to access information and move forward. More older workers will have the advantage, hardly a formula for increasing economic opportunity.

A more general principle applies: Employers will invest more in training their workers if they know their workers cannot easily transfer those skills to their competitors.

Non-compete agreements have anti-competitive effects, of course, which are not always positive. A company with a lot of hiring power, for example, might insist on not competing to tie workers to the firm and limit their outside opportunities. It is appropriate for the regulation and antitrust law to evaluate such cases and where necessary to limit the use of the clauses. But keep in mind that noncompetes only cover about 18% of US workers, so it’s unlikely that employers will force them all.

As a matter of law, the state of California does not enforce non-compete agreements. This has stimulated the technology sector and its startup environment. But California’s economy has some special features. The world of technology is a series of interconnected parts that make each stronger, and many of the most popular companies have a strong moat. With or without non-competes, it’s hard to break away from a big tech company and start competing with them. Such a company, on the other hand, is not so afraid to give its employees special knowledge.

The non-enforceability of non-competes in California seems like the right policy. But it might not be appropriate in, say, Nebraska.

Most states already limit non-compete provisions and insist that they take a reasonable form. The current mix of restrictions may not be ideal, but the status quo hardly gives the practice unfettered reign. It leaves some room for non-competes and allows states to exercise legal and regulatory discretion. For example, in recent years Oregon, Massachusetts, and Washington passed laws that limit noncompetes to low-wage workers only. Could this be a superior approach? Federalism might provide an answer, but a national ban would not.

The FTC estimates that eliminating non-competes would raise US wages by $296 billion. However, this number is based on extrapolation from selectively chosen studies that link wages to legal differences, but that do not adequately consider other factors. A 2019 literature review by the FTC, written before the issue became so politicized, offers a more reasonable conclusion:

There are several channels through which NCAs can affect wages, including increasing investment in people and other intangible forms of capital, and reducing wage competition by improving employers’ bargaining position and reducing the entry of competitors. Empirical evidence on which channel tends to dominate is mixed.

Much of America’s genius is based on experimentation and federalism. The current FTC, on the other hand, is rapidly becoming overrun. It operates under what the economist Friedrich Hayek called the “knowledge claim.”

More from Bloomberg Opinion:

• Eliminating non-compete agreements could hurt workers: Stephen Carter

• Many workers are blocked by non-competes: Editors

• The tyranny of the non-compete clause: Justin Fox

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This column does not necessarily reflect the opinion of the editorial board or of Bloomberg LP and its owners.

Tyler Cowen is a Bloomberg Opinion columnist. He is a professor of economics at George Mason University and writes for the Marginal Revolution blog. He is the co-author of “Talent: How to Identify Energizers, Creators, and Achievers Around the World.”

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