America could ban noncompete clauses by the end of this year. The Federal Trade Commission has proposed to void such existing agreements and ban companies from including them in future contracts.
It’s a seemingly simple change that could have massive repercussions.
Economists suspect noncompetes are one reason middle-class wages have stagnated and productivity growth has stalled. At least one in five, or 30 million, workers are bound by them.
Once limited to high-paid professionals with access to sensitive company information, noncompete clauses are now routinely inserted into contracts for even fast-food workers and hairstylists.
Paired with weak protections against dismissal, noncompetes give American employers too much power in labor relations.
Other countries are stricter
Laws are stricter in Europe. Here in the Netherlands, noncompete clauses are only allowed in open-ended contracts, which protect workers against summary dismissal. Employers need to explicitly justify the need for one in the contract itself.
In Italy and Germany, firms must pay former employees compensation to enforce noncompete agreements.
The best evidence against noncompete clauses is from America itself. California banned them 150 years ago, yet the state is home to the most innovative companies in the world.
Noncompetes do more harm than good
Lina Khan, who chairs the Federal Trade Commission, argues in The New York Times that noncompetes are an affront to economic freedom:
You’re not really free if you don’t have the right to switch jobs or choose what to do with your labor.
She also believes they cause more economic harm than they do good.
The theory is that noncompetes promote investment and innovation by assuring companies that their employees won’t run off with valuable secrets.
Michael Strain, an economist at the pro-business American Enterprise Institute, explains:
If your job is to make minor tweaks to the formula for Coca-Cola and you’re one of 25 people on Earth who knows the formula, it makes total sense that Coca-Cola might say, “We don’t want you to go work for Pepsi.”
Noah Smith, a columnist and economist, points out there is evidence companies in states with strict noncompete enforcement do riskier research. But there is a tradeoff, according to Khan: they stifle business creation.
How can a new business break into the market if all of the qualified workers are locked in? Or if the would-be founder is bound by a noncompete?
That, too, is backed up by research, according to Smith.
Khan suggests nondisclosure agreements and trade-secret laws must be enough for companies to protect themselves.
Workers lose out
Whatever the best regime for businesses, there is no doubt noncompetes are a bad deal for workers.
President Joe Biden told his cabinet they “are designed simply to lower people’s wages.”
The theory is that workers should be able to bargain for higher pay in return. The reality is that maybe 10 percent do.
Employers often spring noncompete clauses on workers after they’ve accepted a job, and they drive down wages for everybody. Firms are less likely to offer a competitive salary or agree to a raise if it’s harder for workers to leave.
When Hawaii and Oregon banned noncompete clauses, wages in those states rose by 2 to 4 percent.
The FTC estimates that banning noncompetes nationwide could add 3 to 4 percent to wages, or between $250 billion and $296 billion per year.
The ban is due to go into effect later this year, following a sixty-day period for public comments and a 180-day transition.