What a Ban on Non-compete Agreements Could Mean for American Workers

Last week, the Federal Trade Commission proposed a new rule that would ban the use of non-compete clauses in employment contracts. Companies would also be forced to inform current employees that any previously signed non-competes were no longer binding. The clauses, which typically prevent workers from joining competitors or starting their own company for a certain period of time after their employment, are already banned or largely unenforceable in a small number of states; many others place restrictions on their use, including for certain categories of employee. Still, about one in five American workers have signed them, and the F.T.C. has claimed that the countrywide elimination of these clauses would generate extra job opportunities for as many as thirty million workers, and raise wages by three hundred billion dollars. The U.S. Chamber of Commerce and other business groups have said that the rule exceeds the F.T.C.’s authority; it is likely to face legal challenges.

To talk about non-compete clauses and how they affect workers, wages, and the broader economy, I spoke by phone with Evan Starr, an economist at the University of Maryland who has studied them extensively. During our conversation, which has been edited for length and clarity, we discussed how non-compete agreements have become so entrenched, the stifling effect that they can have on employees, his responses to the best arguments against the F.T.C.’s proposal, and why various industries may actually benefit from the new rule.

Broadly speaking, what role do non-compete clauses have on the economy?

They are found in all corners of the labor market. They tend to cluster in high-skilled, high-wage jobs. Executives are the most likely to sign them—at a rate of like sixty to eighty per cent, depending on the studies. But they also cover a ton of low-wage workers. One survey that I ran in 2014 found that the modal worker bound by a non-compete agreement is actually an hourly-paid worker who makes a median wage of fourteen dollars an hour. And that’s because hourly-paid workers actually comprise about two-thirds of the U.S. workforce. So, even though you might hear about these more frequently in executive non-compete cases, they’re actually most commonly found among average, middle-class Americans.

Non-competes are a prohibition on workers taking jobs with competitors, or starting to be competitors. This has several effects on the economy. One is that it prohibits workers from joining companies at which they would be a much better fit. That’s going to depress productivity, it’s going to hurt firms—they can’t hire the workers that they want to hire—and it’s going to depress wage growth. You’re also going to see declines in entrepreneurship, because new businesses are harder to form. Even if new businesses can form, it’s harder for them to hire. And then there are follow-on effects from that related to product variety for consumers, because there are fewer firms that are producing the products in the market. There’s less competition, so you might see higher prices. There’s a whole range of effects—on entrepreneurship, innovation, employability, wage growth, and productivity—that arise from non-compete agreements.

What, specifically, is the impact on wages, and how have economists tried to study it?

Theoretically, non-compete agreements can affect wages in two ways. One is that they actually prohibit you from taking a better job elsewhere. And we know that a significant portion of wage growth comes from changes in employers. But that’s not a necessity for wage growth, because even getting a job offer can be leveraged at your current workplace. If you have a non-compete, though, your employer is going to be more likely to ignore a job offer that you just got, and not raise your wage in response to it.

How have economists tackled this? The question that is relevant for policymakers is: What happens when we ban non-compete agreements? That’s the policy-relevant question, because that’s what policymakers have control over. It’s actually a different question than: What is the effect of an individual choosing to sign a non-compete agreement with any given employer? And the reason they’re different is that a statewide or national policy can have all sorts of spillover effects through the whole economy, whereas, when a worker signs a non-compete agreement, we’re talking about just one worker out of many.

What economists have done to study the policy angle is to exploit natural experiments. In 2008, for example, Oregon banned non-compete agreements for many employees, including low-wage hourly workers. And so we can set up a natural experiment by comparing hourly workers in Oregon who are covered by this ban to hourly workers in other states. I have a paper that does that, and what we found is that, for hourly workers in Oregon, their mobility rose after the ban came into play. Their wages rose by, on average, two to three per cent initially, and by about five per cent a few years later.

We have a similar experiment in Hawaii. In 2015, Hawaii banned non-compete agreements for only tech workers, and nobody else in the economy. That set up a nice natural experiment where you can look at tech workers in Hawaii and compare them to other workers in Hawaii after the policy came into effect. Or you can compare tech workers in Hawaii to the tech workers in other states whose policies didn’t change. That’s the approach of most of the studies. And they tend to find similar results: when you ban non-compete agreements, wages rise, job mobility rises, entrepreneurship rises.

Looking at the other side of the equation, how do non-compete agreements affect companies?

I have a study that is not published yet looking at a policy in which the state of Washington banned non-compete agreements for workers making under a hundred thousand dollars per year, according to the state’s labor department. What we looked at in this study was a measure of whether firms value the ability to enforce non-compete agreements. That is a pretty high wage, right? It’s not minimum-wage workers that we’re talking about here. We’re talking about the seventy-eighth percentile of the earnings distribution in Washington for our limited data set.

The whole idea of our study is very clear. If you get a worker who’s making ninety-nine thousand dollars in 2019, the firm, at that point, has a chance to enforce that worker’s non-compete agreement. In 2020, that chance is zero, unless the firm gives the worker a thousand-dollar raise. And so, if the firm values the ability to enforce that worker’s non-compete agreement, it would be willing to pay a thousand dollars to get that worker to have an enforceable non-compete. That’s the empirical test. It’s pretty straightforward. All you have to do is look at the earnings distribution in 2019 versus 2020 and after, and see if there is a spike in the earnings distribution at a hundred thousand dollars.

We found no evidence that firms are giving workers raises to reach that threshold. We supplemented this with a survey of employment attorneys in Washington, who told us that, even for workers at the seventy-eighth percentile, firms rarely need to go to court to actually enforce their non-compete agreements. Firms have other tools to protect their interests. The main point we’re trying to make here is that employers often say, “We need enforceable non-compete agreements.” Our study asks, “Well, are they putting their money where their mouth is? Are they actually giving workers some very small raises for the chance to enforce their non-compete agreement?” And the answer is that they’re not. What that reveals to us is that, really, they don’t value the ability to enforce these things.

Do we have some sense of how industries are affected broadly when there are lots of non-compete agreements?

Yeah, the industries in which non-compete agreements cluster tend to be high-skilled industries: manufacturing, professional services, and technical services. And we do have a range of studies suggesting that, in industries where enforceable non-compete agreements are used en masse, the whole labor market is slower-moving, there are fewer job offers made, worker wages are lower, job mobility is lower, and job satisfaction is lower. The whole industry suffers, because who is going to start that new firm when everyone has a non-compete agreement? Who are you going to hire? These agreements can gum up the labor market for everybody and prevent workers from really making it to the firm at which they’re most productive.

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