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

Companies often prevent employees from joining rivals. The Biden Administration wants that to end.
Hands points to text on paper another hand is holding a pen
Non-compete 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,” the economist Evan Starr says.Photograph from Getty

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.

There’s an argument that non-compete agreements might not be necessary for low-wage workers, but that they’re absolutely necessary for C.E.O.s, and others at the very top of the food chain, in part to protect corporate privacy. What do you think about that argument?

It’s a fantastic question, and it’s one that I think policymakers have been dealing with. During the last six years, if you look at what states have been doing, they’ve typically been allowing higher-wage non-competes for executives and top managers. And I think that the justification is “Yeah, we need these agreements for these sorts of workers.”

I’ll just summarize a recent paper, which is by Liyan Shi, at Carnegie Mellon University. She studies the executive labor market, where we actually have data on who signs non-compete agreements for publicly traded companies. What she tries to do is characterize the optimal non-compete policy by quantifying, on the one hand, the investment incentives that firms might get from non-compete agreements, in terms of protecting their resources, and on the other hand, the misallocation of executive talent across firms. An executive is employed at Firm A. If they want to join Firm B, they’re prevented from doing so by their non-compete agreement. But maybe they’re actually a much better fit at Firm B. And, because executives make such important decisions for the companies, these situations can have enormous implications for value. So she builds a model that shows the tension between these two channels, the misallocation of labor across firms against the investment incentives in the executive market, and her finding suggests that the optimal policy is close to a California-type ban, even for executives.

Another argument is that, without non-compete agreements, companies will share less with their employees, stifling innovation. What do you think of this argument?

Non-compete agreements are such a blunt tool to use when more narrowly tailored tools can suffice. For example, firms have nondisclosure agreements, which can prohibit workers from sharing information. They have trade-secret laws. The non-compete agreement is the most blunt of all of these, because it protects things by prohibiting mobility in the first place. It's also why firms might value them, because they do protect in such a blunt way.

People will say, “Well, I need to train my employees, and I need to restrict their ability to leave after I train them so that I can recoup my training expenses.” This idea has been around for a long time, and some states do recognize special training as a legitimate interest for enforcing a non-compete agreement. But here’s the issue: If you take a worker who has been trained and the non-compete has been used to justify that training expense, why does the non-compete agreement apply ten years into their tenure, or twenty years into their tenure, well after they’ve repaid the training expenses? If the non-compete is really about justifying the training expenses, all you’re concerned about are those early years, when the worker hasn’t repaid them.

You just figure out how much you are going to have to spend on training the worker. If you’re going to send them to get an M.B.A., for example, you know exactly what that cost is, and then you just have a training-repayment contract that says, “Hey, we’re going to give you this much in training expenses. If you leave before a year or two, or whatever it is, then you have to pay back a portion of the training expenses that we didn’t recoup yet.”

Do you have any examples that illustrate how absurd non-compete agreements have become?

There are so many. Non-compete agreements are everywhere. My wife was a volunteer for Girls on the Run, which is a nonprofit that develops exercise programs for girls. And to be a coach for Girls on the Run, including in Silicon Valley—if you download the Silicon Valley volunteer contract to work with Girls on the Run, it states that you won’t create or contribute to a program similar to Girls on the Run for two years after your involvement. You’re asked to sign a non-compete in Silicon Valley to be a volunteer for a nonprofit in a state that essentially hasn’t enforced non-competes since 1872. [A spokesperson for Girls on the Run said that the organization would be discontinuing the practice this year.] So, non-compete agreements are just everywhere, and they’re easy to include in employment contracts.

Does this suggest that, although a lot of non-competes really do prevent people in certain industries from leaving their jobs and really have an effect on wages and on the broader economy, a lot of them are almost like a product of inertia and there is no real attempt to enforce them?

There’s been an idea around for a long time that boilerplate restrictions persist despite market forces changing. And so, if you think about a typical mom-and-pop firm or even a corporate firm, they don’t want to revisit their employment contracts all the time. They don’t want to hire lawyers. Once you have that language in there, it’s easy to just keep it, to apply it to everybody in the company. If you go to rocketlawyer.com, you can write a non-compete agreement and download it with a free trial. So, I do think that they include these things as boilerplate and it’s not totally clear that they’re thinking about it.

At the same time, when a worker signs an employment contract, they put their signature on a line, and their default perception is that that contract is enforceable. And, when workers do leave, enforcement doesn’t always happen in the courts. Enforcement, in fact, is mostly informal. During your exit interview, you’re going to be reminded of your non-compete obligations. If you do join a competitor, the firm might send you a threatening letter. The firm might send the firm that hired you a threatening letter.

And most workers don’t have the money or the resources to fight even a totally frivolous lawsuit. We found that this is actually most pernicious in California. I have a paper called “Subjective Beliefs about Contract Enforceability,” in which we looked at reminders that firms give workers about their non-competes. And it turns out that firms in states that do not enforce non-compete agreements are the most vigorous at reminding a worker of their non-compete obligations, even though there’s no chance that the court would actually enforce those agreements.

Will the F.T.C.’s proposal have different impacts on different macroeconomic environments?

Sure, yeah. There are open questions about how firms are going to respond if this policy comes into play. There is a great experiment already happening. There’s one notable occupation in the whole U.S. for which non-competes have been mostly unenforceable since the nineteen-sixties. And that is lawyers. Lawyers invalidated non-competes among themselves. One justification was that, when an attorney signs a non-compete agreement, if they’re forced to sit out of the labor market because of it, then the clients they worked with have lost their attorney, and the client’s freedom to choose counsel is sacred. I don’t hear lawyers clamoring for more non-compete agreements to protect training investments or to protect client lists. It’s one of these really interesting case studies because lawyers, of course, are the ones enforcing these agreements, but they themselves aren’t subject to them.

We also have Silicon Valley. California has invalidated non-competes since 1872. Non-competes are still found in California, but I’m sure it’s at upper levels, and workers are generally aware of these laws. And so the California example suggests that maybe you don’t need to enforce these agreements to spur entrepreneurship, to create really valuable companies and trade secrets.

Those two examples should give us some pause in concluding that we’re going to see significant harm from a policy like this.

We are in a moment of inflation right now. Some people will say, “Well, if you raise wages, that might make inflation worse.” That perspective is inaccurate for several reasons. We do have evidence on how non-compete policies influence prices. They actually go the other direction. When you enforce non-compete agreements, prices rise. And part of that comes from the fact that non-compete agreements restrict entry. They promote concentration, and they favor incumbents over new entrants. When you have fewer firms who are serving the customer, prices go up.

By banning non-compete agreements, you actually make labor markets more competitive. Firms eventually will hire more workers, because part of the lack of competition is that firms actually cut back on hiring at lower wages. When you have a competitive labor market, it actually increases hiring, which will push up the quantity that firms produce, and that will actually push down prices. So I think there’s confusion on this point about the wage angle alone. Competition is, in general, good for prices, it’s good for consumers, and it’s good for workers. ♦