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Thursday, March 7, 2024

There’s Nothing Wrong with Non-compete Clauses

Non-compete clauses get a lot of hate, but the arguments against them don’t have much merit.

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What is a non-compete clause (NCC)? It is an agreement, usually between the buyer of a business and a seller thereof, that at least for a specified time period, and usually in a given geographical area, the latter shall not compete with the former.

For example, dentist or lawyer or grocer A sells his practice or emporium to B. Part of the contract of sale provides that A will step aside and not stay in operation, certainly not compete against B.

This type of commercial arrangement also takes place between an employer (B) and an employee (A). B hires A if and only if A agrees not to compete with B, nor share trade secrets with any future employer, should they go their separate ways in the future. Again, a time period—and a geographical area, if relevant—is often specified.

Why do these types of contracts occur? It is easy to see the benefits for the Bs—the buyers or the employers. There are only so many customers out there in them thar hills, and the fewer the competitors for them, the better off the newcomer (or the employer) is. The As of the world often have a long-term relationship with their patrons. They are now in effect recommending them to the Bs. The latter are willing to pay for this goodwill in the hope that these new folk will come to patronize them. But if the As can open up shop a short distance away from their original place of business and/or remain in commercial contact with their old customers, that might well undermine the transfer of allegiances. The Bs will then not be willing to pay as much to purchase the practice or the store.

In like manner, the employer would be willing to pay an additional salary to an employee who legally obligates himself not to compete with the boss or to give away trade secrets to a new employer.

In other words, the sale of a business, in addition to the physical plant, the dentist’s office, or the auto repair shop, also encompasses goodwill. Upon numerous occasions the latter is actually worth even more than the former.

The fact that these contracts are consummated is proof positive that they are mutually beneficial, at the very least in the ex-ante sense of expectations.

However, all is not well in this little corner of the economy. The usual suspects are on the warpath against these accords. In the view of Federal Trade Commission Chair Lina M. Khan: “The freedom to change jobs is core to economic liberty and to a competitive, thriving economy… Noncompetes block workers from freely switching jobs, depriving them of higher wages and better working conditions, and depriving businesses of a talent pool that they need to build and expand. By ending this practice, the FTC’s proposed rule would promote greater dynamism, innovation, and healthy competition.”

But this is economic illiteracy. Employees may quit jobs to their hearts’ content, even if they sign these clauses. They are only prevented from competing with an old boss, or telling their new ones of his secrets. Nor do they have to sign these agreements in the first place. And if they do, their wages will increase, not decrease. After all, they are giving up something that would otherwise be their right to engage in. People earn more, not less, when they give up an option that would otherwise be theirs.

According to Time magazine, “Non-compete clauses have no place in labor markets. These contracts prevent workers from leaving for greener employment pastures and starting their own businesses.” Of course, the NCC does not “prevent” any worker from quitting and seeking a better opportunity. Rather, it limits what he is able to do in his next job or entrepreneurial venture, a limitation for which he was paid. Lookit, when a person is hired to fix cars, he gives up what would otherwise be his right to play golf. And he is paid to relinquish his golfing. He voluntarily agrees to limit his options! It is hardly a coherent argument against employment that it entails no golf-playing on the job.

The Government Accountability Office (GAO) weighs in as follows: NCCs “can also lead to less job mobility.” Of course they can. That is pretty much their entire justification (apart from the fact that they constitute “capitalist acts between consenting adults,” in the insightful words of Robert Nozick). They move the economy in the direction of optimal job mobility! If workers changed their jobs every 5 seconds, job mobility would be maximized, and we would all starve to death. We want optimal job mobility, not maximum job mobility.

Where, oh where are these people learning economics? Probably from a bunch of Marxist professors. I fear for the future of the economy with such people in charge of regulating it.

  • Walter Edward Block is an American economist and anarcho-capitalist theorist who holds the Harold E. Wirth Eminent Scholar Endowed Chair in Economics at the J. A. Butt School of Business at Loyola University New Orleans. He is a member of the FEE Faculty Network.