All Commentary
Monday, November 28, 2016

Why Non-Competes Are Anti-Competitive

Non-competes hamstring workers by binding them to jobs and businesses by preventing them from hiring fresh talent.

Non-Compete Agreements Limit Competition

Competition is the life-blood of a free market economy. The pushes and pulls of resource supply and demand work to efficiently digest risks and opportunities in the economy.

18 percent, or 30 million, American workers are currently covered by non-compete agreements.

Non-compete agreements limit competition in labor markets by artificially decreasing labor supply creating situations of sub-optimal labor use. Workers are bound to jobs, working environments, and pay levels that are unnatural to the wider economy and businesses are unable to hire the best talent to produce the best results.

Non-compete agreements vary in scope but generally are contractual agreements between an employer and an employee governing when and where an employee is allowed to work. Effective non-competes are limited in their temporal and geographic scopes with a narrow focus in what they attempt to accomplish and what knowledgeable parties they are given to.

Benefits of non-compete agreements might include the protection of trade secrets, an increased incentive to invest in worker training and education, and the protection of client and sales lists.

Currently in the United States, “18 percent, or 30 million, American workers are currently covered by non-compete agreements” including “15 percent of workers without a college degree” and “14 percent of individuals earning less than $40,000.”

Decreased Worker Mobility

Workers who have signed non-compete agreements cannot test the job market to fulfill their labor potential. After signing a non-compete, workers have to either stay at their current job, not work, or transfer outside the confines of a non-compete that likely encompasses the areas they are most skilled and experienced.

Because workers can’t test the market for the most preferable jobs, they are more likely to stay at their current job and accept inferior working conditions and lower wages.

Normally in a free market, we would argue that if an employer does not pay market rates or offers bad working conditions they will be naturally pressured towards more efficient outcomes. Whether that is in raising their standards, becoming less successful as employees leave, or reshuffling who they employ. With non-competes, however, the threat of workers leaving is lowered because their alternatives are artificially limited, which decreases the market pressures on companies to improve.

“Employers will only pay their workers more if they fear those workers will leave or rebel. With lower levels of labor-market and geographic mobility, and with more two-income families, it’s harder for many workers to threaten to quit than before.” – Tyler Cowen

Uncertainty & Transparency

Signing contracts with extended effective timeframes limits how new market information is digested. An employee may believe it is a good decision to sign a non-compete with current information, but later with new information have access to other better opportunities.

Non-competes take advantage of this lack of information by forcing employment decisions to be made over increasingly long timeframes of future uncertainty. How can one accurately predict market trends, conditions, emerging technologies, and job situations 2 years after their last day of employment?

Making major employment decisions under these uncertain conditions leads to more inefficient outcomes.

Worker uncertainty not only applies to these future market pressures, but also to the day-to-day implementation of non-compete agreements across different states.

Non-competes in states like California are nearly unenforceable, but are still used and required by some companies for employment. Employees’ lack of knowledge on the enforceability, legal consequences, and terms of non-competes allow them to still be an effective way to retain employees, depress wage growth, and avoid worker promotion.

Non-competes benefit businesses by distorting labor markets in the same way that labor unions benefit organized labor by distorting labor markets.

Non-compete contracts themselves are sometimes left intentionally broad to have the maximum possible effect, even if this effect extends past the hazy legally enforceable limits. It is common for non-competes to use vague language that allows businesses to retroactively change the initially signed agreements and use third-party arbitration instead of courts. Referred to as the “Blue Pencil Doctrine,” agreements that are deemed unenforceable or illegal in courts can be rewritten to impose the fullest legal limit of the document’s original intention.

This turns non-compete agreements into a black box of what a court or arbiter decides and not necessarily what is actually stated in writing. An agreement might say one thing, but after a court battle the effective “blue inked” agreement is something else entirely.

If a business is not able to know and clarify the extent of what they are asking in the legalese of a multi-page agreement, how is the individual, especially one of low-income and/or education, supposed to understand the ramifications of a broad retroactive “fullest legal extent” agreement? The businesses, in these cases, are not narrowly protecting themselves from specific use cases, but instead are trying to inhibit competition and get the most possible from unknowledgeable parties.

The dynamics of competitive labor pressures yielding the most efficient outcomes are limited to the initial decision to sign or not sign a non-compete agreement, but are absent, or are greatly diminished, for the amount of time a non-compete is active (normally 6-months to 2-years after leaving a company). 

The volume and speed of competition are reduced to the limits of the agreements and not to the more efficient current market pressures, job opportunities, and emerging technologies. When worker mobility and transparency are increased, the natural shuffle of competitive employment pressures creates better working environments and more efficient labor outcomes.

Labor Market Dynamism

One of the primary areas of research on the effectiveness of non-competes is comparing Silicon Valley, California to Rt. 128, Massachusetts. California does not enforce non-compete agreements in most cases, while Massachusetts does.

Orly Lobel, in the linked FEE article, argues that, “The distinguishing factor for Silicon Valley was an economic environment of openness and mobility.” Silicon Valley’s success is attributed to the freedom workers have to start companies and actively switch jobs to new emerging technologies. This creates a business culture full of “agglomeration effects” that offer, according to The Whitehouse non-compete report released in May 2016, “geographic clustering effects of factors like a large, deep pool of skilled workers, a more competitive market of suppliers, and information spillovers across workers.”

The freedom gained from increased competition in California’s labor markets is what breeds progress versus the contractually imposed stagnation “inhibiting innovation” in Massachusetts.

Education can increase worker pressure on businesses to decrease the overall use of non-competes.

Not only does this affect competition within individual states and state-to-state, but internationally where technological successes in places like China are more and more, “the result of a collaborative process, in which engineers discussed ideas over drinks and on online forums… helped along by the network effects of a cluster of manufacturers, and the infrastructure was in place to scale up production to meet demand.”

Instead of limiting labor by walling in the separation of ideas and employees, technological progress is encouraged by the spread of ideas through openness and competition.

Follow Through

Non-competes can benefit individual businesses by distorting labor markets in a similar way that labor unions distort labor markets to the benefit of organized labor.

Workers can voluntarily form labor unions to exert upward labor pressure on employers similar to how employers can use voluntary non-compete agreements to exert downward labor pressure on employees. These pressures, in a general sense, limit competition creating more inefficient uses of labor and production.

The way to increase labor market competition and limit non-competes is through increased market pressures from more educated employees and businesses.

Increasing education can increase worker pressure on businesses to decrease the overall use of non-competes and limit their scope and narrow their focus. Businesses, and venture capitalists, within an industry can team together to avoid using competition-limiting aspects of employment agreements, like in the “Protocol” agreement between brokers.

Some questions employees can ask when confronted with a non-compete agreement include:

  • Geographic scope: Does the non-compete apply to only a specific geographic area?
  • Temporal scope: What is the effective length of the non-compete? Is that time period applicable from the employment start date or the employment end date?
  • Is the non-compete active for laid off workers or fired employees?
  • When receiving a job offer, ask about non-compete agreements before accepting or declining job offers from other companies.
  • If you do not understand a non-compete agreement, ask the business representative to explain the legalese or hire a lawyer to look over the agreement.
  • Does signing a non-compete affect promotions, raises, and advancement within the company?

The more specific a non-compete contract is the less wiggle room there is for uncertainty and retroactive changes with the blue ink doctrine. The goal should be for increased clarity to help workers make more informed choices and encourage more competition in the labor markets.