The economic literature doesn’t support banning non-competes

The new year has only just begun and the Federal Trade Commission (FTC) is already wading into another major political battle. This time, the fight is over the future of non-compete clauses and their use by employers. The outcome of this political battle could have lasting consequences for millions of hardworking Americans.

On January 5, the Commission announced the creation of a new rule that would ban employers from imposing non-compete clauses — legal agreements that typically prohibit an employee from divulging proprietary information to or entering into employment with a business competitor immediately following the end of employment — on workers and enforcing existing clauses. The sweeping proposal would apply to all employers, including independent contractors, and require companies to inform workers of the immediate termination of any active contracts. The only exception would be for non-disclosure agreements and a few other types of employment restrictions that don’t function as non-competes.

The FTC believes drastic action is necessary to end a practice that it describes as not only “often exploitive,” but also responsible for suppressing wages, hampering innovation, and blocking “entrepreneurs from starting new business.” Unfortunately, the agency’s proposal is based on shoddy research and a deep misunderstanding of the subject matter. A thorough review of existing literature makes it clear that the academic community’s views on non-compete agreements are far more complex than the FTC would prefer to believe.

Research on the effects of non-competes is quite sparse. As noted by the FTC’s own Bureau of Economics in the paper Non-Compete Agreements: A review of the Literature, as recently as 2020, just “four surveys of non-compete use in the U.S.” even existed. Those that do exist tend to be narrow in scope and cover only a limited range of occupations. One of the only surveys that does have national reach and covers multiple occupations has been used again and again as the basis for most other studies. At the very least, this research environment should give the FTC pause when making broad pronouncements.

The limited research that exists on non-competes has consistently found a logical reason for their existence. While acknowledging the potential misuse of non-competes by employers, researchers have nonetheless concluded that non-competes serve a valuable market function by allowing employers to spend significant time and energy on employees via schooling, training and information-sharing without having to worry about lost investment.

Recruiting and training employees is an expensive business. Most employers don’t want to have to worry about whether their money was well spent. Non-compete agreements provide them with a sense of security that they would not otherwise have. That security is also good for workers, who enjoy the fruits of that investment in the form of free or heavily subsidized degree programs and other useful programs like technical trainings.

For various practical reasons, workers are often unwilling or unable to pay for these training opportunities, making their subsidization by the firm more important. Research shows that non-competes are associated with firms providing more on-the-job training opportunities. For instance, a 2017 study of hair stylists found that the presence of non-competes made firms 14 percent more likely to offer trainings.

Supposed evidence that bans on non-compete agreements have been effective in preventing the exploitation of workers rest largely on a small number of cross-sectional studies that examine state differences in non-compete enforcement. The results of these studies have been extremely ambiguous. For instance, while some evidence suggests that non-competes have led to a decline in worker mobility, other evidence indicates that non-competes are not only associated with more training opportunities but also, in some cases, higher wages. It’s not at all clear that any negative effects that non-competes may have outweigh the many positives.

There’s little to no agreement among researchers that a broad non-compete prohibition, like the one proposed by the FTC, would be either wise or effective. Indeed, researchers have made it clear that “further work” is necessary before reaching any definitive conclusions. The agency would be wise to heed this advice and allow Congress to address any perceived problems with non-competes rather than propose broad rules that almost certainly exist outside of its legal authority as an executive agency.

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