The Bogus Justification for Worker Non-Compete Clauses


Published April 24th, 2019 - 04.24.1946


Even as employers have deprived nearly 30 million workers of the freedom to leave using non-compete clauses, they and their advocates insist that non-competes promote the public good. The case for robbing workers of the freedom to earn a living where they want goes as follows. Employers often invest in job training, disclose trade secrets to workers, and share customer lists with them. These valuable “intangibles” are vulnerable to appropriation by rival firms and workers who can profitably use them. Non-competes, by restricting workers from decamping to a rival or starting their own businesses, protect against this type of appropriation and ensure employers recoup their upfront investment in intangibles. Without non-competes, employers would not have the necessary incentive to build customer relationships, develop new technologies, and invest in their workers’ skills.

On closer examination, this justification has at least three critical weaknesses. First, it presumes that information should be protected by property and quasi-property rights to create incentives to collect and develop this information in the first place. Economic theory heavily qualifies this assumption, and experience shows that broad dissemination of knowledge is socially beneficial. Second, non-competes are a flawed means of protecting intangibles. Third, employers, to the extent they should be permitted to protect their intangibles, have several superior alternatives. These include trade secret law, improved employee retention policies, and employment contracts.

Given the real harms of non-competes and their lack of credible social benefits, a federal ban on worker non-competes is essential. A group of 20 labor unions and public interest organizations (including the Open Markets Institute) and 46 legal advocates and scholars petitioned the Federal Trade Commission (FTC) last month to write a rule banning non-compete clauses for all workers. The FTC must use its legal powers to protect workers’ freedom to leave for higher wages, more stimulating work, and fair treatment on the job.

The case for non-competes rests on a belief that robust property and property-like rights provide incentives to create and invent. The theory is that more economic rewards translate to more and better books, music, and pharmaceutical drugs. For example, Congress has justified expansions of copyright and patent protections on providing creators and inventors greater incentives to write novels, produce music, and develop new pharmaceutical drugs. (This assumption has little empirical basis.) In a similar spirit, defenders of non-competes assert that they create a quasi-property interest in intangibles and promote employer investment in, for example, training programs for workers or a new method of doing business.

This property case for non-competes is limited as a theoretical matter. Viewed through the lens of neoclassical economics, laws should create only sufficient incentives to invest. Establishing maximal incentives is undesirable. Consider a job training program offered to an employee on day one at a new job. If the employer’s investment in this training “pays off” after the employee has been on the job for three months, the public, including when it acts through state institutions such as the courts, has no interest in restricting the worker from leaving through compulsion of law. Under these circumstances and applying the logic of neoclassical economics, no court should enforce a non-compete if the worker decides to leave and accept another job at the three-month mark. Society receives nothing in return for sacrificing the worker’s freedom to leave and preventing her from applying her experience and knowledge elsewhere.

Real world evidence further undercuts the case for protecting intangibles through non-competes. Contrary to the claims of proponents, non-competes appear to impede, rather than promote, investment and innovation. Orly Lobel’s research has shown that the relatively unrestrained dissemination of knowledge through labor mobility promotes innovation and invention. On top of the benefits for workers themselves, free labor mobility leads to the sharing and synthesis of knowledge and thereby the creation of new firms and even industries. Other evidence also finds that increased  worker mobility promotes innovation and invention.

Ronald Gilson has argued that differential legal treatment of non-competes in Massachusetts and California is one reason the Golden State eclipsed the Bay State as the country’s leading tech hub. Massachusetts law has traditionally supported judicial enforcement of non-competes. In contrast, California has barred their enforcement since the 19th century. Gilson contends that the unenforceability of non-competes in California allowed workers to join nascent firms, pursue their own ventures, and spread knowledge widely, while their counterparts in Massachusetts did not have the same freedom.

Even taking the intangible protection story at face value, non-competes are a flawed mechanism of implementing this goal. As Viva Moffat has written, they are both too broad (depriving workers of their freedom to exit) and too narrow (failing to actually protect intangibles from appropriation). Non-competes restrain a worker from fully using her experience, knowledge, and skills at a place of her choosing. A single employer may make a negligible contribution to a worker’s knowledge and skills and yet have the power to control this person’s labor through a non-compete. An automated speech recognition technologist bound by a non-compete made this point to Matt Marx:

“I’ve been in this industry for 20 years. I have a PhD in the field. I walked in the door with an enormous amount of experience, and while I worked there for a year in a half they added maybe, what, 2% to that? And now they want to prevent me from working in speech [recognition] and using any of what I know?”

At the same time as they broadly restrain workers, non-compete clauses do not directly protect intangibles. An employee motivated by spite toward his boss is free to covertly share a customer list or trade secret with a competitor so long as he does not enter into an employment relationship with that competitor. The non-compete does little or nothing to protect against this risk.

Employers have effective tools to protect their intangibles that also do not impose a broad one-sided restraint on workers. The law today features wide array of legal tools to protect intangibles. In addition to copyright and patent law, employers have trade secret law and non-disclosure and non-solicitation agreements. To be sure, these tools pose their own threats to workers but they do not necessarily bind workers to employers in the way non-competes do.

For employers who believe that employee retention is the key to protecting intangibles, they have no shortage of ways to ensure a loyal, committed workforce. Employers can offer higher wages and salaries, better benefits, and promotions to retain employees. They can also opt out of the default at-will employment regime. Employers determined to keep workers can offer them the same deal Major League Baseball teams make to players: commit to an employer for a fixed term in exchange for protections against arbitrary dismissal.

The FTC and other policymakers should not be swayed by the arguments in favor of non-competes offered by employers, their trade associations, and their advocates. The case for non-competes rests on flawed—and false—assumptions. To the extent employers should be permitted to control intangibles, they have superior alternatives such as trade secret law and employment contracts. Non-competes are unnecessary. Weighing the real harms to workers against the specious offsetting public benefits from non-competes, the FTC should move quickly to outlaw these contracts for all workers.

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