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Are Non-Compete Clauses Legitimate? Yes.

Summary:
What exactly, is a non-compete clause? It appears, typically, in a labor contract. In view of the wages and working conditions and other benefits the employer will be bestowing on the employee, the latter agrees that for the duration of his employment there, and if and when his relationship with the firm is later severed, he will not compete with his employer. This is usually stipulated for two years or so afterward, although the noncompete duration may vary. The fear on the part of the company is that the employee will either set up on his own as a competitor, or work for a different firm in the same industry. He will have the benefit of his first employer’s trade secrets, ways of doing business, etc. The employee, presumably, is paid a bit extra for agreeing to

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What exactly, is a non-compete clause? It appears, typically, in a labor contract. In view of the wages and working conditions and other benefits the employer will be bestowing on the employee, the latter agrees that for the duration of his employment there, and if and when his relationship with the firm is later severed, he will not compete with his employer. This is usually stipulated for two years or so afterward, although the noncompete duration may vary. The fear on the part of the company is that the employee will either set up on his own as a competitor, or work for a different firm in the same industry. He will have the benefit of his first employer’s trade secrets, ways of doing business, etc. The employee, presumably, is paid a bit extra for agreeing to limit himself in this manner.

Why then, is there any opposition to contracts of this sort? What is the case against them?

First, a little history.

In 2016, the Obama Administration determined that these agreements were not in the public interest. With the help of his pen and telephone this former president issued in April of that year an Executive Order, “Steps to Increase Competition and Better Inform Consumers and Workers to Support Continued Growth of the American Economy”. This was followed up in March 2016 by a Treasury Department report, “Non-Compete Contracts: Economic Effects and Policy Implication”. Hard on the heels of that came another White House report, in May 2016, “Non-Compete Agreements: Analysis of the Usage, Potential Issues, and State Responses.” This was followed by yet another October 2016 White House report, “State Call to Action on Non-Compete Agreements.”

What were the justifications of this plethora of attacks on these agreed upon contracts?

First, it was charged, the welfare of workers was decreased, because they had fewer options with them than without them. Well, superficially, this is indeed true: they cannot compete for a given time period. However, they were paid for this restriction on what they would otherwise be free to do, presumably with a higher wage. The employees are also precluded from outright stealing from the company, and this, too, curtails their freedom. Not all limitations are illicit.

Second, they these stipulations are accused of artificially restricting competition. This is indeed correct, if by “competition” we mean, literally, numbers of competitors. Each such agreement reduces that number by exactly one. But these contracts are part and parcel of the competitive system. They were reached because of competition among employers for employees, and of the latter for the former. Mergers, too, as well as bankruptcies, decrease the number of firms still in operation. Shall we prevent them by law also? Hardly.

A third criticism is that non-compete contracts hamper economic efficiency. But this, too, is difficult to accept. Suppose they were entirely outlawed. Then, firms would be loath to share with their employees trade secrets, formulae, methods of doing business, etc. that could later be used against them. If this would not stultify progress, inhibit innovation, then nothing would. Non-compete clauses help guard against such an eventuality.

Another supposed flaw is that these pacts limit mobility. Of course they do. But we do not want infinite mobility, wherein workers switch jobs every millisecond. Rather, if we want economic development, we need optimal mobility. It would appear we could locate closer to that ideal on the basis of freely agreed upon contractual arrangements rather than by precluding options.

Then there is the charge of depressing wages. This is perhaps the weakest of all the counter-arguments, in that first, remuneration will tend to rise, not fall, other things equal, when employees give up a bargaining chip. Second, wages depend upon productivity, and this will increase, not decrease, if firms do not fear sharing information with members of their teams.

It has also been bruited about that these institutional arrangements are particularly onerous for minority group members, and thus constitute an instance of systematic racism. But this too is difficult to accept, since this demographic tends to be lower on the industrial jobs pyramid. If these clauses hurt workers, which they do not, minorities would thus be the least vulnerable to them, not the most.


Walter E. Block is Harold E. Wirth Eminent Scholar Endowed Chair and Professor of Economics at Loyola University New Orleans

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