On the case for and against banning "non-competes"

Some underdiscussed theoretical aspects

Following the proposed FTC ban of so-called “non-compete” clauses in labour contracts, there has been a lively discussion on Twitter and in the blogosphere about its merits. The standard case against allowing (binding) non-compete clauses is that they limit competition in the labour market. Seems totally obvious, right? If workers cannot switch jobs easily, that seems to obviously limit competition. Yet, things are a bit more complicated. If workers expect to be required to sign a non-compete clause, they will require compensation ex ante to accept the terms, otherwise they choose to join a company that does not put a non-compete contract before them. This is the case if there is sufficient competition in the labour market and workers are reasonably informed. Thus, non-competes do not necessarily lead to lower wages and suboptimal employment; instead, they may push competition between firms for workers’ services completely to the ex ante phase. Of course, workers may not have that much knowledge about the industry before they start working for a firm and may be able to develop bargaining power on the job, so there is a case to be made for ex ante competition not beng “sufficient”. Still, I rarely hear about ex ante competition from those arguing for banning non-competes. This is a general pattern: fans of “hypster antitrust”, including those currently at the top of FTC, often have an impoverished understanding of competition, which comes in more forms than they sometimes imagine. Therefore, the case for banning non-competes is not as compelling as some might think. Yet, if non-compete clauses had no legitimate uses, supporters of an outright ban could still have a case, namely, that non-competes theoretically can, and empirically, do have some uncompetitive effects, even if that is not as obvious as it seems at first sight. (But even in this case, “more scrutiny” might be better than an outright ban, especially at a federal level.) Yet non-competes do have legitimate uses (for an overview, see the previously linked article). The first, widely acknowledged to some extent, is that non-competes prevent the easy transfer of intellectual property from one firm to another, and hence can lead to more innovation, which benefits both firms and workers. Critics of non-compete clauses, however, often point out that this justification does not really hold in the case of low-skilled jobs, such as working for a fast food restaurant. Yet, sometimes even low-skilled workers are bound by non-compete clauses. There comes the other justification for non-competes: they help firms to reap the benefits of investing in the training of their workers. Firms have ample incentives to invest in firm-specific human capital even without non-competes, yet, their incentive to invest in general training might be much lower when the worker can quickly take her newly acquired human capital elsewhere. This argument, however, is not without defect. We know at least since Gary Becker’s seminal work on human capital that firms do in fact invest in general training provided the workers actually pay for it in the form of wages that are (temporarily) lower then their marginal product. If this is so, then the case for non-competes seems weaker. Or is there something that prevent this mutually beneficial “trade” from happening? There is indeed, namely different kinds of wage standards, such as the minimum wage. The existence of a minimum wage, especially if it is high enough or rising, can prevent workers from accepting substantially lower wages in exchange for more training. Wage standards set by trade unions can have a similar effect. This implies that in the case of workers for whom the minimum wage is binding there should be more use of non-compete clauses in their labour contracts. Is this actually the case? Has anyone done any research on that? I haven’t found any, but I would like to find out! Meanwhile Alex Tabarrok here offers what I think is the strongest case for not allowing non-competes: they restrict the spread of ideas. But should every state and country do as California does in this case? I think not, and I again refer to the very much existing legitimate uses of non-competes. As Tyler Cowen puts it: “Much of America’s genius is based on experimentation and federalism. The current FTC, by contrast, is fast becoming associated with overreach. It is operating under what economist Friedrich Hayek called “the pretense of knowledge.”” When the case for banning non-competes is not sufficiently strong, and I think this is the case, it is better to let different states compete and experiment with different rules.