Treasury Department Report Blasts Noncompete Agreements

 I wrote awhile back about President Biden's executive order on noncompete agreements. In it, he asked the FTC and other agencies to look into curtailing the use of noncompete and other anti-competitive agreements and practices. The Treasury Department just issued a report, presumably in an effort to comply, and it's damning in the extreme on the topic of noncompete agreements. 

Some juicy excerpts:

Firms can engage in tacit collusion by sharing wage information for different occupations, conspiring to fix wages, adopting no-poach agreements where firms agree not to hire other firms’ workers, or forcing workers to sign non-compete agreements that limit their ability to switch jobs.

Wage-setting power is also evident in the large number of workers who are subject to rules and agreements that limit their ability to switch jobs and occupations and, hence, their bargaining power. For example, a recent paper estimates that one-in-five workers is currently subject to non-compete agreements and double that number report having been bound by a non-compete agreement in the past.

Employers can also act to decrease the value of a worker’s outside options. For example, restrictive employment agreements that require workers to repay training costs if they leave the firm or non-compete agreements (both discussed in greater detail below) reduce worker power by increasing the costs of leaving the firm. Those costs are explicit in the case of training repayment programs but implicit in non-compete agreements. By preventing a worker from accepting positions well-suited to their skills, firms decrease the expected gains from a worker’s job search. 

By design, non-compete agreements limit employees’ outside options, which, in turn, weakens workers’ bargaining power and raises hiring costs for other firms. The limits are typically within a geographic area for a specific period and within a set of relatively similar occupations or industries but may be much broader. Balasubramanian (2017) models the effects of non-competes to show how this narrowing of outside options reduces employee bargaining power relative to their employer. All else equal, this leads to what they call a “lock-in” effect: lower worker mobility and longer tenure, as well as a flat or declining wage profile. Both the mitigation of the “hold-up” effect and “lock-in” effect mentioned above can reduce worker mobility. Lower worker mobility increases recruitment costs for all firms as fewer workers are seeking to switch jobs than otherwise would, absent the post-employment restrictive employment agreement. The increases in recruitment costs can lead to worse matches between employers and employees, lowering wages and aggregate productivity (Javanovic 2015).

However, the share of people who negotiate over a non-compete agreement appears to be quite small. Starr, Prescott, and Bishara (2021) find only about 10 percent of employees negotiate over their non-compete agreements. Therefore, it is unlikely that most employees demand (or receive) a compensating differential from signing a non-compete agreement. Furthermore, a worker with little bargaining power (e.g., low-income workers) or who is unaware they are bound by a non-compete (which may be more likely for less-educated workers) is unlikely to be able to secure a compensating differential in exchange for signing a non-compete agreement. To the extent that a compensating differential requires an explicit negotiation, certain workers may be less willing or able to do so—for example, Babcock and Laschever (2009) argue women are much less likely to negotiate during the hiring process. Accordingly, the share of workers whose wages increase as a result of non-compete agreements is small. While one of the main justifications for noncompete agreements (as well as other types of restrictive employment agreements) is mitigation of the “hold up” effect, there are far less restrictive means of addressing this problem. For workers with access to genuine trade secrets, there may be overlapping authority with trade secrecy laws, irrespective of the existence of a noncompete agreement.

Restrictive employment agreements, including non-compete, non-solicitation, and non-recruitment agreements, may reduce firm entry. In aggregate, this tends to lead to reduced demand and wage competition, leading to fewer appealing outside options for similarly situated workers. Samila and Sorenson (2011) find that increases in supply of venture capital funds has a stronger impact on firm start-ups, patent creation, and employment growth in states that have weaker enforcement of non-compete agreements, suggesting non-compete agreements may reduce certain types of entrepreneurial activity.

So long as the perceived probability of an employer attempting to enforce the contract is non-zero, restrictive employment agreements can create frictions. Consistent with this, Starr, Prescott, and Bishara (2020) present survey evidence that workers with non-compete clauses frequently decline job offers because of their preexisting non-compete agreement, even in states that do not enforce such agreements. Likewise, survey evidence also suggests that the incidence of non-compete clause inclusion in employment contracts is not strongly correlated with enforceability of non-compete agreements, which could suggest employers include such clauses even when they do not expect them to be enforceable. This partially occurs because people tend to be risk averse. Therefore, even in places where non-compete contracts are outlawed, the presence of unenforceable non-compete clauses can have a chilling effect on job-switching. The effects may be particularly severe for lower-wage workers, who may have limited access to legal counsel.  

Twenty-one percent of workers in the top income quintile are covered by a non-compete agreement compared to eight percent of workers in the bottom quintile of hourly wages. However, this still leaves millions of workers with minimal employer-specific training subject to non-compete agreements.

Unlike higher income workers, lower wage workers likely lack sufficient bargaining power to refuse a non-compete agreement. As a result, whereas non-compete agreements may increase top-earner wages at the expense of mobility, non-compete agreements appear to reduce both wages and mobility for lower-income earners. For example, Lipsitz and Starr (2021) find that the ban on non-compete agreements for hourly workers (who tend to be lower income) in Oregon increased overall hourly wages by 2–3 percent, with a stronger efect for female workers.

Starr, Prescott, and Bishara (2021) find that the huge number of low-skill workers subject to non-competes suggests that employers routinely apply them to workers who do not possess trade secrets or customer lists and are not given specialized training. They cite as an example a large sandwich chain, which subjected its workers to extremely broad non-competes. Though these non-competes are not likely enforceable under state law, they point out that they may have an in terrorem efect that deters employees from obtaining jobs at competing employers.

A decline in the competitiveness of labor markets lowers worker wages, may decouple wages from productivity, and likely diminishes the relative share of income that goes to workers. Moreover, actions of the firm such as requiring workers to sign non-compete agreements and limiting workers’ access to information diminishes worker mobility, implicitly reducing workers’ bargaining power relative to employers. 

These direct effects on workers’ wages, employment, and mobility have important broader negative impacts on the economy. Higher inequality likely makes it more difficult to sustain sufficient aggregate demand. Lower wages disproportionately impact women and workers of color. A large pool of low-priced labor likely weakens firm incentives to invest and improve productivity, while lower mobility diminishes productivity growth by hindering the reallocation of labor to more productive firms and industries. Non-compete agreements may prevent workers from starting their own businesses and discourage innovation. In short, a growing body of evidence suggests that declining labor market competition may stymie the drivers of U.S. economic growth. 

The use of non-compete clauses, especially among internet-based commerce firms, could be discouraging firm entry (Congressional Budget Office 2020). For instance, Marx, Strumsky, and Fleming (2009) finds that an unintended change in Michigan law boosting the enforceability of non-compete agreements led to sharp declines in the mobility of patent holders. Restricting the use of non-compete agreements and other restrictive employment agreements could allow for new firm creation, as workers at incumbent firms could leave the firm to pursue new ideas, thereby forcing incumbent firms to innovate to stay dominant. 

These are just some highlights. There's lots to unpack in this 68-page report, and I suggest you read it if you are interested. Summary: noncompetes are bad for society, bad for competition, particularly bad for low wage workers, and have the effect of suppressing wages, worker mobility, and innovation. 

And haven't I been saying this all along?