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Want More and Better Jobs? Ban Noncompetes. – Newsletter 7

Charles H. Martin Contract Law and Public Policy

Pizza MakersWant More and Better Jobs? Ban Noncompetes.

I. The Problems – There are Fewer New Businesses and Fewer Well-Paid Jobs in the U.S. Than Before the Great Recession

II. A Solution – Employee Noncompete Agreements Hurt Labor Mobility and Business Formation, and Should Be Banned by State Law

III. Noncompetes Proliferate, As Do the Studies That Criticize Them

 

I. The Problems – There are Fewer New Businesses and Fewer Well-Paid Jobs in the U.S. Than Before the Great Recession

Why did it take seven years for U.S. employment to return to its pre-Great Recession level?

Why, according to the Census Bureau, is real median U.S. household income still below its 1999 peak?

Why does income inequality continue to grow in the U.S. despite increases in worker productivity?

Why have the levels of annual new business start-ups declined in the U.S. since 2006?

Some reasons offered for these trends are: globalization, labor-replacing technology, legislative and regulatory agency “capture” by pro-employer lobbyists, and lagging or misdirected U.S. education. I offer here another cause that might not explain these trends, but which probably aggravates their effects. It comes with a relatively simple and quick solution.

II. A Solution – Employee Noncompete Agreements Hurt Labor Mobility and Business Formation, and Should Be Banned by State Law

 Agreements to restrict competition are generally prohibited by law, because they are used to raise prices, or to provide fewer goods or services than would otherwise be available in a free market. Contract law in most states, however, allows exceptions to this general rule for “reasonable” “covenants not to compete” (“noncompetes”) in employment agreements. These agreements usually prohibit a departing employee from doing work similar to the work they did for their employer for a period of months or years after they leave their job, and within a specified geographic area.

Most states that enforce employee noncompetes (which does not include California, North Dakota or Oklahoma), believe that they protect certain valid employer interests. These are reduction of the cost of employee turnover, prevention of disclosure, or competitor use, of trade secrets or customer secrets, and recoupment of the cost of training provided to employees.

States that enforce noncompetes require them to have: 1) reasonable limits on the activities prohibited, 2) reasonable limits on the geographic scope of their application, and 3) reasonable limits on their time duration.

Reasonable limits on noncompetes sounds reasonable, doesn’t it? Growing economic research, however, indicates that the overall effect of noncompetes in employment contracts might be to reduce new business formation, employee mobility and compensation, and to create long-term mismatches between employee skills and the jobs that employees perform.

III. Noncompetes Proliferate, As Do the Studies That Criticize Them

Noncompetes were long believed to apply only to highly-compensated professionals or managers, who bargained for contract limitations on their post-employment work in return for higher income. In recent years, however, employees at all skill and income levels, including sandwich shop deliverymen, have been required to accept noncompetes as a job condition.

This proliferation has generated criticism from Congress, from noncompete-bound employees, from would-be entrepreneurs, and from venture capital firms that desire to invest in new businesses. Bills have been introduced in a few state legislatures to ban or to limit the enforcement of noncompetes. They have often been motivated by the desire of economic development promoters for a new version of “Silicon Valley” in their states.

Economic research indicates that California’s long-standing ban on employee noncompetes might be one factor in Silicon Valley’s overtaking of Route 128 as the preeminent high-technology location. Michigan’s ban on noncompetes might explain Detroit’s ascendance over competing automobile manufacturing locations during the period from 1905 to 1985, when the ban was in effect.

Some benefits of a ban on noncompete enforcement might be a greater incentive for high-skilled employees to improve on the practices of their former employers, the clustering of happy “alumni” around their previous firms in order to maintain cooperative as well as competitive relationships, and the attraction of employees away from states or firms that enforce noncompetes to states and firms that permit their employees to start “spin-out” companies.

Eight Beckman Instruments employees quit as a group to found Fairchild Semiconductor, in Silicon Valley. Fairchild eventually spawned dozens of “Fairchildren” firms (including Intel) that were started by its former employees who departed without being burdened by noncompetes. In Detroit, the Dodge Brothers left Ford Motor Company to create their own car company.

Employers can protect trade secrets with trade secret law. They can protect client secrets with confidentiality agreements. Higher employee turnover might increase their recruitment and training costs, but these higher costs might be offset by easier recruitment of highly motivated employees, and by the benefits of a network of friendly and entrepreneurial former employees.

A recent survey indicates that at least one in four of U.S. workers has signed an employment noncompete agreement at some time, and that almost half of that group are currently bound by a noncompete.

When noncompetes are imposed on highly skilled and compensated workers, any resulting misfit of employee talent might be partially remedied by the transition of departing employees to other industries or states to avoid noncompete enforcement. Even engineers have reported in surveys, however, that this type of transition can derail their careers by reducing their technical knowledge and employment networks.

Workers with low skills and compensation are unlikely to have the options of career switching or geographic migration (such as to California). If they are prevented by noncompetes from applying their talents in optimal ways, they suffer in place. The American economy suffers in all cases in which employees feel forced to stay in jobs that they are not best suited for, because of noncompete agreements.

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Charles H. MartinWant More and Better Jobs? Ban Noncompetes. – Newsletter 7