Restricting Employment Restrictions
Non-compete agreements can keep workers—even those too junior to possess trade secrets—from moving to a rival firm. Yale SOM’s Olav Sorenson and MIT’s Matthew Marx write that limiting enforcement of the agreements encourages entrepreneurship and economic growth.
In 2014, 19-year-old Colette Buser found herself without a summer job—not because she hadn’t looked (a local camp wanted to hire her), but because the previous summer her employment contract had stipulated that she could not work as a counselor for another local camp for at least a year.
Non-compete agreements, such as those signed by Colette, have been used for years to prevent key salespeople, engineers, and executives from leaving to join or found a rival company. But they appear to have become increasingly common for all employees. The rationale for these restrictions has been that they help firms to protect valuable knowledge. When pressed for an explanation of how he could block a teenager from finding a summer job, camp owner Joe Kahn told the New York Times, “Our intellectual property is the training and fostering of our counselors… It’s much like a tech firm with designers who developed chips: You don’t want people walking out the door.”
Colette’s story illustrates the costs that non-competes can impose on employees. Workers subject to non-competes have less career flexibility, earn less, and may need to move to a different industry or state (such as California, which will not enforce non-competes) to find a job. Non-competes also act as a brake on entrepreneurship, a key to innovation and economic growth.
The White House has recently issued a call to action on non-compete agreements, encouraging states to change their enforcement of them in three ways:
- to limit their use for low-wage employees;
- to require employers to include these agreements with job offers; and
- to penalize firms that impose overly restrictive agreements on their employees.
As social scientists who have studied non-compete agreements for more than a decade each, these proposals seem sensible to us.
Our own research, as well as that of others, has examined how companies use—and abuse—these contracts. Employers, for example, often require non-compete agreements not just for executives but for all employees, even those such as Colette, who probably have few trade secrets that they could bring to rivals. Forty-three percent of the engineers in the U.S. report having been subject to a non-compete agreement, and a recent survey suggests that they may cover 18% of workers nationwide—30 million people. While executives can hire lawyers to protect their interests, low-wage workers often have little recourse if their former employers sue them.
Companies frequently spring these agreements on people only after they have turned down their other employment opportunities, sometimes not until their first day on the job, and portray them as routine legalese. In a recent survey, 70% of engineers nationwide reported that they did not learn of being expected to sign a non-compete agreement until after they had accepted their jobs. Workers moreover often do not realize the implications of what they have signed until it prevents them from moving to another firm. For the company, however, restricting the mobility of employees helps to keep costly turnover— and wages—down.
In some states, so-called “blue pencil” provisions allow judges to reduce the term or scope of a non-compete—say, from five years to one—rather than rendering an up-or-down decision. But this option encourages companies to require their employees to sign overly restrictive agreements. In the rare event that the case goes to court, the judge might reduce the terms, but in the majority of cases the firm enjoys the chilling effect of a stricter contract.
The White House proposals would limit these practices. But the use of non-compete agreements should also concern those not covered by a non-compete and those who do not necessarily see any injustice in the current system.
Research has consistently found that the enforcement of these agreements impede entrepreneurship and slow economic growth.
Some states, such as California and North Dakota, will not enforce almost any non-compete agreements, while others vary in what they allow. Other states, such as Michigan, have changed their policies over time. Our research has used these differences to determine how the enforcement of non-compete agreements affects the economy.
States that enforce non-compete agreements and those that enforce them more strictly have fewer startups. Entrepreneurs usually have prior experience in the industry they enter, or in a closely related one; non-compete agreements can thus prevent them from striking out on their own. Even if they can found their own firms, these agreements hamper their ability to hire early employees. As a result, a dollar of venture capital goes further—in terms of creating more jobs and more economic growth—in states that restrict the enforcement of non-compete agreements. Some of our research indicates that venture capital creates two to three times as much economic growth in regions that do not enforce these agreements as it does in regions that do.
States that enforce non-compete agreements also suffer from a brain drain, with sought-after employees leaving states like Massachusetts, which enforce non-competes strictly, for states like California, which do not. Many of the students we teach at MIT and Yale to move to California for this very reason. The enforcement of non-compete agreements therefore imposes an economic cost on all of us. We support these reforms not so much because they might help to right some of the wrongs associated with non-competes—though they should help to do that as well—but because they would promote economic growth.