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President Truman famously asked to be sent a one-armed economist, having tired of his economic adviser proclaiming, “On the one hand, this,” and, “On the other hand, that.” Unfortunately, most public-policy issues involve economic trade-offs. The economics of employer-employee noncompete clauses are yet another example.
Several states and the federal government have considered or are considering restricting or banning noncompete agreements. Under these agreements, employees typically agree not to start a company or accept a job in a similar line of work that competes with their original employer.
On the one hand, noncompete agreements protect firms’ investment in intellectual property and proprietary development. Firms spend a lot of time, effort and financial resources developing business processes, cultivating customers, refining products and fine-tuning marketing plans. Employees might join competitors or form competing firms, using their knowledge of the original firm’s investment. Noncompete clauses help motivate firms to make these investments and invest in current employees.
On the other hand, competition in both product and labor markets is at the heart of a free-enterprise system and is the basis of many of its benefits. Noncompete agreements reduce employee mobility and can suppress wages. Firms might also have more difficulty competing for quality employees because of noncompete agreements. Less competition might increase product prices, harming consumers. To reduce competition, employers might also write noncompete agreements that restrict employee freedom well beyond what is required to protect employer intellectual property.
About 18% of workers in the United States are bound by noncompete agreements. Interestingly, the rate is similar in states like California that don’t enforce noncompete agreements.
What do recent studies show about the economic impact of noncompete agreements? Noncompete agreements reduce mobility and increase employees’ job tenure. Some studies find that noncompete agreements decrease wages since employees have fewer other job options. Other studies find that noncompete agreements increase wages since workers become more productive.
Marx et al. (2015) found that noncompete agreements cause a brain drain away from states with noncompete agreements to states where such agreements are not enforceable. They also found that the most productive and collaborative workers are the most likely to move. Another study finds that noncompete agreements discourage women from leaving their current employer or hiring talent for high-growth startups. The authors hypothesize that women are more risk-averse and more likely to want to avoid potential litigation.
We are two-armed economists; noncompete agreements reduce competition and can protect employers’ intellectual property.•
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Bohanon and Horowitz are professors of economics at Ball State University. Send comments to ibjedit@ibj.com.
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