The FTC’s New Plan to Ban Non-Compete Agreements

F ollowing Joe Biden’s guidance and acting on the mistaken presumption that economic competition is something to be artificially manufactured by government, the Federal Trade Commission (FTC) last month proposed a ban on non-compete clauses, which are employment agreements that stipulate that workers leaving a firm cannot form their own competing company or join a rival company within a certain time frame.

The FTC claims the ban would increase competition and raise wages. But in reality, a ban on non-compete clauses would have the same effect as any other labor regulation: By dictating to workers how they must compete, and thus perversely limiting workers’ options, such regulations reduce wages rather than raising them. The best evidence of the harmful effect of a ban on non-compete clauses is the revealed preferences of workers. Today, nearly 20 percent of American workers have non-compete employment arrangements, and almost 40 percent have had one at some time in their career.

The most obvious reason workers accept jobs with non-compete clauses is that many employers are willing to pay for it. “Companies use non-compete clauses to protect their intellectual capital, which is often between the ears of its employees,” according to a recent Wall Street Journal editorial. “Tech firms in particular often pay higher compensation, including stock grants, in return for non-competes.”

In any case, a non-compete arrangement essentially occurs whenever a worker’s ability to start or join a competing firm is worth more to the employer than to the worker himself. In such situations, the employer simply pays the worker to sell that ability by agreeing to a non-compete arrangement. And despite the FTC’s claims, many workers’ chosen jobs may not even exist in the absence of non-compete agreements.

Indeed, many business initiatives, or even an entire company’s operations, may rely on non-compete agreements to be economically feasible. If a business wants to invest in research to create a new product, for example, but cannot prevent employees with critical knowledge of it from starting their own competing firms or taking the knowledge to a competitor, the initiative may not be economically viable. Without non-compete agreements, many businesses would not be willing to take on such risk. The related jobs, benefits to consumers, and returns to investors would never be realized.

As five authors of a research paper published by the Global Antitrust Institute at George Mason University explain, banning non-compete clauses “would risk falsely condemning procompetitive uses of non-competes and thereby reducing productivity and dampening the incentives to invest in trade secrets and to disseminate firm-specific knowledge widely among a firm’s workforce.” And basic economics is abundantly clear that the sure effects of lower productivity, less investment, and less dissemination of knowledge are lower wages and reduced employee welfare.

Of course, non-compete clauses are not unmitigated goods; they come with costs for workers and the economy. But the standard assumption in labor economics — in fact, the standard assumption in all economics — is that the parties involved in any given transaction have the best incentives and the best knowledge to maximize their joint welfare in contractual arrangements. At the very least, they have better incentives and better knowledge than government regulators at the FTC. The competitive process itself, then, protects against exploitation, ensuring that both parties win. Meanwhile, regulatory initiatives that dictate the terms of transactions reduce the joint surplus of trade, to the detriment of all.

So when it comes to labor regulation — whether a ban on non-compete clauses, minimum-wage legislation, mandatory paid sick days, or anything else — the best government policy is a hands-off one. Laws said to protect workers or guarantee them certain benefits (minimum wages, minimum paid sick days, or, in the case of the FTC’s proposed ban, a minimum level of future mobility) are, as Richard Epstein has called them, “microeconomic madness.”

Since employers must compete for talent by offering the most attractive compensation packages to workers in the most cost-effective way possible, an employer’s unwillingness to offer certain benefits, as Epstein writes, “is well-nigh conclusive evidence that the cost of the disputed benefits package exceeds the gains for his or her employee.” And just as minimum wage laws said to “protect” workers end up putting many of them out of employment, so too may a ban on non-compete clauses destroy jobs or, at the very least, cause employers to claw back on wages and other benefits.

The FTC’s proposed rule is all the more deleterious because it does not propose to phase in a ban or even implement it only for contracts yet to be written. Instead, it proposes to rewrite the labor contracts for the tens of millions of workers and employers who have existing non-compete clauses in place. In doing so, the FTC is already creating additional regulatory uncertainty for future contracts. Now, before employers hire new workers, they have to consider the possibility that unelected bureaucrats may alter the terms of the contract after it is signed. It is not a prospect likely to encourage hiring and business investment.

In sum, the FTC’s new ban hurts businesses, workers, and consumers. And no one receives any compensating benefits except the regulatory activists who get a thrill from central planning.