Gabriella Monahova and Kate Foreman published an article about economic evidence on noncompete agreements in labor markets. In our column, we try to summarize the outputs of that article.
In the article, the authors divided the study into some parts; (i) theoretical framework (pros and cons), (ii) empirical evidence (employment, firms, and impact), and (iii) general discussions.
When we look at the theoretical benefits of the practice, the report prepared by US Treasury states some benefits. Firstly, firms can protect their trade secrets like intellectual property rights that improve the effectiveness of employees by adding noncompete clauses in their agreements. A lack of such terms may lead to a decline in effectiveness since employers may refrain from sharing trade secrets with their employees. Secondly, there might be a motivation for employers to invest more in training employees to reduce employees’ churn. On the other side, a lack of non-compete terms may reduce investment done by employers to employees. Finally, non-compete terms may lead to higher wages for employees in return of higher effectiveness and reduced capability of switching jobs.
On the costs side, the same report states some topics too. In general, the report expresses that non-compete agreements may decrease workers’ leverage in wage negotiations, force workers to leave the industry in which they are skilled and lead to a decline in overall experience and knowledge, decrease productivity by reducing labor market liquidity, prevent competitors from offering better terms to skilled employees. In detail, the report states more issues. Firstly, some employees are able to be skeptical about noncompete agreements and negotiate with employers whereas some employees (especially the low waged ones) may not have such a chance. In addition, firms founded by ex-employees of established firms can be prevented as a result of non-compete agreements, and founding new firms and enhancing competition may become more difficult Secondly, knowledge dissemination based on the transfer of employees may have good outputs on consumers since thanks to those employees, the competitors may make up new or low-cost products based on the same knowledge and skill. Finally, non-compete terms may force employees to stay at their current exploitative employers.
The authors examined some empirical studies in the following section of the article. Accordingly, there are studies about the outcomes of both employees and firms. The studies use enforceability of noncompete agreements across states in the US and over time, the method used in those studies is generally difference in difference models. In the employees’ side, studies generally focus on wages and worker mobility. For example, in research about the impact of the noncompete ban on the Hawaii technology market, researchers reached that the ban on noncompete agreements led to an increase in employee mobility by %11 and an increase in new-hired wages by %4. Another paper evaluates the impact of noncompete enforceability on wages and training. The researcher concludes that there is a positive relation between noncompete agreement enforceability and training (%14 increase) while there is a negative relation between noncompete agreement enforceability and hourly wages (%4 decreases). The study also states that wage decrease is higher for less skilled laborers.
When we come to firms’ side impact, we see positive relation between the existence of noncompete terms and an increase in investments. In a research, firms in states where non-compete terms are legally accepted have a greater appetite to have riskier investments than the firms have in states where non-compete terms are not accepted. In another study based on Linkedin data employment historical data, the researcher found that the stronger existence of noncompete terms not only leads to a decrease in employee leaving and entrepreneurship but also an increase in investments in existing firms 2 million $ on average.
In conclusion, the authors state that much study is needed to give an answer to the question of “are noncompete agreements overall beneficial or harmful”. The authors think that the claim of “noncompete agreements encourage capital and R&D investments” is based on strong theoretical and empirical arguments. On the other side, they see strong evidence that noncompete agreements lead to decreased worker mobility, limit entrepreneurship, and have more negative impacts on women and less educated workers and those with less bargaining power.
As economics.legal, we think that the need for economic studies to examine theoretical and legal arguments is growing. Economic evidence and economic analyses will become more vital in discussions in both competition law and the general policy-making process. The article that we examined above also shows that all stakeholders of a new and hot debate topic require empirical economic evidence to prevail.