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Treasury Notes

 The Economic Effects of Non-compete Agreements

By: Karen Dynan
3/31/2016

 
Having the freedom to work at a job that best fits one’s skills is a key way in which people can develop their careers and earn the highest wages possible.  Institutions that limit workers’ opportunities therefore deserve very careful scrutiny.  “Non-compete” agreements, which restrict how long a worker leaving a firm must wait before joining a competing firm, are one such institution.  Treasury’s new report on non-compete agreements explores usage of these agreements, highlighting their economic benefits as well as their harms.  The report makes the case that reform is needed in this area so as to ensure that these agreements are being used in ways that best benefit firms, workers, and society as a whole. 
 
U.S. employers commonly require workers to sign such non-compete agreements as a condition of hiring or continued employment.  Recent research suggests that about 18 percent of employees – nearly 30 million Americans – are covered by these agreements.  Covered workers span the educational, income, and occupational distributions:  For example, 14 percent of workers earning less than $40,000 per year are bound by non-compete agreements.  The employment restrictions associated with non-compete agreements are often quite broad, both in terms of the geographic area they cover and what defines a competing firm.
 
Non-compete agreements have economic benefits in some situations.  They can make firms more comfortable sharing their trade secrets with employees, which, in turn, can boost employees’ productivity and wages.  In addition, because non-compete agreements make workers more reluctant to leave a firm, employers may be more willing to invest in training for their workers.  Thus, when used appropriately, these benefits can provide real value to both firms and workers. 
 
However, a growing body of evidence suggests that non-compete agreements, as currently experienced by workers and enforced by states, are often deployed in ways that lack transparency and fairness.  For instance, workers are often presented with a non-compete agreement only after they have accepted a job offer or started work.  In addition, workers are frequently not well-informed about the laws associated with non-compete agreements in their states, allowing employers to write broad contracts that may not be enforceable but nonetheless have a chilling effect on workers’ perceived mobility.  They are also deployed in ways that may serve little social purpose—for example, many workers who appear unlikely to possess valuable trade secrets are still bound by non-competes.  The practical effect of all this is to reduce worker bargaining power, sometimes causing workers to leave their fields entirely or to forego valuable opportunities for advancement and career growth. 
 
These effects also have important consequences for the broader economy.  When workers are prohibited from switching jobs, new firms find it difficult to hire.  Innovations spread more slowly, possibly inhibiting the development of industrial clusters like Silicon Valley.  And the overall “match quality” of workers and firms is reduced as workers are prevented from making the optimal use of their talents. 
 
Our report seeks to begin a discussion of potential reforms in the usage of non-compete agreements.  Making non-competes more transparent to workers is an important first step.  In addition to mitigating the worst economic effects of non-competes, enhanced transparency is a matter of basic fairness to workers.  We plan future work that will build on our findings here, shedding more light on the economic impact of non-compete agreements and specific constructive reforms.
 
 
 Karen Dynan is Assistant Secretary for Economic Policy at the US Department of Treasury.
Posted in:  Category 1
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