Noncompete Clauses: Markets Are Made, not Given by Nature

April 23, 2024

The Federal Trade Commission (FTC) will hold a hearing later today on noncompete clauses. These are a part of tens of millions of employment contracts that limit the ability of workers to quit their current employer and find jobs elsewhere.

While noncompete clauses were originally only included in contracts for highly paid workers, for example, lawyers at a large firm might be limited in their ability to leave and take their clients with them, they have become much more widespread in recent decades. They often prevent lower-paid workers’, such as barbers or beauticians, from starting their own business or working for a competitor. In one famous case, a fast-food chain actually limited the ability of their employees to get jobs elsewhere.  

The effect of noncompete clauses is to reduce the wages of workers affected by them. The direct impact on workers subject to clauses could be as much as 15 percent, and the impact on all workers’ pay could be over 8.0 percent. In short, they are a big deal in determining wages and the distribution of income.

The question the FTC is considering is whether they should be enforceable. Anyone who thinks that making them unenforceable would be a case of the government interfering in the market needs to think further. The government always decides what sort of contracts it will enforce.

To take one from history, in England it used to be common to have encumbrances attached to property that was inherited or sold. These often gave relatives of the original owners claims against a property, such as a share of the harvest of a farm. Most of these sorts of encumbrances are non-enforceable.

A more recent type of unenforceable encumbrance was the provision in many deeds that a property could never be sold to a Black person or a Jewish person. The government will not enforce such provisions.

Taking an example in the labor arena, 28 states have “right-to-work” laws. These are misnamed because they actually have little to do with anyone’s right to work. What they actually do is ban contracts that require all employees in a workplace represented by a union to pay a representation fee to the union. Such a contract would be unenforceable in one of these states.

Another example of the government superseding contracts is bankruptcy laws. Under bankruptcy law, the government tells creditors that they can’t collect on legal obligations regardless of what contractual provisions they may have agreed to.

This issue comes up not only with explicit loans between a borrower and lender, but can also arise with unintended creditors, such as a supplier who has delivered goods, a landlord waiting for rent, or a worker waiting for wages. (Donald Trump took advantage of this loan forgiveness program six times, something perhaps worth mentioning in the context of President Biden’s student loan forgiveness program.)

The point here is that contracts don’t enforce themselves, they rely on the government to use its police power to make the parties follow through on obligations. There are all sorts of contracts that the government will refuse to enforce or will not enforce in the ways written (ones that explicitly discriminate based on race or sex are the most obvious).

The FTC is assessing whether noncompete clauses are the sort of agreement the government should be enforcing. We know the impact of enforcing these clauses is to lower wages. The issue before the FTC is whether or not it is good to lower wages and limit workers’ employment opportunities. There is no “free market” issue in this story.


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