The Case for Non-Compete Agreements
By David Henderson
I sometimes learn from people’s comments. So I want to hat tip a recent commenter on one of my four pieces on the Council of Economic Advisers’ report on alleged monopsony in the labor market. In Part II, I said that non-compete agreements for workers who don’t have company secrets seem to “suck.” Well, at least I said “seem.” My late professor and mentor Armen Alchian would have tut-tutted if he had seen that. One of the most important things I learned from Armen is that when you see a practice that is adopted voluntarily but that doesn’t seem to make sense, don’t immediately assume that it doesn’t make sense. Instead, ask under what conditions it might make sense.
I forgot that momentarily.
But commenter Aaron McNay caught my error, pointing out:
Both employers and employees would like to be able to train the employees if the cost of doing so is less than the gains in productivity. However, there is a potential collective action problem here. What happens if the employer provides the training, but the employee then moves onto another job? The employer bears the burden of the training costs, but does not receive any of the benefits. As a result, the employer does not provide the training, and a mutually beneficial trade is not made.
By preventing the employee from being able to move, a non-compete agreement eliminates the collective action problem. The employer provides the training and the employer and employee are made better off. There are more complications to this than presented here, of course. However, I still think it is an issue that is ignored too often when talking about these type of agreements.
Jason Furman and Alan Krueger followed up on the CEA report with an op/ed in the Wall Street Journal.
That led me to write this letter, which was published today:
Jason Furman and Alan B. Krueger (“Why Aren’t Americans Getting Raises? Blame the Monopsony,” November 4) claim “There is no reason why employers would require fast-food workers and retail salespeople to sign a noncompete clause–other than to restrict competition and weaken worker bargaining power.”
That’s false. There’s potentially a very good reason for employers to require such clauses: so that they can get a payback on the training they provide.
A dilemma that faces any employer who provides training to his employees is how to collect on the training. Imagine that the worker produces output worth $10 per hour and is paid $10 per hour. Imagine also that the employer can provide training that costs $1 per hour but increases the employee’s productivity by $1.50 per hour. It makes sense to do that, right?
But what if the employee, with that training, can get $11.50 per hour elsewhere that reflects his higher productivity. He may well leave. Then the employer who provided the training lost on the deal. Solution: a non-compete agreement so the employee can’t work for a competitor in the same industry that finds that training useful.
The WSJ editor changed the last sentence in a way that’s not quite faithful to my view, to make it sound as if I advocate such contracts. I don’t know enough to advocate them. Rather, I’m suggesting that employers see non-compete agreements as a solution.