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New FTC Ruling May Kick Restrictive Contracts to the Curb
The FTC wants to eliminate noncompete agreements in the U.S. to make labor markets more competitive, but will likely face strong pushback from the U.S. Chamber of Commerce, a leading lobbying group.
The Federal Trade Commission (FTC) wants to put an end to noncompete agreements, which would impact over 30 million American workers. These agreements restrict an individual’s ability to move between certain jobs in a geographic region for a certain amount of time and inevitably hold back workers' pursuit of better pay and working conditions. FTC Chair Lina M. Khan hailed the move as good news for workers who have been held back by such agreements:
The freedom to change jobs is core to economic liberty and to a competitive, thriving economy. Noncompetes block workers from freely switching jobs, depriving them of higher wages and better working conditions, and depriving businesses of a talent pool that they need to build and expand.
Supporters of noncompete agreements say they protect confidential company information, and that they encourage employers to invest in workers’ education. These justifications almost imply that noncompete agreements are only used in highly technical roles in which employees may have access to propriety trade secrets. While they are more commonly used in high-paying fields such as finance and tech, they’ve also been increasingly used in low-wage sectors as well. In one high-profile case back in 2016, Jimmy John’s settled a lawsuit over a noncompete agreement that restricted employees in Illinois from working at other sub shops within a 3-mile radius of their stores for two years.
In Michigan, a complaint was filed with the FTC because Prudential Security and Prudential Command allegedly required more than 1,000 minimum-wage security guards to sign noncompete agreements. Those agreements threatened workers with a $100,000 penalty if they took jobs with competing security firms within a 100-mile radius within two years of leaving the company.
While the FTC is starting the push at a national level, a handful of states already ban noncompetes outright and a few other states prohibit their use with low-wage workers. The FTC is stepping in because they believe noncompete agreements have finally gone too far. Many low-wage workers don’t have access to enough secret company information that justifies a $100,000 fine for violating the agreement. While Jimmy John’s may be a national chain, the process of creating a sandwich isn’t exactly proprietary.
In competitive labor markets, workers are free to pursue better opportunities and higher wages by moving between employees, leading to improved working conditions for employees. It’s one of the key assumptions of competitive labor markets covered in an economics course. When we build those traditional “supply and demand” models, we assume people can costlessly move between jobs, workers have complete information about the job, and there are no unique characteristics about individual workers (in econspeak, we say that workers are homogenous).
Firms can’t pay below-market wages in competitive markets because workers could easily quit and go somewhere else paying higher wages. As those assumptions change, it introduces friction into the labor market. The more friction that exists, the more monopsonistic the labor market becomes. As markets become more monopsonistic, wages can be pushed down and firms increase profits. The Biden administration has been vocal about challenging longstanding practices that restrict workers’ ability to move between jobs or negotiate higher wages.
In the case of noncompetes, firms are making it more difficult (and costly) for workers to move to better jobs. Using Jimmy John’s as an example, productive sandwich makers who felt they weren’t being adequately paid could apply to work at Jersey Mikes or Subway. Those companies would likely pay this productive worker more for their experience, which ends up costing Jimmy Johns more money if they decide to match the competing offer or spend money training a new worker. If Jimmy Johns can successfully institute a noncompete agreement, that productive worker has fewer competing opportunities to seek higher wages in an industry they’re familiar with and are more likely to stay with the company.
Frictions come from a variety of sources and aren’t always the result of firm exploitation. When workers are attached to an area, perhaps because of family obligations, they are responsible for the friction. College students working while enrolled in classes can’t easily move to new cities since they must stay close to their university for at least a few semesters. While these students are enrolled, the labor market is more monopsonistic. Once graduation rolls around, their labor market opportunities become much more competitive.
While the FTC has voted on this groundbreaking decision to outlaw noncompetes, it is almost certain to draw legal action and pushback. The U.S. Chamber of Commerce, the leading lobbying group for business interests in the United States, has denounced the proposal as "blatantly unlawful" because they argue that the FTC doesn’t have the legal authority to alter competition rules. If the proposal is upheld, the decision to ban noncompetes would mark a significant victory for workers and one that will surely have a lasting impact on the business world.
Approximately 18% of labor force participants are bound by noncompetes, with 38% agreeing to at least one in the past [Starr, Prescott, and Bishara 2021]
A national survey of private-sector American business found that 49.4% of responding establishments indicated that at least some employees were required to enter into a noncompete agreement [Economic Policy Institute]
Banning them could increase US workers’ earnings by $250 billion to $296 billion each year [Federal Trade Commission]
A recent survey finds that 41% of employed Americans would be more likely to look for a job if the FTC were to ban non-compete clauses [Ipsos]
The U.S. Chamber of Commerce claims to represent the interest of over 3 million businesses, as well as state and local chambers and industry associations [U.S. Chamber of Commerce]