Moneybox

The FTC Is Right: Noncompete Agreements Are a Scourge

They’re bad for workers, they’re bad for the economy, and the arguments to keep them make no sense.

FTC Commissioner nominee Lina M. Khan testifies during a  Senate Committee on Commerce, Science, and Transportation confirmation hearing on Capitol Hill in Washington, DC, April 21, 2021. (Photo by Graeme Jennings / POOL / AFP) (Photo by GRAEME JENNINGS/POOL/AFP via Getty Images)
Ban ’em, FTC Chair Lina Khan. GRAEME JENNINGS/Getty Images

This article is from Full Stack Economics, a newsletter about the economy, technology, and public policy.

When I saw the news on Thursday that the Federal Trade Commission wanted to ban most noncompete agreements, I thought of a friend I’ll call Eric who had a stressful experience with these contracts almost a decade ago.

Eric had recently earned his MBA and was working at a small consulting company in the Midwest. He wanted to change jobs, but had signed a sweeping noncompete agreement with his employer that prohibited him from working for a competing company for two years anywhere in North America.

Advertisement

Unfortunately, the agreement wasn’t specific about which companies were considered competitors. Eventually, Eric took a job at a software company that helped customers solve some of the same kinds of problems as his old consulting firm. He hoped that software was different enough from consulting that he wouldn’t get into legal trouble.

Advertisement
Advertisement
Advertisement

But a few months after switching jobs, Eric got a cease-and-desist letter from his old firm.
Eric was lucky enough to get some pro bono legal advice through a family connection. The lawyer told him he’d probably win in court, but the contract was so vaguely written that it was impossible to be sure. And while the lawyer was willing to help him negotiate a settlement, Eric would have to pay hefty legal fees if the case went to trial.

Advertisement
Advertisement

For months, Eric worked at his new company with the threat of a career-destroying lawsuit hanging over his head. With a mortgage and a young daughter, he couldn’t afford to lose his job. But he also couldn’t really afford to fight the case in court.

“It was the worst time of my life,” Eric told me. “I was constantly worried.” Eric said he battled depression, lost friends, and “was not a great spouse during that time period.” Eric ultimately reached a settlement. Its terms were confidential and prohibited him from disparaging his old employer, which is one reason I’m not using his real name in this article. He says that he wound up taking a three-month break from his new job “to make the problem go away.”

Advertisement
Advertisement

Eric’s story is far from the worst abuse of noncompete agreements I’ve heard about. Back in 2021, I wrote about three nurses who were ordered to stop practicing their profession in Wyoming. One was forced to take a new job across state lines that paid less and required a two-hour commute; she burned through her savings paying for extra child care. Another woman near retirement age was forced to take a grueling job as a traveling nurse.

None of this would have happened in California, where courts have not enforced noncompete agreements since 1872. Now the FTC wants to make the whole country work like California.
“I wholeheartedly support that,” Eric told me.

Silicon Valley’s Secret Weapon

Defenders of noncompetes argue that these contracts are necessary so that businesses feel comfortable investing in their workers. One of them is Alden Abbott, the FTC’s general counsel during the Trump years and now a scholar at the Mercatus Center.

Advertisement
Advertisement
Advertisement
Advertisement

“Companies could say ‘We’re not going to invest in specialized training or pass on trade secrets to employees, because they might just go off and use that against us,’” Abbott told me. Abbott worries that banning noncompetes could lead to companies investing too little in developing the skills of their workers.

Advertisement
Advertisement

While that worry seems reasonable in theory, it’s hard to square with the existence of Silicon Valley. California’s refusal to enforce noncompete agreements really has promoted a culture of job-hopping in the state’s technology sector. But it does not seem like this has been a serious impediment to the development of Silicon Valley or its ability to innovate—quite the contrary.

In a famous 1999 article, law professor Ronald Gilson argued that California’s lack of noncompete enforcement was actually an important factor in Silicon Valley’s success in the late 20th century. Drawing on earlier research by UC–Berkeley’s AnnaLee Saxenian, Gilson compared Silicon Valley to the tech corridor along Route 128 outside of Boston. Until the 1970s, both of these regions were major centers for the fledgling computer industry.
But in the 1980s, Silicon Valley pulled ahead. And Gilson and Saxenian argued that Silicon Valley’s job-hopping culture was a major factor.

Advertisement

Because Massachusetts law allowed businesses to limit employee mobility, many engineers spent their careers at a single company. In contrast, California law gave engineers the freedom to spend a few years at one tech company before moving on to another one. This job churn was surely frustrating to Bay Area employers, but it also promoted the rapid spread of ideas from one firm to another.

Advertisement

California’s approach has also been a boon for startup creation. One of Silicon Valley’s first big successes was Intel, a company founded by veterans of another semiconductor pioneer called Fairchild Semiconductor. Fairchild, in turn, was founded by a group of engineers who left a company founded by industry pioneer William Shockley.

Advertisement

That tradition continues to the present day, with people regularly quitting jobs at Google, Facebook, or Apple to start new companies that might wind up competing with their old employers. Startups are free to poach talented engineers from the technology giants, allowing the startups to grow rapidly if they have promising ideas.

Advertisement

Again, this is undoubtedly frustrating for industry incumbents who are constantly losing talented engineers—indeed, several tech giants got in legal trouble for maintaining a no-poaching agreement with one another. And some economists have theoretical models where easy job-switching harms innovation by discouraging companies from investing in new technologies or in employee training. But it’s hard to take these models very seriously given the spectacular success of Silicon Valley.

Indeed, I suspect that these models are backward: that the rest of the country is being held back by the enforcement of noncompete agreements. If that’s right, then it would be a good thing for the U.S. economy if workers outside of California were as free as California workers to hop from job to job, taking their skills and knowledge—but not the employers’ trade secrets—with them.

An Uphill Battle in the Courts

The most important question about the FTC proposal is whether it will stand up in court. Federal law prohibits “unfair methods of competition” and gives the FTC authority to enforce that prohibition. To a layman like me, it seems plausible that a noncompete agreement could be an unfair method of competition. But Abbott, the Trump-era FTC lawyer, is skeptical.

Advertisement
Advertisement
Advertisement

To understand this debate, it’s helpful to know a little bit of history. In the 1980s, there was an intellectual revolution that narrowed the scope of antitrust law. Scholars like Robert Bork argued that some business arrangements that might seem superficially anticompetitive can actually be beneficial in practice, and so should be allowed under antitrust law. These arguments were embraced by the Reagan administration and the Supreme Court, and as a result they have been the law of the land for the past 30 to 40 years.

Advertisement
Advertisement

The FTC’s new rule on noncompetes is part of a broader effort by the Biden administration to roll back the Bork revolution. Biden laid out his vision for competition policy in a 2021 executive order, and he appointed the antitrust hawk Lina Khan to chair the FTC around the same time. Last November, Khan’s FTC published a new policy statement laying out its expanded vision for Section 5 of the Federal Trade Commission Act, which provides the legal foundation for Thursday’s new rule on noncompete agreements.

Advertisement

Defenders of the antitrust status quo don’t like the direction Biden and Khan are pushing antitrust law, and argument over the noncompete proposal is best understood as a front in that larger war.

Advertisement

Opponents’ core argument is that the FTC doesn’t have a history of regulating noncompete agreements, and that it’s not appropriate for the agency to start regulating these agreements without explicit authorization from Congress. Christine Wilson, a Republican member of the FTC, wrote in her dissent that the FTC proposal was a “radical departure from hundreds of years of legal precedent.”

Wilson also pointed to the Supreme Court’s landmark decision in West Virginia v. EPA this year, which held that Obama’s Clean Power Plan exceeded the EPA’s authority under environmental laws. The high court held that regulatory agencies needed explicit authorization from Congress before they tackled major new policy questions.
Wilson and Abbott argue that similar reasoning applies to the FTC’s new noncompete proposal. They say that the FTC does not have a history of regulating noncompete agreements, and so it needs explicit approval from Congress to do so.

Advertisement

But advocates counter that Congress deliberately gave the FTC broad powers to define and regulate anticompetitive conduct. The law prohibits “unfair methods of competition” without defining this phrase in any detail. Presumably Congress wanted to give the FTC some discretion to deal with new issues as they came up.

Advertisement
Advertisement
Advertisement

In our phone conversation, I asked Abbott about the story of the Wyoming nurses who were forced to quit their jobs and move out of the state to find work. Didn’t that seem like it could be an unfair method of competition?

Abbott didn’t think so. The nurses’ noncompete agreement “affects the nurses and harms them but it may not affect competition in the marketplace,” Abbott told me.

I pointed out that the term “noncompete agreement” literally has the phrase “noncompete” in it. That has to be a clue that it affects competition right? Abbott didn’t buy it.

Advertisement

“That’s not the way antitrust laws define competition,” Abbott told me. “Antitrust laws talk about a relevant market, competition between two steel companies or two utility companies, or whatever.” Antitrust laws didn’t apply to the relationship between a nurse and her employer because that was a “vertical relationship,” he said.

I’ll confess that this did not make very much sense to me. But I do think there’s a good chance that Abbott’s view will prevail in court. While there is a lot of grassroots interest in more aggressive enforcement of antitrust laws, on both the left and the right, there has been little sign that the Supreme Court’s six-justice conservative majority is ready to rethink the prevailing antitrust orthodoxy.

Advertisement