Noncompete Clauses and the Depression of Wages

By James Dail (CMC ’20)

One of the most consequential macroeconomic phenomenon of the past half-century has been widespread wage stagnation. From 1979 to 2016, wages have barely grown at all (and in some cases have declined) for the lowest sixty percent of workers by income distribution. The average yearly rate of inflation from 1979 to 2016 was 3.52% above the average rate of wage growth for the bottom sixty percent of the workforce. This means that, at best, a majority of the work force has only been able to keep even with the cost of living since 1979, and therefore, that a majority of the workforce have seen no improvement in their livelihood since 1979 (excluding improved livelihood from technological advancement). Until recently, many economists have been puzzled by this trend. A recent paper co-written by two economics professors at Yale and Columbia, and a law professor at the University of Chicago, may have finally solved this mystery. Their research points to the increased market power of large corporations – with the dominant culprit being noncompete clauses in worker contracts. Their research points to the conclusion that noncompete clauses need to be eliminated if the United States is to see evenly distributed wage growth again.

Simply put, a noncompete clause states that a hired employee shall refrain from quitting their new place of employment in order to work for a competitor, with a possible exception if the employee is laid off. On the face of it, this is a sensible idea: no company wants its former workers to disclose trade secrets to its competitors. However, this comes with a negative consequence. With noncompete clauses, trade secrets are protected by enabling an employer to bring suits against the employee if they breaches their contract, instead of out bidding a competitor to retain the employee. This depresses an employee’s wages by not allowing other firms to compete for their talents.

In lieu of a bidding contest between employers, noncompete clauses create a massive deadweight loss in the labor market. Suppose that there is a mechanic who spent several years in trade-school specializing his skills after he graduated from high school. When he enters the labor force, the only competition for his wage will be during the hiring process. If his future employer has him sign a contract that contains a noncompete clause, then the mechanic will not be able to transfer to another firm who will pay him a higher wage unless he is laid off. Even if he turns out to be exceptionally good at being a mechanic, he will be stuck working for the first firm that hires him, with no way to drastically improve his life standing. The only way for him to earn a significantly higher salary, apart from a promotion that could take years to happen, would be to return to school and learn a new profession. Since the firm that hires him wants to maximize its profit, and if it is publicly owned, its shareholder’s value, then it has incentive to keep this mechanic’s wages as low as possible after the hiring process ends.

Scenarios like this have played out all across the United States, and the amount of lost wages as a result of these clauses is staggering. The median compensation for a worker in the United States today is $30,500. If the labor market was freed from these noncompete clauses and was allowed to be competitive, then wages would rise to at least $41,000, according to the new research(?). What’s more is that noncompete clauses are not confined to a few specific industries. They exist across all sections of the economy, from Silicon Valley tech firms to nurses, to fast food workers, although the pain they cause is most acutely felt in jobs that do not require a college degree.

The elimination of noncompete clauses in worker contracts could allow for an increased quality of life for Americans in the private sector. Additionally, banning these clauses wouldn’t mean that corporations will always have their trade secrets divulged. They will just have to pay a higher monetary price to retain these secrets. The only group that will be negatively affected would be business owners and shareholders, who would see a smaller, though still substantial, amount of a firm’s profits. The federal government could have significant positive impact on the labor market if it decided to ban noncompete clauses.

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