Noncompete agreements, wherein an employee agrees not to work for a company’s competitors for some period of time after leaving the company’s employ, came into vogue during the dot-com era of the late 1990s, when Internet companies were struggling to grow as fast as possible. The race for growth was due to network effects that were typical of the dot-coms. A network effect makes a webservice more useful simply because more people use it. Think about texting: a device that can send and receive texts is only useful to the extent that other people also have devices that can send and receive texts. Network effects are why so many people keep using Facebook despite the fact that they dislike Facebook. Each of us uses it because the rest of us use it.
When you’re a dot-com company looking to grow as quickly as you can, one of the worst things that can happen is that one of your employees goes to work for a competitor, taking with him valuable knowledge about your product. A competitor can shave months or even years off of their development time by poaching employees from a company that is further along in development.
Noncompete agreements protected dot-com companies’ valuable intellectual property. But employees could also use them as they competed for jobs. An employee who was willing to sign a noncompete was more attractive to an employer than one who wasn’t.
As the internet space matured, the need to grow fast quickly became less pressing. Yet, noncompete agreements remained, and spread beyond technology companies into healthcare, finance, and even retail. And they appear to have become weaponized, such that employers now use them to prevent employees from demanding higher wages. A noncompete agreement makes it harder for workers to obtain competing offers to use as leverage in asking their current employers for raises. Imagine what would happen if, as a condition of buying a car from your local car dealer, you had to agree not to buy your next car from a competing dealership. When it came time to buy your next car, you wouldn’t be able to comparison shop, and so would find it much harder to negotiate the price on your next car. That’s great for the car dealer, but not so much for you.
What’s new is that President Biden is pushing to ban noncompete agreements. One of the dangers of banning contracts is that the people who typically do the banning also typically don’t understand what role the contracts play. Consider the occasional call for banning futures contracts. To those who don’t use them, futures contracts look like mere gambling and, in fact, can be used for gambling. But futures contracts serve an important role in enabling farmers to lock in the price of a crop before it’s even planted. This significantly reduces the farmer’s risk in planting a crop, and so increases the quantity of crops planted. Banning futures contracts is a horrible idea that would only be proposed by someone who has no understanding of why futures contracts exist in the first place. A similar danger lies in banning noncompete agreements.
It’s almost never a good idea for the government to intrude in private contracts. If two parties freely agree to enter a contract, provided the arrangement doesn’t impose harm on any third parties, the government has no business interfering. But just arrangements are often symmetric – or, as the saying goes, what’s good for the goose is good for the gander. If the government is intent on weighing in on noncompete agreements, there is a better option than banning them. Instead, require that noncompete contracts apply equally in both directions. If a noncompete agreement prohibits a worker from going to work for a competing employer for a period of 12 months, then the agreement, by symmetry, should also prohibit the employer from hiring a competing worker for 12 months. That is, if the employee may not switch jobs, then the employer may not switch employees.
This doesn’t mean that an employer couldn’t fire a worker covered by the noncompete agreement, any more than it means that the worker couldn’t quit. It simply means that the employer couldn’t hire another worker to fill the vacant position, just like the worker couldn’t take a job at a competing company. Likely, many companies would not be willing to enter such a contract. And those companies likely don’t need noncompete agreements in the first place. The companies that would be willing to enter such a contract are those that truly require the noncompete protection.
Banning noncompete agreements is a ham-handed approach to addressing their potential weaponization. A better approach is to ensure that employers and employees are on equal footing when it comes to job mobility and competition, by requiring that the terms of the noncompete apply equally to both the company’s and the employee’s competitors.