The defective case against non-competitors

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Recently, President BidenJoe BidenBriahna Joy Gray: White House thinks extended student loan hiatus a “bad look” Biden to meet with 11 Democratic lawmakers on DACA: report Former New York State Senate candidate indicted in riot MORE signed an executive order which, among other things, orders the Federal Trade Commission to prohibit or limit non-compete agreements. Non-competition prevents departing employees from working for a competitor, usually in the same industry for a period of one to two years and sometimes in a limited geographic area. For example, a design engineer who resigns from Ford may be prevented by a non-competition from working at GM for a year. Non-competition in various forms has been used for centuries and is today most prevalent in professional, scientific and technical professions.

The many policymakers, economists and lawyers who have recently argued that non-competition depresses wages, hinders innovation and slows economic growth are the driving forces behind the presidential decree. According to this school of thought, there is virtually nothing good about non-competition. For example, FTC President Lina Khan asserts that such clauses “deter workers from changing employers, weakening the credible threat of workers leaving and diminishing their bargaining power.” To support these arguments, policymakers and academics repeatedly refer to multiple studies allegedly showing that non-competition inhibits innovation by reducing employee mobility.

Unfortunately, these arguments and studies are seriously flawed.

As we show in a comprehensive review published in the University of Chicago Law Journal, all major economic studies claiming that the negative effects on innovation and economic growth of non-competition have significant errors or are incomplete. Invariably, these studies are produced by economists and business school professors whose interpretations of state law are simplistic or contain serious errors. The result is that the results of these studies are not a reliable basis for making major policy changes that would shift the tailor-made enforcement regimes of most states with a sweeping national non-compete ban.

For example, a leading study that claims to show the negative effects of a 1985 Michigan law that allowed non-competition incorrectly assumes the law was retroactive, applying to existing employment contracts. As a result, the authors mistakenly infer that an almost immediate decline in the relative movement of employees was caused by the 1985 law. Other errors in major studies include the erroneous categorization of states that apply non-competition as not enforcing them (or vice versa), neglecting important exceptions to restrictions on the application of non-compete, ignoring legal substitutes for non-compete (such as the acquisition of shares over the course of time), incorrectly measuring the strength of non-compete enforcement and ignorance of interstate “choice of law” rules.

The largely unqualified conclusions of these studies that non-competition has almost uniformly negative welfare effects run counter to the older and more nuanced views of economists that non-competition has effects. compensation on innovation, employee training and economic growth.

Non-competition can generate economic gains by encouraging employers to invest in training their employees and in R&D. If competitors could “take advantage” of each other’s investments in training and R&D, there would be a chilling effect on those investments in the first place. Against these pro-competitive interests lie the costs of non-competition attributable to reduced employee mobility, which can lead to reduced flow of ideas and possibly lower wages. Consistent with this compromise, other empirical studies find that non-competition to some extent decreases the movement of employees, but encourages employers to invest in some form of R&D, training and capital investment.

These complex political compromises are old news for the common law, which has traditionally permitted non-competition, but subject to requirements of “reasonableness” that severely limit their scope and reach. This approach in various forms remains the law in almost all states except a handful.

A well-known exception is California, which has significantly limited the application of non-compete. Opponents of non-competition often cite the success of Silicon Valley as the reason for restricting non-competition. However, we show that other reasons are more likely to explain this success. These include a diverse technological ecosystem, local venture capital and educational resources, cultural attitudes towards risk, desirable weather conditions and, to a large extent, luck. Additionally, states that have traditionally enforced non-competition (subject to limits on reasonableness) have cultivated leading technology clusters, such as biotechnology in Boston, medical devices in Minneapolis, and information technology. in Austin.

Unlike tech workers, we agree that the reasons for limiting post-employment options for low-wage workers – for example, in sandwich shops – are weak and that there is little risk of economic harm from restricting employment. non-compete in these situations.

On the other hand, there is strong reason to believe that nationwide restrictions on non-competition in knowledge-intensive industries could lead to substantial economic losses due to reduced investment in R&D and employee training.

At the very least, before making sweeping national changes that would supplant states’ nuanced approaches to this long-standing contractual provision, President Biden and the policymakers and academics who have argued for his decree should re-examine the flawed studies motivating their opinions. Otherwise, as the saying goes, bad facts will make bad laws.

Jonathan M. Barnett is a professor at the Gould School of Law at the University of Southern California. Ted Sichelman is a professor at the University of San Diego School of Law, where he directs the school’s Center for Intellectual Property Law & Markets.


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