Noncompete clauses: What are they and are they good or bad?

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published 6 January 2023

The Federal Trade Commission has proposed banning companies from binding their employees and contractors with noncompete agreements. Such clauses bar workers from moving to a competitor or starting their own rival business for a fixed period of time, typically six months to two years. About 30 million U.S. workers, or between 20 percent and 45 percent of private sector employees, are bound by noncompetes. Here's a look a their upsides, and why the FTC is proposing to get rid of them.

Pro: Protect trade secrets

Companies require noncompete clauses for "a multitude of economic reasons related to training, high minimum wages, company secrets, and more," says Ryan Borne at the Cato Institute. For example, "if your job is to make minor tweaks to the formula for Coca-Cola and you're one of 25 people on Earth who knows the formula," American Enterprise Institute economist Michael Strain tells The New York Times, "it makes total sense that Coca-Cola might say, 'We don't want you to go work for Pepsi.'"

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Many journalists and policy analysts started paying attention to noncompetes "a few years back when it was revealed that the sub chain Jimmy John's was forcing its sandwich makers to sign the agreements," Jordan Weissman writes at Semafor. Jimmy John's dropped that requirement after a lawsuit, but noncompete clauses have morphed into a "yoke for low-wage hourly workers who ordinarily have little say over terms of their employment." In fact, "the only source of power non-unionized workers have vis-à-vis their employers is their ability to quit and take a job elsewhere," the Economic Policy Institute said in a statement.

Noncompete agreements may be spreading to hourly employees making minimum wage, but they are still "most common among higher-paid workers," The Associated Press reports. And those workers will get the bulk of the collective $296 billion annual raise the FTC projects U.S. employees would get from banning noncompetes. But in this tight labor market, wages are already rising, "which the Federal Reserve says is a chief contributor to the highest inflation in decades," Derek Saul notes at Forbes.

The flip side of that, Sen. Elizabeth Warren (D-Mass.) said, is that "noncompete clauses give companies unfair power over workers, enabling them to cut wages and benefits without fear of workers finding a new job or starting their own business." Evan Starr, a University of Maryland economist who has studied noncompetes, told the Times they appear to lower wages both for workers who have signed them and some who haven't due to across-the-board increased hiring costs.

Companies are more likely to invest in their employees by training them and trusting them with sensitive information if they know they won't jump to a competitor with that training and information, proponents argue. When "appropriately used, noncompete agreements are an important tool in fostering innovation and preserving competition," says Sean Heather at the U.S. Chamber of Commerce, because "they protect (among other things) an employer's special investment in, training of, and disclosure of sensitive business information to its employees."

"Noncompetes are basically locking up workers, which means they are not able to match with the best jobs," FTC chairwoman Lina Khan said Wednesday. "This is bad for competition. It is bad for business dynamism. It is bad for innovation." Many observers speculate that "Silicon Valley eclipsed Boston's Route 128 as America's premier tech hub in part because California bars noncompetes, while Massachusetts does not," Semafor's Weissman adds.

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Peter has worked as a news and culture writer and editor at The Week since the site's launch in 2008. He covers politics, world affairs, religion and cultural currents. His journalism career began as a copy editor at a financial newswire and has included editorial positions at The New York Times Magazine, Facts on File, and Oregon State University.