Nearly one in five American workers are affected by noncompete agreements, which prevent workers from working for or creating a rival firm. In new research, Axel Gottfries and Gregor Jarosch estimate that the Federal Trade Commission’s proposed noncompete ban could raise wages by 4%.
Noncompete agreements between a worker and their employer restrict the worker’s ability to move to or create a competing firm. Such “noncompetes” are surprisingly widespread in U.S. and European labor markets, covering not only top executives and other employees trusted with business secrets, but also low-pay workers, such as fast-food cooks. It is estimated that about a fifth of workers in the U.S., a quarter of workers in the United Kingdom, and about 16% in Italy are bound by noncompetes. The practice has recently become the focus of policy makers and competition watchdogs in Europe and the U.S., and the Federal Trade Commission (FTC) in the latter has taken a particularly strong stance and proposed what amounts to a blanket ban of the practice.
In recent work, we study the economic effects of noncompetes, from both a theoretical and quantitative perspective. We find that noncompetes, in particular when they become widespread, have the potential to sharply erode wages by reducing competition for workers in the labor market. We estimate that a ban as envisioned by the FTC could raise U.S. wages by about 4%. This headline number, however, masks substantial heterogeneity across local labor markets, where some workers might see wage gains as high as 15% while some others might even see mild wage losses.
How do we arrive at these conclusions? We build on a model of the labor market in the tradition of the canonical dynamic monopsony model of Kenneth Burdett and Dale Mortensen (1998). This is a model in which firm competition for labor arises because employed workers search for jobs with higher pay. Offering a higher wage hence rewards firms with a lower turnover rate, reducing the costs associated with hiring and training new workers. The tradeoff between pay and turnover is governed by the job openings and wages offered by other firms in the labor market. This “threat” of turnover is the essence of firm competition for workers in the model and results in firms paying workers more than a job offer from a different company. This framework is a natural laboratory to assess the impact of noncompetes—which inherently restrict the poaching of workers by rival firms.
We extend the textbook model and introduce large employers—think megafirms and factory towns—and therefore a granular labor market structure with a small and finite number of firms. Additionally, we allow for firms to have market power not only in the labor but also in the product market. This allows us to capture that very large employers can arguably exploit their size in both input and output markets. These modeling decisions allow us to analyze the effects of local monopsony power on worker wages.
We then use our theory to ask what happens when some employers in the market use noncompetes. We show that these employers post wages that look—at face value—fairly attractive. The reason is that they compensate the worker for giving up on future job mobility. The job looks good in terms of pay, but bad in terms of future career opportunities. Once that effect is accounted for, the jobs with noncompetes turn out to be the worst in the market. Without noncompetes, jobs that provide such little value to workers would not last long because competition would undo them. The workers would leave for better jobs so quickly, it would not pay to create such jobs in the first place. How, then, are these unattractive jobs sustainable when paired with a noncompete? Almost by definition: The job is shielded from outside competition.
There are also strong spillovers to firms without noncompetes. Since firms that use noncompetes offer a low value to their workers, workers are more willing to accept a job with a lower wage from all other firms, since the average job is now less attractive. Similarly, the other firms are now also less worried about their workers quitting and market-wide negative wage spillovers arise. In other words, when parts of the market offer noncompetes the remaining employers reduce wages in response since such contracts reduce overall competition in the labor market. These spillover effects are large in our quantitative evaluation of the model. The theory shows that, as more and more firms introduce noncompetes, the consequences for workers can be disastrous, with competition and wages collapsing.
We also discuss an additional downside of noncompetes. Because firms that employ noncompetes have lower turnover they tend to be inefficiently large, leading to misallocation of workers across firms. Yet noncompetes also have an efficiency upside according to our theory. They lower turnover cost and increase firms’ willingness to hire and invest in their workers.
To tie things together, we offer a simple quantitative assessment of the FTC’s proposed ban of noncompetes in the US. We calibrate the model to the U.S. labor market, targeting average local concentration and turnover measures. We consider a baseline setting where 20% of workers are subject to noncompetes and then compute a counterfactual long-run equilibrium when all firms lose access to noncompetes. We find that wages rise by about 4%.
We investigate how the impact of a ban would vary with local labor market characteristics. Wage gains are particularly pronounced when any of the following is true: i) many workers have noncompetes, ii) employers can pass through the rise in cost due to higher turnover to product prices, because otherwise the rise in cost reduces labor demand which hurts workers iii) the level of competition, measured in job-to-job quits, is already high, or iv) training and hiring costs are high such that firms have a strong incentive to pay workers higher wages to avoid these costs.
Wage gains for workers can quickly grow to 15% in labor markets where noncompetes are widespread and training costs are high. At the same time, they can even be negative when firms operate in a highly competitive product market where they have no scope to pass through the rising turnover cost into prices and thus recoup the costs from higher turnover.
The overall picture is that noncompetes can substantially hurt workers by reducing competition among employers in the labor market. Our analysis suggests that a ban by the FTC will lead to sizable wage gains in the U.S., although the impacts will differ quite a bit depending on local labor market characteristics.
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