Drawing on the theory of Albert O. Hirschman’s Exit, Voice, and Loyalty, Brian Callaci argues non-compete clauses stifle the important channels of communication between employees and businesses necessary for improving firm competitiveness. The evidence also shows that, despite claims from businesses, non-competes harm rather than reward employees for their loyalty.
As the Federal Trade Commission (FTC) turns its attention from soliciting public comment on its proposed rule banning non-compete contracts to reviewing the comments and writing the final rule, certain sections of the business lobby, led by the United States Chamber of Commerce, have turned up the heat in opposition.
The Chamber, which has already threatened to sue the agency if it enacts a rule banning non-competes, has made a range of procedural arguments contesting the agency’s authority to enact a rule. However, the core of its substantive case against the rule is that non-competes actually help workers by binding them more closely to their employers. (The Chamber also argues that non-competes are necessary to protect employers against workers stealing trade secrets and customer lists, but this ignores the ready availability of existing laws already tailored to this purpose, such as trade secrets laws.) According to the Chamber, the value of non-competes is that they reduce turnover and promote employer investments in worker training by reducing worker free-riding: if an employer can prevent workers from leaving, then that employer has more of an incentive to train them, which ultimately benefits both parties. According to the Chamber, “firms benefit by retaining well-trained employees, and employees benefit from more training opportunities and the stability of lower workplace turnover, which can improve team efficiency and morale.”
However, using the Chamber’s own argument, non-competes also lower workers’ own incentives to invest in their own training: why try to learn new skills if you can’t find a new job and get fair value for them? Are non-compete contracts merely an attempt to align the incentives of employers with workers to enable mutual flourishing, or are they instead an exercise of raw power?
The great 20th-century economist Albert O. Hirschman, whose heroism rescuing refugees from Nazi Germany was recently portrayed in the Netflix series Transatlantic, offered some clues in his seminal 1970 work, Exit, Voice, and Loyalty. As Hirschman explained, organizations stagnate and decline when they are unable to obtain high-quality and timely information about their own functioning. An employer has two ways of learning about internal problems: they can observe workers quitting to work for a competitor (exit), or they can hear the workers’ complaints (voice). While they function in different ways, both exit and voice are vital signals that businesses must interpret to improve their operations and right an unsteady ship.
The anti-union Chamber of course has a longstanding history of resolutely opposing any increase in worker voice through labor law reform. However, by now coming out in opposition to worker exit as well, it is seeking to close the only other information channel workers use to communicate problems to management. Hirschman warned doing so would accelerate business decline, as companies would have then sealed off any way of learning about internal dysfunction.
Hirschman had more to say, however. He argued that voice is not always a substitute for exit, but in key respects a complement to it. And the key to voice is loyalty—workers who are loyal are invested in the firm and committed to its success. Loyal workers use voice when they believe their input, combined with that of other workers, will be heard and successful. While a disloyal worker quits without warning, a loyal worker threatens to leave first. Loyalty prevents the most discerning (likely the best-performing) workers from being the first to jump ship. But loyalty must be earned. A worker reluctant to leave because they are bound by a non-compete is not loyal, she is simply trapped.
Trapping workers in their jobs through non-compete clauses might seem like an easy substitute for earning worker loyalty through mechanisms like good treatment, decent wages, and the possibility of future advancement. But it is also a cheap and inferior substitute. While the value of loyal workers is their voice, the loyal worker’s voice is only effective if they can credibly threaten to exit. As Hirschman pointed out, a necessary precondition for loyalty is the possibility of exit: a trapped worker without an exit option lacks the leverage to force management to listen to their concerns, and therefore the motivation to raise those concerns in the first place. Hirschman warned that businesses ignore loyal workers at their peril: “The threat of exit will typically be made by the loyalist—that is, by the member who cares.”
Hirschman’s profound insights about the self-defeating consequences of blocking exit are deeply relevant to the issue of non-competes. According to Hirschman, while organizations that remove the threat of exit as an effective instrument of voice might be able to thereby repress both voice and exit, they in the process deprive themselves of the benefits of either recuperation mechanism. Such actions, Hirschman commented, were most common among authoritarian but brittle organizations like gangs and totalitarian parties.
The Chamber argues that non-competes are not brute force exit-blockers at all, but rather instruments of building mutual commitment, from which both parties gain. Are non-competes mutually beneficial contracts that align employer-employee incentives for the gain of each, encouraging both parties to commit to the relationship? If so, we would expect to see higher wages for workers subject to non-competes. Non-competes are supposed to facilitate training, after all, and employers would be expected to share at least some portion of the gains with workers. However, if Hirschman’s views on exit and loyalty were correct, we would expect to see wages rise precisely when non-competes are banned, because then employers unable to force workers to stay by barricading the exits would be forced to earn worker loyalty through higher wages.
What does the evidence show? A recent study exploring the 2008 Oregon ban on non-compete agreements found that banning non-competes increased wages by as much as 14%-21%. The negative effects of non-competes fell hardest on workers with low bargaining power, such as female workers. Another study found that wages of technology workers rose 4% after non-competes were made non-enforceable in that sector in Hawaii. My co-authors and I similarly found that franchise employers were forced to raise wages after the state of Washington obtained an agreement from franchisors to stop using no-poach agreements in franchise contracts. Finally, a national survey study found that non-competes tend not to be negotiated at all, but are instead simply imposed on workers by employers: only 10% of employees negotiate over their non-competes, and one-third are presented with them after only accepting their job offers.
The Chamber of Commerce, of course, represents employers rather than workers, and incumbent corporations rather than potential startups, so they might not be expected to be overly concerned with issues of worker rights or reduced business dynamism. (Indeed, non-competes do in fact stifle new business formation, which the Chamber might see as a benefit rather than a cost.) Incumbent corporations might feel threatened by employees leaving to join competitors or start new firms in competition with them. They very well might like to retain the ability to trap workers in their jobs through non-compete agreements, even at the expense of stagnating wages and lower business dynamism, rather than being forced to earn worker loyalty and compete against new entrants.
It is much less clear why the FTC should favor their approach. Quite the opposite: the FTC should enact a total ban on non-competes and functionally similar coercive labor contracts.
Articles represent the opinions of their writers, not necessarily those of the University of Chicago, the Booth School of Business, or its faculty.
