Friday, July 25, 2014

Non-Compete Clauses Makes Us Non-Competitive

By Evan Robertson, Senior Project Associate.

If there is one hot button economic development issue I hold dear, it is my complete disdain for non-compete clauses in employment contracts. These clauses allow a particular company to place future restrictions on what types of businesses or jobs a worker can migrate to upon leaving the company voluntarily. Anecdotally, I've seen, first-hand, non-compete clauses limit entrepreneurship.

A few years ago my friend decided to enter the cell phone repair business, which it turns out is a fairly lucrative endeavor or at least was at the time. He decided to join a cell phone repair shop to learn the ropes before he ventured out into his own business. Upon his hiring, the company had him sign a non-compete clause with some unbelievable restrictions regarding what he could and couldn’t do after he left. The non-compete clause was so stringent – admittedly probably wouldn’t have held up in court at the time, although some state’s like Georgia are passing stricter non-compete legislation to the detriment of the state’s entrepreneurs – that he was effectively barred from competing with the company within the state in which he lived. Simply put, in order for him to start businesses he would need to leave the state he’s called home for so many years.

Everyone loses out on non-compete clauses, local economies (through loss of experienced professionals branching out to start their own businesses), companies (through a restricted labor market that limits information sharing), and the worker (who must either hold off on career transitions or professional advancement). To me, non-compete clauses are the antithesis of economic mobility and, ultimately, economic development. And yesterday, I was happy to discover, it’s not just me.

The Kauffman Foundation’s Rethinking Non-Competes: Unlock Talent to Seed Growth is a short, but compelling read on the subject. My favorite line, and perhaps the foundational argument against non-compete clauses, the Foundation states “The free movement of individuals in and out of jobs is a crucial component of an entrepreneur-driven economy, in which those with good ideas can easily leave employment to start new businesses.” Labor mobility, as the policy brief correctly identifies, is limited by these contracts.

So, what is the impact? The Kauffman Foundation identified a number of adverse economic impacts caused by these clauses, the list includes; lower compensation, skill atrophy, degradation of professional networks, expensive legal battles, lower rates of return on venture capital investment in state’s that enforce non-compete clauses, brain drain, increased income inequality, and fewer workers changing jobs.

On the upshot, state’s that strictly enforce non-compete clauses tend to invest more in workforce training and companies within these states are more likely to engage in long-term R&D processes that could potentially transform their market.

Kauffman recommends a number of key policy changes including limiting the duration of the non-compete clause, narrowing their scope, and ensuring that potential employees know that they will need to sign a non-compete agreement long before they accept the job offer.

And, I’d take it one step further, because this is a blog and I’m allowed to go a little crazy. Employees leaving a firm to create their own business or joining a startup, should be given complete amnesty from their non-compete clause. To prevent abuse, these employees would be unable to be hired by a firm aged one year or older within their industry for one-year, but are free to pursue their own business idea. This has the potential to support entrepreneurship, ensure that the state’s best and brightest remain, and ensure these employees don’t lose their vital skills.