Antitrust Enforcers to Ban Indentured Servitude
Yesterday, the Federal Trade Commission proposed a ban on non-compete agreements that prevent workers from switching jobs. This move could boost wages by $300 billion a year, or $2000 per worker.
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Three days ago, the Federal Trade Commission Chair Lina Khan shocked the labor and employment law world, and proposed a broad rule to eliminate contracts that stop people from switching jobs. The President and Vice-President, as well as multiple members of Congress from both parties, spoke up in strong support, while the U.S. Chamber of Commerce called the action ‘blatantly illegal.’
I’m going to explain what just happened, why it matters, the politics, and the path forward. There’s also a role for BIG readers, since we were some of the earliest commenters at the FTC back in 2020 in favor of this proposal.
“My employer comes far too close to owning me than should be possible in a ‘free’ country.” - Anonymous commenter to the FTC
Over the last ten years, policymakers have become aware of a pervasive practice in labor markets known as a ‘non-compete’ agreement, an employment contract provision that bars people from leaving their jobs to go work for a competitor. Non-competes have been around for centuries, though they’ve almost always been rare. In the 1600s, they were used for things like a baker selling his shop, and as part of the sale the buyer had the baker commit to not opening a new bakery next door for some period of time. In the 20th century, non-competes applied to high-level executives, the proverbial CEO with access to Coca Cola’s secret recipe.
The reason for the lack of usage was simple - employment contracts themselves were rare. As law professor Dave Hoffman noted, in the early 20th century, employers avoided written contracts with employees, and those employees who had power used arrangements such as unions in place of them. But also, without computers, producing contracts used to be expensive. You’d have to have a lawyer write something out, get someone to sign it, and store and catalogue that document, for every single employee.
Today, producing and signing an employment arrangement is as simple as copying and pasting text from a model contract found online. At the same time, stricter arbitration laws made written employment contracts more attractive to employers. Today, non-compete provisions are part of boilerplate employment contracts. (This is true in virtually every area of the economy, except in the legal profession itself, where the American Bar Association has decreed that non-competes for lawyers are unethical. As one person complained to the FTC, the exemption of the legal profession from these agreements is “self-evidently absurd and ironic given that the profession has crafted the body of non-competes.”)
The net result is that such contracts, along with adjacent tools like non-disclosure agreements or training repayment agreement provisions (or TRAPs) have became a staple in many industries. Since 2000, the use of non-competes at all levels of society has exploded. Eight years ago, one in five employees in the United States was bound by one of these contracts, or 35-40 million people. It’s no longer just high-level employees who have them, but sandwich shop workers and janitors. For instance, 30% of hair stylists works under a non-compete, as do 45% of family physicians.
Now, first it’s important to note that such contracts are already unenforceable or restricted in many states, including California, Colorado, Illinois, Maine, Maryland, New Hampshire, North Dakota, Oklahoma, Oregon, Rhode Island, Virginia and Washington. And a lot of non-competes are never enforced and barely noticed by the employer or employee. For instance, the day before issuing its rule, the FTC settled with three different companies who dropped their non-compete provisions after being approached by the commission. One firm had contracts with near-minimum wage security guards that included a threat to fine low-level workers $100,000 if they left for a competitor. Upon being sued, the firm got rid of its non-competes, and said “We applaud the FTC's efforts to halt unlawful noncompete restrictions and to protect workers." So these are not really a big deal to most firms.
Still, for many people, being bound by a non-compete can be a truly horrible experience, a soft form of indentured servitude if you are tethered to a place and a specific skillset. While the ostensible purpose of such contracts is that an employee and employer are bargaining in a relatively equal position over the terms of work, it’s usually the case that employees don’t know what they are signing or aren’t in a position to refuse. In some states where non-competes are legally unenforceable, employers still threaten employees who don’t know any better. And while technically you should be able to go to court if an employer overreaches, most people don’t have the tens of thousands of dollars necessary to do that. So it becomes a silent threat to litigate you into bankruptcy. (It’s especially absurd when the employee can be fired at will but can’t leave to work for a competitor.)
And this happens. A lot. One person who complained to me is a real estate agent who had to put up with sexual harassment by a particularly litigious boss. I’ve heard from doctors whose lives are ruined by being forced to work in a bad practice, but who cannot move because their family is rooted in a particular area. One comment to the FTC came from a graphic designers for signage who was bankrupted by a lawsuit from her control-hungry former boss and a small town judge. These agreements are in every industry - finance, doctors in rural areas, startup founders, printing, floor installations, title and escrow work, software, NASA contracting, computer anti-virus research, and video game production. The overall goal is to cut wages by reducing the ability of people to bargain with rival employers.
And while it’s true non-competes hinder wage growth, they do much more than that. For instance, they prevent would-be entrepreneurs from starting companies. As historian Margaret O’Mara noted, California’s ban on non-competes, which has existed since the 19th century, was a key reason for Silicon Valley’s success. In the 1970s, Massachusetts had Harvard and northern California had Stanford, and Massachusetts was wealthier, better connected and more technologically advanced. But it was Northern California that prevailed in digital technology. In Massachusetts, the startup culture never became as ripe, and the porous information ecosystem of engineers changing companies that led to lots of companies in Silicon Valley never developed. Without California’s ban on non-competes, top semiconductor engineers could never have left their original employment to form legendary companies such as Fairchild Semiconductor or Intel.
These kinds of agreements also facilitate consolidation, particularly in health care. One of the biggest groups of complainants against non-competes are doctors, who are often specialists working in practices bought by private equity groups. Theoretically, there’s no reason a doctor couldn’t leave and join a better shop if his or her current practice is managed badly. And yet, leaving a practice is almost always blocked by a non-competes, which is particularly devastating in rural areas.
The arguments for non-competes are that workers can leave and take specialized knowledge or customers with them, and this harms existing firms and reduces the incentive to train people. While not an outlandish claim, such possibilities are better covered with non-solicitation agreements or trade secrets law. Other practices, such as tenure-based wage increases, can reduce people leaving to go to competitors or setting up shop on their own. As for the idea that non-competes reduce investments in knowledge-industries, well, that California exists undercuts that claim.
Over the last ten years, scholars and journalists have been covering the increasing prevalence of non-competes. Economists have done research and found overwhelming amounts of empirical evidence that such agreements are bad for growth, wages, and innovation. For instance, one study showed that when “Hawaii stopped enforcing non-compete clauses for high-tech workers, earnings of new hires increased by about 4%." There is a lot of research on these contracts at this point.
In 2020, the FTC held a workshop on non-competes, which can be a prelude to action. When the FTC does an event like that, they often open a comment docket so the public can weigh in. At that point, readers of this newsletter got involved. In a piece titled “Free Our Doctors, Engineers, Daycare Workers, Cheer Coaches, etc. from Fear,” I described the problem of non-competes and asked people to send comments to the FTC. And many of you did. This isn’t something most needed to hear explained, because the experience is so widespread.
One result is that yesterday, the FTC put forward a proposed rule under which these contracts would become illegal. According to FTC economists, such a change could potentially raise the aggregate wage of Americans by $300 billion a year, which works out to a little less than $2,000 per worker in the U.S. Under the rule, all non-competes would be unenforceable. Existing agreements must be canceled, and employers have to *tell* employees those agreements are null. Moreover, attempts to get around this rule by using non-disclosure agreements or other similar agreements are also banned. It’s just a straight-forward bright-line prohibition, though for statutory reasons it wouldn’t apply to non-profits, certain banks, credit unions, and common carriers.
Legally speaking, this rule is important for three reasons. First, the FTC is wielding rarely used authority to write a rule that prohibits an unfair method of competition. The FTC hasn’t done that since the 1970s. Second, there’s no consumer welfare element, the cases already settled by the FTC didn’t require proving changes to wages or output reductions. And third, this is the FTC trying to ensure competition in labor markets.
Democratic and Republican members of Congress chimed in with support, including Senators Todd Young, Kevin Cramer, Chris Murphy, and Tim Kaine. So did the President and Vice President. Of course, the U.S. Chamber of Commerce and Wall Street Journal were hostile, as were big tech-funded ITIF and NetChoice trade associations. They will no doubt litigate.
The pro-monopoly representative at the Federal Trade Commission, Republican Commissioner Christine Wilson, had a dissent that lays out the basic legal arguments that will be used against this rule - regulatory overreach, the ‘scientific’ data isn’t conclusive, etc. But it’s essentially a long diatribe in legalese that says ‘how dare you!?!’ Or as Wilson put it, “With all due respect to the majority, I am dubious that three unelected technocrats have somehow hit upon the right way to think about non-competes, and that all the preceding legal minds to examine this issue have gotten it wrong.”
The bottom line, this fight is heading for the courts, where hostile judges await.
Whatever happens, thousands of lawyers today are starting to explain to their clients how to comply with this rule. Standardized contracts that include non-compete sections by default are being edited to remove them. And business leaders are recognizing that non-competes are on the way out. Procedurally, there will be a 60 day window for comments, and I am going to give you a link when it is ready so you can weigh in. Then 180 days after the rule is finalized and voted on by the commissioners, it goes into effect.
It’s important to take a step back and recognize what Chair Lina Khan, along with fellow commissioners Rebecca Kelley-Slaughter and Alvaro Bedoya, just did. They took a blatantly unfair practice that affects tens of millions of people - I mean it’s literally called a ‘non-compete’ - and banned it. That’s governing. That’s wielding power in service of the public. They also took the idea that employers are allowed to have enormous control over their employees and contractors and said the government no longer allows it. The government’s job is to ensure our liberty from coercion, in all its forms. And for the first time in a very long time, the Federal Trade Commission acted like it.
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