On the Inefficiency of Non-Competes in Low-Wage Labor Markets

By Bart Hobijn, André Kurmann and Tristan Potter

http://d.repec.org/n?u=RePEc:fip:fedfwp:93658&r=dge

We study the efficiency of non-compete agreements (NCAs) in an equilibrium model of labor turnover. The model is consistent with empirical studies showing that NCAs reduce turnover, average wages, and wage dispersion for low-wage workers. But the model also predicts that NCAs, by reducing turnover, raise recruitment and employment. We show that optimal NCA policy: (i) is characterized by a Hosios like condition that balances the benefits of higher employment against the costs of inefficient congestion and poaching; (ii) depends critically on the minimum wage, such that enforcing NCAs can be efficient with a sufficiently high minimum wage; and (iii) alone cannot always achieve efficiency, also true of a minimum wage-yet with both instruments efficiency is always attainable. To guide policy makers, we derive a sufficient statistic in the form of an easily computed employment threshold above which NCAs are necessarily inefficiently restrictive, and show that employment levels in current low-wage U.S. labor markets are typically above this threshold. Finally, we calibrate the model to show that Oregon’s 2008 ban of NCAs for low-wage workers increased welfare, albeit modestly (by roughly 0.1%), and that if policy makers had also raised the minimum wage to its optimal level (a 30% increase), welfare would have increased more substantially-by over 1%.

While NCAs could make sense for jobs where firms have heavily invested in a worker or where inside knowledge becomes an issue, they are difficult to justify for lower skill jobs. This papers lays out nicely that they serve to depress wages and overall welfare. A 1% welfare impact is not negligible, especially when you consider that the most affected are a fraction of the population, and the poorest one.