Send Noncompete Agreements Back to the Middle Ages

(Bloomberg Opinion) -- Noncompete agreements, once restricted to tech workers and high-level executives, have become commonplace among ordinary workers, including security guards, home health aides or hair stylists. If history is any guide, the spread of these contracts could have far-reaching negative implications for the U.S. economy.

Critics oppose requiring ordinary, low-skill workers to comply with these restrictions, arguing they should be reserved for well-compensated employees who benefit from specialized training and investment. But the history of these covenants suggests that there's a strong economic case for banning them entirely.

The agreements, known as NCAs, forbid workers from taking valuable skills acquired from one employer to a competing firm. They first appeared in the Middle Ages, when master artisans required them of apprentices because they didn't want to face direct competition once their protégés set up shop on their own. Courts eventually sanctioned these restraints, provided they didn't harm the public interest, establish a monopoly or unduly restrain an employee's right to work.

But this trend toward wider use of the contracts, which gathered steam from the late 18th century onward, conveniently omitted that they originally applied to skilled laborers operating in a pre-capitalist society. Yet employers increasingly used noncompete clauses to limit the mobility of unskilled wage laborers along with skilled workers.

In Great Britain, courts generally endorsed NCAs so long as they remained “reasonable” -- a quality that was very much in the eye of the beholder. In the U.S., courts approached NCAs in much the same way through the 19th and 20th centuries, often upholding them, but occasionally voiding them if they seemed too, well, unreasonable.

To complicate matters still further, individual states passed laws that circumscribed the use of NCAs, and in some cases, banned them altogether.

This has created a curious patchwork of statutes governing these agreements. But the divergent approach to NCAs pursued by individual states also has provided economists with an opportunity to answer a broader question: Have NCAs helped or hindered economic growth?

The most famous study looked at California, one of only a handful of states that do not permit NCAS. The de facto prohibition of the agreements affected skilled and non-skilled workers alike, and employees high and low could jump from job to job without any fear of legal reprisal. The mobility seems to have disseminated innovation very swiftly from company to company, creating the kind of dynamism and technological spillover that helps foster long-term success.

The prohibition of NCAs clearly benefited Silicon Valley. Further proof was provided by the comparison to another claimant to high-tech supremacy: Route 128 in Massachusetts. The conclusion was that California's ban -- and the embrace of the agreements in Massachusetts -– helped tilt the balance of power to California.

Other studies have echoed this finding. Michigan, like California, had no place for noncompete clauses. But this was undone when the state repealed several antitrust statutes in 1985.

The shift allowed researchers to conduct a “before-and-after” study of the effect of NCAs. They found that worker mobility in Michigan declined significantly after the state changed the law. They also determined that patenting rates -- a useful proxy for innovation -- dropped after the change.

This makes sense: Workers moved around a lot less, and the kind of constructive cross-pollination of ideas that follows increased mobility dropped as well. So even if companies were able to keep their innovations to themselves -- and reaping short-term gains -- they lost out on the long-term, larger benefits that come with allowing high-skill workers to move freely from company to company.

Subsequent studies have confirmed that non-competition clauses mute the diffusion of cutting-edge knowledge by generally benefiting older, more established -- and more sclerotic -- companies.

Worse, these studies also show that there's a tendency for high-skilled workers to migrate from states that enforce non-competition agreements to those that don't. In other words, states with NCAs may well suffer a “brain drain” on account of their policies.

Perhaps there's a minor place for NCAs under very specific, delimited conditions. But the historical record suggests that policy makers eager to spur technological innovation and the growth of high-wage jobs should ditch these medieval restrictions.

To contact the editor responsible for this story: Max Berley at mberley@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Stephen Mihm, an associate professor of history at the University of Georgia, is a contributor to Bloomberg Opinion.

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