What are non-compete clauses? What are their pros and cons?

Non-compete clauses (NCCs) are contracts between employers and employees that prohibit the practice of a trade or profession for a specified time, and within a specified region, after termination of employment. From 2027, employers will no longer be able to enforce NCCs on workers earning under $175,000 per year.

These clauses are intended to protect employers’ proprietary information and investments in employee training.

However, their impacts on labour market dynamics and macroeconomic performance are a subject of debate.

NCCs offer several advantages for businesses. They help protect trade secrets and confidential information.

This ensures that sensitive data such as proprietary processes and client lists aren’t used by competitors.

They also may encourage firms to invest more in employee training, knowing that their investment is less likely to benefit a rival employer.

Additionally, they can help retain key talent, reduce turnover and lower the cost of hiring and training new employees.

Research indicates that NCCs can encourage firms to invest more in training their employees. However, they may also discourage employees from investing in their skills.

Studies have also found that although NCCs can boost firm-specific investments and productivity. But they may also reduce overall labour market mobility and stifle innovation. This can weaken the economy overall.

Because NCCs limit employee mobility, their proliferation can also hurt wages by limiting career advancement opportunities and creating skill mismatches.

Additionally, NCCs stifle industry-wide innovation. Without knowledge sharing, employees miss out on valuable learning experiences at innovative companies.

Under an NCC, they’re unable to share their expertise with other firms. Enforcing NCCs can also be costly and time-consuming, involving legal disputes that can lead to litigation.

 

How common are non-compete clauses in Australia? What happens when they become common?

NCCs first appeared in Australian employment contracts in the early 20th century, mainly for workers in high wage roles.

By the late 20th century, their use had expanded to middle management and specialised technical positions. NCCs became common in industries like technology, finance, and professional services.

The 2023 Australian Bureau of Statistics (ABS) Restraint Clauses Survey reveals the prevalence and types of restraint clauses used by Australian businesses: 21 per cent of businesses used NCCs for at least some employees in 2023 (Figure 1).

 

Figure 1: Restraint clause use by employers

 

These clauses were prevalent across various sectors, affecting both high-wage and low-wage roles.

They affected fast-food workers, childcare providers, and security guards (Figure 2).

 

Figure 2: Use of NCCs by industry

Using 2023 ABS survey data linked to employer-employee microdata, recent e61 research found that increased use of NCCs is associated with reduced job mobility and lower wage growth, particularly for low-skill workers.

Specifically, workers at firms that increased their use of NCCs experienced an 11 per cent decline in job-separation probability and a 10 per cent decline in job-to-job transition probability, with a notable 29 per cent fall in within-industry transitions.

Importantly, these workers were paid 4 per cent less on average than those at firms using only non-disclosure agreements (NDAs). Lower-skill workers saw around a 10 per cent lower wage level after five years of tenure.

 

Why non-compete clauses are an unnecessary barrier for low-wage workers

NCCs are particularly challenging for low-wage workers because they limit job mobility and restrict opportunities for better employment, trapping workers in low-paying jobs.

These workers also often lack the power to negotiate better conditions and the money to contest these clauses legally. As a result, they can face prolonged periods of unemployment or underemployment.

Evidence on the impact of the 2008 Oregon ban on non-compete agreements for hourly-paid employees revealed a 2 to 3 per cent increase in hourly wages on average.

It also showed improved job mobility, and better occupational status.

In Oregon, a ban benefited female workers the most, and those in occupations where NCCs were common. These findings underline the need to restrict the use of NCCs, especially in low-wage sectors.

In Australia, a recent Working Paper from the Tax and Transfer Policy Institute at the Australian National University (ANU) proposes several measures to reduce the negative impact of NCCs on low-wage workers.

These includes a ban on NCCs for low-wage jobs with a minimum salary threshold like the government’s. But also, requiring employers to clearly explain NCC terms and to provide their workers legal support for challenging unfair NCCs.

Overall, it calls for stronger government intervention to protect these workers and strengthen their bargaining power. This will involve legislative change.

 

Why aren’t workers compensated for agreeing to non-compete clauses?

Economic theory suggests that jobs with undesirable characteristics must offer higher wages to attract workers. Applied to NCCs, this implies that workers should receive higher wages to compensate for restricted job mobility.

However, in practice, this compensation is often not provided. This is especially common for low-wage workers with less bargaining power – there’s evidence that compensation for NCCs varies based on an employee’s position within a firm’s hierarchy.

Employees in top positions often receive high compensation, including wages and benefits, to offset the restrictions imposed by NCCs.

This is because their departure could significantly impact the firm. In the middle of the hierarchy, they are uncommon, to incentivise effort.

Unexpectedly, NCCs then reappear at the bottom of a hierarchy. These employees receive minimal compensation.

This is a result of their limited bargaining power and the lower perceived risk to the firm of them leaving.

These findings show that prohibiting NCCs for these workers is likely good for their welfare.

 

A step in the right direction

Regulatory interventions can limit the duration and scope of NCCs and require employers to compensate them. This includes fairly banning their use for low-wage jobs.

They balance their value to businesses with the benefits of worker mobility to wages and innovation.

In all, the Budget’s proposed ban on NCCs for low-income workers seems a step in the right direction.

 

Top image: Andrey_Popov/Shutterstock.