There are some good economics whodunits out there. One of my favorites is why real wage growth has slowed in several countries over the past two decades. Economists have identified several possible culprits, from the slowdown in global productivity growth to the decline of labor unions. To that list I want to add another suspect: lawyers. Or rather, the fine print that lawyers write.
Until recently, economists have paid little attention to the Ts and Cs of employment contracts. But what’s in these documents quietly shapes how labor markets work — and not necessarily for the better.
The story begins in the US, where economists and law professors such as Evan Starr and Orly Lobel have charted the extent to which benefits traditionally associated with top executives have actually spread across the workforce. confidentiality statement; non-disparaging clauses; non-compete agreements — many American workers are now caught up in a thicket of the stuff.
Non-leagues have attracted the most attention. Nearly one-fifth of American workers are bound by these clauses, which prohibit them from working for or starting a competing business within a certain period of time after leaving their job. They are more common in professionals, but the research suggests that about 14 percent of people earning less than $40,000 are also subject to them. The Federal Trade Commission took legal action this year against a security company that, according to the FTC, had banned its low-paid security guards from working for a competing company within 100 miles of their job site two years after leaving the company. The guards were threatened with a $100,000 fine if they violated the clause.
The argument for non-compete clauses is that they encourage employers to innovate and train employees, because they know their investments are protected. If an employee could just go straight to a competitor, why train them in the first place? People on this side of the argument admit that some companies apply overly restrictive non-compete clauses to employees who lack valuable trade secrets or training. But they point out that the courts can and will rule unreasonable clauses as unenforceable. The problem is that employees may not know that, or be willing to go to court to find out. A Starr study found that 70 percent of employees with unenforceable non-compete agreements mistakenly believed they were enforceable.
Critics believe they nip innovation in the bud and “gobble up” the job market by preventing workers from moving freely to where they would be most productive. They see non-competition as a way for capital to quietly stack the deck against labor.
A number of studies do suggest that such clauses depress labor mobility and wages. When Hawaii banned noncompetitive workers, researchers found that worker mobility increased by 11 percent and wages for new hires rose by 4 percent. Non-competition also seems to be making life harder for young startups: Another study found that in US states where non-competition was more enforceable, new companies died earlier and even those that survived remained smaller in their first five year. It’s probably no coincidence that non-compete clauses are legally unenforceable in California, the innovation capital of the world. The FTC announced plans to ban them altogether this month.
But the story doesn’t end there. In Europe, many economists assume that it is a uniquely American phenomenon. But that doesn’t seem true. A recent study by Italian economists found what Andrea Garnero, one of the authors, called “stunningly similar patterns” of non-competitive use in Italy and the US. A study in Japan, yet another type of economy, found similar patterns.
Lawyers aren’t necessarily the bad guys. Employers are increasingly using standard language, which can result in more restrictive clauses than is really necessary for most employees. “I always try to advise customers [that] it’s a bad approach [to stick the same clause in for everyone] but of course it happens,” said David Samuels, employment partner at Lewis Silkin.
But whether they spread unintentionally or not, the effect of these clauses on productivity, compensation, innovation and mobility is significant. Time to pull out the magnifying glass: The economics of fine print can have a major impact on how we understand the world today.