Non-competes are a drain on the economy and innovation

In 2022, news broke that Australia's biggest accounting firm had used secret government plans to help clients avoid a new multinational tax law. As the story unfolded, some of PwC's customers decided to take their business elsewhere. Some PwC staff also decided that they would prefer to work elsewhere.

But there was a catch. When partners and employees sought to leave PwC - or its spin-off Scyne Advisory - they began to hit barriers. One clause in the exit agreement imposed a two-year ban on partners working with any client that their business unit had previously advised. Because of the breadth of PwC's client base, this effectively ruled out partners working for almost any government or large business in Australia. After giving notice, the agreement allowed PwC to withhold up to 100 per cent of salary for some partners.

Citing a one year non-compete clause, Scyne took junior partner Connie Heaney to court to stop her taking a job at a rival firm. The case was finally settled after Ms Heaney agreed to take a different position at her new company.

Non-compete clauses are a common way that professional service firms look to lock down their staff. They've also become ubiquitous across the economy. According to a survey by think tank e61, one in five Australian workers are subject to a non-compete clause; a higher share than in the United States.

When signing a contract, few people are likely to quibble over the exit terms. When you're starting with a new company, there's a sense of excitement and possibility. Everything is smiles and handshakes. In that environment, what kind of a grinch would you have to be to negotiate over the non-compete clause? I've heard stories of non-compete clauses being applied to fitness instructors and early childhood workers, security guards and disability support workers. Anywhere a standard-form employment agreement is to be found, non-compete clauses are sure to follow.

In some cases, non-compete clauses are invalid. As the case of Connie Heaney courts may side with the worker rather than the firm. But most cases never get to court. When legal costs could run into tens of thousands of dollars, employees tend to just abide by their contract, rather than challenge it in court. Even unenforceable non-compete clauses can have a chilling effect on job mobility.

In the US, the Federal Trade Commission has decided to crack down. This year, they announced a nationwide ban on non-compete clauses, regardless of the salary that people are paid. The regulator estimated that the ban would raise average annual wages by $US524, lead to the creation of over 8000 additional businesses.

In Finland, non-compete clauses are only valid if the employer pays the ex-employee for the duration. The minimum compensation must be 40 per cent of the wage. This approach puts a cost back on the employer, making them think twice before simply banning former staff from moving to a rival.

The risk of non-compete clauses is that they don't just hurt early childhood workers; they can also hamper entrepreneurs. Suppose you decided to establish a firm called “Principled Wisdom Consultants”. In a full-employment economy, it's unlikely that you'd be able to staff your new company by hiring people who were previously unemployed. More likely, you would be looking for people working at existing consulting firms. Yet if all the talent in the consulting sector is tied down by non-compete clauses, then Principled Wisdom Consultants might never get off the ground.

Right now, the Australian Government is considering the best way to regulate non-compete clauses. Submissions to our issues paper closed recently, yielding a range of thoughtful submissions. We are working through those submissions, and will have more to say soon. If we opt to limit the use of non-compete clauses, we will engage in an open consultation process, as we do on other economic reforms. The big question is: will increasing the freedom of workers to move boost Australia's prosperity and productivity?

This article was first published in the West Australian on July 23, 2024.