Opinion Piece: Competitive Wedge

Australian Treasury

Twenty‑one‑year old ‘Tony’, a boilermaker, switched to work in‑house for a former client. It was a rural town and customers were hard to find, so his previous employer wasn’t pleased about losing a customer. Tony was branded a troublemaker and was sent a letter saying he breached his post‑employment obligations. The letter further applied the blowtorch by threatening court action seeking thousands of dollars in damages plus costs.

‘Lauren’, a young mum, worked for a hairdressing business. She was a casual employee, who could be terminated with one day’s notice. After 14 weeks, Lauren quit and started her own business. When she posted about it on her Facebook page, her former employer sued her for $200,000 for breaching a 2‑year non‑compete clause.

Although their names have been changed, these are real examples of how employees’ opportunities can be restricted. Businesses impose many kinds of restraints of trade on their workers, and non‑competes are the bluntest tool in the shed. They constrain workers from moving to a competing business, or from starting a new one. A growing body of evidence suggests the increasing use of non‑compete clauses is harming job mobility, innovation and wages growth.

Last year, Treasurer Jim Chalmers and I established the Competition Taskforce to examine whether Australia’s competition laws, policies and institutions remain fit for purpose. One of the priorities we set for the taskforce was to examine the impact of non‑compete clauses and other restraints on workers, businesses and the broader economy. On this, I have 7 observations.

First, job mobility matters to the entire economy. In fact, job switching is something economists use as an indicator of a well‑functioning, competitive and dynamic labour market. For businesses, it means improved productivity, as they can attract the talent and skills they need. This is especially important for start‑ups and firms looking to expand. For workers, it means job satisfaction and higher wages as they move to more productive or innovative firms. In a career, the biggest wage gains typically come from switching employers. Aaron Wong, from economic research institute e61, found job switching and the pay increases that come with it are worth $5,700 a year for typical workers. It is worth even more for younger job switchers, who can earn on average $7,500 more a year than job stayers.

Despite these benefits, Australia has seen a general decline in job mobility. This is part of a broader fall in dynamism. Over the past 2 decades, entry and exit rates of employers, job re-allocation, the proportion of high‑growth firms and the proportion of employment by young firms all declined. So it makes sense to carefully assess any barriers that may be limiting people from moving jobs, limiting businesses from expanding and limiting the flow of innovation in the economy.

Second, the use of non‑compete clauses has become commonplace in Australia. A survey of employees conducted by Dan Andrews, formerly at the e61 Institute, and Bjorn Jarvis from the Australian Bureau of Statistics found that 22 per cent of Australian workers had a non‑compete clause. This is comparable to estimates in other countries, with 18 per cent of workers covered by non‑compete clauses in the United States, 26 per cent in the United Kingdom, and 37 per cent in the Netherlands (up from 19 per cent in 2015).

Third, we know from new Treasury surveys that these restraint clauses don’t just apply to the boardroom; they apply to workers in the mailroom too. Once upon a time, only the best paid corporate executives were required to spend a period of ‘gardening leave’ between jobs. Now, gardeners are being forced to take gardening leave. Non‑compete clauses are increasingly being applied to employees in lower‑paid jobs, such as early childhood workers, yoga instructors and hairdressers.

The fact that non‑compete clauses also apply to lower‑paid workers is significant, especially when negotiating agreements. With low bargaining power, negotiating an employment contract is hard, and awkward. A study in the US found only 10 per cent of employees negotiate over a non‑compete clause, with many assuming the terms were not negotiable. Another issue is awareness, with Treasury’s taskforce hearing reports about Australian workers signing contracts without even being aware of the terms.

That leads to the fourth observation: enforcement threats can create a ‘chilling effect’ on worker mobility. Contesting one of these clauses in court can cost tens, if not hundreds of thousands of dollars. Workers may be too afraid to risk unemployment or a court dispute, and won’t move to a better‑paying job. Worker enquiries to employment lawyers about restraints of trade are common, but are rarely continued beyond initial letters or reminders. Understandably, workers often adjust their behaviour to avoid further escalation. Legal Aid NSW found that, of the more than 100 matters relating to restraints of trade between 2020 and 2023, only one commenced court proceedings.

‘Cascading’ non‑compete clauses are particularly pernicious. For example, a clause might seek to prevent a worker from moving to a competitor for one, 2 or 3 years, and restrain them within the city, state or nationally. A 3‑year, Australia‑wide ban might get struck down by a court, whereas a one‑year, city‑wide ban could be enforceable. But without litigating, how is the employee to know?

My fifth point is around alternative options to non‑compete clauses. Whether it’s the recipe to a secret sauce, the code to an algorithm or access to a celebrity client book, businesses have reasons to protect their turf. But they have other statutory, contractual and common‑law protections that may be less restrictive on job mobility. For example, businesses can use the Corporations Act 2001, which prohibits employees during or after employment in a corporation from improperly using a company’s information for personal gain, third‑party gain, or to cause detriment to the company. From a business perspective, non‑compete clauses are a relatively low‑cost option. It’s easier to restrict someone working for a competitor than proving a former employee has spilled the beans. But what’s good for one business may not be good for the economy.

The sixth observation is that no‑poach agreements between businesses warrant closer consideration. In a no‑poach scenario, 2 or more businesses agree to not solicit or hire each other’s current or former workers. No‑poach agreements can occur where rivals are competing for the same often limited talent pool. Unlike non‑compete clauses, employees aren’t involved in negotiating no‑poach agreements. In the United States, the Department of Justice successfully went after a group of tech companies, including Apple, Google, Adobe and Intel, after it was revealed they had a ‘gentlemen’s agreement’ not to recruit or solicit each other’s software engineers. Such arrangements can also emerge in franchise agreements. Major franchises such as McDonald’s, Bakers Delight and Domino’s have standard clauses that prevent franchisees from hiring workers in other stores. And when a McDonald’s franchisee has a contract that tells them not to hire from competing stores, why would they take the risk?

Seventh, Australia is in the early stages of our assessment of non‑compete clauses. This allows us to observe the different regulatory approaches taken overseas. In April, the United States announced a nationwide ban on non‑competes. The US Federal Trade Commission estimates that this will lead to new business formation growing by 2.7 per cent a year, boost earnings for the average worker by US$524 a year, and drive innovation, leading to more than 17,000 additional patents annually.

The United Kingdom is planning to limit the length of non‑compete clauses to 3 months, reducing the average duration from around 6 months while maintaining flexibility for businesses. Austria has banned non‑competes for lower‑paid workers and put in place rules for higher‑paid workers to ensure they don’t unreasonably impede careers. In Spain, agreements are not able to exceed 2 years for technical employees (such as engineers or computer programmers) or 6 months for other employees. Further, the Spanish system requires adequate compensation for workers where restraints apply. In Finland, employers must compensate employees for all non‑compete agreements, starting at a minimum of 40 per cent of the employee’s regular salary for up to 6 months.

Beyond these 7 points, we can look to history to see how worker mobility can lead to a stronger economy. Since the 1870s, non‑competes have been unenforceable in California. One instance of how this helped spur Silicon Valley’s success was the case of Shockley Semiconductor Laboratory. In 1956, William Shockley shared the Nobel Prize in Physics for his research on semiconductors. Shockley was undoubtedly a brilliant scientist, but he was also a bad boss. At his namesake company, he spied on employees and was both racist and paranoid. Consequently, 8 of his top engineers left and founded Fairchild Semiconductor in 1957. Shockley called them ‘the traitorous 8’, but couldn’t stop them. A decade later, members of the group had founded the companies Intel and AMD.

Today, millions of Australians don’t have the freedom to quit their jobs and start a competing firm. Our government is at the fact‑finding stage, but we do know that non‑compete clauses are widespread and apply to many low‑wage workers. We know that, even when unenforceable, clauses can have a chilling effect, and that businesses have other options to protect their interests.

Non‑compete clauses affect job mobility, wages and new business creation. To build a more dynamic and competitive economy, we need make it easier for workers to get a better job.

This is an edited extract from the speech ‘Unshackling Innovation’, which Andrew Leigh presented at The McKell Institute.

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