The Challenge and Opportunity

Main Problem and Challenges

The overall challenges of productivity stagnation in the UK economy, depressed real wages, and the disempowerment of working people across the country are well-documented. The specific challenge this paper addresses is the contribution made by non-compete covenants in employment contracts to this overall picture. In essence, such covenants exacerbate labour market concentration by placing frictions and costs on the ability of workers to move to a new employer or set up a competing business.

First, the evidence of productivity stagnation, depressed wages, and worker disempowerment:

Sources: Financial Times, The Productivity Institute

The decline in real wages broadly reflects the productivity data:

Sources: BBC, Financial Times

The consequences of this stagnation are that workers in this country are left £5,000 - £11,000 per annum worse off than they should be.

Worker power is, of course, harder to measure than real wages and even productivity. However, Eurofound has developed a variety of measures which give a fair picture of worker empowerment. The UK performs particularly poorly on ‘industrial democracy’, which includes worker participation in how businesses are run and how corporate decisions are made. Figure 5 compares the UK to selected peer countries and the average across the EU.

Source: Eurofound

In the UK, disaffected workers, paid no better than the previous generation, are stuck in unproductive ways of working, and with low productivity in the economy: a recipe for economic and wage stagnation and social discontent. The position is exacerbated by the decline in trade union membership over the past fifty years and the severe legal restrictions on trade union activity that have been well-documented elsewhere. 

This leaves unhappy workers with only one option: to exercise their right to labour mobility and leave their jobs. This is where non-compete covenants enter the picture and work to employers’ advantage.

Non-compete Covenants: Data and Existing Legal Regulation

As far back as the 15th century, we see established businesses trying to restrict the ability of their employees to move job to their rivals, or set up a new business in competition with their former employer, by means of terms of the employment contract. In recent decades, their use has spread from senior employees in highly specialised industries, throughout the economy, all around the world. In just the last few years, governments from the United States of America to Australia are making efforts to crack down on the abuse of these ‘non-compete covenants’. 

Non-compete covenants are express terms in employees’ contracts of employment which prohibit them from working for a business which competes with their employer after the termination of the employment contract. They vary in how widely a competitor is defined (for example, specific industries or areas of the country), and for how long the restriction is in place (six to twelve months is not uncommon). They are currently regulated in the UK by the common law and in any given case, it is left to the courts to determine whether they go no further than is reasonably necessary to protect an employer’s legitimate commercial interests, like trade secrets and  goodwill with clients.

There is evidence to suggest that widespread use of non-compete covenants hinders productivity and innovation, depresses wages and enables employers to extract excessive rents at the expense of workers. This is because they either disincentivise, restrict or prevent: 

• more productive businesses from hiring experienced workers to grow output,

• workers from leaving employment immediately to start a new business to compete with their employer, and

• workers from shopping around for the highest wages on offer in an industry.

The most significant problem for further restricting regulating non-compete covenants in UK employment law is that we have very little data on how prevalent they are, nor on their effects across industries and the economy as a whole. Most studies on non-compete covenants are specific to the US labour market, and it is unclear whether either the prevalence or effects of non-compete covenants indicated by that research transfers to other economies. The limited research conducted to date on this aspect of the UK labour market is inconclusive, and to a certain extent contradictory: a 2022 survey commissioned by the (then-) Department of Business, Energy and Industrial Strategy on the prevalence of non-compete covenants indicated 19% of employees have a non-compete covenant in their contract of employment, and that such covenants are used by 52% of businesses for at least some of their workers; but in January 2024, a report by the UK Competitions and Market Authority (‘CMA’) claimed 26% of workers have non-compete covenants in their employment contracts (rising to 40% in the information and communication technologies and professional and scientific services sectors), but only 15% of businesses use them.

The second problem is that, as the Government’s 2022 Impact Assessment acknowledged, there is evidence pointing in both directions on the effect of non-competes on productivity and wage growth in the UK economy specifically. Even this mixed assessment in the CMA report is made on the basis of evidence which has been called into question. Although the balance of available evidence seems to favour some kind of ban, it does not compare the current equilibrium with one where different institutional arrangements may be available. 

As for worker power, non-competes self-evidently restrict the ‘exit’ option for workers to assert their interests and exercise their freedom of mobility, and thereby reduce the incentives for employers to take worker ‘voice’ seriously.  But, on the other hand, in principle, the ability to ‘lock in’ skilled workers may incentivise businesses to make long-term capital investments, and provide training to staff and pay higher wages. This may improve skills and make workers more productive. For example, the CMA report suggested that workers with non-compete covenants receive more formal training from their employers and that employers may be more likely ‘to share confidential client relationships with employees... [and that such] investment in general human capital and client relationships may make employees more productive and therefore increase their earnings’. The CMA also points to a number of factors which affect labour market competition, including concentration of firms in a geographic area or industry, making it hard to assess the effect of non-compete covenants specifically.

As such, we simply do not know which dynamics are at play in the UK economy as a whole, and in particular we do not know if the effects of non-compete covenants are different across sectors. The first opportunity, therefore, is to understand the UK labour market better by commissioning further, more targeted, research. It is certainly the case that the evidence from the US-based research relied on by the UK Government in 2022 is informative for the UK, given the institutional similarities between the two economies. But there are specifics to the present UK economic situation which urge caution. For example, we note below the approaches taken to the regulation of non-compete covenants in the US, Germany, France and Australia. Depending on how businesses respond to recent changes in the regulation of non-compete covenants elsewhere, a more permissive regime may allow the UK to attract investment from jurisdictions where they are banned, and banning them here may divert domestic or foreign investment to jurisdictions where they are allowed. With this in mind, rigorous econometric data is required on both the prevalence and effect of non-compete covenants in the UK labour market specifically. 

In the final analysis, we do not know what the legitimate ‘uses’ of non-compete covenants in the UK economy might be, and how much ‘abuse’ there is. If the costs associated with the latter outweigh the benefits related to the former, then we need regulation to curtail abuse of non-compete covenants: there is already research identifying an economic model as to how such a cost-benefit analysis would be best undertaken. This would involve recasting the UK’s approach to non-compete covenants and their place in the labour market, with their curtailed use improving productivity, efficiency and economic growth and increasing the earnings of workers. 

But we cannot know what works and why if we adopt a single regulatory response on the basis of existing evidence. If there is any value to non-competes in the form of higher investment in skills and training, it will be very difficult to measure this after a ban is imposed. A more targeted approach might allow us to mitigate some of the negative impacts while retaining some of the beneficial effects of these contractual relationships; that is why this paper offers the menu of options below.

Policy Rationales for Intervention and Reform and Menu of Options for Reform

There are three distinct policy objectives for tighter regulation of non-compete covenants: first, the economic efficiency objective; secondly, the fairness objective; and finally, the (economic) freedom objective. The economic efficiency case for reform is that restraining the employer’s use of non-compete clauses will enhance growth, boost productivity and investment in R&D and human capital and facilitate innovation and entrepreneurship, because talented workers will be able to immediately leave their employment to work for a competitor or set up their own competing business. Secondly, the fairness rationale provides that since non-compete covenants exacerbate labour market concentration and suppress wages and working conditions for workers, reform will boost wage levels and improve working conditions. Finally, reform to enhance the (economic) freedom of workers will ensure that workers are not unnecessarily restrained or prevented from plying their trade, deploying their skills and exercising their freedom of mobility.

Each of these rationales is clearly a valuable goal for the UK Government to pursue. But as flagged above, there are limits to how confident we can be that a one-size-fits-all regulatory response will accomplish them. For example, there may be costs to economic efficiency if a ban on non-compete covenants mean employers invest less in skills training for their workers. Likewise, wages could decrease if workers are left without those skills. In this, the comparison could be made with intellectual property protection: we know that allowing businesses to patent innovative technology reduces its adoption across the economy and stifles competition, but we pay this cost to incentivise more research and development. So the compromise is time-limited patent protection.

For the purposes of this paper, however, we should follow the balance of evidence and take the policy justifications at their height. Flowing from these three policy rationales, we have identified five alternative ways of regulating non-compete covenants, each with advantages and disadvantages relative to the variety of policy goals the regulation may pursue. Whichever of the five options in the menu for reform is or are selected is largely dependent on the priority accorded by policymakers to each of these three policy objectives relative to each other. 

In summary, the options are:

• Ban after a certain time period;

• Ban above (or below) a certain income level; 

• Mandatory compensation

• Industry-specific regulations;

• Reform of existing common law tests.

The first option is a product of each of the economic efficiency, fairness and freedom rationales and would mirror the reforms proposed by the previous Conservative Government. Under this scheme, non-compete covenants would be treated as unenforceable if they exceeded a particular time period, e.g. three, six months, etc. 

The second possible reform involves an embargo on employers using non-competes above or below a particular salary threshold. Banning non-compete covenants for highly-paid workers would encourage mobility of the most productive and innovative workers, allowing start-ups to acquire experienced employees. Banning non-compete covenants below a salary threshold is consistent with both the fairness and (economic) freedom goals to the extent that workers without high-demand skills should never experience any limitations on their freedom to move jobs, whereas high-skilled staff who have the market power to bargain for themselves could agree to be ‘locked in’.

As for the third option, this envisages that employers must pay the worker for the benefit of the non-compete covenant, reflecting again the fairness rationale and the law in other European countries, eg Germany and France. 

The fourth reform is one which largely reflects the efficiency objective insofar as it tailors the strength of the restriction on the use of non-competes to the economic needs of the industry or market in which the employer is operating, with the potential for ongoing revision in line with changing conditions. 

The final option again is one that combines the efficiency, fairness and freedom rationales. It would enjoin the courts to strike down non-compete covenants where they are contrary to the public interest, ie that the courts take into account the economic power of the employer, and the extent to which the employer benefits from such power and the covenant imposes excessive social costs on the public if it were to be enforced. However, the weakness from the perspective of economic efficiency is that covenants would continue to be struck down on a case-by-case basis, rather than having a bright-line rule.

Benefits: Short, Medium and Long-Term

We should stress that we are presenting possible methods of legal intervention, without expressing a preference as to which of the five options in the menu should be chosen. As lawyers we can say that non-compete clauses inherently raise dignitarian concerns: they restrict workers’ autonomy in the use of their skills, and by obliging them to choose between remaining in workplace environments where they are unhappy, or else leaving the workforce and thus experiencing social exclusion (at least temporarily). We are not in a position to forecast the extent to which changes in the law will promote economic growth, boost existing disappointing productivity levels, and facilitate innovation and entrepreneurship. The composition of the Expert Working Group should reflect the need to bring a broader range of expertise to bear on the choice of regulatory options we have presented.