Removing regulatory barriers to worker mobility such as non-compete agreements can influence worker-level outcomes. This column exploits the changes in the enforceability of non-competes to explore their interaction with investment in intangible assets and market imperfections. Banning these agreements disproportionately benefits workers employed in intangible-intensive firms. When firms develop intangible assets that give them a competitive advantage, they may keep workers with valuable knowledge by offering wages above their marginal revenue product. As such, investment in intangible assets generates a positive correlation between price-cost markups and wage markups.
Recently, the media have paid much attention to the Diarra ruling, which followed on the 1995 Bosman ruling. These judicial rulings limit the ability of sports clubs to control the future employment of their employees and are grounded in Article 45 of the Treaty on the Functioning of the EU. Essentially, the Article states that the free movement of workers cannot be restricted unless on grounds of public policy, public security, or public health. While the rulings improve the labour market position of footballers, they reduce the incentive of clubs to train their players.
For those not making a living by using their head, or feet, to propel a ball into a net, the Bosman and Diarra rulings have little impact. Yet, for many workers, non-compete agreements (NCAs) prevent them from joining a competitor or starting a similar business. In the US, the use of NCAs was banned by the Federal Trade Commission in early 2024 (Federal Trade Commission 2024). However, since then, a court case in Texas overturned this ruling, and many more similar cases are on the dockets in other states (Kaye 2024).
In the EU, the approach to NCAs is diverse across countries. While most EU countries do allow NCAs, many have conditions that limit their scope and enforceability. In this column, we argue that NCAs interact with investment in intangible assets and market imperfections, and that this contractual feature is relevant to the debate on innovation, productivity growth, and market power.
The theoretical arguments for, or against, NCAs are complex (Potter et al. 2024). NCAs provide incentives for firms to invest in innovation and worker-specific knowledge but hamper dynamic, competitive labour markets. They limit the potential efficiency gains that come from knowledge spillovers that occur when workers move across companies and share their expertise. To balance this trade-off, policymakers require empirical evidence on the various markets and mechanisms affected by the particulars of existing NCAs and regulatory changes. Such evidence is slowly becoming available.
For labour markets in the UK, it is found that 26% of workers fall under NCAs, higher than in the US or Italy (Alves et al. 2024), and that NCAs also bind low-skilled workers. In the Dutch case, NCAs are found to impact approximately 18% of the labour force (Streefkerk et al. 2015). Most of these studies find that NCAs are not limited to high-skilled workers but are ubiquitous across different occupations, hierarchical levels, and industries. Young (2024) finds that a ban on non-competes for low-earning workers increased the quantity and quality of transitions in Austria. Johnson et al. (2023a) show the implications of changes in enforceability for US workers’ earnings and job mobility. Balasubramanian et al. (2022) investigate the effects of NCA restrictions in Hawaii on the careers of technology workers. In existing jobs, NCAs also affect training, wages, and job satisfaction of US workers (Starr et al. 2021).
Another set of papers examines the impact of NCAs on firms’ investment decisions. Conti (2014) finds that stricter NCA enforceability induces US companies to choose ‘riskier’ R&D projects, while Johnson et al. (2023b) show that making NCAs easier to enforce substantially reduces the rate of patenting in US firms. Jeffers (2024) provides evidence that increased NCA enforceability leads US firms to increase their investment in physical capital but not in intangibles.
In our view, the effect of NCAs is intertwined with a mechanism that drives the observed co-movement in product and labour market imperfections. In a recent study (Bartelsman et al. 2024), we propose a heterogeneous firm model where firms invest jointly with workers in intangible assets, and we demonstrate empirically that a change in NCA regulations affects workers in a way consistent with our model’s mechanism.
Removing NCAs increases wages for workers in intangible-intensive firms
Starting with our empirical exercise, we use linked employer-employee data to evaluate the impact of a 2015 policy change in the Dutch Work and Security Act, which ended the enforceability of NCAs in temporary employment contracts. Our analysis matches treated workers who had an NCA in their temporary contract before the reform with control workers on temporary contracts without an NCA. It then characterises differential worker outcomes (wages, mobility) using an event study framework based on a sample of 378 workers.
Compared with the control group, treated workers have on average 13% higher wages post-reform. Importantly, this effect is driven by workers employed in firms that rely more on intangible assets such as data, software, and specialised knowledge that tends to be tacit in nature (Figure 1).
Figure 1 Heterogeneous impact of lifting NCAs on wages for workers employed in either intangible-intensive or non-intangible-intensive firms
Price-cost and wage markups are positively related to intangible intensity at the firm level
We link this finding to the broader debate on the co-movement of product and labour market imperfections in the economy (see e.g. Ding et al. 2024). This debate has important implications for the welfare-enhancing effects of market competition: firms’ ability to charge high price-cost markups may indicate the presence of market power. Similarly, when firms wield excessive power over workers, it can compress the labour share of income.
We analyse market imperfections in the Dutch economy and observe that the majority of firms set prices above their marginal costs and pay workers wages above their marginal revenue product of labour (left panel of Figure 2).
Figure 2 Product and labour market imperfections by industry
Notes: (Left panel) Median labour market imperfection (ψ, measured by the deviation of wages from the marginal revenue product of labour) and product market imperfection (μ, measured by the deviation of prices from marginal costs) parameters for each 3-digit NACE manufacturing and services industry, which is represented by a circle. The size of each circle is proportional to the real value-added share of the industry. (Right panel) Proportion of each quadrant of the left graph, broken down by 1-digit NACE industries, with real value-added weights.
Our study presents descriptive evidence showing that firms that rely heavily on intangible capital and automation technologies (such as software, automated data processing and exchange, and AI) tend to have higher price-cost markups and pay wage markups. Additionally, the bottom-right panel of Figure 2 highlights that such joint product and labour market imperfections are particularly prevalent in the scientific and technical services and wholesale trade industries, both of which are highly technology-driven in the Netherlands. These firms also show heightened susceptibility to the Work and Security Act reform on NCAs.
Tacit knowledge embedded in specific technologies drives the co-movement of product and labour market imperfections
To rationalise these facts, we present a model that provides a micro-foundation for the observed co-movement of product and labour market imperfections, and the role of NCAs in firms with high intangible-asset intensity. The core idea is to analyse how firms’ investment in intangible assets affects their pricing-setting (price-cost markup) and wage-setting (wage markup) behaviour. In doing so, we build on and add to the recent theoretical literature modelling investment in intangible inputs as the driver of productivity dispersion and market power (Aghion et al. 2023, De Ridder 2019, 2024).
Our model posits that firms that successfully accumulate significant intangible assets can operate with lower marginal costs. This feature allows them to undercut their competitors, gaining higher market shares and profitability. The model also incorporates a wage-bargaining process where firms share a portion of their profits (rents) with their employees. This rent-sharing occurs because workers with tacit knowledge about the firm’s intangible assets hold valuable information that directly contributes to the firm’s competitive advantage. To retain these workers and prevent them from moving to competitors, firms with high intangible intensity are more likely to offer better wages and conditions, resulting in a positive relationship between price-cost markups and wage markups.
The model further explains that NCAs play a critical role in limiting worker mobility by preventing employees from taking away knowledge upon departure. NCAs protect firms’ profits and thereby also act as an incentive to invest in intangibles. The empirical evidence shows that in the short run, when NCAs are removed, as observed in the Dutch policy change, firms are forced to increase wages to retain their key employees, especially in intangible-intensive industries. This leads to stronger rent-sharing dynamics in these firms, which is consistent with the model’s predictions.
Conclusion
Our study concludes that policymakers should carefully consider the trade-offs associated with NCAs, balancing the need to protect business interests with the goal of promoting labour market fluidity and innovation. The debate concerning NCAs not only raises concerns about curtailing individual freedom to pursue better job opportunities but also about firms’ incentives to innovate and invest in employee training, especially in an environment where the risk of separation is elevated. A potential side effect of banning NCAs could be a reduction in employee training and investment in R&D, for example.
Our results provide evidence showing that lifting NCAs is beneficial for workers and can help provide a rationale for observed imperfections in firms’ product and labour markets. Nonetheless, the literature does not yet offer solid guidelines to policymakers wondering whether to strength or relax NCAs, and under what conditions. Likely, a mix of micro-based moments, together with cross-country panel evidence on historical variation in NCAs, can be used together with general equilibrium models similar to ours to provide an integrated approach to designing better policy.
Source : VOXeu
