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>> Tom Church: You're listening to the Libertarian Podcast from the Hoover Institution. I'm your host Tom Church, and I'm here with the Libertarian professor Richard Epstein, here at Hoover, Richard is the Peter and Kirsten Bedford senior fellow. He's the Laurence A Tisch professor of law at NYU, and he's a senior lecturer at the University of Chicago.
And Richard, I'd like to start by reminding you that you've signed an exclusive non-compete agreement with me that you may not leave and create another, well, let's call it the still Libertarian podcast. I'm hoping that we'll stand up in court. >> Richard Epstein: I'm such an honorable citizen that I would never think of leaving somebody who's given me such an advantageous relationship. And in fact- >> Tom Church: I appreciate that.
>> Richard Epstein: Well, and then we have this guy, immigrant in the background. I know he's a dubious sort, but we love him, too. >> Tom Church: Indeed, indeed. Well, so I bring it up, Richard, because earlier this year, I think it was in January, the FTC proposed banning non-competes in the United States. And as part of this process, of course, the Federal Trade Commission seeks public comments. And you in fact made a public comment.
You sent me an article making three points perhaps in favor of keeping them, and im hoping we can kind of go through them one by one and talk about a few more things. So first, start me off with the historical look at non-competes in the US and maybe even the theoretical arguments for having them in place. >> Richard Epstein: Well, the actual being begins in England around 1711 in a case called Mitchell against Reynolds.
And it was a case of a former employee trying to go into direct competition with his current employer. And what happened is they understood very early on that a rule of reason was necessary, which meant that you had to trade off the benefits and the burdens of putting these things in place. And it was always a tradition which never had a per se illegality with respect to these covenants. So here is what the situation is.
If you have a former employee who wants to go into competition with you, what happens is that will increase the opportunities of customers. And so to that extent that it's the only thing that matters, it's a good. But on the other hand, this fellow has received large amounts of information from his employer, his former employer. He may have learned some techniques of the trade, he may have gotten customer lists, he may have had all sorts relationships.
So that what happens is if you give this information to the employee, he now acquires it free of charge and is able to underproduce and out compete his former employer because he's got a lot of stuff for which he pays nothing, and the employer has had to pay full situation.
That is not all that different from the situation with patents and copyrights, where essentially if somebody can use somebody else's patented device free of charge, he can out compete the inventor by virtue of being able to charge a lower rate. And so what you're trying to do is to figure out how you balance these two things off. And it's a kind of complicated process.
But basically the rule of thumbs that has emerged first in England and then in the United States has been remarkably common and remarkably stable. And I don't believe that I saw anything in the FTC report which actually referred to what the equilibrium is. So the first thing is, what's the duration with respect to these things? And the common consensus is that you could do it for six months, but not for any long.
And many of the cases in which the FTC says that there is some egregious behavior, you see two, maybe even three year restrictions on trade, to which the answer is they would be caught under the current rule. So you can't use those as arguments for knocking it out. What you have to do is to explain where it differs from the rule of reason, instead of just simply saying that it is odious. Then there's the question of what product line that you can start to deal with.
And it turns out, again, it's pretty restrictive. If you're in financial services, you could prevent somebody from going into business and financial services. But if it turns out they wanna go into some other kind of business, like mortgage lending, for example, you'd have to ask whether it's the same kind of business or a different kind of business. If it's a different kind of business, then you could go into competition because you were never working in that business.
And so therefore, the risk that you'll take information provided by the former employer and use it against him is no longer there. And then there's the question of geographical expand. And if you're in one town and only do business in that town, and what happens is your former employee wants to go to the town next where next door. You may think of expanding there, but that's no reason why it is that you can essentially stop him from going there.
The theory is you develop no human capital or special knowledge about that thing. So the two of you should be able to do it. Now, the geographical scope issues is very complicated today because we're not just dealing with barbers and bakers and so forth, you're dealing with people who work for companies like Blackrock, which have nationwide operations.
And generally, the view is, if you're doing nationwide observations in your business, the covenant could run that way, and the protection to the worker comes from the situation with respect to the duration of the covenant and the kinds of activities that are covered. Now, are these covenants for the advantage of the employee? If you look at the FTC, they say, well, no unequal bargaining power, nothing going on there.
But what you have to do is to try to ask yourself, not whether there's an explicit bargain, but whether or not the amount of information and training that you're prepared to give to an employee will depend upon whether or not it's some future time you could use against it. And you have to also ask whether or not you're gonna get a kind of a wage bump by virtue of the fact that everybody knows going into this situation that there are gonna be restrictions expose.
And if you start looking at this whole thing, what you have to do is to show that the current equilibrium position, which is pretty much adopted everywhere in the United States, is wrong. And a per se rule, which is adopted nowhere in the United States, is now all of a sudden there.
You would think that that would behoove you to give a very close comparison between the two rules and to give at least a presumption of legitimacy to a series of practices that are used pretty much not universally, but say 90% of the United States or more. And the FTC does none of that. What they do is they give you grandiose estimates of the billions of dollars that will start to be added into labor markets.
If you strike these covenants down without once asking yourself whether or not the way jobs are offered, the way in which training is given to workers, and all sorts of other stuff is going to be influenced. If, in fact, you say that an employer can walk out of the job and start up immediately with respect to a competition. There are also very serious concerns associated with trade secrets.
If you have to give a trade secret to one of your employees, and he could take that trade secret and use it in his own business. The real difficulty here is it's extremely difficult to detect the situation where a process is being used, cuz when he goes into the marketplace, he is basically selling a product, and it can be made by 10 different processes. And simply knowing that he has access to one of them doesn't even tell you whether it's that process or another process that was used.
And so one of the things that you'd have to do for example, if you weaken the protection that you get from covenants, not compete, you're gonna have to change the way trade secrets are organized. You're gonna have to change the way in which information is made accessible to your employees. These restrictions will be costly, and these restrictions will make the firm somewhat less efficient than it would have been otherwise.
So you got this two stage process, and to the FDA or the FTC is just a one stage process. Everything is ex post, nothing is ex ante. And that can't be the right way to look at this problem. >> Tom Church: Help me think this through a little bit more, Richard, because on one hand, what you described are Certain limitations on non-competes, right? You're talking about geographical changes, you're talking about maybe timetables.
And to me that sounds like a lot of distinct rules that can get a bit complicated. You need the government to rule on these things, it kind of slows things down. Now, on the other hand, and I'm trying to interpret this from a classical liberal constitutional position here, on the other hand, if an employer and an employee come to a volunteer agreement, then what's to stop them from doing that? I mean, where are the limits on both those sides?
>> Richard Epstein: Okay, well, the problem that you're worried about the agreement between the two sides is that it's a perfectly good agreement that may benefit both parties. But there's gonna be a negative externality if it turns out that the employee cannot offer his services, say, anytime after he leaves. And so you may be able to find a situation where I wanna basically hire you now. And what I'm gonna do is to give you a contract which says once you leave, you can't go back into business.
But what I will do is I will pay you half your former salary. I mean, you could do that, but the danger is the negative externality with respect to the rest of the community that can't get the benefit of those services. Then the other question you ask is, what are the terms that are involved? What's interesting about it is this is a rule of reason, and you would start to think that that means it's gonna be ad hoc in every particular case.
But the way the practices have developed both in England and the United States, it turns out that you don't see that degree of variation. The norms that I gave you about length of time, six months, are very standard throughout virtually all industries, only put them into places where the employer is competing with you. Which means for working for nationwide brokerage houses, for example, it's gonna be a nationwide blockage, and then only in the same product line.
So that if you have a company that completes in ten different product lines and you work for only one of them, you could enter immediately into the other product lines in question. And so the real question you want to ask is, why is this system worse than the other system? And you can't answer it by showing cases in which the restrictions in questions are illegal, not only under the proposed rules, but under the current rules.
I mean, for example, I remember several articles that were written about the restrictions that McDonald's had imposed upon its employees going somewhere else, which seemed to everybody to be arduous and indeed they were. But it's one thing to point it out, it's another thing to remind people that they were challenged in Illinois court. And it turns out that the government essentially was able to put these covenants aside and to stop the practice. And that also something else that happened.
And since these things are public policy issues, you don't want to say, is it the fact that the individual worker does or does not know whether these covenants are enforceable? There's also the question of whether or not the state antitrust division in the attorney general's office knows about that. And the odds of that being the case are, of course, vastly higher than they would of any other kinds of circumstances.
And so what's wrong with the FTC is what's always wrong with the FTC, whether it's this or merger policies or anything else. They see one side to the problem, they don't see the other side to the problem. If there's only one side to a problem, you want to have a per se rule. If there are two sides to a problem, then you need to have a rule of reason. So what's an example of a one sided problem?
Price fixing and territorial division are basically the kinds of things which it's very difficult to find efficiency gains. And so there tends to be a per se rule but even that overstates it. What a per se rule means, an antitrust is that you have to show a very strong justification to avoid the implication that the horizontal division, for example, is going to be some kind of an illegal antitrust arrangement.
So you're always allowed, for example, to talk to your competitors in order to figure out a way in which you could clear banking notes. It's very clear that you can talk to your competitors to figure out how you set standardized insurance lines so that you know which coverages can be offered by which company.
And if you do this correctly, it means that the policies are gonna be standardized so you can get one kind of coverage from one guy while getting another kind of coverage from another insurance company. So those things are deeply pro competitive. And I can recall 40 years ago, I worked on some of those things for an organization now defunct or merged into something else, the insurance services organization.
And we were trying to figure out how you standardized insurance policies of pollution coverage cases. And I certainly remember walking into the room and the first thing that was said by the lawyer who convened the situation is, we understand that the antitrust laws are operative. We cannot talk about prices, we cannot talk about current distributions. What we can talk about is trying to standardize the form so as to make it possible for people to compete in multiple markets at the same time.
And that's all pro competitive. So, when you do these things, if they're repetitive issues, after a while, you get a pretty good sense of what you can and cannot good. But what's always the case with the FTC is they show no respect for industry practices. They assume that everybody out there is some kind of a moron.
And in fact, the more accurate description is, ask yourself, how many of the people who drafted this particular memo have had any experience in business with working with covenants of these sorts? And almost invariably what you do is you get a highly cerebral brunch who have no business experience whatsoever. And so they managed to screw everything up. And I'm not saying this just as an academic.
I think you know, Tom, that for over 50 years I've been doing consulting of one form or another in a whole variety of industry contexts, including extensive work with respect to an insurance company back in the 70s and 80s. And I've renewed that from time to time. So there's at least some practical wisdom between what I've said and the other point about the FTC is they're lousy theorists. Lena Khan is not a very good lawyer.
She wrote one student paper seven years ago, which is decided decidedly influential and decidedly mediocre in that. And there's just not enough intellectual capital in what she's acquired so that she has the kind of judgment that you would touch. I mean, this is a field in which it's not only that you have to have raw analytical strengths, which she doesn't have, but it also helps to have some real experiential knowledge, or at least access to people whom you trust, who can give you that.
And you start looking at this thing and you ask yourself, did they ever consult with anybody inside the industry before they put the proposal forward? And the answer to that question seems to be no. And so what it is, it's a kind of insular arrogance that drives the FTC. And this and virtually everything else that it does, this administration's FTC is something of a modest horror story. >> Tom Church: All right, well, Richard, you've still got a bit more, I think, to convince me here.
I'm still looking at this from the perspective of non-competes, probably used more by existing companies. I'm worried about stifling competition in that way, even if we got rid of them. I can remember a couple of tech companies here in Silicon Valley getting in trouble a few years ago for having a collusive. We're not going to poach your people without having to enforce non-compete agreements, where do you want this to go? What level of non compete.
>> Richard Epstein: That is a very different, that's a very different problem. >> Tom Church: It is a different problem but if they did get rid of this. >> Richard Epstein: And that's per se illegal. >> Tom Church: Right, of course, it's like gotten trouble for it. So what level of non compete agreements will still promote competition without enshrining existing companies and stifling new competition? Where do you wanna leave things as they are now? I mean, are there ways to sculpt this?
>> Richard Epstein: I think the current situation is pretty good. If somebody wanted to change it, rather than starting from the presumption of a per se legality. You would ask them to look at the particular rule rules that I mentioned with respect to time, duration and product line and geography and then figure out how you wanna tweak them. But they don't wanna do that at all, they don't wanna take anything from the current laws. Giving it the modest legitimacy.
What you mentioned was something else. And it turns out that if you enter into a non-compete clause with your rivals, that's basically a horizontal division of labor markets, and that's per se illegal. And I have no desire whatsoever to kind of change those sorts of rules. It seems to me that they're perfectly sensible and that it is extremely dangerous to allow that thing to happen. And so I would not change it. Now, put it to you the other way, put it back on you.
If you know that the horror story that you just mentioned is subject to an antitrust law and a per se rule with that, then they should reduce the urgency to try to deal with the covenants with compete. Which only deal with the rules that takes place between employers and employees to govern their conduct after the employment relationship is separate. >> Tom Church: Last one for you, Richard, because we're dealing with, as you mentioned, Lina Khan's FTC.
Let's say that, well, the party control switches for the presidency. Next round, we get a different approach to the FTC. Are we likely to see from a more conservative legal avenue a re embrace of non compete agreements? Are we likely to see them leave it alone? What would you expect? >> Richard Epstein: This is such an enormous issue. I don't know if any firm has worked in these markets which agrees with the FTC, even though they may have some disagreements with the current law.
And so I would assume that there would be a tidal wave and that virtually everything that this administration has done, they would repeal. Now, this is not novel. The FTC comes in and there are all sorts of merger guidelines, and the first thing it does is it removes them all and puts its own stricter guidelines in place. And so what happens is you're talking with an administration that does not believe that tweaking is the appropriate response.
What they always want to do is to rip everything down and put everything up. And so let me sort of give you just one illustration of why so utterly frustrating to write responses to the FTC, which is, I have done. So they put out a request for information and so forth, and they say, we are looking ways to strengthen the antitrust laws with respect to mergers. That's the wrong question to ask. The right question to ask is we are looking for ways to figure out that we can improve the merger laws.
And if it turns out that one of the things that should be on the table is a relaxation of one or another of the prohibitions, that should be fair game. But the way in which they stack the inquiry, what they do is they assume that everything which we have today is under enforcement. And so therefore, the only thing we want to do is to have greater enforcement. But it turns out this is clearly false. If there's the same kind of trade off with mergers as there is with covenants not to compete.
And the simple observation is that if you have a merger that has genuine [INAUDIBLE] you do is you put this thing on hold with some kind of administrative review through the FTC. What happens is the two companies have to essentially keep their operations separate, which means all the synergies that would otherwise be obtained are going to be denied. And what will happen, therefore, is it may well kill off the merger.
One of the things that is very clear is these things are time sensitive, the technologies that many of these companies have evolved very quickly. And it may be that you can make a sensible merger, given what things are on January 1, 2023. But if you had to wait two years, the whole thing starts to make no sense, because the way in which the industry is done. The question if you ask the FTC to explain, what do you think about the risk of blocking mergers that ought to have taken place?
Their attitude, there is no such thing. That is, they've come virtually to almost a per se position, which says that if you want to merge with somebody else, what happens is it's just bad. We always want you to take your particular business and to grow it internally and organically, and never to sell it out to somebody else. And nobody in their right mind, which does not include the FTC, would think that that kind of a draconian position is always effective.
There are enormous synergies that could be made. And if you have a company that needs a particular asset that another firm has, these are the choices. You could buy it right now and perhaps spin off the stuff that you don't need and get the gains. Or you could try at great expense, to develop it internally and have to spend 18 months before you could either hire or train the workforce in order to do that.
And there's no reason whatsoever to put this prohibition on, particularly since many of the transactions that are involved are between two firms that have relatively little market share. The FTC issued a terrible opinion in the recent case having to do with illumina and Grail, blocking the merger. But the thing that was most frightening about it is the kinds of cases they cited were cases like Brown Shoe, which were very important cases from the early 1960s.
Which allowed you to block a merger in an industry which was highly competitive between two firms, each of which had less than 10% of the market or even smaller amount. So they are clearly trying to go back to the antitrust laws in the earlier days, where essentially any kind of structural reorganization has a presumption of illegality. And they've never come close to justifying what's going on.
And if you start reading this report and realizing that they do not have a section saying, here are the objections to opposition, and this is the way we want to deal with them, and then, you know, essentially that this is programmatic and ideological. There's really very little evidence in these particular cases that they're taking a self critical look of what they do. The FTC at this particular point is like a house organ. The Justice Department is more or less the same way.
It turns out that the damage that will be done by the Biden administration through these organizations and through the SEC are just enormous. The Supreme Court may yet intervene on this. Just the other day we had the Cochrane case, which made it very clear that you can now challenge the jurisdiction of the SEC and the FTC before you have to go through an ordeal and then only go to court afterwards. And that was a nine nothing decision. So I think what one has to say is the word is out.
It's out far enough so that it's not even a liberal versus conservative dispute when you get to the judicial system. What it is, is you have this organization, which has gone so far to one direction that virtually everybody who's not part of it says, we may disagree amongst ourselves as to what we ought to do, but we can't possibly agree on the kind of agenda that they're putting forward. This is a very sad day for the United States.
These organizations have enormous influence, and as far as I'm concerned, they're sadly abusing and misusing their power. >> Tom Church: You've been listening to the libertarian podcast with Richard Epstein. If you'd like to learn more, you can read Richard's column, The Libertarianm over on Defining Ideas at Hoover.org.
Now, if you found our conversation thought provoking, we'd appreciate it if you would share it with your friends and rate the show on Apple Podcasts, or wherever you're tuning in. For Richard Epstein, I'm Tom Church. We'll talk to you next time. >> Speaker 3: This podcast is a production of the Hoover institution, where we advance ideas that define a free society and improve the human condition.
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