Human Capital, Employee Mobility, and Economic Development

The business community in SW Pennsylvania beats a regular drum for the one "reform" that it argues will prompt renewed economic growth: lower business taxes. The argument is that PA's business climate is not competitive with that of other states, and PA's competitive disadvantage can be traced to its higher taxes. Higher taxes discourage investment in new and expanded businesses. Reducing taxes would prompt more investment. It sounds pretty straightforward. But I have never been persuaded, despite data like this chart regarding new business formation (plus this one). (In the comments, feel free to toss in links to more detailed and up to date data.) At best, lower taxes help the folks who own and run employers; they don't do much, necessarily, to help the employees. What would help employees more? Public policy aimed at increasing labor market flexibility and employee mobility.

Here's my plug for a change to PA law that would positively impact the local economy: Abolish the enforceability of employee noncompetition agreements. Adopt a rule that essentially mirrors the law in California -- where noncompetes are unenforceable, except in a small number of exceptional cases -- and abolish the current PA rule, which makes noncompetes enforceable so long as they are "reasonable" in duration, geographic scope, and (job) market scope.

Folks familiar with the literature will recall Annalee Saxenian's work comparing the California high tech economy with its counterpart in Massachusetts, along with other, related work by Ron Gilson that associates historical differences in growth rates in the two states with their different approaches to noncompetition agreements. Massachusetts, like PA, has enforced them.

Earlier this month, the Third Circuit Court of Appeals (the federal appellate court that has jurisdiction over Pennsylvania, among other states) decided a case that is important mostly for its entertainment value: Bimbo Bakeries v. Botticella, involving a senior manager, Botticella, who left Bimbo for a new job with Hostess -- and who was poised to disclose the secrets behind the production of Thomas' English Muffins. Bimbo sought and obtained an injunction against Botticella's taking the new job, and the Third Circuit upheld that ruling. Muffin secrets will stay put.

The case is more interesting for what it did not involve -- namely, a noncompete. Botticella was accused of threatening to disclose the secret recipe for English muffins. He was not accused of violating a noncompete -- because he didn't have a noncompete with Bimbo. But as with many trade secrets cases involving former employees, the outcome was the same: Botticella was prevented from taking a new job in the one field where it appears he has special expertise. In other words, trade secrets claims are often used instead of noncompetition covenants to protect company interests. That's true in California as well as in Pennsylvania. And there is nothing wrong with that. I don't propose to change the law of trade secrecy.

Where there are no trade secrets at stake, however, the public policy balance shifts. I read about English muffins just before I heard a presentation of some research at a conference in California, and that presentation summarized a body of research on noncompetes as follows. What the presenter called "weak post-employment controls" (low enforceability of noncompetes - in the absence of related trade secrecy claims)
-- increase inventor mobility, both within and between states
-- increase entrepreneurship
-- increase corporate R&D spending
-- increase the performance-based component of salary (because lateral employment tends to drive up salaries)
These effects are "bi-directional," meaning that the effects show up both with respect to "losing" firms (employees depart) and "winning" firms (employees arrive).

I'll work on tracking down some of the relevant underlying work, in case some folks think that some of the empirical data is thin. For a sample, try this link to a recent paper about noncompete enforceability and employee mobility. That article is summarized here. The short version is that non-enforcement increases inventor mobility.

The public policy choice, then, comes down to this, more or less: PA could loosen its labor market and increase employee mobility, a move that almost certainly would contribute positively to new business formation and entrepreneurship, while putting some existing firms at unknown risk of losing some employees and having to hire others. Or, PA could maintain its current more restrictive labor market, a decision that almost certainly contributes negatively to new business formation and entrepreneurship, while preserving existing firms in their current condition and preventing some people from practicing their skills.


4 Responses to "Human Capital, Employee Mobility, and Economic Development"

Jim Russell said... 8/24/2010 5:13 PM

Saxenian is a big influence on my thinking about encouraging the geographic mobility of talent. Your argument about firms applies equally well to regions.

The Wiz said... 8/30/2010 11:09 PM

There are big differences between non-compete clauses and trade secrets. I built homes for years. I hired guys, took several years teaching them to frame, wire, shingle, side drywall plumb, etc. After a few years, just they finally learned enough to leave on a jobsite while I chased materials, worked on bids, did payroll, etc, they would quit and go on their own. I know of three guys that I trained that I now compete with. A non-compete clause would stop that.

In other businesses like retail, law, insurance or almost anything else, people will leave and take your entire customer/client list with them along with the business knowledge you taught them.

None of this would be protected by trade secret laws. Businesses need to protect themselves somehow. The invest huge amounts of capital in employees and business development. You just can't let people walk after such an investment in them.

Mike Madison said... 8/31/2010 7:40 AM

It is absolutely right that the law of noncompetes is quite different than the law of trade secrets - though they are related. Customer lists, by the way, often *can* be protected as trade secrets.

As to the larger point, though, my argument is that the legal system *should* let people "walk" after that kind of investment. In other words, that noncompetes should be illegal in most cases. There are large regions of the country -- California, most prominently -- where this has been the law for decades, and the business world has not collapsed. In fact, it has thrived. Some people argue that California has thrived *because* noncompetes cannot be enforced. And there are professions -- law, most prominently -- where noncompetes are illegal because they violate the ethical rules that govern lawyers. Don't laugh, you nonlawyers: Ethical rules prohibit enforcing noncompetes for lawyers because *clients* should be able to choose the lawyer they want without having to worry that the lawyer is handcuffed to a particular office or firm. The legal profession has not collapsed. In fact, it has thrived.

Finally, I always think that it's odd that employers think that they "own" their investments in human capital. Don't the employees "own" what's in their heads and their hands?

Or, perhaps, "investment" and "ownership" are really bad metaphors in this context. I have heard of noncompetes being enforced in Pittsburgh against hairdressers and HVAC guys. These aren't exactly high income careers. Enforce a noncompete against someone like that, and someone may literally be out of a job. Is that fair to him or her?

MH said... 8/31/2010 11:38 AM

I know of three guys that I trained that I now compete with. A non-compete clause would stop that.

No, it wouldn't, for home building. I'm not a lawyer and I don't know if you could write a non-compete clause to stop somebody from installing dry wall in southwestern PA (but I doubt it), but that wouldn't protect you from competition since there are thousands of people with the skill. I've never run a contracting business, but I would think that working on getting jobs and keeping tradespeople happy would be much more effective than trying to stop the spread of skills.

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Updated September 2020:

Pittsblog 2.0 was written by Mike Madison, a law professor at the University of Pittsburgh, from January 2004 through December 2011.

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