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.

Over at my other blog, I posted a note the other day about what the case means in terms of trade secrets. The takeaway: not much.

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)

AND

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.

Meanwhile, up in Massachusetts, there is a strong move afoot to change its rule and adopt something closer to the California approach.