The Dynamic Case for Non-Compete

Here’s Peter Mannino’s Featured Comment on my recent post:

Isn’t the entire case against non-compete clauses exactly that they stifle dynamic efficiency? Imagine if the traitorous 8 couldn’t leave Shockley to found Fairchild semiconductors, or Noyce and Moore couldn’t leave Fairchild to found Intel. California’s hostility to non-competes is one reason why we have a tech sector… I guess the problem is that some business practices prevent the world from being a place where “entrepreneurs know they can profit as they please if they make their firm great.”

Plenty of people do indeed make this case against non-compete clauses.  But their effect on innovation is far more complicated than it looks.

Suppose you have a great new idea.  To implement your idea, you have to share it with eight crucial employees.  But once you share it, any of these employees can take their knowledge and found a new firm to compete with you.

In this scenario, non-compete contracts are actually a great way to foster competition.  How?  By reassuring businesses that if they invest in new ideas, their employees can’t steal them at the first opportunity.  What’s the point of creating or implementing new ideas if your hired helpers can readily betray you?

If this argument seems odd, notice that it’s structurally identical to a simpler argument.  For example: Wouldn’t it be great for innovation if every firm had to make all their business secrets publicly available for free?  On the surface, this makes perfect sense: Every aspiring innovator could quickly learn everything that every existing innovator already knows.  Cornucopia!  On reflection, though, this would be dynamically disastrous.  What’s the point of coming up with new ideas in the first place if you have to give them all away gratis?

Question: If I’m right, how can California be so innovative?  My best guess is that existing non-compete clauses are so weakly enforced that there’s little de facto difference between the law in California and the law in any other state.  And in any case, the legality of non-compete clauses is only one of many ingredients of dynamic efficiency.  So why care about this one?  Because, per the Sorites’ Paradox, even minor ingredients add up.  Wise policy-makers will focus on enhancing overall dynamic efficiency whether or not any specific policy seems especially crucial.

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