Ties that bind: The market for smart people is clogged up by all manner of dubious legal restrictions

Ties that bind: The market for smart people is clogged up by all manner of dubious legal restrictions

Dec 14th 2013 | From the print edition

THE business press is full of heartwarming stories about the “talent wars”. It reports that eBay pays its lead technologist twice as much as its chief executive. Apple recently slipped a high-flyer $8m to prevent him from jumping ship. Tech firms regularly spend lavishly on startups in order to “acqui-hire” their employees. They also compete furiously to provide workers with the best food and the most fashionable yoga instructors.But the talent wars have a darker side, one that is fought with lawsuits and handcuffs rather than bonuses and California rolls. Firms are increasingly resorting to litigation—some of it extraordinarily unpleasant—to prevent employees from moving to rivals. The result is that the labour market is becoming clogged.

The most popular weapon on this front is the “non-compete” agreement, which prevents employees leaving a firm from working for a rival for a fixed period (usually up to two years but as many as five in Italy) or setting up a competing business. These were once mainly confined to the upper ranks of knowledgeintensive firms. Now they are ubiquitous: about 90% of managerial and technical employees in America have signed them.

Other weapons in the arsenal include “confidential information” and “pre-invention assignment” requirements. Companies can prevent former workers (including those who have not signed non-compete agreements) from moving to a rival on the ground that they are taking trade secrets with them. They can also assert astonishingly wide-ranging rights over their employees’ inventions—claiming ownership of ideas that people had been working on for years before they joined the firm or which they came up with in their spare time or even after leaving.

It is easy to see why companies like these weapons. Firms can lose millions of dollars’ worth of knowledge and contacts when a senior executive joins a rival. They can lose even more if the executive knows their secret recipe or algorithm. It is equally easy to see why employees hate them. Non-competes prevent people from selling their labour for long periods during which skills atrophy and contacts fade away.

How can the competing claims of employers and employees be reconciled? Judges have tended to put a heavy emphasis on the free-rider problem in dealing with this conundrum. Employers have little incentive to invest in training and innovation if the beneficiaries can move to a rival whenever they feel like it. Restrictions like non-compete clauses ultimately benefit everybody because they increase companies’ incentives to invest in human capital without that fear.

A new book, “Talent Wants to Be Free”, by Orly Lobel, a law professor at the University of San Diego, presents a powerful counterblast to this argument. The drawbacks of the free-rider problem are as nothing compared with the advantages conferred by mobility. The free flow of talent encourages economic efficiency because it allows people to work in jobs and for wages that fit their skills. And no one likes being tied down. It also encourages innovation because it spreads information, extends professional networks and encourages cross-fertilisation.

An obvious example of the virtues of mobility is California: the home of Silicon Valley and Hollywood has been more reluctant than any other state to recognise non-competes and other restrictions on the tide of talent. This might be pure coincidence. But California is part of a more general pattern. American states with weak restrictions have better records of capital investment and innovation than those with strong ones. Freedom of movement is especially valuable for startups, which can easily be beaten to death by incumbents wielding a legal stick. Places in the West with lenient restrictions, such as the Scandinavian countries and Israel, tend to be more innovative than countries with tough ones like Germany and France.

That a free market for skilled people benefits the economy as a whole seems to offer cold comfort to firms that open themselves to raiders. But Ms Lobel retorts that the free flow of talent is good for individual companies whether they win or lose a particular battle in the wars. Firms that operate in such open markets for the highly skilled tend to have better-quality human capital. They make more use of performance-related rewards in a bid to recruit and retain stars. Those that lose their best people to rivals can also benefit by learning about their own weaknesses: Schlumberger, an oil-services firm, conducts internal inquiries whenever it loses somebody it wants to keep. Firms can also benefit from a raider’s success: Cooley, a big law firm, suffered angst over losing a leading lawyer to a then unknown website. It was forgotten when their ex-employee hired the company to act as eBay’s counsel for its $63m IPO.

America’s got talent

Ms Lobel can sometimes takes her case too far. Companies surely deserve protection from rivals who try to steal trade secrets by hiring privileged insiders. But her instincts are absolutely correct. Human capital is the most important source of wealth in the modern economy. It is a looming problem that established companies are weaving a web of legal restrictions on the free movement of talent.

Policymakers need to remove these restrictions: they should presume that free trade in human talent is a good thing unless there are obvious attempts to steal corporate secrets. And firms need to stop regarding workers as chattels. McKinsey has done well by treating its ex-employees as alumni to be stroked rather than enemies to be persecuted. Other companies should do likewise. A ball and chain might look like a good idea when confronted by an aggressive competitor. But there is a reason why it is an impediment seldom associated with front-runners.