R&D strategies if they operated in a state that strictly enforced non-compete agreements. Confident that their boundaries were not too porous, companies had greater willingness to engage in high-risk, high-reward research, leading to more “intrapreneurship” than entrepreneurship.
Reasonable people can debate whether more “intrapreneurship” is really a desirable economic outcome (or whether patents are a good proxy for innovation), but other research has shown entrepreneurial benefits of non-competes. A recent paper presented in Germany, using data from 30 American states, found that enforcement of non-compete agreements did indeed suppress rates of new business creation. But, the new businesses that were created in strong enforcement states had higher rates of survival and faster growth than in non-enforcing states. Because non-compete agreements raised the threshold for entrepreneurs, it may have meant that higher quality companies were started.
This would seem to align with prior research that examined the rate at which new biotech firms were started, and compared the founding rates across regions with differing levels of non-compete enforcement. States that did not enforce non-compete agreements had higher rates of startup activity.
Quality v. Quantity
According to the research, the question is, do you want a higher rate of startups, or fewer startups but with potentially longer survival and faster growth among those startups? The answer is not straightforward.
New and young companies are the principal source of net new job creation in the American economy. And, that net job creation adds millions of dollars to state economic output. Moreover, while high-growth firms are seen as the holy grail of economic policy, there are still open research questions about the enduring economic contributions of these fast-growing businesses.
In any case, the debate over entrepreneurial quality versus quantity may miss other factors that feed a state’s entrepreneurial ecosystem. For one thing, no matter which side of that divide you come down on, the companies starting up still need talented employees, and some research has shown that strict non-compete enforcement may drive such employees away.
Thirty years ago, Michigan enacted the Michigan Antitrust Reform Act, which, among other things, accidentally changed the state’s stance toward non-compete enforcement. It’s still not clear to us how a state “accidentally” switches its policy on something like this, but stranger things have happened.
However it occurred, Michigan was now officially enforcing non-competes and lawyers across the state took notice. Unfortunately, highly skilled workers in science and technology industries also took notice and began to leave the state. Thus, even if it were true that the quality of Michigan startups was now potentially higher (as indicated by the research mentioned above), those startups had a shrunken pool of talent on which to draw. Other states, of course, were happy to reap the benefits of Michigan’s accident.
The debate over enforcement of non-compete agreements will continue beyond the failure of reform in Massachusetts. Of course, variability across states in how they approach this issue is a boon to researchers—it’s a “natural experiment” wherein economists can compare causes and effects across the country. So hopefully, more research will be forthcoming that can be of assistance to policymakers.
In the meantime, the divide remains in place. We recently participated in a conference with state officials, big companies, and entrepreneurs in a state that has a relatively strict approach to non-compete agreements. When the subject came up, the policymakers and corporate representatives agreed that this was not a problem in their state. Every single entrepreneur in the room then raised their hands: it certainly is an issue, they said, and a big one. So much so, that the head of an accelerator said he half-jokingly calls his organization a “witness protection program” for entrepreneurs from the big companies in their city.
