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Do Non-compete Clauses Discourage Innovation?

August 16, 2002

The legal ban on non-compete contracts may have played a role in and continues to affect the development of the high tech sector in California. This is the conclusion of Rob Valletta, Research Advisor, in the August 16, 2002, edition of the Federal Reserve Bank of San Francisco Economic Letter. The article, On the Move: California Employment Law and High-Tech Development analyzes the relationship between high tech development and states that do not legally allow non-compete contracts.

Using at- least squares statistical analysis, Valletta concludes that when non-compete contracts are prohibited, employee mobility and knowledge transfer are enhanced. While employees may not be able to share specific trade secrets, general industry knowledge can be shared readily. This freedom can then play an important role in the advancement of innovating technology sectors.

The precursor to the California law dates back to 1872 and current law still prohibits these types of contracts. Colorado is mentioned as another state that does not allow "non-competes" and as one with a robust tech sector.

Valletta also found the relationship held for yearly salary growth but acknowledges that other factors also play a role in the development of high tech sectors.

The full article can be found at: http://www.frbsf.org/publications/economics/letter/2002/el2002-24.html