How Texas can become the next Silicon Valley

Texas is making another bid to become America’s technology hub. It will be an uphill battle, to put it mildly. But one seemingly small policy tweak could give the state a big boost in its quest to lure the tech industry: banning the enforcement of noncompete agreements.

London:In the 1970s, Austin, Texas, established itself as a technology cluster but never attained the heights of Silicon Valley or Seattle. To do that, a city needs a critical mass of talented engineers, big employers and venture capital.

Now, the urban dysfunction of the San Francisco Bay Area and a desire for lower taxes have prompted some tech companies and investors to move from the Bay to Austin.

Elon Musk’s companies, Tesla and SpaceX, are probably the most notable big companies making new investments in the area, and Musk himself has moved to Texas. Oracle and a smattering of venture capitalists are also making the move.

This is good news for Austin, but so far it’s a trickle, not a flood. Tesla factories are nice, but if Austin is going to become a software and startup hub on the level of Seattle or San Francisco, it’s going to need a lot more than that. As my colleague Justin Fox has written, the entire state of Texas has lagged badly in both areas.

So the Texas state government needs to pull out all the stops in order to make sure the current trend accelerates. And one of the easiest things it could do would be to ban the enforcement of noncompete agreements.

Noncompete agreements restrain the ability of workers to move between companies in an industry (or starting their own new venture). All else equal, companies would like to be able to block their workers from moving to competitors. Ideas will inevitably leak between companies when employees move, even if proprietary technologies are formally protected by intellectual property law and nondisclosure agreements.

But by preventing these ideas from spreading around, a company does a little bit of damage to the entire industrial ecosystem around it. Ideas are synergistic — they can be rearranged into different combinations and produce new technologies, products and management techniques.

Sometimes simply having the same employee in a different working environment or role will allow them to do great things. Fairchild Semiconductor, for example, famously gave rise to a huge number of spinoff companies that formed the backbone of the original Silicon Valley.
That might not have been possible if California had allowed the enforcement of noncompete agreements.

Scholars have cited California’s refusal to honor these clauses as a reason Silicon Valley became so dominant among U.S. tech clusters.

In her book “Regional Advantage: Culture and Competition in Silicon Valley and Route 128,” researcher AnnaLee Saxenian cites it as one big reason California was able to overtake Massachusetts, which had a big head start in terms of the technology industry.

Empirical studies back this up. A 2017 paper by economists Evan Starr, Justin Frake and Rajshree Agarwal finds that in states that enforce noncompetes, industries with more of these agreements “receive relatively fewer job offers, have reduced mobility and experience lower wages.” Another 2017 paper by economist Jessica Jeffers finds that the reduced labor mobility caused by noncompetes reduces the number of new startups, especially in knowledge industries.

And that gums up a whole tech cluster. Places like Silicon Valley exist precisely because tech companies and venture capitalists want to take advantage of the deep pool of engineering and managerial talent that exists in the area. Noncompetes lock that pool away; if all your potentially best hires are legally prevented from working for you, you might as well move your company out to the middle of Wyoming or the Philippines, where at least the rent is cheap!

This is why Texas needs to change its law to make noncompetes unenforceable, like in California. Big businesses will probably lobby against this move — from their own narrow vantage point, noncompetes seem like a good deal. But the small benefit they derive comes at the expense of the entire tech ecosystem. Each Texas company that makes its workers sign noncompetes is helping itself at the expense of the state itself. So the state needs to step in. While Texas law discourages the agreements, they're still enforceable when deemed "reasonable." That's not good enough.

Banning noncompetes would be inconsistent with Texas’ principles and reputation as a defender of free markets. Noncompete agreements are restrictions on the free movement of labor; they gum up markets. Ultimately, the market is more important than the prerogatives of any particular company.

In fact, Texas isn’t the only state that needs to ban noncompetes; every other state should do the same. Many — including Massachusetts — are acting to limit the practice. Incoming President Joe Biden has even proposed a federal ban on noncompetes. If it could pass Congress, such a ban would put all the states on a more level playing field when it comes to luring tech away from Silicon Valley.
But Texas shouldn’t wait for Biden — it should act now.

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