Tom Heintjes: Hello, and welcome back to another episode of the Economy Matters podcast. I'm Tom Heintjes, managing editor of the Atlanta Fed's Economy Matters magazine, and today I'm sitting down with Salomé Baslandze, an economist here at the Atlanta Fed. She's written a paper titled "Entrepreneurship through Employee Mobility, Innovation, and Growth," and in it she examines the role of companies formed by employees of high-tech firms who strike out on their own to form newer firms. She also discusses the impact of noncompete laws on the broader economy, which is always a timely topic. Thanks for being on the podcast today, Salomé. I've looked forward to sitting down with you and discussing your work for a while now.
Salomé Baslandze: Thank you so much, Tom, for inviting me to the podcast. I'm excited to talk about my research. So generally, spinout firms—also, they're often referred to as spinoffs—are entrepreneurial ventures created by employees of other firms. In my research, I study innovating spinouts: those spinouts that filed for patents, and whose patent applications in the first year when they entered were filed by inventors from some other firms. In the data, these spinouts are actually important. They account for about 30 percent of entry in the industry. And you are right that—in addition to the fact that they are just a sizable share of entry—they are also very different from other entrants without prior experience.Heintjes: You tell us what a spinout is, but what makes them different from other startups, or new businesses in general?
The Atlanta Fed's Salomé Baslandze. Photo by Ted Pio Roda
Baslandze: They're different in the data. They appear as being more successful. They survive longer, and they file for two to three times more patents during their lifetime. They spend 30 percent more on research and development and have 33 percent higher sales growth in the data.
Heintjes: So, quite different. Salomé, how far back do spinouts go? I imagine there was an employee of Thomas Edison or Henry Ford who struck out on his own, right? How far back do these go?
Baslandze: Well, good question. I guess spinouts go as far back in history as entrepreneurship, actually. But it's good that you mentioned Thomas Edison, because in addition to us knowing him as the very prolific inventor, he's actually the one who invented innovation process in teams. He's the first one who created the research and development lab where he had inventors, and he would just sketch an idea and give the sketch to the inventors and say, "Okay, work on that." Basically, then, if you think about innovating spinouts, they probably originated first from Thomas Edison's lab. And actually, Henry Ford—who you mentioned—was a spinout from Edison's lab. He was working in one of his companies, and then he came up with his idea on the side and was working on how to create the automobile.
Heintjes: Wow—I had no idea how good that question was.
Baslandze: I did some research, so—thank you. [laughs]
Heintjes: Thank you! In your paper, you show a family tree of the spinout firms that came out of Bell Labs and Hughes Aircraft. It was pretty amazing, and that family tree was from the 1960s. Do we still see that sort of propagation today?
Baslandze: Yes, good question. So given that you mentioned this family tree, I actually want to expand on it a little bit because I think this is a fascinating example. William Shockley was a Nobel Prize winner and the inventor of transistors, and he was working in Bell Labs in an engineering team—his was ahead—and then he created his own spinout because he wanted to have the mass production of transistors. So obviously, he got lots of good scientists. What happened is that in a couple of years after the spinout was established as Fairchild Semiconductor International, the eight so-called "traitorous eight" scientists actually left the semiconductor leader and they invented their own spinouts, and they gave rise to dozens and dozens of firms, which gave rise to Silicon Valley as we know it right now. So, this is a very good example of how in the past the spinout industry was working—and now you're asking me about current days, and indeed, our everyday example right now is Zoom. Actually, Zoom is a spinout itself. it was created by an employee in the engineering team of Cisco Webex Technologies. So here we go.
Heintjes: That's great, because Zoom seemed to come out of nowhere, and now it's ubiquitous.
Baslandze: Exactly. During the pandemic, it really hit the telecommunications market and became one of the leaders.
Heintjes: Yes. Salomé, as your research shows, it's not just the founders of the company who play an important role in a spinout's performance, but it's also the earliest employees of that company. Can you discuss the importance of the employees who, let's say, get in on the ground floor?
Baslandze: Yes—you're right. In my study, I identify not only the founders—entrepreneurs—of the firms, but also those inventors who were there on the first patent filed by the firms. Well, the founding team is important, and recent studies actually show the importance of these teams. The study by Choi, Goldschlag, Haltiwanger, and Kim
using the census data actually shows that the unexpected loss of founding team members due to premature death actually has long-lasting implications for the firms. Firms contract in scale—so the employment is reduced by 16 percent, revenue even more by 32 percent, and productivity is lower.
Heintjes: Before we get farther into this, I want to ask you: What initially led you to research this topic? What put it on your radar as something to really delve into?
Baslandze: Let me start with the following observation. We know in the data that firms are very heterogeneous in their qualities. When firms enter the market, most of them fail in several years after their entry. So what makes firms special? This is the question, really, that everybody wants to answer in order to understand how to drive entrepreneurship and innovation, and what has been noticed by some studies is that actually it is important to understand ex-ante heterogeneity at birth: some firms are just born different. So then, the question is: what drives it? What are the potential determinants of that? And I thought to understand this, we need to really maybe look at the background of founders—founding teams—and explore this heterogeneity in spinouts.
Heintjes: Great—thank you for that background context. In your paper, you ask a great question, which I will now ask you: If spinouts are important for growth, could policies be designed that would foster spinout entrepreneurship without distorting the innovation incentives of the incumbent companies?
Baslandze: Yes, thank you for this question. So far, I have talked only about the positive side—that spinout entrepreneurs are just amazing performers. But there is also a negative side to the story, the one that you mentioned: that many incumbents invest a lot of money in research and development. They also invest in human capital of their employees—and if they expect to lose this capital right after the investment, that that will reduce the innovation incentives, because they will not appropriate the returns to the investment. As a result, it is important to understand the policies, how they affect both the entry incentives but also incumbents' innovation incentives. And in fact, there are these labor regulations called noncompete policies that affect both of these margins. And this is what I studied in this paper.
Heintjes: Right. Well, I want to hold that thought because we're going to touch on noncompetes in a moment, but I'm going to ask you if you think there's a relationship between the size of a firm and the likelihood of it spawning spinouts.
Baslandze: Yes, there is a relationship, and this relationship has been documented in the various studies. One of those studies is by Elfenbein, Hamilton, and Zenger , which follows a large sample of science and engineer graduates in the US, and what they find is that when those scientists work in smaller firms—let's say fewer than 25 employees—they are six times more likely to spawn and create spinouts than when they work in very large firms. But in my study, what I want to emphasize is that—conditional on size—what matters is whether the incumbent firm is a technological leader and the top, leading firm in innovation. What I find is that when parent firms come up with top inventions and top patents and they file these patents, their inventors also tend to come up with better ideas and create their spinouts. And when they create spinouts—if the parent is really a top leader in the industry—they also perform much better. So there's this knowledge inheritance going on. Iit matters which company you are working for. If the company is better and a technological leader, then you are more likely to be a leader as well.
Heintjes: Great. We'll be right back with our discussion, but please take a moment to listen to this message from the Atlanta Fed.
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Heintjes: We're back in the studio with Atlanta Fed economist Salomé Baslandze, discussing her research into entrepreneurship and innovation. Salomé, let's touch on your discussion of noncompete laws, which you mentioned briefly before. I understand why firms favor noncompete laws—they don't want competition from former employees who might strike out on their own. What are your own thoughts on noncompete laws?
Baslandze: My thoughts are, based on the existing body of research and my own analysis, that people and ideas should be free to move. But the intellectual property owned by the firm should be protected. And in fact, there are many forms of intellectual property protection. For example, patents—they protect the inventions owned by firms, and others cannot really use this invention without the consent and licensing from the firm. On the other hand, there are trademarks that protect the reputation and brand power of the firms. Also, there are trade secrets that protect certain technical or commercial information, including the customer lists. These kinds of things, which are property of the firms, have to be protected. But if these protections work well, I personally think—based on what I see from research—that protection in the labor market probably is less efficient. And indeed, like currently 28 to 47 percent of employees in the US are estimated to have signed contracts which have noncompete covenants. Even if those covenants are not strictly enforced in some states or by some firms, these restrictions may have chilling effects on mobility and entrepreneurship.
Heintjes: Right. Well, let me ask you this: in the course of conducting all this research—and I know it takes a lot of time—did your thinking on noncompetes change in any way?
Baslandze: Different policies always have two sides, and this is an example here, too. I think what this study shows is more of a quantitative assessment of whether pluses dominate or minuses, and what I find is that actually minuses dominate. So if you restrict—as we currently have in the US—we actually see lower productivity growth. So, it's better to remove these restrictions.
Heintjes: I'm not sure you answered my question. Did your own thoughts change on the role of noncompetes? I'm not going to let you dodge me on this one. [laughter]
Baslandze: No, that's okay—I think I did not have a priori, like I for sure thought that it should be this way or the other. I thought they could go any way, so yes: my thoughts have changed, given that I did not have strict opinions.
Heintjes: Right. Well, earlier in our conversation, we talked about the "family tree" of parent firms and spinoff companies. Can I assume that noncompetes would sort of stunt the growth of such a tree today? Was the notion of noncompete laws different back in the day?
Baslandze: Yes—actually, the noncompetes started very early. Even in the Middle Ages in Europe, noncompete restrictions were enforced. There were some cases actually filed. In the US, they enter it in the 17th century, and over time there have been a lot of changes in these laws. You mentioned the family tree that we discussed, and that family tree grew in California, and California always—and also now—has been the state which does not enforce noncompetes. In fact, there is this amazing book by AnnaLee Saxenian, who actually attributes the success of Silicon Valley to this free movement of ideas, of people, of creation of knowledge and diffusion of it in new ventures—so yes, maybe if the laws were different, then maybe we would not see Silicon Valley the way we see it now.
Heintjes: Fascinating. You mentioned California—is there an overall trend among states and noncompete laws, or do they vary widely by geography or other factors?
Baslandze: Yes, they vary a lot—across states, as well as over time. As I mentioned, California bans these restrictions, as does North Dakota. B ut states like, for example, where we are now, Georgia, as well as Florida, are on the other end of the spectrum, and they actually enforce lots of restrictions. You asked about what factors are different. So, the enforcement may be different, for example, in terms of the length of enforcement—how many months or years you need to stay away from the labor market or entry—or geographical scope—how far away you need to establish your competing firm—and other considerations—for example, if you enter the same industry as opposed to another. So overall there are lots of changes, and they're over time as well. And perhaps over time, there has been a push towards easing restrictions more—but it needs to be noted that despite that, the use of these covenants is rising, and this is partly because lots of firms—including, especially, the smaller firms—use default template contracts for their employees that have by default these covenants to noncompete. When employees sign, in many cases they actually don't realize what the implications of these covenants are.
Heintjes: Salomé, on a broad macroeconomic level, what are the effects of noncompete laws? I imagine they're hard to quantify, but do you have a sense of how they affect the overall labor market, job formation, and so forth?
Baslandze: My attempt in this paper was exactly to try to answer these macro questions. Some of those macro effects are easier to estimate in the data, but others require some economic model to think about them in some thought experiments. And one clear aspect that we already talked about is the entry, which is one of the macro effects—entry of the firm. What I see in the data is that entry of firms in states where noncompete restrictions are stricter is obviously lower, and the entry by spinout—good spinout firms—is 12 percentage points lower than in other states with no restrictions. At the same time, obviously, we see that the incumbents' innovation is high in those states where noncompete restrictions are stricter. There are also some other, subtle effects that I identify in the paper, and I refer to them as "knowledge diffusion channel" and the "type composition." What do they mean? When there is a large entry of spinout firms in states where noncompetes are not enforced strictly, we know that those spinout firms are better. They grow into better, more productive firms. Well, what does it mean for next generations? It means that those firms will spawn better spinouts, and those in return will spawn better spinouts—so there will be this proliferation and diffusion of ideas, which will finally result in higher growth and entrepreneurship. And indeed, if you combine all of these effects, you see that the net effect from removing the restrictions completely is actually positive. If you compare the states with no restrictions to the state with the strictest restrictions, you see that productivity growth is lower by 12 percent.
Heintjes: Wow. I read recently about a move in Washington to do away with noncompete laws, and it made me think of your research. I don't want to get into a discussion of partisan politics, of course, but what are your thoughts on this sort of initiative?
Baslandze: Yes, you're right. There have been numerous attempts, initiatives, in DC that were trying to reform these noncompete laws in recent years. There has not been much progress, actually, and partly this stalemate was the result of lots of debates about ills and goods of these noncompete laws. But actually, recently, just a couple of weeks ago, the FTC [Federal Trade Commission] proposed a rule to ban noncompete clauses which hurt workers and harm competition. The FTC, actually, in their report, estimates that this rule could increase earnings by nearly $300 billion per year and expand career opportunities for nearly 30 million Americans in the US. These are big numbers, and I need to say that if after this podcast you have your own opinions about noncompetes, the FTC still accepts public opinion through March, so feel free to share them.
Heintjes: Very good, thank you. Salomé, does your research imply any policy recommendations or suggestions for enhancing innovation and entrepreneurship?
Baslandze: Yes. My analysis shows that currently in the US, the optimal labor market regulation is no regulation. Banning noncompete restrictions are growth- and welfare-enhancing for all the states in the US. Another policy that I also look at is entry subsidies. Entry subsidies are a popular policy in how to drive entrepreneurship and growth in the US, and the very simple implication of my paper is that the targeted entry subsidies are much more effective than just regular entry subsidies. It just takes looking at the CV of founding members and entrepreneurs who you give the subsidies to, and distinguishing those entrepreneurs that are spinouts and subsidizing them more.
Heintjes: OK, we'll let that be the final word on the subject. Salomé, I want to thank you so much for being here and sharing your thoughts and insights on your work. This was a really interesting conversation, and I appreciate it.
Baslandze: Thank you so much, Tom. This was amazing.
Heintjes: And that brings us to the end of another episode of the Economy Matters podcast. Again, I'm Tom Heintjes, managing editor of the Atlanta Fed's Economy Matters magazine, and as always—I appreciate your spending some time with us today. On the Atlanta Fed's website at atlantafed.org, we'll have a link to Salomé's research that we've been discussing, and I encourage you to check it out. It's really interesting and timely. Thanks again for listening, and let's meet again next month.