One of the more interesting points to come out of the law and economics perspective to trade secrecy is that a legally binding obligation to keep something confidential operates as a kind of substitute for literal secrecy. It therefore acts to encourage and facilitate the disclosure of information, albeit on terms that keeps it within the private sphere.

This post explores how the law of confidentiality allows someone to construct legal rights so that they can share the information while continuing to control access. It then compares the costly alternatives to relying on legal obligations restricting the use and disclosure of information with the kinds of relationships this type of right enables in a knowledge economy.

Think a Gate, Not a Wall

From a commercial perspective, what the law of confidentiality or trade secrecy achieves is to enable someone to control access to a source of information, and to set the terms for such access. Confidentiality acts as a gate, not a wall. This is crucial because potentially valuable information rarely does much good unless it can be shared and used in some fashion. Our legal system has evolved into allowing holders of a useful source of information that is not readily accessible to the public to construct legal rights that enable them to continue to act as its gatekeepers.

To illustrate this point, two American legal academics, Michael Risch and Mark A. Lemley, have both contrasted how inefficiently firms are forced to operate when legal rights to secret or confidential information cannot be enforced relative to what has become possible in today’s advanced economies. Where commercial actors trust the court system, a legal obligation to maintain confidentiality or to otherwise preserve a specific party’s “proprietary rights” operates as a rule of law backed substitute for literal secrecy. The ability to rely on legal obligations that restrict the further use or disclosure of privately held information acts to facilitate either sharing it, or bringing on third parties to create it in the first place. This potential allows a privately controlled safe space for the exchange or generation of information outside of the public domain that is a hallmark of modern, knowledge-based economies.

The Costly Alternative to Legal Obligations

And the alternative, literal secrecy, is often very costly indeed. This is true in terms of the time and expenses involved in maintaining secrets while seeking to squeeze some utility out of them, and of the very real costs of foregone opportunities.

As a starting point, keep in mind that from the perspective of an individual business whatever competitive advantage they may capture by developing or deploying some useful item of information tends to dissipate once it becomes generally known. Absent robust and reliable legal protections, disclosing information is therefore inherently risky. One reason the patent system was developed was to replace this baseline “state of nature” with time-limited legal rights that serve to incentivize developing and then publicly disclosing certain types of innovations. A similar point applies to know-how and business secrets, although, in this case, our legal system will only protect rights to such information if it is not readily available from publicly accessible sources.

In places where businesses do not trust the local court system to effectively enforce their legal rights, firms tend to instead rely on a combination of personal loyalty, physical security, and sharply limited disclosure. This is one reason that, both historically in the West and in many developing countries today, firms often remained relatively small and family run. If a secret got out there was no effective way to halt its further use and disclosure. One outgrowth of this is that valuable secrets or techniques were often only shared with family members or well-known lieutenants. Seeking out a stranger who might perform the task in question more effectively was inherently risky because it might destroy whatever hard-earned competitive advantage a firm had developed.

For similar reasons, production tended to be kept in-house because contracting out such tasks to third parties involved sharing information regarding secret processes or techniques. Limiting acts of disclosure in this manner was often coupled with expensive forms of physical security. Far from simply locking the door during off hours, the workshops or laboratories in which secret processes were deployed often had high walls, barred windows, and guards posted to monitor all comings and goings. Today, businesses that are operating in countries where they suspect they may be an active target for trade secrecy theft similarly combine robust physical security with such efficiency-reducing measures as restricting their worker’s access to the internet and placing strict controls on what IT devices and services they may use.

The Free Circulation of Privately Held Information

Contrast this situation with the relatively free flow of sensitive information within modern knowledge economies. Firms are willing to bring on new hires or engage subcontractors at least in part because they are willing to rely on confidentiality obligations relating to, for example, customer or operational particulars. Dependable confidentiality obligations similarly facilitate leveraging the efficiencies to be gained by drawing on outside expertise, as well as the now seemingly ubiquitous subcontractor relationships involving everything from various forms of outsourcing to maintaining IT systems to handling payroll.

With this context, it is worth taking a step back to conceptualize why rights to confidential information are useful, and, by granting and enforcing them, what modern legal systems achieve. A basic problem in “selling” or coordinating the exchange of knowledge-based products or services is that the information in question typically needs to be disclosed to potential buyers for them to be able to accurately evaluate whether this information is worth purchasing, and for how much. Yet for the seller, making this disclosure this is risky – once known, what is to prevent the recipient from simply using the information anyway? And if a new and relatively unknown individual is brought into the circle, what prevents them from spilling the beans? Enforceable legal obligations to respect confidentiality and another party’s right to control the further use and disclosure of information does not completely solve this problem, but it does help plug the gap.

Enabling a Knowledge Economy

The practical difficulties involved in detecting a breach of confidence or actively enforcing legal obligations should not be understated. Nonetheless, the dependable existence of court-backed rights sanctioning the misuse of confidential or proprietary information operates as a “good enough” substitute for literal secrecy. This has in turn normalized relying on outside expertise, hiring knowledge workers, and constructing complex inter-firm relationships.