That's a lot of things for Google these days, though. Not just search engines, but also: local search, video streaming, webmail, contextual advertising, maps, route planning, social networking, flight search, RSS aggregation, collaborative document editing, machine translation, VOIP, web browsers, mobile operating systems, app stores, programming languages/compilers/VMs, web frameworks, cloud-computing services, etc., etc.
But that doesn't mean that they're obligated to keep sending you a paycheck, either. California is an at-will employment state, and violating your employment contract tends to remove the "will" to employ you.
http://answers.onstartups.com/questions/19422/if-im-working-...
Has this ever happened? I would imagine that if some guy got his FU money taken away and given to some big company where it would be too small to even register on the income statements that said person wouldn't just lay there and take it.
After all, what you're describing is literally slavery (i.e. anything the slave makes belongs to his/her owner).
Ignoring the PR problem, if they sued one of their engineers over, say, an iPhone racing game, a sane judge is going to make them work pretty damn hard to demonstrate that it has any relation to their business.
Besides, the last thing you'd want to do is to work after-hours and find out your employer is owning the IP of your project (that's besides pager-duty and other after-hour things your employer might make mandatory anyway).
Regarding taking twice as long, just imagine projects like Dropbox or Twitter taking twice as long to get to the market - I doubt they would be competitive in the same manner.