The Risks Of Building Innovation Ecosystems | The Horizons Tracker

After the tremendous growth of Silicon Valley, and the economic propulsion its residents have given to the American economy, policy makers around the world have tried to capture the secret sauce and build ecosystems of their own.  As new research from Yale reminds us, however, such a strategy is not without risk.

The study explores the impact of such ecosystems on other industries, and found that when VC money floods into a region, it produces understandable benefits to some companies, especially those who serviced the wealthy new residents, but other companies did much worse as a result. These typically revolve around companies offering tradable goods and services that are often sold outside of the region.

This was also reflected in wages, as while wages at high-end firms would often increase as a cluster developed, those at low-end firms would often fall.

“There needs to be some caution in thinking that Silicon Valley is the model,” the researchers say. “While a high-growth sector can generate a lot of value, it’s important to have a stronger safety net. Because without that, you’re likely to increase inequality.”

Dutch disease

The authors suggest that the Silicon Valley of today echoes the Netherlands of the 1960s after huge deposits of natural gas were discovered in the North Sea, resulting in a huge growth in the industry that resulted in the Dutch currency sky rocketing, and prices rising across the economy.

This made it much harder for other sectors of the Dutch economy to remain competitive, especially in areas such as manufacturing, which left the economy more vulnerable as a result, and helped to coin the ‘Dutch disease’ phrase to capture the phenomenon.

The authors believe something similar is happening in Silicon Valley, as the success of various tech giants has resulted in huge growth in real estate costs and salaries in certain fields, especially involving coding and software development.  This has resulted in much of the talent becoming concentrated in a relatively small number of giant firms.

A common problem

The researchers explored economic data from over 350 metropolitan areas across the US from 2003 to 2012, to explore whether this is a common phenomenon.

The hypothesis was that non-tradeable sectors, such as restaurants and hair salons, where the customer lives in the same area as the store, would thrive, whereas tradeable sectors, where the product is sold outside of the area, would suffer.

It’s a hypothesis that appears to be born out by the data, as when VC funding poured into an area, the number of non-tradable businesses would typically grow, alongside the number of jobs in those businesses and the average pay employees in them earned.  By contrast, the fortunes of non-tradable businesses declined across all three of these metrics.

Uneven fortunes

Similarly, the fortunes of workers across the non-tradable sector were far from equal.  The researchers split the non-tradable companies into four tiers depending on their income, with the likes of banks and medical centers at the top end, and convenience stores and casual restaurants at the bottom.

The data suggests that nearly all of the benefits from the rise in VC money in the area were concentrated in the high end firms, with average wages in those firms growing by 2%, compared to a decline in income in the bottom tier by 1%.

This is likely to be because the pull of the dominant sector in the ecosystem is so great, that they tend to attract the best talent from the region, which results in those working at the lower end less able to command decent salaries.

The authors hope that their work is a reminder that while developing a strong ecosystem can bring significant benefits to a region, it also has costs that policy makers need to consider if inequality isn’t going to be the inevitable consequence.