The downside of high-tech wages, venture capital

A new study suggests that high-technology wages and venture capital, two of the elements that have fueled booms in areas like Boston, can hurt such areas disproportionately during economic downturns.

High-tech hubs such as Boston and Silicon Valley suffer more than other regions when the economy declines, partly because their wages are high and they're too dependent on venture capital, which flows to start-ups with unsound business models in the final stages of a boom, says the report. It was published last week by two professors at the University of New Hampshire's Whittemore School of Business and Economics.

''Business networks associated with venture capital fund flow might be detrimental at critical economic turning points, often resulting in a rush of dollars in a limited business sector, rather than a diversified set of entrepreneurial ventures," co-authors Ross Gittell, a management professor, and Jeffrey Sohl, director of the Center for Venture Research at UNH's Whittemore School, wrote in the study.

While previous research has noted that high-tech centers are more prone to boom-and-bust cycles than other areas, Gittell and Sohl examined the varying performance within the 25 top US technology centers in the aftermath of the late 1990s boom. They found that the areas with the highest concentrations of venture investment and the most narrowly focused tech sectors experienced the steepest declines.

In the Boston area, one of the strongest regional economies during the high-tech boom, total employment plunged about 4.6 percent, or nearly 100,000 jobs, between December 2000 and March 2002, the most pronounced period of decline. That compared to an average employment drop of 2.8 percent among the top 25 tech areas.

Greater Boston lost a smaller share of its job base during those lean years than the San Jose, Calif., area, the heart of Silicon Valley, which lost 9.3 percent, or the San Francisco and Seattle areas, each of which lost 6.1 percent. Gittell cited the greater diversification of the Boston technology sector as well as the overall regional economy.

Gittell said the hardest-hit tech centers when the bubble popped were those, like Boston's, where wages had soared across all sectors during the boom. ''Our model suggests the technology industry drove up wages in all industries," he said, noting that other businesses had to vie with high-flying tech start-ups to hire network technicians and other professionals. ''And all those other industries became less competitive because their wages were too high."

Venture capital, which helped to spur the tech boom in its early stages, played a reverse role in the late stages of the boom, Gittell said, especially in Silicon Valley and New England, the nation's two largest centers for venture-funded technology start-ups.

''Boston had a run-up in venture capital right through the end of the boom," Gittell said. ''You had employment based on speculation and unsound business plans. When those companies started, they hired a lot of people and drove up wages. Then they laid off a lot of people when the bubble popped. Boston, with its higher education and healthcare sectors, should have been somewhat protected during the decline. But it wasn't, because of the high wages and the venture capital."

Gittell's and Sohl's study drew criticism from one venture capitalist, Carl Stjernfeldt, a partner at Battery Ventures in Wellesley, who said a venture-fueled economy is better for a region over a complete economic cycle because it introduces innovation and new industries.

''The beauty of the venture capital model is that you adjust very rapidly to changes," Stjernfeldt said. ''It's true the VCs invested in dot-coms. But they stopped investing in dot-coms and moved to biotech. The feedback mechanism in venture capital is significantly faster. If we didn't want to make these adjustments, shouldn't we all be farmers?"

Former technology entrepreneur Marc H. Meyer, a professor at Northeastern University's College of Business Administration, agreed that many venture firms had invested irresponsibly during the dot-com era. Meyer, however, called that period unique and said he doubted it will be repeated in future cycles.

''Those venture capitalists that survived are being more selective and funding more considered business models," Meyer said. ''Therefore, I don't think we're going to see the crash we saw before."

Robert Weisman can be reached at weisman@globe.com.