Google “the next Silicon Valley” and you’ll find stories about Chicago, Boise, Pittsburgh, Los Angeles, even cities in Europe and India. For decades now, everyone has been trying to replicate the Bay Area’s booming, venture capital-backed technology industry.
But new research out of the Yale School of Management traces many of the region’s most glaring problems — soaring income inequality, high cost of living and shrinking middle class — can be traced to the venture capital that helped build Silicon Valley.
“Most of what we’re showing in this paper is that the returns, who is benefiting from that, are very unevenly distributed,” said Olav Sorenson, the professor that co-authored the new research.
Sorenson wasn’t always so down on venture capital. Before he started his research, he thought that as investors pumped money into startups, those new companies would hire more employees who would, in turn, go to restaurants and shops, spreading money around and boosting the local economy.
But once Sorenson analyzeddata about the impact of venture capital on 359 different metro areas in the US, it painted a much darker picture.
Venture capital moneycrowded out other traditional industries, beating them in the competition for land, talent, and capital, Sorenson found. At the same time, while incomes for already high earners rose — doctors and bankers were more in demand — they stayed flat or even fell for everyone else. Restaurant workers, bartenders, and hairdressers saw little benefit.
“To the extent that the area is getting more expensive, it’s actually getting worse for these people,” said Sorenson.
More surprising perhaps was that venture money didn’t really expand employment in technology companies, he said. Take, for example, scooter companies. Instead of a dozen competing businesses, venture capital investors choose one or two winners to back. As competitors shut down, the winners wind up employing fewer workers overall than there would’ve been in a more competitive market.
Titled “The Silicon Valley Syndrome,” the studyserves as a warning for cities hoping to emulate the success of the Bay Area’s tech industry.
Of course, there is a reason everyone wants to replicate Silicon Valley. A 2015 analysis from the Stanford Graduate School of Business — one of the most recent comprehensive looks at the impact of venture capital on the economy — found that 43 percent of all publicly traded companies founded since 1979 were backed by venture capital, including the five largest U.S. companies by market capitalization — Apple, Microsoft, Amazon, Alphabet and Facebook. Venture-backed public companies employed 4 million people as of December 2013.
But among the potential losers in a venture capital-fueled economy, Sorenson said, are other locally-based companies that have to compete nationally or globally. The classic example is manufacturing.
Kate Sofis, CEO of Manufacture: San Jose, said tech and manufacturing often are ideal partners and have worked together successfully in Silicon Valley, where manufacturing makes up about 12 percent of San Jose employment. Her organization, a public-private partnership with the city of San Jose, promotes and advises local manufacturing businesses.
The problem, she said, is that tech needs fewer employees and less space than manufacturing. It also can afford higher wages and rents, which in turn crowds out manufacturing.
But Sofis doesn’t think venture capital is automatically bad — it’s just an accelerant for existing problems, she said.
Robert Eberhart, a management professor at Santa Clara University and a visiting scholar at Stanford, thinks focusing on venture capital misses the larger issue. Venture capital is part of the problem, but it’s not the cause, he said. Instead, he thinks cities misunderstand the role of venture capital in creating a place like Silicon Valley, which grew out of government defense and research spending.
Eberhart said he’s been researching cities in Wisconsin that are trying to lure venture capital in hopes of kickstarting their own economic booms.
“They have, for example, great industries in plumbing, in creating (bone) broth from cows, in trucking, and they’re very profitable,” he said. “But they’re not sexy in the Silicon Valley way.”
Instead of investing in those existing industries, venture capitalists give money to a few lucky individuals trying to create entirely new industries without juicing the larger local economy, Eberhart said, creating the outcomes Sorenson found.
Similar issues arise when venture capital firms try to invest in manufacturing in Silicon Valley, according to Sofis. Those investors, she said, are used to explosive growth — something that’s easier when your product is an app or website than when itrequires costly, specialized equipment to build.
“Because of the pressure to grow very quickly, it leads those manufacturers to immediately outsource either out of state or overseas,” she said.
That can force out companies making everything from specialized tools to craft beer and erase jobs paying middle-class wages that often don’t require a college degree, she said.
Whether you blame venture capital or not, everyone can agree on one thing: The Bay Area is getting way too expensive. Eberhart’s wife is a dentist, he said, and some of her dental assistants commute from more than two hours away.
“She finds it almost impossible to find a bookkeeper,” he said, because all the accountants either work for a tech company that pays much more, or they’ve moved to a cheaper region.
“What does the world look like when all of the people that service and make our world nice can’t afford to live in the area?” Eberhart said.