By Michael Mandel Every decade has its hot industries -- the ones that drive local growth and turn some cities into superstars. In the 1990s information technology was the main engine of prosperity, boosting incomes, creating new jobs, and sending real estate values soaring. Tech leaders such as San Jose, Calif., Seattle, and Austin, Tex., home of Dell Computer (DELL), rode the wave. And even after the tech bubble burst, much of their gains still remained.
Now states and regions around the country, seeing their factory and back-office jobs slip away permanently to China and India, are hoping to emulate these winners. But rather than pinning all their hopes on trying to lure big factories -- like they might have in the past -- states like West Virgina, Florida, and Ohio are formulating plans to attract and encourage technologically innovative companies and industries.
HARD TO GUESS. Such reasoning is right on the mark. Innovation drove the New Economy, and it seems like a region's best hope for remaining economically relevant today. The U.S. still has a comparative advantage over its main competitors in education, technology, and the ability to finance and support risky and innovative startups.
There's a problem, though. Because of the unpredictable nature of technological change, relying on innovation as an economic-development strategy is far more risky than, say, trying to attract big manufacturing operations. If a state offers big incentives to Toyota (TM) or Mercedes-Benz (DCX) to get them to set up a new car plant, it most assuredly gets a factory that produces motor vehicles and employs a lot of workers.
It's very hard, however, to guess what the next big growth sector is going to be. That's the fundamental nature of innovation. No one guessed in the early 1990s that info tech was going to be able to lift local economies the way that it did. In 1994 the San Jose Mercury News, for example, published an article that was pessimistic about Silicon Valley's prospects, forecasting that the local economy would "slog along throughout most of the decade as firms continue to expand elsewhere."
AREAS WITH POTENTIAL. Similarly, in the early 1990s the "Massachusetts Miracle" seemed to be over, as outfits such as Data General, Prime Computer, and Digital Equipment laid off hundreds of thousands of employees. And in Seattle, who knew that tiny Microsoft (MSFT), which employed a paltry 15,000 workers globally in 1994, was going to end up being as economically important -- let alone more so -- for the region than Boeing (BA), with a workforce then of 115,000. (In 2001, Boeing moved its corporate headquarters to Chicago.)
However, while the risks of an innovation-driven economic-development strategy may be greater, so are the potential rewards. The key is for regions to diversify their bets as much as possible.
Several technology areas have the potential for driving local growth. These include telecom, biotech, energy, nanotech, and space, each with its own positives and negatives. With biotech, the advantage is that the first biotech drug was developed more than 20 years ago, implying that the technology is maturing. But the disadvantage is that drug-approval process is necessarily a lengthy one.
GOVERNMENT HELP NEEDED. Or take nanotech, which covers a range of new technologies, all of which have to do with building new materials up from individual atoms for a variety of purposes. Nanotech can potentially revolutionize manufacturing -- which in many industries has been technologically stagnant -- and thus help stem or even reverse the massive outflow of factory jobs. The problem, though, is that nanotech is still in the very early stages, meaning that it's very high-risk.
In addition to investing in a range of technologies, regions should also spend on the crucial inputs for innovation. Education is a key area. According to one economic study, workers in metropolitan areas with a higher percentage of college graduates get higher wages compared to similar workers elsewhere.
Another essential ingredient is finance -- in particular, the sorts of risk capital that new and growing companies need. The track record of government-backed venture-capital operations isn't particularly promising, since the choices have often been motivated more by politics than viability. Moreover, public agencies often have difficulty coping with the sheer uncertainty of innovation and the fact that most new businesses fail. Nevertheless, finance is so important for innovation that some sort of government action is probably needed to improve the flow of money to innovative startups.
Trying to accelerate innovation's progress in a region can be difficult and frustrating. But the potential payoffs are big -- and in the end, it's the only game in town. Mandel is BusinessWeek's chief economist