IN this city of academics, higher education is a prime industry. Directly and indirectly, the colleges and universities help drive the local economy.When the students return each fall, local merchants smile a bit more broadly in anticipation of a surge in business; many display signs saying, "Welcome Back, Students!" The concentration of colleges and universities in the area has "probably been the single greatest engine of economic development in the modern period," says Richard M. Freeland, dean of the College of Arts and Sciences at the University of Massachusetts, Boston. The two largest employers in the state of Massachusetts, Raytheon Company and Digital Equipment Corporation, were both started by graduates of Massachusetts Institute of Technology (MIT). Along with these two economic powerhouses, an MIT study documents several hundred major companies in the Boston area that were founded by alumni. Many students come from other regions of the country but start companies or take jobs in Boston. "There is something about coming here from Omaha and being a successful undergraduate or graduate student and finding that this is a helluva lot more exciting place than going back to Omaha for a career," says John C. Hoy, president of the New England Board of Higher Education. Research by faculty and students in university labs helps feed the high-technology and health-care industries. Federal research money brings vast resources to the region. More than 10 percent of all National Institutes of Health research grants are awarded to Boston-area universities and affiliated laboratories, says Clare M. Cotton, president of the Association of Independent Colleges and Universities in Massachusetts. Much of the creative thinking that goes on at the universities eventually makes an impact locally. "Because the universities are here, a lot of their applied research and public-policy research ends up being focused on Massachusetts," says Dean Freeland. "Public-policy academics are crawling all over the state looking for ways to demonstrate their expertise." But there is a downside to the region's reliance on this research and technology transfer. "There has been a certain built-in tendency toward boom-bust cycles arising from the relationship of the Massachusetts economy to innovation," Freeland says. "Our economy is driven by relatively new technology, and we tend to take off in periods when a new technology is getting under way." For example, he says, during the early boom of the computer industry the region built factories and generated new products. "But as the industry matures, the manufacturing components and the jobs tend to drift away to other states where labor costs are cheaper. Then Massachusetts has to find some new innovation to get itself going again. We are somewhat in that stage now. People are hoping that the biotechnology industry will be the next great wave after the computer industry to drive the local economy."