Star potential

INNOVATION POLICY:From its number of high-tech start-ups to attracting venture capital, Israel is weathering the tough times better than most. But where does the country get its strength? asks MARK WEISSin Jerusalam

NOT TOO LONG AGO Israelis used to be in awe of the Celtic Tiger. But not any longer. While Ireland is struggling to pull itself out of the recession, the Israeli economy is forging ahead having established itself as the world’s start-up capital.

Israel has more high-tech start-ups per capita and, after the United States, more companies listed on Nasdaq than any other country – it had 63 in 2009, compared to Ireland’s five. Israel attracts five times as much venture capital investment per capita than Ireland and leads the world in civilian RD expenditure – 4.5 per cent of GDP between from 2000 to 2005, compared to Ireland’s 1.2 per cent.

Israel weathered the global recession remarkably well without requiring any state support for its banking system. The Tel Aviv stock exchange is at an all-time high, house prices continue to rise and interest rates are already on the up. Analysts at Barclays recently described Israel as “the strongest recovery story” in Europe, the Middle East and Africa. Economic growth this year is forecast at more than 3.5 per cent.

This month Israel was invited to join the Organisation for Economic Co-operation and Development (OECD). In a few months the country’s per capita GDP is likely to reach the €23,958 ($30,000) mark, and prime minister Benjamin Netanyahu has set the bar even higher: he wants Israel to become one of the 10 or 12 richest nations in the world.

The economic achievements come despite the fact that Israel is ostensibly a country with all the cards stacked against it.

A small country of just over 7 million people, Israel has spent much of its first 62 years fighting wars in a hostile region, whilst simultaneously absorbing millions of immigrants from all over the world. Natural resources were conspicuous by their absence in this oil-rich part of the world.

Contrary to some perceptions, US government aid has not been a key factor in its growth. It accounts for less than 2 per cent of Israel’s GDP and goes directly to the military to purchase US weapons. Where Israel is successful is in attracting venture capital (VC) investments. In 2008, Israel received 2.5 times more VC per capita than the US and 30 times more than Europe. Almost half the world’s top technology companies purchased Israeli start-ups or set up RD centres in Israel

In Start-Up Nation: The Story of Israel's Economic Miracle, Saul Singer and Dan Senor examined the secret behind Israel's economic success story. "It's hard to stay at the cutting edge of technology, but if you can do it you will always be in demand," Singer told Innovation. "This is what Israel has learned to do. This skill is especially useful in downturns because start-ups need relatively little capital and are not as affected by big drops in consumer demand. Indeed, it is well known that many of the most successful start-ups were launched during downturns."

Israel has no shortage of clever people and can boast a list of Nobel laureates significantly disproportionate to its small population. But this is only a small part of the story.

Israelis have managed to turn adversity into opportunity. Unable to trade with its hostile neighbours, they developed a culture of looking further afield for commercial opportunities. Bringing water to the desert was essential for Israel’s development and the country soon became the world leader in drip irrigation systems.

Back to its population, no other country has had to absorb as many new immigrants in such a short period of time. The central ethos of Zionism was the gathering of the exiles and 90 per cent of Jewish Israelis are immigrants or first or second-generation descendants of immigrants. What the country soon found out was new immigrants are risk-takers par excellence, with few inhibitions when it comes to seeking out business opportunities.

Shai Agassi, for example, is the founder of Better Place which next year plans to set up a national grid for electric cars in Israel. He is the son of an Iraqi immigrant.

The most significant recent influx of immigrants was from Russia and the other former Soviet republics. The one million “Russians” in Israel – 15 per cent of the population – arrived highly educated, in contrast to previous waves of newcomers, and a large proportion are scientists and engineers.

Highly-motivated and eager to make it in their new country, these immigrants have had a massive impact on Israel’s start-up success.

Another factor helping to explain why Israel is performing so well is the role of the military. Most Israelis serve a compulsory three-year stint in the army (two years for women), followed by three to four weeks annual reserve duty until they reach the age of 40. This forces many Israelis, particularly those in elite combat units, to take on responsibility unparalleled by their peers in other countries while still in their early 20s. Junior officers are taught to think for themselves, challenge existing norms and improvise – lessons they take with them into the workplace. Some who served in cutting-edge intelligence and technology units work on highly complicated projects and acquire skills that can be readily transferred to the technology start-ups in the civilian sector.

Singer argues that the military has been a critical element in Israel’s economic success but not in the way most people would guess, and while some of the impact has come from the commercialisation of military technologies, the bigger effect has been cultural. “Through military service, Israelis gain experience, skills and values that they can’t learn in academia or business; such as leadership, mission-orientation, improvisation, teamwork, maturity and sacrificing for something larger than yourself,” he says. “This training gives Israelis the drive and entrepreneurial attitudes – like willingness to take risks – that are critical to turning great ideas into successful start-ups.”

Added to all this is the uniquely Israeli element of “chutzpah”. This Yiddish word has no English equivalent but loosely translates as a mixture of gall, cheek and arrogance, and explains why many Israelis can appear rather rude to foreigners. Chutzpah manifests itself as assertiveness and a reluctance to accept traditional hierarchies, whether in the military or civilian sphere, and a constant questioning or arguing and a reluctance to take no for an answer. These traits go a long way to explaining the Israeli psyche and, critically, have been a driving force behind Israel’s start-up culture.

Singer concludes that the key to a start-up culture is not smart people, which all countries with strong educational systems have, but a culture that encourages those people to risk founding and working in start-ups, rather than automatically joining big companies.

But despite the country’s economic success story there are dark clouds on the horizon threatening Israel’s ability to sustain the current boom. Ongoing diplomatic deadlock in the Middle East peace process, combined with the possibility of Israel’s arch-enemy Iran acquiring a nuclear bomb, could prompt foreign investors, together with much of Israel’s high-tech community, to relocate to a more stable environment.

Israel also faces internal challenges, highlighted in a November 2009 OECD report, which noted that the benefits from economic growth are being distributed unequally. “On the one side there is the general Jewish population with poverty and employment rates similar to those of OECD countries. On the other, there are Arabs and ultra-Orthodox Jews, who have large families, poor education and low employment rates. As a result, just over half of Arab and ultra-Orthodox families live in poverty,” it was stated in the OECD report.

A recent study by Israel’s Taub Centre for Social Policy Studies found that approximately 19 per cent of Israelis aged 30-54 – predominantly from the ultra-Orthodox and Arab communities – are classified as non-employed (ie, unemployed and not looking for work). The report warned that Israel is facing a demographic time bomb. Based on current trends, by the year 2040, 78 per cent of Israeli children enrolling in primary schools will be from the country’s two most impoverished sectors, the ultra-Orthodox and Arab communities.

“We are talking about rates of non-employment that are simply unparalleled in the western world,” says Prof Dan Ben-David, executive director of the Taub Centre. “Sixty-five per cent of ultra-Orthodox men are non-employed and the rate has trebled over the last three decades. We are talking about a sector of the population that is getting much larger, very quickly. We are on a long-term trajectory that is simply unsustainable.”

But there is hope, according to Ben-David. The ultra-orthodox are a learned community. If they endorse science, maths, English and other subjects required by a modern society, Israel could reap the benefits with an unprecedented new leap forward. If not, Israel’s start-up revolution may be in jeopardy.