Technological Innovation as Israel’s Primary Engine of Growth

Technological innovation is the lifeblood of the Israeli high-tech industry, which is currently the country’s leading industry. In effect, technological innovation has become the Israeli economy’s primary engine of growth, as indicated by the country’s macroeconomic performance and by its position on the world stage.

There is a close cause and effect relationship between a country’s development of technological innovation and its economic performance. However, innovation is not created ex nihilo. Innovation is made possible by a country’s investment in R&D infrastructure, the cultivation of personal capital, the promotion of the financial system and of venture capital, and a long list of additional parameters. This investment yields welcome results, and consequently, countries that invest in the development of innovation enjoy growth and profitability that are not typical of countries that still operate on the old economy of raw materials and traditional industry.

This can clearly be seen in global intellectual property data, where there is an explicit correlation between a country’s economic growth and a spike in its registered patents, and vice versa (as will be demonstrated in the upcoming chapters). In this respect, intellectual property data serves as a mirror image projecting economic performance in various countries.

Moreover, innovation is the lifeblood of the high-tech industry. It is the element that makes investing in technological developments worthwhile, while it streamlines existing industries. Disruptive innovation is its most interesting form. Not only does it change the existing industry; it seizes it, dusts it off, and revolutionizes it. This is what Uber did to the taxi and transportation industry, as Airbnb did to the hotel industry, and as WeWork did to workspaces.

Disruptive technology of the high-tech and startup industry will extend to an increasing number of disciplines in the upcoming years, from insurance and banking, which are at the cusp of a revolution, to industries that we have not even thought of yet. The main obstacle impeding this innovation is not combative entrepreneurs; rather, in many instances, it is investors who lack the vision and the courage to go all-out with the entrepreneur.

And in Israel?

In Israel, these characteristics are particularly significant due to the Israeli economy’s explicitly technological orientation, and due to it being an export-driven economy, with half of its exports comprised of technological services and products.

In Israel, maybe more than anywhere in the world excluding China, there is a clear, definitive, direct correlation between economic growth and technological innovation, as we will discuss later in our report. In effect, it is technological innovation that has thrusted Israel from being a second world country to becoming a first world country, establishing and cementing its status as a world leader. It is also the factor that has raised Israel’s GDP per capita to roughly 40 thousand dollars, surpassing that of France and Italy, and approaching that of Britain and Germany – all unequivocal industry superpowers.

Three decades of dramatic improvement in economic performance

According to the OECD report from 2017, Israel has been showcasing impressive economic data for 15 years in a row. Almost no other country out of the 33 OECD member countries has demonstrated such impressive growth over this number of consecutive years. While the report criticizes the underdeveloped state of public transportation and infrastructure for roads and trains alongside a plethora of social issues (such as poverty measured at higher than acceptable rates, and the low level of education of some Israelis), it underlines that Israel’s economic data is very positive: high growth, low inflation, the lowest unemployment rate among member countries, high-tech at its best, reforms enacted by governments in recent years have significantly advanced the country, and Israeli citizens are content with their lives. Indeed, over the past three decades, Israel has been undergoing an unprecedented economic transformation both in scope and in substance. The core of this transformation has been changing from a closed, centralized economy with a large public sector and a heavy tax burden, into an open, competitive market economy attracting foreign investments, and successfully integrating globalization processes of financial markets. Concurrently, it has transformed the construct of its economy, redirecting its center of gravity from an economy of industrial manufacturing, with an abundance of working hands, to a knowledge-based economy based on the development of technological innovation. This has led to the creation of a flourishing high-tech industry, especially in life sciences, communications, software, internet, and cyber.

The combination of tireless entrepreneurship, groundbreaking invention capabilities, impressive fundraising abilities, and a fierce drive for success, has appealed to many multinational companies that have established over 300 international development centers in Israel, which play a crucial role in innovation development.

Indeed, in a series of indicative economic indices and important business parameters, Israel has dramatically improved its performance over the course of the three decades between 1984 and 2014. For example, Israel’s population grew by 100% in this time period (from 4.1 million to 8.2 million), its GDP grew by 920%, its GDP per capita grew by 414%, its foreign-exchange reserves grew by 2,866%, while it has also been able to shrink its government debt (as a percentage of its GDP) by 76%. The government deficit, as a percentage of its GDP, also declined in this period: from 17% in 1984 to 3% in 2014. Security expenses, as a percentage of its GDP, also dropped by 75%, the government deficit dropped by 82%, the tax burden dropped by 30%, and US aid (as a percentage of its GDP) dropped by 90%. These are unprecedented accomplishments in comparison to other Western countries and to fellow OECD member countries.

This depiction is also applicable to a series of other economic parameters. The weight of the government sector on the overall economy has declined in these past three decades by 42% (from 75% in 1984 to 43% in 2014), inflation has declined from 450% to 1% (a 99% drop), annual bank interest rates have also dropped by 99% (from 770% to 5%), and government control of the capital market has dropped by 68%. These all result from the 1985 Economic Stabilization Plan that put Israel on the right track for growth, low inflation, and a shrinking deficit.

The surge in Israel’s GDP since the beginning of the century has been nothing less than remarkable – from 500 billion shekels to over one trillion shekels. Incidentally, in 2000, the Bank of Israel forecast that by 2015, Israel would only reach a GDP of 750 billion shekels. This impressive growth can be explained, at least in part, by the accomplishments and output of the tech industry, which has yielded a long series of momentous exits and a stream of foreign investments for Israel’s economy.

Moreover, total exports have increased in the past three decades by 860%, with the export of high-tech growing at a remarkable rate of 3,700%. In this period, Israel was even able to develop independent energy sources valued at 38% of its energy basket (in contrast with 0% in 1984), thus moving towards energy independence. Israel has demonstrated impressive achievements in the water industry as well, with water derived from desalination of seawater reaching about 41% of Israel’s total water sources over the course of three decades.

In several social and research parameters, which are affiliated with tech development, Israel has reached considerable achievements as well. For example, the number of students enrolled in universities and colleges has increased by 378% in the past three decades, and the national expenditure on R&D, as a percentage of its GDP, has increased by 223%.

In light of this, in 2015, the British magazine Economist disclosed that “Since joining the OECD in 2010, Israel has outperformed the rest of the rich-country club on many measures.” Legendary investor Warren Buffett declared that “Israel has an extraordinary amount of sharp minds and energy.” These statements correlate with important data demonstrating that Israel ranks 19th place in the world in the UN’s HDI (Human Development Index), ahead of countries like Belgium, Austria, France and Finland. This index is an adjusted calculation of life expectancy, education level, and income level, and it is a standard means for evaluating welfare. A 2015 analysis of financial data indicates that over the course of five years, Israel’s rate of growth reached an accumulative 21%, the second highest of all 34 OECD member countries. In effect, Israel emerged from the 2008 financial crisis in better shape than any other OECD member country in terms of all important parameters: debt-to-GDP ratio, budget deficit, balance of payments deficit, GDP growth, as well as other parameters.

Furthermore, the flexibility of Israeli exports, which are comprised of thousands of companies that primarily specialize in niche fields, and both branch and inter-branch diversification, allow the economy to better cope with global deceleration. Israel’s trade-to-GDP ratio is among the highest in the Western world (over 30% of its GDP), and is not based on commodity exports, which can be risky in times of crisis. Israeli high-tech and entrepreneurship are heading this phenomenon.

The positive trend continues

The positive data on the Israeli economy continued over the course of 2015-2017 as well with impressive growth, historically low unemployment, and higher wages.

Data on 2015 showed a 2.6% growth in GDP, with per-capita income growth of only 0.5%. Data on 2016 indicated an almost fourfold increase, demonstrating another encouraging improvement in all indices on the Israeli economy – strong growth, higher wages, more investments, a drop in the debt-to-GDP ratio, alongside a reinforcement of the robust high-tech sector, historically low unemployment, and a continual drop in poverty rates. Economic growth (GDP) for 2016 was roughly 4%, and per-capita GDP grew by approximately 1.9%. These data are some of the highest among all OECD member countries.

In 2017, the growth rate of the Israeli economy was 3%, but this is lower than 2016, when the growth rate was 4%. Israel’s population grew by 1.9% in 2017, so that the GDP per capita grew by 1% following an increase of 1.9% in 2016. Likewise, in 2017, the GDP per capita was 40.1 thousand dollars in current prices (144.5 thousand shekels). An additional improvement could be seen in indices examining social issues. Israel’s inequality index, for example, (the Gini coefficient for measuring income inequality) showed a continual decline over the course of these years, reaching the same rate in 2017 that had been recorded twenty years ago.

Alongside optimistic data, the familiar maladies of the Israeli economy continued to present themselves in 2015-2017. The main problem exhibited was productivity. In 2016, productivity per worker grew at a relatively disappointing rate of 0.4% in comparison to 2015. This rate could not allow Israel to catch up to stronger OECD member countries. Productivity is low due to import barriers, competition, bureaucracy in the economy, as well as relatively low capital per worker. Furthermore, the population is aging. These are the factors that will ultimately determine Israel’s ability to catch up to Western countries. The good news is that there is a demonstrable positive trend in all these aspects; however, there is still a great deal of work ahead in order to narrow the gap.

Israel on the world stage – The race to innovation

In order to learn about Israel’s competitive status on the world stage, it is important to examine several relevant global indices. One well-known index is the GCI (Global Competitiveness Index) by the WEF (World Economic Forum). The report released by the forum measures the competitiveness of 137 countries. Economic capabilities and policies, which determine productivity, are assessed. Over the course of most of the past decade, Israel has been ‘stuck’ in the middle of the table of developed countries, ranking closer to 30th place than to 20th place on the GCI. However, in the past two years (2015-2017), Israel’s ranking in the index spiked by 11 places, from 27th place in 2015 to 16th place in the most recent report from 2017. This was the first time that Israel was ranked in the top twenty of the GCI, making it the first new country to break through to be counted among the twenty leading economies in the world.

In addition, the report indicates that Israel has managed to maintain its position in the top three in the innovation ranking. According to the report, “The startup nation is famous due to the remarkable number of inventions and innovations it has developed since the establishment of the state, despite all the challenges it faces.”

Moreover, 2017 was the first year that Israel made it into the top twenty countries in human capital quality, according to the human capital report published annually by the WEF. One key factor in Israel’s high ranking is its ability to reap economic value in the workplace from personnel’s knowledge. Israel was ranked 18th out of 130 countries – demonstrating a leap of 11 places within two years, from 29th place in 2015 and 23rd place in 2016. These findings position human capital quality in Israel ahead of human capital quality in England, France, Ireland, Australia, Luxembourg, and Italy.

Israel’s high ranking is also the result of its extraordinary leap in the TRI (Technology Readiness Index), a GCI index comprised of several subindices. Israel has a high ranking in financial market development, technology readiness, and innovation. It also demonstrated an improvement in fields where it had previously shown weakness: institutional quality, which showed an improvement over the past two years, and goods market efficiency. However, according to the report, the two factors that are hindering growth in Israel’s economy are government bureaucracy and high tax rates. As a result, Israel ranks very low in these fields. Israel’s ranking in government bureaucracy dropped to 21.6 from last year’s ranking of 18.6. In this context, the World Bank’s publication analyzes ease of doing business in roughly 190 countries, with Israel ranked at an unflattering 54th place.

Technological innovation and global breakthrough

All of these indices have had a substantial impact on the composition of the high-tech industry, while correspondingly reflecting it.

If we are to point to one representative detail, in 2015, Israel had 86 companies trading on the NASDAQ, making it the third country in the world in terms of the quantity of its publicly traded companies, trailing the US and China. Also, over 300 leading multinational, leading companies have chosen Israel as their destination of choice for establishing their R&D centers. In 2015, The Wall Street Journal, one of the most prominent financial newspapers in the world, stated that Tel Aviv-Yafo ranks 3rd out of the 12 most important cities worldwide in the field of high-tech, after Austin and San Francisco, and ahead of New York, Stockholm, London, Singapore, and others. The newspaper also claimed that Israel has the second most educated population in the world, after Canada and ahead of Japan. Brandeis University rated another Israeli city, Be’er Sheva, which in recent years has become a focal point for multinational tech companies, primarily cyber companies, as one of seven up-and-coming high-tech cities.

All of this led the accounting and consulting firm Deloitte, one of the four largest accounting firms in the world, to announce that it ranks Israel as the 4th top destination in the world for attracting foreign investors.

Furthermore, Israel is ranked 5th in the world in the amount of its patents per capita. It is a world leader in its relative number of R&D personnel: 140 per 10,000, with the US coming in at 2nd place with 85 per 10,000. Israel also produces more science-related jobs per capita than any other country in the world. It is one of the mere eight countries in the world that can launch satellites into space.

Strong tech infrastructure, with gaps in infrastructure and education

According to data released by the IMD Research Institute, which analyzes the economies of 63 countries across the globe, Israel is a leader in all critical parameters important for building and running a tech industry that develops innovation: technological and scientific infrastructure, a sophisticated capital market, flexibility, an attitude that lends itself to globalization, developed venture capital, a skilled workforce, a daring business sector, and extensive scientific research.

In this report, which has been in publication for over 25 years, the significant scale that runs as a common thread throughout the report, is the manner in which countries nurture their competitive skills on their path towards sustainable growth. The competitiveness expressed by these countries today is perhaps one of the most critical factors in an era of global competition for foreign investments.

The macroeconomic factors examined in the report are: government effectiveness, the effectiveness of business operations, infrastructure, and economic performance. According to recent IMD reports, Israel has bolstered its general competitive edge over the years. In 2015-2016, it ranked 21st place (in contrast with 24th place in 2014), and in 2017, it ranked 22nd place out of the 63 countries included in the research; in other words, among the top three participating countries. However, this information is general. The weaknesses and strengths of the Israeli economy should be viewed through the lens of more specific indices, which the report measures, analyzes, and details. When comparing Israel to European countries, the Middle East, and Africa using the same index, Israel ranks 14th out of 40 countries. When compared to countries with populations under 20 million, Israel ranks 15th out of 34 countries – a solid middle position.

Israel’s strengths can be seen in parameters such as: technological infrastructure (ranking 4th in the world, a significant improvement after ranking 12th place in 2014), scientific infrastructure, investment incentives (especially in high-tech), raising capital for venture capital funds, entrepreneurship, R&D expenditure in relation to GDP, technological innovation, technological collaboration, scientific research, collaboration between academia and industry, as well as other parameters. In all of these fields, Israel is ranked among the top four countries in the world. In 2017, the institute also began to publish an index examining the extent of these countries’ competitiveness in the field of digital. The index includes three elements: know-how (knowledge essential for discovering, understanding, and building digital technology), technology (a comprehensive infrastructure that facilitates the development of digital technologies), and future preparedness (for making use of the digital transformation).

While Israel is ranked in 7th place in the field of science and 11th in the field of future preparedness, it only ranks 27th among the participating countries in the field of technology.

According to this index, Israel ranks 13th place out of the 63 countries included in the index. It comes in at 9th place out of the 34 countries whose population is below 20 million. When compared to countries whose GDP per capita is over 20 thousand dollars per capita, Israel ranks 13th out of 31 countries. According to this index, in the geographical region of Europe-Middle East-Africa, Israel ranks 8th place out of 40 countries. 

A discrepancy between technological capability and physical infrastructure

Nonetheless, according to the report, there is a substantial gap between Israel’s scientific, technological, and research capabilities, which position it at the top of the table, and capabilities in other disciplines, such as physical infrastructure, productivity, and cost of living, where Israel is situated towards the bottom of the table. In terms of physical infrastructure, for example, Israel comes in at 44th place, in the very bottom section of the table. Educational and health infrastructure receive moderate marks, 28th and 24th place respectively, but Israel comes in at 46th place when it comes to cost of living.

These gaps are evident in other fields as well. In terms of its economy, for example, Israel was graded quite favorably for its economic performance, with its domestic economy receiving relatively high marks (21st place in contrast with 33rd place in 2016!), scope of employment (28th place), and foreign investments (28th place). However, it received relatively low marks in fields such as international trade (38th). In terms of its overall economic performance, Israel demonstrated impressive growth, coming in at 21st place in contrast with 31st place last year.

When it comes to the effectiveness of its government sector, Israel received mediocre marks. A particularly negative segment in this context is public funding, where Israel received a low grade of 31st place. The effectiveness of its business sector received higher marks, excluding the issue of work productivity. A positive point in the report underlines the practical and value-based approach of Israel’s business sector towards its competition, where it received very high marks in the global competitiveness index (9th place). Nonetheless, there is a discrepancy between Israel’s tendency for competition in the government sector and its tendency characterized by its business sector, with a preference for the latter.

According to the report, the fields in which Israel showed an improvement in contrast with previous reports were an increase in GDP and in GDP per capita, student mobility, internet speed, and high-tech exports.

The annual report concludes that Israel’s key challenges today are alleviating the bureaucratic burden placed on the business sector, increasing the export of goods and services, decreasing the reach of the public sector, increasing investments in education and infrastructure in the periphery, and building a long-term strategy to change the economic and political landscape in order to adapt it to the global arena.

Narrowing gaps both within Israel and with the rest of the world

The simple conclusion that can be deduced from the data is that Israel cannot rest on its technological laurels, and that it must narrow gaps. It should start with the domestic gaps between the center and the periphery. Next, it should narrow the gaps between excelling in tech fields and grappling with its sluggish infrastructure and social issues, as well as gaps between the business sector’s capabilities and the government sector’s capabilities.

Furthermore, Israel should – or more accurately, must – narrow its gaps with the rest of the world, mostly in terms of attracting foreign investments, its business climate, and its productivity.

Nevertheless, it is important to remember that technological innovation in Israel is not a transient thing. As stated by Pro. Avi Simchon, head of the National Economic Council, the high-tech revolution does not exist in a bubble, and it is not a passing phase. He believes that the high-tech revolution is here to stay, and that it has made Israel’s economy particularly stable and robust. One explanation for this is the connection between Israel’s military R&D system and its varied technological knowledge.

In conclusion, it is no surprise that at the end of the day, Israelis are happy. The happiness index survey found that Israelis are happier than their counterparts in most of the Western world, ranking 6th place among OECD member countries, and 11th place out of the 156 countries across the globe that were included in the index.