The Challenges Facing The Israeli High-Tech Industry: 2017

One of the main challenges for Israeli high-tech is the crisis in technology education. There are worrying signs that the crisis is already here: the steady decline in the number of high school graduates with a 5-unit matriculation in mathematics (prior the launch of the new Ministry of Education plan). These young men and women are the candidates for university studies in science and engineering. The current evaluation system in which high schools are measured according to the number of matriculation exams rather than their quality (which is a key factor in university acceptance) does provide incentive for high schools (and thus, students) to opt into advanced science studies (even though success in a high number of units in mathematics and science is a good indicator of academic success in engineering or science).

The full significance of a weakening of science curriculum can already be felt. Today, Israel suffers from a shortage of about 10,000 engineers. If in the past Israel's success relied in large part on its human capital, in just a few years we will be straddling a significant problem which may result in multi-national companies diverting their operations elsewhere. This would be an unthinkable crisis for Israel indeed.

The solution, however, is not simple—mainly because it is not in the hands of a single entity. Sadly, there is no quick fix. Israel needs a long-term, holistic process with the involvement of the State, the private sector and the third sector.

The plan for strengthening the study of mathematics is a step in the right direction, as is the adoption of the round table method, which brings together private entrepreneurs, relevant government ministries and the educational institutions. But mathematics is not enough; high school and matriculation studies are not enough. We have to think about the entirety of science and technology studies and come up with a plan for continuous education that starts in elementary school and continues through junior high and high school, military service and academic studies, and does not end with placement in technology companies.

Change in the Business Climate

Another point of concern is the growing international competition, particularly from Asia—China and India are breathing down our necks, and every self-respecting country in the world is investing considerable sums in R&D. In the current climate, the Israeli government must prioritize the creation of an economy and culture that will safeguard the place of innovation and entrepreneurship in it through legislative and financial action. The removal of the bureaucratic and regulatory barriers, incentivizing investments from within and without, and implementing a long-term plan that will reduce economic uncertainty of this sector and attract international bodies to expand their activity in Israel are just a few of the challenges facing the government.

A new government body, the Authority for Innovation, will shoulder many of these challenges in place of its predecessor, the Office of the Chief Scientist. The aim of the Authority will be to move at a pace akin to the pace of world markets—expediting processes and creating tools to support the high-tech sector with (less) red tape.

The first step is to create a supportive tax framework and reinstate programs that were used in the past to encourage institutional investment in high-tech. We should not lose sight of the vital importance of investment and the role of venture capital funds as the principal financers of the young technology companies, which in the past 20 years have been the primary growth engine of the technology industry in Israel.

The subject of investment in R&D is critical in this context, notably the poor contribution of the government on this front. Government investment in R&D has been in steady retreat and currently stands on 20%. Fortunately, the government's reduced investment in R&D has been offset by increasing investments from the business sector and the multinationals. Today, less than 5% of the government investment in R&D is invested in the business sector, a relatively low number when compared to other western countries.

Helping Mature Companies Grow

Over the past twenty-five years, hundreds and thousands of high-tech companies have opened their doors, but only about 50 have been valued at upwards of one billion dollars. Of these, at least fourteen broke that barrier in the past two years. Without entering into a discussion of the merits of selling these companies at the technology stage or trying to grow them into prominent leaders in their field (the authors of this report believe that both options are essential to the continued success of the industry), the companies that are bought out at relatively early stages will continue to draw international companies to Israeli industry. One of the high-tech industry's challenges for the next 25 years will be to produce 50 local companies valued at one billions dollars. Currently, the numbers of companies that answer that definition number no more than ten.

The Expansion of Institutional Investment

Financing is crucial to continued development, and the numbers give us cause for concern. More than 90% of investments in Israeli venture capital funds come from foreign investors. As it stands, the primary beneficiaries of the Israeli high-tech and life sciences industry are American pension funds rather than the Israeli public. On this note, Israel could take a page from the U.S. and other developed countries by shifting its focus to institutional investors and Israeli funds.

Diverting just 1% of institution investor funds, estimated at some 1.2 billion shekels, to investments in Israeli high-tech would enable the technology sector to take off once again. Obviously, such investment is not without its risks, but it certainly constitutes a smarter choice than the Eastern Europe real estate market (which is fast becoming a common destination for Israelis' investment dollars).

Wanted: A National Revaluation

The importance of the Israeli high-tech industry to the national economy cannot be overstated. This sector is not solely measured in terms of the number of people of people it employs both directly and indirectly, but also by its contribution to export the injection of foreign currency, Israeli leadership in global markets, attracting investors and investments, and strengthening the "Israeli brand" as a technological super-power ("Startup Nation").

The data present a mixed picture—even though Israel continues to exhibit overall strength, when we look to deeper at the state of exits and capital, a certain weakness becomes apparent.

Responsible government policy should provide an answer to these challenges. Nationally, this is the government's role—to support, push and invest in an industry that will find itself on the brink of crisis without sufficient planning and forethought.

What Should The Government Do? 

For the high-tech industry to continue to play a leading role in the Israeli economy, maintain the Israeli edge in global markets and ensure the best use of the country's existing intellectual assets, the government must formulate comprehensive national plan for the development of the technology sector based on the following principal elements:

• Fostering the human capital along the entire chain of production – the higher education system, the link between the academic world and industry, and the connection of all these to the military technology development system.
• Implementing regulatory and tax support of other platforms to raise capital for entrepreneurs and do away with crowd-funding over the Internet.
• Creating an additional safety net that includes tax breaks and benefits for investors, and channeling a portion of institutional investments to high-tech.
• Offering incentives to multinational corporations to set up their R&D centers in Israel.
• Decentralizing export to markets beyond the U.S.
• Providing aid for entrepreneurs, early-stage startups, and research institutes.
• Encouraging the development of generic technologies and the transfer of know-how from academia to industry.
• Allocating additional budget to research and development.
• Encouraging traditional industry to adopt new technologies that will give them added value in international markets.

To conclude, it seems that the circumstances that led to the success of Israel's high-tech industry are changing, and if we are to avoid getting left behind, the system needs to undergo far-reaching changes. As described in this report, part of the foundation on which the technology sector rests are still strong—a superior entrepreneurial ability, excellent academia, relatively high national investment in R&D, a national innovative penchant, and the ability to acclimate to the changing conditions of a competitive and dynamic global market. However, other factors that paved the way to Israeli success are eroding, particularly against a backdrop of accelerated competition from Asian countries, and creating a dangerous gap. These are critical times when the fate of the industry hangs in the balance. We must not only safeguard the achievement of the technology industry but also take the next steps to ensure our continued legacy.

The government must forge a clear path forward with a vision that places Israel's scientific-technological development at the top of the national agenda and draws on ample budgetary support, regulatory reform, and high-level inter-ministry cooperation.

As the backbone of the economy for three decades running, the Israeli high-tech industry has certainly proven that it deserves to be taken seriously by policymakers. We can but hope that the Prime Minister, who also currently serves as the Minister for Economics and Industry and the Minister of Finance, will have the wisdom to breathe renewed energy into this vital sector of the Israeli economy before it is too late.