IsraelFactors in the Emergence of an ICT Powerhouse

Soumitra Dutta

Augusto Lopez-Claros

Irene Mia

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Israel: Factors in the Emergenceof an ICT PowerhouseAUGUSTO LOPEZ-CLAROS, World Economic Forum

IRENE MIA, World Economic Forum

Introduction1

It has been the Israeli government’s explicit goal to positiontheir country at the center of the knowledge economy,but the process has been neither fully planned nor completely organic.There has been close collaborationbetween government and business, with governmentinvolvement focused and limited, ready to withdraw assoon as the private sector was able to continue on its own.

This case study highlights the important role of thegovernment in the emergence of Israel as a high-techpower, encouraging and supporting the capacity of theprivate sector to compete in international markets.Significant components of government action have takenthe form of a) heavy investment in education, reinforcedby large-scale immigration to provide the necessaryhuman capital, b) effective investment incentives favoringforeign investors to build industrial momentum, c) invest-ment in R&D in a proportion of GDP (4.6 percent)higher than that of any other industrialized country, andd) incubator and venture capital programs to convertresearch into cutting edge businesses.

Alongside these helpful interventions, providing abackdrop for the development of information and com-munication technologies, Israel has also made importantstrides in laying the foundation for macroeconomic stabil-ity. Not only has inflation fallen sharply from the runawaylevels seen in the mid 1980s, but wide-ranging reformshave been put in place aimed at reducing the scale of thepublic sector and the role of the state in the allocation ofresources, and, more generally, at supporting the modern-ization of the economy.

This paper will outline the role of the Israeli govern-ment in supporting ICT development, and the influenceof education, culture, immigration, and security issues onIsrael’s achievements.This is followed by a detailed discus-sion of the role of government in investment and R&D,and the relationship between the ICT sector and Israel’soverall economy.

The role of governmentRecent Israeli economic history is an excellent showcaseof the key contribution efficient government interventioncan make to the overall innovation potential and ICTreadiness of a nation. In this respect, there is broad agree-ment on the major role played by the Israeli governmentin the emergence and development of today’s vibrant high-tech sector. Indeed public policies have been instrumentalin fostering and complementing private sector initiatives,by laying the basis for an environment conducive to inno-vation, by means of both an appropriate regulatory frame-work, as well as infrastructure and ancillary services, suchas education and financing. Furthermore, the government

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has been at the forefront of ICT readiness, adoption, anduse.This is evident in the remarkably high positions Israeloccupies in the 2005–2006 Networked Readiness Index(NRI) for variables capturing government readiness anduse, such as government procurement of ICT (5th), gov-ernment R&D subsidies (7th), government ICT vision(19th), success in ICT promotion (17th), ICT productivity(19th), and the pervasiveness of ICT use (16th). Figure 1gives a more general overview of the many government-related variables comprising the NRI, as well as of therespective rankings for Israel in 2005–2006.

Government intervention has been remarkable for themarket-friendly spirit in which it has been conductedfrom the outset. Until very recently,2 the guiding principlehas been neutrality toward the private sector, with thefocus placed on remedying the market failures intrinsic inthe generation of optimal levels of investment in innova-tion,3 rather than on “winner-picking” practices.The caseof the Incubator Program, analyzed in detail later, is anexcellent illustration of such an approach, since it has pro-vided, and still provides, financing and support to venturesin the early, pre-seed, stage, when the funding gap couldprevent many of them from moving from the idea phaseto projects attractive to private investors (see Figure 2).

The market-friendly nature of government interven-tion in Israel has resulted in considerable flexibility anddynamism, permitting specific policies and instruments toevolve over the years, and adapt to what were perceived as

the most pressing needs of the time.An example is the arrayof programs put in place by the government to encourageR&D at different points over the past two decades.

It was also market considerations which led Israelipolicymakers to concentrate on innovation and R&D.Thegovernment realized very soon that Israeli comparativeadvantage resided in its qualified human capital rather than in its relatively scarce natural resources and land.Thenational market was too limited to sustain national indus-tries and the political situation precluded selling to neigh-bouring countries.Thus, the target inevitably had to beinternational, requiring a focus on innovative productswhich could be sold on international markets.These unfavorable structural parameters—market size and theadverse political geography—served as catalysts to spur thedevelopment of an industry which ultimately would notdepend for its success on these two factors.Thus, Israelmay well be an illustration, in reverse, of the “naturalresource curse,” a concept popularized by Sachs andWarner (1995). Unable to tap into a plentiful extractablecommodity, Israel has been forced to trade globally on itshuman capital endowment.

EducationAs a small country with limited natural resources, the gov-ernment has long recognized the importance of investingin human capital for its development. Building on a strong

Figure 1: Government role in networked readiness in Israel

Source: World Economic Forum, 2006.

Government ReadinessRank/115

Government prioritization of ICT ..............34Government procurement of ICT ...............5Government ICT vision...............................19Government R&D subsidies ........................7E-Participation Index..................................30Web-Readiness Index................................20

Government UsageRank/115

Success in ICT promotion .........................17Availability of online services...................34ICT productivity ...........................................19ICT pervasiveness ......................................16

Policy and Regulatory EnvironmentRank/115

Tertiary education.......................................25Administrative burden................................38Tax burden....................................................74Speed of new business registration ......46Ease of new business registration ..........10Effectiveness of law making.....................28Laws relating to ICT ...................................23Independence of judiciary ........................14Intellectual property protection ...............21Legal framework to settle disputes .........23Property rights laws ...................................26

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cultural heritage stressing excellence in education, univer-sities began to be established in the 1920s.With thefounding of the state of Israel in 1948, the governmentfocused its attention and resources on the development ofa first class educational and scientific research establishment.By the early 1970s, there were half a dozen university-level centers of teaching and research: the Technion inHaifa, the Weizman Institute in Rehovot, HebrewUniversity in Jerusalem, Ben Gurion University in BeerSheba, and the Universities of Haifa and Tel Aviv.

While traditional universities have not changed great-ly, with about 30 percent of students receiving degrees insciences and engineering, the growing demand for highereducation over the last 30 years has been met by liberaliz-ing higher education to allow private colleges, foreigncompetition, and by recognizing degrees granted by technical schools accredited by the Ministry of Education.Between 1980 and 2000, the percentage of the populationwith at least 13 years of education rose from 21 to 41 percent for Jewish citizens, and from 7 to 21 percent fornon-Jewish citizens. By 2000, degrees from non-traditionalcolleges responding to market demand for business andtechnical training represented 32 percent of the total(Khavul, 2005).This process provided the trained managersand workers needed by a rapidly expanding industry.Furthermore, attempts have been made from time to timeto reprioritize various professional streams within Israel’ssystem of higher education. For instance, in the early

1990s, industry leaders saw the need to retrain many ofthe graduates from the top universities in electronics andcomputer science.Task forces were created and a majorboost was given by the universities to these particularareas. In other words, there have been fairly successfulattempts to shift the priorities of career workstreams with-in the public university system to reflect the most pressingneeds of industry, particularly the high-tech sector, becauseof its perceived growth potential.

The informality of much human interaction, coupledwith the educational and cultural emphasis on initiativeand risk-taking, may also have contributed to a moreentrepreneurial culture.As with other world technologycenters, the symbiosis between top research universitiesand dynamic industries has been so significant that Israel,despite its small size, has been ranked by the GlobalCreativity Index—a measure of technology, talent, and tol-erance—as the 14th most creative country in the world.4

One unique feature of the educational process inIsrael is the significant catalytic role played by the military.With compulsory military service for both sexes, the mili-tary can select and train the brightest young people inelite computing units, giving engineers considerableresponsibility for project management at a young age.While Israel has not explicitly sought to commercializemilitary information technologies directly, the skills devel-oped in young programmers have produced innovativenetworks when they return to civilian life, creating strong

Company’s phase

Financing

Public marketsand own sales

VC funds

Idea

Investment Gap

R&D Initial sales Large sales

Figure 2: The investment gap: The role of the Incubators

Source: LabOne, 2005.

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links between research teams in the military and in indus-try. In addition, the Computer and Data CommunicationsNetwork Center of the army continues to train softwaredevelopers when they return to the unit for reserve dutyevery year, while these experienced reservists teach theirskills to new conscripts and other reservists. Nevertheless,there are not that many examples of innovations in themilitary with clearly successful commercial applications—firewall development by Check Point being the mostnotable exception. Perhaps because of this, the majority ofIsraeli high-tech companies see themselves as innovatingfor the global market.The research capabilities of theIsraeli Defence Forces have been boosted by the existenceof rolling five-year budgets which facilitate product development and encourage them to take on substantialprojects with a high-technological component.

ImmigrationImmigration, welcomed and supported by the government,has always been a central feature of the development ofthe State of Israel, as Jews from many countries returnedto their historic homeland, bringing diverse talents andcapacities, combined with the motivation and creativity ofa pioneering movement.The fortuitous coincidence of thecollapse of the Soviet Union, combined with the explo-sion of information and communications technologies inthe late 1980s gave the Israeli ICT industry a major boost.

As shown in Figure 3, almost one million refugees fromEastern Europe arrived in Israel in the decade between1989 and 1999, many with advanced degrees, technicaltraining, and often bringing with them ambition, innova-tive approaches to problem solving, and a strong scholastictradition.This increased the population by a fifth and reinforced its general educational level.

These immigrants included more than 100,000 scien-tists and engineers, giving Israel by far the highest numberof engineers per capita in the world—140 per 10,000employees, more than twice the level of the United Statesand Japan, the second and third ranking countries in thelist.5 This massive influx of manpower ensured the devel-opment of the ICT industry until near the end of thatcrucial decade. However, it did create a major challenge toabsorb so many people, and the government set upretraining and business development programs to facilitatethe process.With the rapid expansion of the industry,skilled immigrants were quickly integrated.This expansionalso attracted highly trained and experienced Israeli engi-neers, many of whom had previously emigrated to the US and Europe, but who now saw the opportunity to setup research centers for their foreign employers or startupsof their own in Israel.There are clear parallels in this areabetween the experiences of Israel and Taiwan, as notedelsewhere in this Report.

0

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400

600

800

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Figure 3: Immigration to Israel, 1990–2004 (cumulated yearly values, thousands)

Source: Central Bureau of Statistics, 2005.

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

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Box 1: Peace dividend

The hoped-for peace process with Syria and thePalestinians, intended to establish credible and lastingsecurity arrangements with these neighbors, wouldlikely have a positive influence on Israel’s long-termeconomic outlook and its ability to sustain high growthrates. The following might be considered some of themost obvious benefits of peace in the Middle East:

• The scope it would provide for a medium-termrestructuring of budgetary expenditures, diminishingover time the burden of defense and the mainte-nance of the associated military establishment.Annual defense expenditures have amounted tosome 9–10 percent of GDP in recent years (downfrom 25 percent of GDP in the early 1980s), com-pared to 2.5 percent in the EU and some 3 percentin the United States. Peace would permit furtherspending cuts over the next several years, releasingresources which could be allocated in other ways,particularly in the area of infrastructure, where Israelsuffers from a number of shortcomings, in compari-son with EU members with similar levels of per capi-ta income.

• The coming on stream of a number of potentiallylarge infrastructure projects (water works, electricitygeneration, and railroads) in the border areas withSyria and Lebanon could have potentially lasting effectson investment demand. Beyond this, peace wouldalso be expected to boost intra-regional trade in theMiddle East and cross-border direct investment.

• The further expansion of the vast potential of thetourism sector, where activity has tended to closelyreflect the underlying security situation, as illustratedby the large losses in the sector as a result of terror-ist attacks and the second intifada. Israel receivedsome 2 million tourists in 2005, a 26 percent riseover the previous year, but still small when comparedto 65 million in Spain and 15 million in Portugal.Making generous allowances for population size andother factors of scale, and with appropriate invest-ments and upgrading in the facilities supporting thesector, there is no reason why the numbers of touristscould not double within a few years, with beneficialeffects on growth and the balance of payments.

• With its highly educated labor force, its close tradelinks with the EU and the United States and theremarkable expansion of high-tech industries seen inrecent years, Israel is singularly well positioned tobecome a leading center for a broad range of multi-national corporations, intent on expanding their activ-ities in a post-peace settlement environment.

• Last but not least, peace with Israel’s neighborswould be a permanent boost to the confidence offoreign investors, as economic agents would be ableto view decision making in a medium- to long-termperspective, characterized by less uncertainty aboutthe political environment and greater faith in the sta-bility of the country’s policies and institutions.

CultureIn a globalizing world, international networking becomesa key competitive advantage. For over a century, Israel has benefited from the influx of Jews from the diaspora,characterized by well-established social networks, a strongsense of social responsibility, and the drive to establishthemselves and succeed in their new homeland. Morerecently, this trend has been reinforced by the immigrationof significant elements of the diaspora into Israel, bringingskills and connections to international industries and networks.

For centuries, in the vast majority of European coun-tries, Jews were systematically denied the opportunity toenjoy secular education, to enter the professions, or toown land.This, no doubt, contributed to their ability to remain self sufficient even in extremely inhospitableconditions.Their new-found freedom in Israel, coupledwith the long tradition of frank and forceful Biblical argu-mentation—one of the most highly valued “occupations”open to Jews in the past—has given rise to a remarkably

egalitarian culture of openness, risk-taking and individual-ism, which places a high value on one’s capacity to speakout, think freely, and constantly question. Unlike Asiancountries,6 where attempts to foster innovation are some-times constrained by rigid, hierarchical structures whichplace a premium on obedience, rather than on challengingauthority, human interactions in Israel are much morerelaxed (Harel, 2005). Indeed, senior managers in topIsraeli companies in the high-tech sector will often referto their strong preference for original thinkers, who willnot hesitate to tell their bosses how wrong they are, andwhy a particular alternative approach will be better.Conformity with and awe of one’s supervisors is neitherencouraged, nor in keeping with the culture of independentthinking and active intellectual dissent.

Another interesting feature of the Israeli high-techscene is the acceptance of risk-taking.There is a relativelylarge number of serial entrepreneurs, people who start upnew high-technology ventures, develop them, take themto the market, and then sell them, before starting the same

cycle again with a fresh idea. Others have failed in theearly stages but, driven by a philosophy that “failure is notdisgraceful if you fail honestly,” have started over again,sometimes more than once.

It is worth asking if there may be a cultural dimen-sion to the difficulty Israeli companies have in command-ing a world presence in terms of market capitalization.Possibly, the atmosphere of a small, innovative or congenialcommunity, in which human relationships and independ-ent thinking are important, may outweigh the advantagesof large-scale institutionalization.At the same time, it maywell be that the emphasis on individual initiative andimprovisation makes management less of a strength.Asimportant as the subject may be, it is outside the scope ofthis study to explore in greater detail the role of culture inthe development of a spirit of entrepreneurship and tech-nological innovation.

Investment incentives and capital market reformsOne major area of government intervention has been inthe policies and measures encouraging domestic and for-eign capital investment in Israel.The investment incentivepackage had its origins in the Law for the Encouragement ofCapital Investment (LECI), adopted in 1959 to attract pri-vate investment—especially in the most remote and leastdeveloped areas of the country7—and to foster businessinitiatives, employment, and exports.

The law, revised on a number of occasions to takeinto account new technological and economic develop-ments,8 did not explicitly favor the high-tech or any specific industrial sector,9 but, rather, ventures with highvalue-added and marketing capabilities in local and inter-national markets.The importance given to both new andexisting projects varied according to the specific zone,whereas the contribution to exports had to be more substantial for the central areas, zones C and B, than forthe peripheral one, zone A, for which the contribution tolocal employment was valued more.Those enterprises,both Israeli and foreign-owned, which were deemed eligible by the Israeli Investment Centre—a department of the Ministry of Industry,Trade and Labor in charge ofthe law’s administration—gained the status of “ApprovedEnterprises” or “Beneficiary Enterprises.”They were thusin a position to benefit from government grants—up to24 percent of tangible fixed assets—and/or tax benefits invarious forms, depending on the geographical locationand the percentage of foreign ownership.

Beyond the stated goal of LECI to promote privateinitiative and internationally competitive products, themarket-friendly character of the law can be seen in itsattempt to provide institutional underpinnings to the ini-tiatives of private investors, and to share with them thehigher risk associated with the development or expansion

of a venture, addressing in this way the market failuresinherent in the preliminary stages of investment.

LECI deliberately introduced a bias in favor of foreigninvestors, which took the form of preferential tax treatmentwith respect to national investors. It was thought that afavorable tax regime and the relative abundance of well-trained engineers and scientists would strengthen theattractiveness of Israel as a location for multinationals.Thepolicy was based on a specific rationale: multinationalswould not only create employment in Israel, but theywould also bring with them the technology, know-how,operating procedures, managerial skills and exportingchannels that the nascent Israeli industry needed. In otherwords, the idea was to leverage the spillovers derivingfrom the operations of the multinationals in Israel for thedevelopment of the local high tech industry.

The government’s strategy worked well: internationalinvestors flocked to Israel during the 1960s and 1970s,including high-tech giants such as IBM, Motorola, andIntel, and were followed by many others. Figure 4 showsthe evolution of FDI over the 1991–2005 period.

This process has been facilitated by a number ofreforms in the capital markets which have considerablyimproved the efficiency of, and competition within, Israel’sfinancial system.These have mainly involved deregulationand the elimination of a host of administrative restrictionsand interventions, and the welcome reform of the capitalmarket which centered on the separation of the variousfunds from the banks. Reserve requirements, which hadranged well over 30 percent in the late 1980s, had fallento an average of 4 percent by the end of the 1990s.This,in turn, contributed to a marked narrowing of interest ratespreads. Undue segmentation of the credit markets wassharply reduced; for instance, the share of mortgage creditallocated by the government fell from 70 percent in themid 1980s to less than 25 percent by the end of the1990s. Even sharper drops took place with respect toother forms of credit.

The reforms also saw a sharp reduction in the shareof obligatory investments in government bonds by pensionand provident funds. Provident funds, the largest institu-tional investor in the Israeli economy, were allowed toinvest a much larger share of their holdings in equities andother financial assets.Alongside these efforts aimed atderegulation, there was also significant streamlining andmodernization of the stock market, which emerged as oneof the most technologically advanced in the world, withcontinuous trading and short clearing periods, against abackground of fairly sound securities legislation.There areongoing efforts to broaden the range of financial instrumentsoffered to the public, to ensure equal tax treatment of dif-ferent classes of investors and/or savings instruments, andto encourage more long-term savings.The modernizationof the financial sector is thought to have played a strong

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supportive role in the development of the ICT industry.To the extent that these reforms were driven by a desireto improve market efficiency, they made it easier foremerging companies to obtain funding under more favor-able circumstances. Parallel progress in bringing inflationlevels down to international levels also contributed to thecreation of a more stable macroeconomic environment,conducive to private sector activity in a more predictableclimate.

Foreign investors in the ICT sector have typicallyused one of two options to establish a presence in Israel:they have either set up operations directly, or adopted astrategy of mergers with, or friendly take-overs of, smalllocal companies.As shown in Table 1, as regards operationscarried out in Israel, foreign investors have placed theemphasis on the installation of research and developmentfacilities,10 taking advantage of Israel’s ample supply ofhighly skilled engineers, and its solid track record forinnovation and problem solving. In this regard, some haveargued that the above competitive advantages have been amixed blessing for the Israeli economy, in that researchfacilities do not generally make the same contribution tojob creation and exports as do manufacturing plants.Theyalso act as a drain on limited Israeli brain power,11 whichcould otherwise be used by local firms.

The above considerations notwithstanding, the contribution made by multinationals to the developmentof the Israeli high-tech industry is generally viewed as

Table 1: Multinational companies with R&D centers inIsrael (partial list)

Source: Israel Venture Association, 2005.

0

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2,000

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Figure 4: Foreign Direct Investment in Israel, 1991–2004 (inflows, US$ millions)

Source: UNCTAD, 2006.

AlcatelAnalog DevicesAMCCAvayaBMC SoftwareBoston ScientificBroadcomComputer AssociatesCEVACiscoConexantFreescale SemiconductorGE Medical SystemsHP (including HP Labs)IBMInfineonIntelInterpharmKLA-Tencor

Kollmorgen ServotronixMarvell SemiconductorMicrosoftMotorolaNational SemiconductorOracleOrgenicsParamic TechnologyPfizerPhillipsQUALCOMMSamsungSAPSiemensSilicon GraphicsSun MicrosystemsSunGardTexas InstrumentsVeritas Software

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

US$

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ions

positive, given the many spillovers to the local economy,such as easier access to the international financial andbusiness markets, improved export channels, and the trans-fer of know-how and managing/marketing skills from thepersonnel of multinationals to local companies.

In addition to creating state-of-the-art R&D centers,companies such as Intel and Motorola established manu-facturing facilities, which rapidly became some of thelargest private employers in Israel.At last count, Intel was employing more than 6,000 workers at several plantsscattered around the country (Haifa, Jerusalem, Kiryat Gat,Petach Tikva, and Yakum), and has developed into one ofthe top Israeli exporters, with a volume of US$1.6 billionin 2003, equivalent to 13 percent of total Israeli electronicexports.The linkages between Intel and Israel are particu-larly strong, as evidenced by a rapid ramping up of multi-billion dollar investments, mainly to expand capacity atexisting plants, some of which have become world leadersof research and innovation.

Government support for R&DAs a coherent body of policies and programs, governmentsupport of R&D began somewhat later than the policy ofincentives to private investors. By then, the economy andthe flow of immigrants had slowed, after two decades ofstrong growth.The need to define a new developmentstrategy was seen as a priority. Building on considerationssimilar to those which had motivated the policy on invest-ment incentives—notably, the abundance of a highlyskilled labor force, a culture of technological and scientificexcellence, and the scarcity of natural resources—the gov-ernment decided to actively promote the development ofa science-based sector by subsidizing private-sector R&Dprojects.

A first step in this direction was the creation, in thelate 1960s, of the Office of the Chief Scientist (OCS), atthe Ministry of Industry,Trade and Labor.The OCSadministers and grants government funds for R&D, and, inthe words of Dr. Eli Opper, the current Chief Scientist,“operates on the premise that the business sector alone isincapable of carrying on an optimal level of R&D formarket growth…and that under such conditions govern-ment involvement through support of industrial R&D iswarranted.”12

Another milestone was the adoption of the Law forthe Encouragement of Industrial R&D (LEIRD) in 1984,which still represents the fundamental legal framework forgovernment support to private industrial R&D.This law isnot fundamentally different in spirit from the LECI(which focuses on fostering capital investment) and callsfor the development of a science-intensive, export-orientedindustry, able to accommodate the expansion of the

national labor force, improve the balance of payments, andprovide grants, loans, and other incentives.

The OCS together with the LEIRD, which it admin-isters, constitute the two main instruments for implemen-tation and administration of government policy in R&D,and have shown a remarkable degree of flexibility over theyears, and the capacity to adapt and expand their scope inresponse to changing technological and economic priori-ties.As shown in Figure 5, the programs and interventionsof the OCS take in the whole spectrum of the innovationprocess, trying to make up for market failures, when itappears necessary to overcome potential bottlenecks inprivate initiative/funding.

Figure 6 gives a general overview of several programswhich are currently conducted by the OCS, together withtheir respective budgets.As shown in the figure, the OCSprograms can be either national or international, and theycover pre-seed activities as well as generic and competitiveR&D. It is worth mentioning that the evolution of OCSprograms shows how dynamically the law has beenapplied.

Indeed, the strategy has responded well to signalscoming from the market and to political priorities, adaptingand/or adopting new programs where appropriate.

Looking at the composition of national programs,support for industrial R&D is by far the most important,in terms of budgetary allocations: US$300 million peryear. Priority is generally given to those projects whichresult in know-how and technology, and which can leadeither to new products and processes, or to substantialimprovements of existing ones. Under the program, quali-fying companies can apply for government grants, whichnormally cover 20 to 50 percent13 of the approved R&Dexpenditure budget.A Research Committee, chaired bythe Chief Scientist, is in charge of administering the pro-gram, notably by evaluating the eligibility of projects, anddefining the conditions for approving the grants accordingto the general terms set out in the 1984 law. In thisrespect, eligible projects should be executed by the apply-ing company itself, and although the provisions on thenon-transferability abroad of both know-how and manu-facturing rights resulting from the R&D projects haverecently been relaxed, transferability is still subject to clearly defined costs and conditions.

If the products and processes resulting from the gov-ernment-sponsored project are commercially successful,the company must pay the government back royalties,which correspond to a defined percentage of the totalannual product sales.The annual budget for industrialR&D research covers an average of 1,000 projects,implemented by 500 companies.

Another important program is called Magnet, put inplace in 1993 to strengthen the linkages between industry—a fragmented landscape whose entities seemed to

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Proximity to the market

International programs

Nofar

EU FP6

Risk

Magnet

CompetitiveR&D

Seed fund

Tnufa

Incubators

Applied academicresearch

Figure 5: OCS support for programs in the innovation process

Source: MATIMOP, 2005.

Figure 6: Programs and activities of the Office of the Chief Scientist (US$ millions)

* Over two years.** Total sum available for the five bi-national R&D funds.

Source: State of Israel, 2005.

Pre-Seed Generic R&D Competitive R&D

Inte

rnat

iona

l

Nat

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l Technological incubators .....30.0Tnufa...........................................3.0Nofar...........................................2.2

Industrial R&D projects. . . .300.0Seed fund...................................1.0*

Magnet.................................................................40.0Magneton ..............................................................5.5

MATIMOPEureka .....................................16.0Bi-national funds.................>23.0**Bi-national agreements

ISERD (European 6th Framework Programme) ................................................4,000.0

struggle to sustain the cost of developing cutting-edgetechnology—and the largely untapped first-class researchcapabilities of Israeli universities. Under the Magnet program, consortia of industrial firms and at least one academic institution are entitled to multi-year grants of three to five years, for up to 66 percent of the totalapproved R&D budget (with no royalty payment) todevelop pre-competitive generic technologies.The con-sortium commits to making the resulting technologiesavailable to any local interested party at a moderate price.In 2005, there were 31 consortia.

On the other hand, the international program of the OCS responds to a different set of considerations.Therelative strength of the Israeli high-tech sector lies in theR&D phase. Its weaknesses, however, stem from lack ofexpertise and skills in international marketing, due to thecountry’s geographical remoteness,14 and the small size ofits companies.These two factors suggest the importance ofestablishing links and formal mechanisms for cooperationwith companies in the target markets. In that spirit, thefostering of contacts between national and foreign compa-nies leading to joint R&D, manufacturing, and marketinghas been an important focus of government R&D policy.Many supporting programs have been established to promote this goal, among which the most notable are bi-national funds (such as the Israel-US BIRDFoundation), parallel funding agreements, and participationin the European agreements offering partnering services(EUREKA and the Sixth Framework Program for R&D,known as FP6).The OCS is assisted in the implementationand administration of these agreements by MATIMOP,which was created to serve as the national hub forencouraging the participation of Israeli enterprises inbilateral/multilateral programs for industrial R&D.

Innovation: Technology incubatorsSuccessful innovation in technology requires two funda-mental steps, the intellectual and the financial. In Israel,the generation of ideas has always been prolific. However,the traditionally high level of research in the universitiesand institutes has resulted in discoveries, which, in general,were not rapidly transmitted to industry through mecha-nisms for the commercialization of university inventions.Indeed, it was the Magnet program, which later sought tostrengthen the avenues of collaboration between industryand the academic community.This was paralleled by theimportance of the military, particularly the army’sComputer and Data Communications Network Centre,which has been an incubator of computer and softwaredevelopment for decades.The rapid return of its staff tocivilian life after military service facilitates the transfer oftheir innovative approaches to software design to the pri-vate sector.The government also created incentives for

returning Israelis who had succeeded in Silicon Valley andother technology centers, enticing them either to set upR&D centers for the companies they worked for, or toestablish their own high-tech startups.As a result, in 2004,Israel ranked sixth after the United States, Japan,Taiwan,Switzerland, and Finland in the number of US patentsgranted per capita. It is noteworthy that a much higherproportion of international patents originating in Israel are held by individuals and universities rather than corporations, as is the case in other countries, such as theUnited States (Khavul, 2005).

In 1991, to promote business startups, and particularlyto assist the new wave of immigrants from the formerSoviet Union of the early 1990s, the OCS initiated theincubator program to enable first time entrepreneurs withinnovative ideas to develop them into a business.Althoughthe program was initially targeted at the many engineersand scientists coming from the former Soviet Union,many of whom had remarkable skills and research potential,but who lacked the know-how required for commercialsuccess—knowledge of Hebrew and English, of methodsto access funding, and familiarity with market economypractices— it was, and still is, open to all.The basic ration-ale of these two programs is to “polish the diamond,” thatis, to take selected entrepreneurs with innovative ideaswith export potential through to first round investmentsin product development, to the point where they canstand on their own, find strategic partners, and raise venture capital on the market.

The incubator initiatives have enabled the governmentto bridge the funding gap present at the early, risky stageof the realization of promising ideas.With a budget ofUS$30 million, a total of 24 technology incubators havebeen set up throughout the country, each conducting anaverage of about 10 projects, with an average life time oftwo to three years.The average budget of each project isapproximately US$450,000 per year. Some 85 percent ofthe funds are provided by the government in the form ofgrants and soft loans, with the remainder provided by aventure capital firm, the incubator, or the entrepreneur, inexchange for a share of equity in the company.The incu-bator’s investment and support allow the new venture todevelop and prove its technology, to file patents, undertakemarket validation, develop a business model, attract thefirst customers, add key personnel to the managementteam, prepare professionally for the approach to venturecapital firms, and gain credibility by being supported by areputable VC. Figure 7 shows how initial government support acts as a stepping stone for private investment.

Beginning in 2001, 13 incubators have been privatized,taking advantage of the growing influx of venture capitalinto the country since the mid 1990s, such as LabOne inTel Aviv, now jointly owned by a venture capital fund andthe Tel Aviv Economic Development Authority.

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There are no plans at present to expand the numberof incubators.The authorities feel that the scope of thepresent program is appropriate, given the number ofpromising ideas which can reasonably be expected toappear at any given time. Instead, they have sought tomonitor the program to ensure strict quality control andhigh standards of excellence.The incubator program hasbecome the number one producer of startups in Israel. In2000, there were 2,000 startups, five times the number adecade earlier.Today Israel has the world’s highest densityof high-tech startups, nearly 2,500 in a country of only 6million people (Harel, 2005). Moreover, the success rate ofincubator startups is 50 percent, measured as the ability toraise private funding to allow the company to operate forat least two years.This figure compares with only 10 per-cent for startups in the United States and for Israelidot.com startups (Trajtenberg, 2001).

Venture capitalTechnological creativity can only lead to successful busi-ness development if there is an adequate flow of venturecapital, and in this area Israel has achieved enviablemomentum. Not only does the country have the highestconcentration of high-tech companies in the world afterSilicon Valley, but it is a world leader in startups, whichcontribute a higher share to GDP than in any other

country (Dar, 2005). Startups require venture capital tohelp them through the product development phase.

In order to address one of the most pressing marketfailures for many years in the Israeli financial system, theIsraeli government played a direct role in creating aremarkably market-friendly venture capital industry.Thelack of a well-developed national capital market was oneof the most serious hindrances to the proper functioningand expansion of Israeli industry, a deficiency which government grants could only partially make up for.

In 1990, Israel had two venture capital funds, manag-ing US$59 million. In 1992, the OCS established theYozma program, to trigger the creation of a venture capital market in the country.The government providedUS$100 million to encourage international venture capitalto enter Israel, invest in Israeli high-tech firms, and men-tor local venture capital talent.To match the governmentinvestment, ten funds were established by internationalventure capital and industrial firms, headed by Israeli managers. Private investors participating in the funds were offered the option to buy back Yozma’s shares at apredetermined price within five years. In this way thegovernment attracted eminent international investors and,together with their funds, their much-needed expertise.Yozma was created in a market-friendly spirit, with a fixedduration of seven years, at the end of which it was priva-tized, with the government selling out its interest to theprivate sector. By 2000 there were over 50 venture capital

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Figure 7: Government vs. private sector investment in the incubator program (US$ millions)

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firms that raised US$9.4 billion. In that year, Israel raisedUS$600 per capita in venture capital, compared withUS$30 per capita in Europe, making it the most attractivetechnology market outside the United States.The level ofIsraeli domestic venture capital as a percentage of GDPwas the highest in the world. In addition, Israel rankedfifth in informal investment (Khavul, 2005). Much of thisfinancing was for relatively small investments in startups.

Over and above government policy and funding,multinational corporations have also played a significantrole through strategic partnerships, which included designcenters, marketing channels, eventually buying companiesto provide an exit for the venture capital (Oron, 2005).

Today, venture capital has become global and mostinvestments are multinational.The Israel VentureAssociation (IVA) is active throughout the world, publiciz-ing opportunities and raising venture capital for Israelicompanies (Harel, 2005). Silicon Valley Bank establishedbranches in England and India in 2004, and in China andIsrael in 2005 (Brown, 2004).There are now some 50Israeli venture capital firms managing over US$12 billiondrawn from the United States, Europe, and the Far East.133 foreign venture capital firms invested in more thanone company in Israel during 2000–2004.As outlined in

Figure 8, in 2004, Israeli high-tech companies raised morecapital than any country in Europe (Harel, 2005), withalmost US$1.5 billion invested in startups and the numberof venture capital transactions reaching 10 percent of thosein the United States. (Dar, 2005).

The leading areas attracting investments are commu-nications and networking, and software, with Israel now aworld leader in security technologies and chip design.Figure 9 illustrates Israel’s open export-oriented economyin the global ICT marketplace, and how venture capitalinvestments in Israel have placed on the NASDAQ Index.The perspective is clearly on the future, and since 2001,more new companies were established in the life sciencesthan in any other sector.

As seen in Figure 10, the success of the venture capi-tal process in Israel is illustrated by the fact that, in thedecade 1995–2004, 359 Israeli high-tech companies with atotal value of US$29 billion were acquired or merged(Harel, 2005).Venture capital investments contributed to a40 percent increase in GDP and 15 percent increase inemployment, and accounted for 50 percent of exports and65 percent of foreign investment over the same period(Harel, 2005).

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Figure 8: Capital raised by Israeli high-tech companies, 1999–2005 (US$ millions)

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Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

1999 2000 2001 2002 2003 2004 2005

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■ Foreign and other entities

■ Israeli VCs

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Figure 9: Investment of VC funds in Israeli startups and the NASDAQ Index, by quarter, 1997–2005

Source: Israel Venture Association, 2005.

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199719961995 1998 1999 2000 2001 2002 2003 2004

Figure 10: Deals in which Israeli high-tech companies were acquired or merged, 1994–2004

Source: Israel Venture Association, 2005.

Number of deals (left axis)

Total value (right axis)

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Box 2: The role of ICT in boosting the growth of the overall economy

The development of the high-tech sector in Israel hasbeen an impressive success story. The main indicatorsfor the last 15 years speak for themselves: the sectorgrew at an average annual rate of 16 percent in the1990s, expanding from 4 percent of GDP in 1990 to 14percent of GDP in 2000, and accounting for one thirdof total GDP growth.1 Software exports skyrocketedfrom US$135 million in 1992—roughly equivalent tototal citrus exports—to US$3 billion in 2004 (see Figure11), some 7 percent of total Israeli merchandiseexports. ICT products represented 21 percent of totalindustrial products in 2004.2 Of the ratio of R&Dexpenditure to GDP—4.6 percent in 2004—close to 80percent was allocated to ICT R&D,3 among the highestin the world. Beyond these impressive indicators, thesignificance of the Israeli high-tech sector can be fullyappreciated when one considers that some of themost important IT breakthrough innovations of the lastyears have been developed in Israel, from the latestIntel processors used in laptop and desktop comput-ers, to the disk on key, ICQ, and firewall technolo-gies—all Israeli inventions.

Nevertheless, if one looks at the overall evolutionof the Israeli economy, the picture becomes moremixed. Not only did the growth rate of the rest of theeconomy not match that of the high-tech sector—2.3 percent versus 10.5 percent for the period

1996–20044—but total factor productivity declined formany sectors, such as retailing and business services(–3.3 percent) or the construction sector (–2 percent).Moreover, according to Bank of Israel figures, between1994 and 2003, the bulk of investment went to theelectronics sector, which rose at an annual averagegrowth rate of 20 percent, compared to 5 percent intraditional industries—such as food, textiles and soon—and no growth for the agricultural sector.5

Such trends also had a negative impact on the patterns of income distribution in Israel. During the1990s, the income of the highest decile rose in linewith GDP growth, while the income of the middle andlower deciles remained more or less unchanged,6

reflecting a large intra-sector wage disparity betweenthe high-tech sector and the rest of the economy.Indeed the average annual salary bill for the high-techindustry in 2002 was higher than the equivalent bill forthe mixed high-tech industries, the mixed traditionaltechnological industries and the traditional technologicalindustries.7 These observations have led a number ofobservers to suggest the existence of a “dual economy,”in which the high-tech sector continues to boom whilethe rest of the economy lags behind.8

This, in turn, raises questions about the growthand competitiveness prospects of the Israeli economyover the medium to long term, given that the high-tech

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Figure 11: Exports of software and citrus (US$ millions)

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Box 2: The role of ICT in boosting the growth of the overall economy (cont’d.)

sector today represents only 15 percent of the econo-my, and only around 6 percent of total employment inthe business sector.9 Therefore, it is important to lookat the reasons behind the relatively limited spilloverfrom the high-tech sector to the rest of the economy.Trajtenberg (2005) identifies a number of key factors:

1. Nature of the government R&D programs:

although neutrality has been the stated guidingprinciple of government policies in R&D, ex-postthere may have been a bias in favor of productinnovation as opposed to process innovation, andtherefore in favor of the ICT sector, as shown bythe very high percentage of R&D expenditure allocated to the high-tech sector. Trajtenberg notes that, whereas in the OECD, on average, 21 percent of R&D spending is allocated to ICT,the share in Israel is closer to 79 percent.

2. Reference market: as noted earlier, the develop-ment of the high-tech sector has been export-led.From its inception, the reference market for thesector has been the international market. In thatsense, spillovers from the high-tech industry mayhave been mainly targeted to and benefited exter-nal consumers and companies abroad, rather thanthe local market, such that local intra-sectoral innovation complementarities did not develop tothe extent one might have expected.

3. The involvement of multinationals: a large shareof R&D in Israel has traditionally been conductedby local R&D centers of multinationals, such asIntel, Cisco, Motorola, and IBM, which mainlyserve the needs of the global market and of theparent company, rather than the needs of the localeconomy. Certainly, there are positive externalitiesfor the overall human resource pool in Israel, inthe sense that the local labor force, working formultinationals, can transfer their acquired knowl-edge and managements skills to local companies,as they move from the former to the latter. At thesame time, however, the fact that multinationalsdraw from the limited highly skilled local labor poolcan exacerbate situations of inelastic labor supply,and lead to salary increases which can potentiallydisadvantage local companies.

4. The massive involvement of VC funds in start

up financing: the very nature of VC funds is suchthat they have a very short time line, usually five toseven years. Thus, they look for an exit after a shorttime, normally by selling off to a US-based or other

international company, resulting in benefits for markets abroad of the innovation developed inIsrael.

What can be done to remedy some of these characteristics of the “dual economy”? How can therest of the economy take greater advantage from thestellar growth and amazing innovation potential of thehigh-tech sector? Again Trajtenberg suggests a poten-tial way forward in the promotion of locally orientedinnovation, to allow the local economy to absorb maxi-mum spillover. Government R&D policies may have tobe realigned, in order not only to maximize knowledgecreation, but also to redirect the impact to benefit thelocal economy. In the case of Israel, it could also beeconomically and socially beneficial for the governmentto promote locally oriented innovation and the adoptionby the rest of the economy of high-tech innovations ina way that will increase their own productivity. TheOCS has recently initiated a program to revitalize thetraditional industries by encouraging innovation andR&D. There is also evidence that the extremely impor-tant contribution made by ICT to productivity growth inthe United States has been linked to the adoption ofICT by sectors (e.g. retailing) which have used ICT tomake important changes in business processes, suchas procurement, distribution, just-in-time production.Such a strategy in Israel could be a win-win approach,both in terms of reconciling the two parts of the “dualeconomy” and for export purposes, since domesticdemand shares a number of characteristics with alarge proportion of world demand, notably that comingfrom developing countries.10 Tailoring innovation toaddress local demand, at least partially, can open awhole new range of export markets, boosting thegrowth of the local economy at the same time.

Notes

1 Trajtenberg, 2005.

2 Central Bureau of Statistics, 2005.

3 Traijtenberg, 2005.

4 Ibid.

5 Swirski and Knoro-Attias, 2004.

6 Ibid.

7 Ibid.

8 Traijtenberg, 2005.

9 Central Bureau of Statistics, 2005.

10 Indeed, as Trajtenberg explains, in the area of ICT, developing coun-tries are more interested in simplicity, reliability of operations, andbackward compatibility, rather than in the development of highlycomplex software packages.

ConclusionThe government policies described above helped tounleash the astonishing development of the high-tech sector in Israel. During the decade of the 1990s, despiteongoing concerns for basic security, Israel took full advan-tage of its high educational levels, skilled immigrants, andcapacity for innovation to cultivate the ICT sector, whichgrew 16 percent per year and increased its GDP participa-tion from 5 to 14 percent (Trajtenberg, 2005). In 2004,Israel ranked 6th in the world in the number of USpatents per capita, preceded only by the United States,Japan,Taiwan, Switzerland, and Finland.

Since Israel is not a low wage country, it must competein high value-added products and technologies. Its successcomes from niche players who have learned to stayfocused.A number of companies have become world leaders in domains such as the Internet, communications,semiconductors, consumer electronics, and digital printing.

In an export-oriented industry such as ICT, it is diffi-cult for companies to grow far from their main customersin the United States and Europe.The solution is outwardmigration, moving headquarters abroad and establishingmultiple locations close to clients, while maintaining R&Din Israel.Also, since small- or medium-sized softwarecompanies targeting niche markets are unable to deliverthe complete solutions that many customers require, thereis a strong tendency for them to be bought up by largeroutside conglomerates, leaving them as local R&D shopsspecializing in innovative technology and unique solutions,whose benefits are largely unrealized by the overall economy.

Israel faces a major challenge in managing the ongoingprocesses of innovation, which constitutes its competitiveedge in the globalized economy.The question is how thissmall country will be able to create and preserve the critical mass of companies necessary to maintain theircompetitive advantage.

Notes1 The authors would like to thank Gilad Almogy, Yair Amitay, Yair

Averbuch, Eli Barkat, Dan Catarivas, Arthur Dahl, Joseph Gansel,Assaf Harel, Moshe Katzenelson, Gillam Keinan, Ami Levin, ErelMargalit, Yoram Oron, Rina Pridor, Rachel Roei-Rothler, IsraelShamay, Yacov Sheinin, Amiram Shore, Manuel Trajtenberg, JosephVardi, and Zohar Zisapel for their helpful comments and insights. Theviews expressed in this paper, as well as any errors or omissions,are the authors’ own.

2 In 2004, for the first time, the government’s Research Committee devi-ated from the neutrality principle, by announcing the granting of pri-ority support to the bio-technology and nano-technology sectors. Asa result, the first bio-technology incubator was established, togetherwith a center of nano-technology at the Technion (Israel Institute ofTechnology) in Haifa.

3 As argued in Trajtenberg (2005), the existence of two types of marketfailures in this context will lead to sub-optimal amounts of investment.The first refers to the inadequate returns to private investment ininnovation due to the spillovers of technological externalities andexcess benefits to customers. The second concerns informationasymmetries associated with the creation of knowledge and therelated so-called “funding gap.”

4 Florida, 2005; Israel follows the Scandinavian countries, Japan, USA,Switzerland, Netherlands, Germany, Canada, Australia, and Belgium,but precedes the United Kingdom.

5 MATIMOP (2005), the principal technology clearinghouse, is the IsraeliIndustry Center for R&D, a public, nonprofit organization, whichcoordinates industrial R&D cooperation between Israel and the international hi-tech community. Available at: http://www2.mati-mop.org.il/1/index.html.

6 Not surprisingly, a number of Asian companies have been extremelygood at copying existing technologies, in some cases without adequate regard for the intellectual property rights of others. For athorough discussion of Asian approaches to development and, inparticular, the interaction between civil and human rights and authori-tarian forms of governance, see Development as Freedom, byAmartya Sen (1999).

7 Under this law, the country is divided into three National PreferenceZones: A (the Galilee, Jordan Valley, the central and southern Negev,Jerusalem (for high-tech enterprises), B (lower Galilee and the north-ern Negev), and C (the rest of the country). The most preferentialtreatment, in terms of investment incentives, is given to enterpriseslocated in zone A.

8 The last revision entered into force on 1 April 2005.

9 The LECI applies to all industrial sectors, as well as to hotels, tourism,industrial and residential construction, and—not by chance, givenIsraeli R&D competitive advantage and willingness to nurture a qualified workforce—industrial development centers.

10 Microsoft built its first R&D facilities outside the United States inIsrael; Cisco has its first R&D center outside the United States inIsrael, and Motorola’s R&D center in Israel is its largest worldwide.

11 This argument gained ground in the late 1990s when, at the peak of the dot-com bubble, Israel’s supply of qualified labor turned quiteinelastic against the background of a growing demand from the localsector. Currently (2006), as the Israeli economy picks up again aftera few years of recession, the labor supply still remains rather elastic(Trajtenberg, 2005).

12 IVC Research Center, 2005, p. 13.

13 For projects located in Zone A or along the Israeli northern border,grants can cover up to respectively 60 and 70 percent of theapproved R&D budget.

14 Israel is, indeed, a peculiar case in this respect. Since the regionalmarket is ruled out for obvious security and political considerations,its export markets tend to be remote. According to data from theIsrael Association of Electronics & Software Industries for 2003, 38percent of exports from the electronics and information sector weredirected to the US, 35 percent to Europe, and 22 percent to Asia.

ReferencesBrown, E. 2004. “The Global Startup.” Forbes, 29. November.

Central Bureau of Statistics (Israel). 2005. Industry Department Database.Available at: http://www1.cbs.gov.il/reader/cw_usr_view_Folder?ID=141.

Cohen, N. 1998. The Israeli High-Tech Industry: Fifty Years of Excellence.International Data Corporation (IDC), Israel Ltd. Available at:http://www.jewishvirtuallibrary.org/jsource/Economy/idc.html.

Dar, V. 2005. “Israel—The Mediterranean Silicon Valley.” Pasgot Ofek, 1August.

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The Economist. “Israel’s Technology Industry: Punching Above itsWeight.” 12 November.

Ellis, S. and I. Drori. 2004. “Evolution and Genealogy of Israeli Hi-TechOrganizations: From Military Units to World Markets.” HMTSWorking Paper (1).

Florida, R. 2005. “Creativity Special: Where It’s At.” New Scientist No.2523, p. 43. 29 October.

Harel, A. 2005. “The Role of Venture Capital in the Development ofIsrael’s High-Tech Industry.” Israel Venture Association, Presentationto the World Economic Forum, November.

Israel Venture Capital (IVC). 2005. 2005 Yearbook. Tel Aviv: IVC ResearchCenter.

Israel Association of Electronics & Software Industries. 2005. IsraelAssociation of Electronics & Software Industries Profile. Tel Aviv.

Israel Venture Association (IVA). 2005. “Israeli Venture Capital and PrivateEquity Directory.” PowerPoint Presentation. Tel Aviv: IVC ResearchCenter.

Khavul, S. 2005. “Israel.” S. Commander, ed. The Software Industry inEmerging Markets. Cheltenham, UK: Edward Elgar. 133–188.

LabOne Innovations. 2005. PowerPoint presentation to World EconomicForum. November.

MATIMOP. 2005. PowerPoint Presentation.

Myre, G. 2005. “High-Tech Industry in Israel Goes from Bust to Boom.”The New York Times. 26 December. Available at:http://www.nytimes.com/2005/12/26/business/worldbusiness/26boom.html.

Oron, Y. 2005. The Israeli VC Success Story. Tel Aviv: Israel VentureAssociation.

Sachs, J. and A. Warner. 2001. “The Curse of Natural Resources.”European Economic Review 45: 827–38.

Sen, A. 1999. Development as Freedom. New York: Knopf.

State of Israel. 2005. “The Israeli Economy at Glance 2005.” Ministry ofIndustry, Trade and Labor. Planning, Research and EconomicAdministration. Foreign Trade Administration. Available at:http://www.moital.gov.il/NR/rdonlyres/AAD43696-3185-40B7-881A-BAB1B3C64F2E/0/2005_ISRAELECENOMY.pdf.

———. 2004. The Intellectual Capital of the State of Israel. Tel Aviv:Ministry of Industry, Trade and Labor. Available at:http://www.moital.gov.il/NR/exeres/88B20917-6535-41FF-83A7-7D9E98659712.htm.

Swirski, S. and E. Knoro-Attias. 2004. Israel: A Social Report 2004. AdvaCenter. Available at: http://www.adva.org/iasr98e.pdf.

Trajtenberg, M. 2001. “R&D Policy in Israel: An Overview andReassessment.” M. P. Feldman and A. N. Link, eds. InnovationPolicy in the Knowledge-Based Economy. Boston: Kluwer AcademicPublishers. 409–454. Available at:http://www.tau.ac.il/~manuel/pdfs/R&D%20Policy%20Israel.pdf.

———. 2005. “Innovation Policy for Development: an Overview.” Paperprepared for LAEBA, Second Annual Meeting. Tel Aviv: Tel AvivUniversity, NBER and CEPR. November.

UNCTAD. 2006. Foreign Direct Investment Database. Geneva.

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Israel

Environment Component Index 21Market Environment 19

Political and Regulatory Environment 21

Infrastructure Environment 23

1.01 Availability of scientists and engineers, 2005........................41.02 Venture capital availability, 2005 ............................................51.03 Financial market sophistication, 2005..................................251.04 Technological readiness, 2005...............................................41.05 State of cluster development, 2004 ....................................161.06 Quality of scientific research institutions, 2005 ....................41.07 US utility patents, 2004 .........................................................61.08 Tertiary enrollment, 2003.....................................................251.09 Burden of government regulation, 2005 .............................381.10 Extent and effect of taxation, 2005 .....................................741.11 Time required to start a business, 2005..............................461.12 No. of procedures required to start a business, 2005.........101.13 Intensity of local competition, 2005 ......................................92.01 Effectiveness of law-making bodies, 2005..........................282.02 Laws relating to ICT, 2005...................................................232.03 Judicial independence, 2005 ...............................................142.04 Intellectual property protection, 2005..................................212.05 Efficiency of legal framework, 2005....................................232.06 Property rights, 2005 ...........................................................262.07 Quality of competition in the ISP sector, 2005....................113.01 Telephone lines, 2003..........................................................253.02 Secure Internet servers, 2004 .............................................233.03 Internet hosts, 2003 ............................................................183.04 Electricity production, 2002 .................................................24

Readiness Component Index 16Individual Readiness 23

Business Readiness 8

Government Readiness 15

4.01 Quality of math and science education, 2005 .....................274.02 Quality of the educational system, 2005.............................174.03 Quality of public schools, 2005 ..........................................304.04 Internet access in schools, 2005.........................................194.05 Buyer sophistication, 2005 ..................................................274.06 Buyer dynamism, 2004........................................................214.07 Residential telephone connection charge, 2003 .................374.08 Residential monthly telephone subscription, 2003 .............325.01 Extent of staff training, 2005...............................................215.02 Local specialized research and training services, 2005.......105.03 Quality of management schools, 2005................................145.04 Company spending on R&D, 2005 ........................................55.05 Business monthly telephone subscription, 2003 ................325.06 Local supplier quality, 2005 .................................................235.07 University/industry research collaboration, 2005.................115.08 Scientific and technical journal articles, 2001........................36.01 Government prioritization of ICT, 2005................................346.02 Government procurement of adv. tech. products, 2005 .......56.03 Importance of ICT to gov’t. vision of future, 2005 ..............196.04 Government R&D subsidies, 2004 ........................................76.05 E-participation index, 2004 ..................................................306.06 E-government readiness index, 2004 ..................................20

Usage Component Index 15Individual Usage 22

Business Usage 3

Government Usage 18

7.01 Cellular telephones, 2003 ......................................................87.02 Telephone subscribers, 2003...............................................127.03 Personal computers, 2003...................................................287.04 Telephone lines, 2003..........................................................257.05 Television sets, 2002 ...........................................................397.06 DSL Internet subscribers, 2003...........................................117.07 Cable modem Internet subscribers, 2003 ...........................687.08 Internet users, 2003 ............................................................337.09 PC households online, 2005 ................................................307.10 Internet bandwidth, 2002 ....................................................398.01 Prevalence of foreign technology licensing, 2005...............138.02 Firm-level technology absorption, 2005.................................58.03 Capacity for innovation, 2005 ................................................28.04 Availability of new telephone lines, 2005 ............................138.05 Availability of cellular phones, 2005.......................................38.06 Extent of business Internet use, 2005 ................................219.01 Government success in ICT promotion, 2005.....................179.02 Availability of online services, 2005.....................................349.03 ICT productivity, 2005..........................................................199.04 ICT pervasiveness, 2005 .....................................................16

Key IndicatorsPopulation (mn) ................................................................................6.8

GDP per capita (ppp) (US $).....................................................22,077

Internet users per 100 inhabitants............................................30.14

Internet bandwidth (Mbps/10,000 inhabitants) .........................2.12

Networked Readiness Index RankYear (number of countries) Rank

2005–2006 (115) .....................................................192004–2005 (104)..................................................................................18

2003–2004 (102)..................................................................................16

Growth Competitiveness Index 2005–2006 (117) 27