from the November 2013 issue

Economic imperative

In part, the economic necessity derives from the military one. Israel's defense budget is inadequate for her to maintain her military advantage. One solution is export. Israel is both a highly successful defense and civilian high-tech exporter.

However, the global defense market is shrinking. Civilian applications of the skills in software, communications, imaging, process control, derived from military industries, have therefore become increasingly important. For example, the need for better night-vision equipment led to local engineers becoming trained in the field of image processing, and to the establishment of two trailblazing Israeli high-tech companies: Scitex (Nasdaq: SCIX; TASE:SCIX), and Elscint. Because Israel is such a small market, export is essential for civilian products too, providing a further incentive to maintain technological excellence, particularly in certain niche markets - network security, for example, where Check Point (Nasdaq: CHKP) is a world leader; Mercury Interactive Corporation (Nasdaq: MERQ) is a leader in enterprise testing and performance management solutions; and Amdocs (NYSE: DOX) is a leader in customer relations management, billing and order management solutions.

In the 1990s, pharmaceuticals and medical devices became a rising high-tech sector. Teva has become a leading global generic drug maker, followed by Taro Pharmaceutical Industries (Nasdaq: TARO) and Agis Industries (TASE:AGIS). Medical device company Given Imaging (Nasdaq: GIVN) and biopharmaceutical companies such as Savient Pharmaceuticals (Nasdaq:SVNT) are becoming prominent players, listed on Nasdaq and European bourses.

The wave of immigration from the countries of the former Soviet Union in the 1990s provided an influx of skilled scientists and engineers. The government's technology incubator program was largely a response to the need to provide these newcomers with employment, and harness their talents to the needs of industry. The immigrants helped fuel Israel's phenomenal growth rate between 1991 and 1994, and helped man the high-tech boom after 1998. In the late 1990s, Israeli high-tech began suffering from a shortage of skilled manpower. The government and industry have been expanding educational and vocational programs to meet the demand. The high-tech slump since late 2000 has slowed demand for trained personnel, but not ended the shortage altogether.

Israel has few natural resources. The aspiration of her population for a Western standard of living can only be satisfied through integration into the global market. Israel's transition from a State-dominated, centralized, protectionist economy to a free market means that traditional industries such as textiles are disappearing, losing out to low-cost overseas competition. How far and how fast this transition should go is a matter of debate, but there is no doubt that high-tech, where Israel enjoys a relative advantage, will be a mainstay of Israel's economic future. As Israel's economy restructures from traditional industries for the local market to export-oriented high-tech, high-tech exports as a percentage of total exports has been steadily increasing, rising from 45% in 1995 to 57% in 2000.

Exports of electronics communications components, electronic components, medical equipment and software and IT products soared to over $13 billion 2000. Although the onset of the high-tech crisis in late 2000 caused a sharp contraction in exports and production, electronics, communications, monitoring and control equipment, and avionics are still key exports. Pharmaceuticals and medical devices and equipment are also becoming increasingly important. High-tech is still the key growth engine for the Israeli economy and a mark of its integration into the global economy.

Foreign investment
An important aspect of Israel's integration into the world economy has been increasing inward investment, particularly in the high-tech industry. Companies like Cisco Systems, Motorola, Intel, IBM, Nortel, Microsoft, Mitsubishi, Deutsche Telekom, aviation and space companies, to mention just a few, have recognized that Israel is a fount of high-tech innovation they cannot afford to ignore. They have set up subsidiaries and research centers here, invested in Israeli companies, technology incubators, and venture capital funds, or found Israeli strategic partners.

Annual foreign investment in Israel grew from $400 million in 1992, to peak at $5.0 billion in 2000. Foreign investment subsequently contracted, due to the high-tech crisis, the global economic slowdown and political tensions in the Middle East, but is still substantial. Foreign venture capital investment grew apace, rising from $587 million in 1998, peaking at $3.1 billion in 2000, before falling to $982 million in 2002, still higher than the level of five years previously. Investment by Israeli venture capital funds followed the same pattern: peaking at $1.27 billion in 2000, but totaling only $481 million in 2002, including $62 million in foreign companies. (Sources: MonetyTree and IVC). The Bank of Israel reported that total foreign investment in Israel amounted to $2.6 billion in 2002, including $1.2 billion in direct foreign investment.

Start-up country
With 3,000 start-ups, the Global Competitiveness Report 2000 ranked Israel second behind the US in the number of start-ups and first relative to population. The weight of start-ups of GDP was 3% in 2000, compared with 0.4% in 1997. The comparable figures for the US was 0.3% and 0.1%, respectively. Israel was was highly ranked in terms of the number of engineers and education, but poorly in terms of physical infrastructure, a situation the government is trying to remedy.

Israel was ranked second in civilian R&D expenditure as a percentage of GDP, rising from 2.7% in 1994 to 4.2% in 1999. Total R&D expenditure in 2000 was $4.2 billion and NIS 23.9 billion in 2001. State expenditure on civilian R&D has been rising faster than GDP through the 1990s, mostly being invested in high-tech, but also agriculture, manufacturing and biotechnology.

Next steps
In any discussion of the future of Israeli high-tech, the following points tend to emerge:

The limiting factor on the sector's growth is a shortage of engineers and managers. Although training programs at universities, colleges and government and industry sponsored retraining courses have been expanding, plus attempts to expand the labor pool by tapping haredi (ultra-orthodox) and other communities, demand continues to outstrip supply, even in the wake of the cutbacks due to the high-tech crisis since mid-2000. Demand to allow the entry of foreign skilled engineers and programmers for the high-tech sector have abated, the issue may re-emerge when the industry recovers and if the Israeli labor pool remains insufficient.

The industry needs to consolidate through company mergers.

The government's role needs to be reviewed. Many argue that government support for civilian R&D is not sufficiently discriminating, resulting in financial and human resources becoming too thinly spread.

Tax reform to ease mergers and acquisitions, better reward employees, and encourage foreign investment. Although progress has been made on these issues, stumbling blocks remain.

New directions: Biotechnology and medical devices are seen as coming fields. While Israel is well placed to exploit it, with outstanding life sciences and medical research institutions, this will mean a departure from the military-industrial symbiosis which has done so much to sustain high-tech development up to now. Nevertheless, Israel has a number of outstanding and growing start-ups and companies in these fields, including many new listings on Nasdaq and European exchanges. Israel is ranked third in the world in biotechnology start-ups.

In 2000 there were 160 biotechnology and 400 medical device companies in Israel, compared with 25 in 1988, employing 4,000 people and generating $800 million in turnover. 20 companies are publicly traded, half in the US and half in Europe. Investment in biotechnology has been growing steadily, reaching totaled $1.7 billion in 2000, including about $200 million in venture capital. There are 15 life sciences venture capital funds operating in Israel.

Some figures
In 2000, exports of high-tech products accounted for 55% of all exports, up from 23% in 1991. Exports of electronics communications components, electronic components, medical equipment and software and IT products peaked at over $13 billion, before the onset of the high-tech crisis in late 2000 caused a sharp contraction in exports and production.

In 2000, 195,000 people were employed in the various high-tech sectors, compared with 148,870 people a decade earlier. Demand for engineers and technicians is estimated at 2,000-3,000 a year. The various academic institutions currently supply 1,000-1,300.

National expenditure on civilian R&D amounted to NIS 23.9 billion (over $5 billion) in 2001, 4.2% of GDP. Spending on civilian R&D has remained stable despite the recession since 2000, although the focus on research has been shifting from Internet and software to new fields such as biotechnology, nanotechnology. Chemical and chemical products, electronic components, communications components, supervision, monitoring, and medical equipment accounted for 87% of industrial R&D expenditure in 2001.

Israel issues the largest number of companies in the US after the US itself and Canada. According to the Bank of Israel, investment by foreign residents totaled $9.4 billion in 2000, up from $3 billion in 1995. Israeli companies raised $4.2 billion overseas in 2000, mostly on Nasdaq, but also including $800 million raised on European exchanges. The 2000 figure is 13 times the amount raised only five years earlier, in 1995, reflecting the immense growth by Israeli high tech and its emergence as a global player. Foreign investment and the raising of capital by Israeli companies overseas has since fallen to a fraction of the 2000 figure.

Reprinted from the Israel High-Tech & Investment Report November 2013

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