Innovation as Natural Resource: Israel’s Journey

Uri Gabai, CEO, Start-Up Nation Policy Institute

Uri Gabai is CEO of Start-Up Nation Policy Institute, an independent think-tank focusing on Israel’s innovation ecosystem.

Era-defining events are usually difficult to recognise when you’re part of them. Yet, even in the midst of the COVID-19 pandemic, it is abundantly clear that it is a historical event. While the death toll alone is overwhelming, the pandemic’s effects have already far exceeded the realm of healthcare.

Quarantines, lockdowns, and fear led the world, for the first time, to treat digital and online as the default. E-commerce is accelerating at an unprecedented pace, routine online check-ins with our doctors are becoming common practice, and hybrid modes of work are becoming standard in many industries. The cultural change brought about by the pandemic is bringing us closer to predictions from the early days of the internet that envisioned a world in which physical distance is far less important. It is therefore not a coincidence that during this period Facebook launched its vision of the metaverse, a totally virtual world. In retrospect, the pandemic will mark the beginning of the “real digital age”.

This transition from physical to digital will further accelerate the global innovation race in which countries and regions compete to build technological innovation ecosystems that attract ideas, businesses, and talent from around the world. Strong innovation ecosystems will spearhead the efforts to meet the rising global demand for technologically innovative solutions that will form the new digital world.

A Surprising Outlier

At the forefront of this race for innovation are regions and cities like Silicon Valley, London, Beijing, Tokyo, and Boston. One name stands out on this shortlist. It is that of a small island-like country of fewer than 10 million people, far from any substantial markets. A surprising outlier in the innovation sphere, Israel leads the world in R&D investments (4.9% of GDP) and start-up density (one per 1,700 people).

Israel’s tech ecosystem emerged from the pandemic with unprecedented performance. In 2021, Israeli tech companies raised USD 27 billion in venture capital funding, two and a half times more than in 2020 and four times more than the average of 2017–2019. As a result, Israel—whose population represents only 0.1% of that of the world—has more than 5% of the world’s tech unicorns (private companies with a value of over USD 1 billion).

Israel’s Secret Sauce

How has a country like Israel achieved this innovation miracle? Many compelling answers have been proposed: mandatory military service, the elusive Jewish entrepreneurial gene, or the famous Israeli “chutzpah”. All fail to provide a convincing answer to why the Israeli innovation journey began when it did—until the 1990s Israel was a rather average nation when it came to innovation—and why countries with similar cultural characteristics have not achieved the same level of success.

My professional experience in the Israeli government, and especially in Israel’s Innovation Authority, have led me to think that Israel’s “secret sauce” lies in bold yet pragmatic innovation policies. In fact, I believe that Israel is one of the best examples of how public-private partnership (PPP) can create and nurture a leading innovation ecosystem.

From the 1980s, Israel advanced an industrial R&D policy that was to pay off in the early 1990s. The rise of the internet—for which Israel had unique capabilities which were fostered in the army’s intelligence unit—and an influx of highly skilled immigrants from the former Soviet Union, combined to create the ideal conditions for the emergence of strong technological activity. The Israeli government catalysed the high-tech sector with seminal schemes like Yozma and the Incubators Program, which supported entrepreneurship and venture capital investment.

The PPP model in which Israel has excelled was built on three pillars: forming a consensus around a clear and ambitious vision, creating an execution mechanism in the form of a government entity with the mandate and capabilities to advance policy measures to achieve the vision, and the continuous adaptation of the policies to the needs of the ecosystem. This “policy trio” of vision–execution–adaptation transformed Israel into an innovation powerhouse in just a decade.

Laser-Focused Policy

Despite its success, the Israeli innovation model is far from perfect. In fact, as every policymaker knows, there are no perfect innovation models or flawless policies; every policy measure is a trade-off. Israel’s innovation policy in the last few decades is no exception. It was a one-dimensional policy that preferred some activities over others. The vision–execution–adaptation policy trio focused almost exclusively on increasing entrepreneurship and industrial R&D. The Office of the Chief Scientist (OCS)—the execution mechanism that led Israel’s innovation policy—launched many programmes over the years but their emphasis on R&D was a constant.

This laser-focus proved quite efficient: Israel’s civilian investment in R&D jumped from 2.2% of GDP in 1991 to 4.1% a decade later and has remained above 4% almost every year since. In comparison, the OECD average during this period was less than 2.5% of GDP. Moreover, the share of R&D performed by the private sector rose steadily from 50% in the beginning of the 1990s to 89% in 2018.

The Flip Side

Unfortunately, other aspects of the ecosystem didn’t evolve quite as smoothly. Although Israel became an expert in launching tech start-ups—earning itself the justified “Start-Up Nation” brand—it fell short in scaling these companies up. The standard success story of an Israeli start-up ended with an acquisition by a tech giant, leaving the founders rich but the ecosystem lacking. This was the story of path-breaking companies such as Waze, which pioneered driving navigation apps and was acquired by Google in 2013 for more than USD 1 billion. PrimeSense, the company behind Microsoft’s Kinect device, one of the fastest-selling electronic devices in history, met the same fate when it was acquired by Apple to boost its face recognition technology.

These acquisitions led to another challenge. In many cases, they were the cornerstone for the acquiring company’s presence in Israel. The result was that Israel gradually became the world’s “tech lab”, where multinational companies clamoured to open R&D centres. In the 2010s, the number of R&D centres in Israel more than doubled, totalling 380 in 2020. While this is a sign of the ecosystem’s excellence, it also made Israeli high-tech less Israeli. The multinationals helped foster cutting-edge technologies in Israel, but at the same time curbed the potential of these technologies to ever become the core of scaled-up Israeli tech companies.

Another troubling aspect has been the gradual formation of a dual economy: a high-productivity, dynamic and engaging tech industry, well connected and widely respected globally, with the rest of the economy by and large low in productivity. This widening gap isn’t accidental. In a small economy like Israel, most innovative and high-productivity resources are attracted to the sector that is most visibly succeeding. So, investments and talent are drawn to the big tech-magnet in the centre of the country, leaving other sectors and regions behind. The 10% of the labour-force engaged in the high-tech industry is now earning three times the average salary, and the gap is constantly growing. Add to that the fact that most tech employees are young men who reside in the centre of the country, and this becomes a matter of social inequality.

This would be less troubling if the quality of life for all Israelis improved as a result of the booming tech industry. But in reality, spillovers from advanced technologies developed by the Israeli tech industry are very limited. For example, despite developing cutting-edge smart transportation solutions, Tel Aviv is one of the most congested cities in the world. The picture is similar in financial services: Israel accounts for more than 5% of global fintech venture capital investments, but its financial institutions are far from innovative. Despite strong digital health and advanced manufacturing R&D, most Israeli innovation in the healthcare and manufacturing sectors only targets markets abroad.

While all these challenges vary by nature, they have one thing in common—none of them can be solved exclusively by the “traditional” innovation policy focusing on government R&D grants.

Changing Course

In the mid-2010s, the Israeli government, and especially the OCS, recognised the gap between the economy’s needs and the policies enacted since the 1990s. This wasn’t easy to acknowledge. During that period, I served as the Head of Strategy at the OCS, and I can attest that most policymakers did not see the sense in changing a policy that was so successful. However, under the leadership of several forward-thinking policymakers, especially the then Chief Scientist Avi Hasson and the then Minister of Economy Naftali Bennett (currently Israel’s Prime Minister), the necessary strategic shift took place. It resulted in the foundation of the Israel Innovation Authority with a wider mandate and a more diverse set of policy tools.

The Innovation Authority gradually expanded its focus from R&D to innovation and productivity. It recognised that without enabling larger parts of the population to work in innovative firms, the tech industry would not grow, and Israel’s productivity would not catch up with leading nations. The Innovation Authority also turned more of its attention to facilitating the growth of Israeli companies, celebrating IPOs over being acquired by multinational companies.

The last major policy shift was acknowledging that innovation is Israel’s “natural resource”. And although innovation is primarily evident in the high-tech industry, it can and should be the engine of every industry and sector in the Israeli economy.

Bottom Line

Establishing, growing, and nurturing an innovation ecosystem is a journey. Israel’s journey is indeed unique, but it is a good model for other countries to learn from too. As Israel started its innovation journey well before other nations, it can serve as a canary in the coalmine, signalling what may lie ahead for other countries in their innovation ecosystem’s evolution.

That said, Israel’s own journey is far from over. Changing the course of innovation policy was just the beginning. It will take many more years of trial and error before the government strikes the right balance. This is the nature of innovation policies which try to accommodate slow-moving government operations with the shifting sands of the global technological arena. But without trying, there is no hope of leading the global innovation race and reaping the fruits of the digital age.

I believe that governments can and should be bolder, especially in the aftermath of the COVID-19 pandemic. The challenges ahead are immense— from dealing with the implications of artificial intelligence and autonomous machines, to updating education systems to fit modern employment needs and addressing climate change. Only strong public-private partnerships can unleash the animal spirits of the private market, while directing some of these spirits towards global and humanitarian challenges.

In this, the public sector needs help. NGOs and civil society must play a bigger role in crafting the future. Paraphrasing Clemenceau’s famous quote: technology and innovation are too important to be left to tech companies. Start-Up Nation Policy Institute, which I lead, was established to help Israeli policymakers steer the county’s innovation journey in the right direction. Our vision is to turn Israel’s technological miracle into an economic and social one. We try to do this through data-backed policy recommendations and open and honest debate
around innovation-related issues. It is our hope that this contribution will aid in the discourse.

Start-Up Nation Policy Institute is an independent think-tank focusing on Israel’s innovation ecosystem