Israeli Government Drive to Revive High Tech Falls Flat

'Comparative Advantage' program correctly identified the problem but suffered poor execution.

When it was introduced in June 2010, the compliment that then Finance Minister Yuval Steinitz chose to bestow on the "Comparative Advantage" program for boosting Israel's high-tech industry couldn't have turned out to be a worse omen. "We can permit ourselves to be ambitious and declare that we want to see the establishment of an Israeli Nokia in the not-too-distant future," he said.

It wasn't so long before the fortunes of the Finnish cellular telephony company were soon sharply reversed.

Nevertheless, the new program was enthusiastically received in Israel's high-tech community. Haim Shani, the director general of the Finance Ministry under Steinitz and who took charge of the plan, had come from the high-tech world himself, where he served as CEO of Nice Systems.

Competitive Advantage mapped out the pitfalls facing Israeli high-tech and addressed some of its major problems - financing difficulties at the early and advanced stages of startups; integrating Arabs and the ultra-Orthodox into the industry; the failure to develop large companies; expanding research and development into new fields; and the focusing of governmental R&D in specific areas.

But three years after its launch, the program still seems to be some way from reaching its goals. The Angels Law, which constituted part of the program, the planned legislation on R&D, and the hundreds of millions of shekels poured into high-tech, still haven't managed to turn the industry around. The amount of private capital flowing into startup companies hasn't grown significantly and employment hasn't expanded.

Last week, Economy Minister Naftali Bennett sounded as optimistic as Steinitz had been, but fulfillment of the program's objectives still seems a long way off.

"We need to take the program, gather the teams together again, and map it out from scratch," says a senior government official, who was involved in its formation. He added that it is still too early to determine whether it's a success or failure, something that can only be judged over the space of a decade.

Tesdt is implementation

"They put together a broad plan, but the test is in the implementation," says Yoav Chelouche, cochairman of the trade group Israel Advanced Technology Industries. "They chose something comprehensive and integrated, and avoided local or easy solutions. This ambitiousness made putting it into effect all the harder."

Competitive Advantage was a welcome idea that created a set of tools for dealing with a slew of lacunae in the industry, says Esti Peshin, head of the high-tech lobby at the Knesset. "The quality of the tools and their effectiveness at the outset are debatable, but the results today aren't and can only be described in one word - lacking," she says.

One burning issue the program tried to deal with was coaxing Israeli institutional investors to put money into the industry, something they have never done in the 20 years since the rise of venture capital investing in Israel. According to the Finance Ministry, 95% of the capital for Israel's venture capital funds comes from foreign sources.

But while the investment portfolios of institutional investors grew by 140% from 2003 to 2010 - from $99 billion to $238 billion - their relative stake in venture capital funds shrunk from a mere 0.22% in 2005 to 0.15% in 2010. It hasn't changed much since.

The treasury allocated as much as NIS 800 million between 2011 and 2013 within the framework of Comparative Advantage to provide institution investors with a guarantee for up to 25% of whatever they invested in venture capital. Ultimately, however, they only put up NIS 360 million of the NIS 450 million they had committed to investing in Israeli venture capital funds.

According to Peshin, institutional investors don't believe the industry will ever provide competitive returns. "This isn't illogical," she says. "Israeli venture capital doesn't make this a trivial investment decision."

The Angels Law provides the best example of where the program took a wrong turn. The law intended to create an incentive for private investors to invest in budding high-risk, knowledge-based startups by providing tax incentives. It recognized investing in approved startups as an expense for tax purposes from the first year money was put into the company.

But when its mechanism was first disclosed in November 2011, many realized it wouldn't be effective since it didn't include investing by Internet and wireless companies, which make up a considerable share of angel investments. Since the law went into effect, only 30 companies have taken advantage of the benefit (although 60 more have applied for it ). Last year saw an increase in seed-stage investments, but it's unlikely this can be attributed to the Angels Law.

"The treasury has recognized [the problem] and formulated, together with the relevant parties, an alternative bill that everyone hailed, but it wasn't included in the Economic Arrangements Bill," says Peshin. "The current law is choking entrepreneurship in Israel. We're reaching a point where our main growth engine, responsible for 50% of industrial exports, can't grow and isn't sustainable over time. It's very disturbing."

In some areas, the plans for putting Comparative Advantage into effect were never formulated - for example, absorbing Arabs and the ultra-Orthodox into high-tech. Other plans did get off the ground but were halted due to budget restraints. The chief scientist's technology incubator program, for instance, underwent a facelift, but budget cuts have now clouded its prospects and managers of the new incubators are worried that the government won't provide the promised funding.

The program also set out to expand R&D into new fields: "The financial service industry depends today more than ever on R&D, and Israel doesn't play a significant role in this market," the program outline stated. To rectify this, it recommends encouraging the development of financial R&D centers by multinationals in Israel.

With the program allocating NIS 100 million over five years toward this goal, centers in Israel were indeed opened by Citigroup and Barclays. Citigroup was given a NIS 93 million grant on condition that it meets a series of objectives, such as employing more than 300 people at the end of five years. But questions remain. Is subsidizing the salaries of Israeli engineers at financial R&D centers justified? Will a flourishing industry develop around the centers? It's still too early to tell.

Nobody in charge

Israel's high-tech community agrees that the program identified the industry's fundamental problems. Where it stumbled was in putting them into effect. Most of the problems still remain, and solutions grow more urgent from day to day.

One of the factors impeding full implementation is the absence of someone in the government taking charge of it since Shani left the treasury. Perhaps a cabinet member or high-placed official needs to take responsibility for high-tech and supervise the government programs in the field.

"The program needs to be booted up again, strengthened, and reinstated," concludes Chelouche. "Two objectives are of the utmost importance: Expanding the circle of participants in the industry; and bringing massive institutional investment to the industry on a consistent basis."

Emil Salman