Is Startup Nation Fraying at the Edges?

South Korea just pushed Israel out of the No. 1 spot for research and development spending. Israel needs to do more to keep up the pace of innovation.

Eyal Toueg

Last week, a little-noticed but important development for Israel’s high-tech sector occurred: For the first time in many years, Israel was surpassed as the country that spends the great percentage of its gross national product on research and development.

Organization for Economic Cooperation and Development reported that in 2014 South Korea spent 4.3% of its GDP on R&D, pushing Israel, with 4.1%, to second place.

That might not sound like a disaster because both countries remain big R&D spenders by a wide margin compared to the rest of the developed world. But Israel’s No. 1 place was long used as an advertisement for its high-tech prowess and the Startup Nation brand.

Policymakers regard the figure as a barometer for an economy’s ability to leverage technology for economic growth, and Israel’s rate has been stagnant. In South Korea, the trend has been clear: In 2000, it spent 2% of GDP on R&D, a percentage that has risen every year since.

Another country pursuing the same strategy is China. At the turn of the millennium it spent less than 1%; now it’s spending 2%, close to the OECD average. In dollar terms, China spent more on R&D than all 28 European Union member states put together.

Britain is also improving its innovative capacity. It pushed its ranking from 10th in 2011 and second in 2015 by improving its rankings for human capital, research and creative work. It’s No. 1 for the quality of its academic researchers and has boosted its patent output.

“Britain has done very well leveraging its top-ranked universities and transferring scientific breakthroughs into concrete innovative products,” said Prof. Shlomo Maital of the Technion Israel Institute of Technology’s Samuel Neaman Institute for National Policy Research.

Eyal Toueg

On a per-capita basis, Israel is in just seventh place for R&D spending among OECD countries. Its $1,385 per person compares with $1,697 for Switzerland, the world leader, and $1,442 for the United States.

In short, the Startup Nation brand remains strong and investments in new tech companies reached a record $4.43 billion last year, but the factors that make Startup Nation what it is are eroding.

In a recent paper, the Neaman Institute examined the good and bad sides of Israel high-tech and found six areas where Israel needs to improve to maintain its global standing. They are making it easier to start a business, a simpler and more efficient tax system, education, political stability, investment in infrastructure and competition in the domestic market.

“There is no room for complacency in Startup Nation. More and more countries are building their innovative capabilities, and the competition is becoming more difficult,” the Neaman researchers warned.

Israel has fallen sharply in the Global Innovation Index, a measure of a country’s technology abilities published by Cornell University, INSEAD and the World Intellectual Property Organization. In 2011, Israel was in 14th place in the index (among 144 countries). Now it’s 22nd, after falling seven places in 2015 alone.

“Israel enjoys a major reputation as an entrepreneurial and creative country, populated by young people bold enough to form 1,000 or more startups every year. It’s true that, compared to other countries, Israel leads in indexes that reflect innovation,” said Maital, who edited the Neaman report with Tsipy Buchnik.

“If we look only on the bright side we put Israel at risk of losing its potential to remain at the forefront of innovation. It’s like the moon — Israeli innovative capacity also has its dark side,” Maital said.

Maital sees the challenge as not just one of keeping the tech industry alive and well, but a strategic issue as well. Neaman researchers found the technology gap between Israel and countries hostile to it, like Iran and Turkey, is narrowing. “They are improving their performance in innovation measures, especially in areas where Israel is weak today. We need to think of this as part of Israel’s defense effort, just like purchasing weapons.”

Israel’s decline has been due to a decline in innovation outputs, that is products derived from scientific, technological and creative work, such as registration of patents, scientific publications and high-tech exports. Likewise, innovative inputs also suffered a decline. These include investment in infrastructure that encourages innovation, like human capital and research.

“Israel’s big spending in military research and development makes it a leader in overall R&D investment as a percent of GDP, but many other indexes that focus on investment in other areas of innovations — like education and infrastructure — lack the required resources,” the Neaman researchers wrote.

Perhaps the most important area where work is needed to ensure Israel’s innovative capacity is education, where the Global Innovation Index ranked Israel most recently at an embarrassing 51. The index takes into account how much of GDP is spent on schooling, the results of the international PISA exam of student performance and parameters like student-teacher ratios.

“These measures are not good predictors of future high-tech nation of Israel,” the Neaman researchers warned.

Another important shortcoming for Israel is the ease which someone can start a business, for which Israel ranked No. 44. The index looks at factors like the time it takes to register a new business, minimum capital requirements and the ease of obtaining the necessary licenses and permits.

Israel’s biggest obstacle to businesses is its opaque tax system, which receives a humiliating 76th place in the world ranking. “The tax system deters many startups from expanding because the bureaucracy involved in tax payments is difficult and complicated,” the Neaman reports said, saying Israel should look to countries like Canada for guidance.

In terms of infrastructure, Israel ranks an even lower 96th. The Neaman researchers said Israel spends 19% of GDP on fixed assets, what is terms a “disturbingly low” figure that results in poor public transportation, roads and telecommunications networks.

In political stability, Israel is in 118th place. Over the last decade, national elections have been held on average every two years. “This creates upheaval — ministers change frequently as does policy. To thrive, innovation needs stable policy and long-term [policies],” the researchers say.

Meanwhile, the presence of cartels and monopolies — Israel ranks 120th for competitive markets — increases the cost of living and deters entrepreneurs from testing a market already controlled by insiders.

There is a bright side to Startup Nation, too. The Neaman researchers also point to six Israeli strengths in innovation, including business sector R&D, although much of that spending is by multinational R&D centers operating in Israel. Israel has more researchers per million population than any other country and is third in the world for venture capital investment as a percentage of GDP. Israel also excels at cooperation between universities and industry and cross-border collaboration in patents and joint ventures.