Israeli High-tech Faces Uncertain Future Amid Labor Shortage

Chief Scientist’s report finds an industry of thriving startups alongside sluggish mature companies. Too few tech graduates making labor shortage more worrisome.

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On the surface, Israeli high-tech seems to be enjoying the best of times: Record levels of fundraising; a buoyant market for mergers and acquisitions and initial public offerings; and worldwide interest in how to imitate the Israeli innovation model.

But, as the first-ever annual report issued by the Economy Ministry’s Office of the Chief Scientist on Monday showed, there is another side to Startup Nation. The report found that technology is accounting for a smaller and smaller part of the economy, and that its future is clouded by a chronic labor shortage.

“Within Israel high-tech, there are actually two industries differentiated by their characteristics and size, which explains why we are getting contradictory reports on the state of the industry,” said Chief Scientist Avi Hasson. “One part of high-tech is thriving, and another is frozen and even in retreat.”

Last year was a record for Israel’s technology sector, with exits – companies either conducting IPOs or being acquired – reaching $6.9 billion. Startups raised $3.4 billion in new capital – the highest since the eve of the tech bubble in 2000.

But, as the OCS report noted, the share of high-tech in the Israeli economy has been in decline since 2007 – when it peaked at close to 13% – to about 11.5% in 2012 (the latest year for which data are available). Meanwhile, the share of high technology in Israel’s overall exports has remained stuck over the past three years, declining slightly to 42.7% in 2014.

“The ability of Israeli high-tech to serve as a growth engine for the rest of the economy is now a question mark,” the report warns.

The percentage of the workforce employed in high-tech has also been in decline. In 2013 (the latest year for which figures are available), technology employed some 270,000 people – or 8.9% of the national labor force. In 2008, it was 10.7%. “This could be interpreted as due to increased efficiency and greater labor productivity in the industry, but in 2012, two-thirds of all companies reported they suffered a shortage of appropriately trained and skilled workers,” the report noted.

The report estimated that Israeli institutes of higher education were producing some 4,700 graduates every year to engineering and computer science, but that the economy needed about 7,000 new entrants annually. The shortfall exists even though the average starting salary for electrical engineers and computer professionals is over 18,000 shekels ($4,500) a month, 2.5 times the national average.

Looking further down the pipeline, the OCS warned that young Israelis were not pursuing math and science in sufficient numbers. Of 108,000 Israeli high-school students in 2009, only about 11,000 were qualified to take five units of math – the highest – for the math bagrut (matriculation exam). Only 5.6% scored higher than 85, and many of those opted for non-technology professions.

To distinguish between the two segments of high-tech, the OCS on Monday introduced an index it plans to update annually.

The first group is medium-to-large companies, such as Check Point Software technologies and Mellanox, plus research and development centers operated in Israel by giant multinationals like Intel. The OCS dubbed this group “the big ships.”

This segment accounts for most of Israeli high-tech – its five biggest companies account for about a third of the value of the local tech industry. The index of big-tech companies, based on factors like exports, value-added and stock performance, was in decline from 2005 until 2009, when – at the peak of the global recession – it reached about minus-1.1. Since then, however, it has recovered only modestly, to about 0.5 in 2013 – the same as its level in 2008.

The other half of the index is the startup companies Israel is famous for, and whose fortunes rise and fall with shifts in global tech and finance: these were designated “the speed boats.” The OCS noted that some of these companies were turning into bigger, more established firms, pointing to WIX and Outbrain.

After four years of sharp declines through the year 2010 when it reached minus-2, the index showed a sharp recovery in 2011 and 2012, but has been treading water since. In 2014, it was at 1.7.

“The big challenge facing the Israeli economy is to continue ensuring we tend to innovation that drives the speed boats, but not ignore the big ships that carry onboard most of the real activity of the high-tech industry,” the report concluded.