Where’s the Israeli Government When Startup Nation Needs It?

Israel’s research and development was once globally admired. Now it is frayed and tired.

Israel may have earned a global reputation as the startup nation, but it hasn’t developed the formula for harnessing the country’s high-tech success to power the rest of the economy. The industry has not generated the jobs or any of the other knock-on effects that government had hoped it would when it embarked on a strategy starting three decades ago to develop a knowledge-based economy. Indeed, many of the policies they put into place in the 1980s and 1990s, which helped spur the growth of thousands of startups, are now looking dated and dysfunctional.

Perhaps the signal failure of the government’s technology policy is the low level of government support for research and development.

On the one hand, Israel leads the world in the percentage of gross domestic product spent on civilian R&D: 4.34% in 2009, far exceeding high-tech powerhouses like Finland (3.88%), the United States (2.9%) and Taiwan (2.9%). But Israel's government funding of R&D is the lowest in the developed world. The state provides just over 10% of all R&D funding, while close to half is paid for by foreign companies operating R&D centers in the country.

Moreover, the government has been drastically reducing its civilian R&D spending since Benjamin Netanyahu introduced his fiscal stability program as finance minister in 2003. Critics say what it does spend is misdirected.

The heart of Israeli government R&D funding is the Office of the Chief Scientist, a unit of what is now called the Economy Ministry. It was created under the Law to Encourage Industrial Research and Development in 1984, a time when the term “startup company” didn’t exist and Israel didn’t have a single venture capital fund.

As chief scientist for the past three years, Avi Hasson is quite aware of the limitations of his office and the drawbacks of the current law. One of the main problems, he says, is the limited tools at his disposal when it comes to finding financial solutions to offer companies.

“Programs that were put into effect here 20 years ago are being studied today in government textbooks – the Yozma program, the technology incubators, the Magnet program,” says Hasson. “In many ways we, as a country and government, were world leaders in everything connected to R&D policy and innovation. Today, governments around the world are using a variety of support tools for the high-tech industry, such as holding equity and providing loans. In this regard, we’re behind.”

Hasson say the situation is now critical. “Excellent projects don’t receive funding nowadays,” he says. “We can see an effect of despair on entrepreneurs and they are no longer submitting their plans.”

The Finance Ministry’s budget division is aware of the problem. With the help of consultants from Ernst & Young, treasury officials are considering ways to change the R&D law and equip the chief scientist with more effective tools. They understand that the problems afflicting high-tech can’t be solved solely through the programs run by the Chief Scientist's Office, which are limited to extending grants to companies in exchange for royalties.

One of the main charges leveled at the Office of the Chief Scientist is that it has become a refuge for second-rate companies seeking capital. Had they been deserving, critics say, they would have managed to secure investment from venture capital funds or other private-sector sources.

But Hasson, a venture capitalist himself, insists there are key differences between the kinds of projects that receive funding from his office as opposed to those that get VC financing.

“Our profile for returns is very different,” he explains, pointing to a failed effort to develop an Israeli modular smartphone called Modu.

“Dov Moran’s Modu, for example, isn’t a good investment for a VC fund – they lost the whole investment," says Hasson. "For the government, it’s an excellent investment because the spillover effect into the economy was substantial.”

Hasson says he examines additional parameters that aren’t relevant to a VC fund, such as job creation, exports and the effect on the country’s balance of payments.

“In contrast with the [VC] funds, when a professional examiner comes to our investment committee and says the project is very risky, we actually get excited,” he says. “Our job is to participate in the risk because one of the things I’m trying to create is additional investments. Our studies show that each shekel we invest attracts an investment of a shekel and a half from the private market.”

Hasson would like to see his office run programs that would enable the government to become a shareholder in companies it supports. That would entitle the state to profits in the case of an exit and would encourage additional investors. But it would also require a mechanism to avoid turning the startup into a government corporation, which would hinder it in further rounds of fund-raising. One way to do this is by establishing a fund that invests in VC funds, a fund of funds.

In Hasson’s view the current government presents an opportunity for a change. He points out that Economy Minister Naftali Bennett comes from the world of high-tech and understands its importance as a growth engine for the economy.

Hasson wants the ability to quickly initiate new support programs in industry without waiting for legislative changes, as his office must currently do. Each change requires a drawn-out legislative process. He would also like to promote a plan to establish accelerators and launch entrepreneurship programs.

He doesn’t think increasing the budget for his office necessarily means the treasury needs to allocate more money to the Economy Ministry. “External budgets could be harnessed through targeted programs and activities,” he suggests. “It could be money coming from financial institutions, multinational companies, or crowdfunding.”

However, it isn’t at all certain that the Office of the Chief Scientist, at least if it continues to be structured the way it is now, is the best method to promote economic objectives.

“My only advantage is that I’m very aware of the needs and opportunities,” says Hasson regarding the possibility of setting up a government agency to control all aspects of high-tech activity. “The chief scientist is the natural candidate, since he does most of the activity in this field and holds the knowledge at every level - for example, in concentrating the handling of the 'digital Israel' plan or innovation in the government sector. Israel’s high-tech could benefit from something like this.”

Other opinions are being voiced elsewhere. In the treasury, for instance, there is talk about the value of several bodies promoting innovation in industry, but they say that all the activity would need to be structurally coordinated and that this would only be possible if the government formulates a uniform, long-term policy.

Roy Keidar, former CEO of the Reut Institute policy group, opposes having the Chief Scientist's Office serve as the only agency entrusted with innovation.

“The chief scientist shouldn’t determine which fields of the economy have potential and which ones don’t,” says Keidar. “The chief scientist’s investment policy should take into account other capabilities required by the economy to strengthen it in world markets.”

Keidar notes that in recent years the Chief Scientist’s Office has seen its budget shrink, causing it to allocate 85% of the support to competitive R&D tracks, meaning product development. On the other hand, spending on long-term generic R&D, which the private sector won’t finance, is immeasurably small. The Chief Scientist's Office can’t be blamed for this policy, but it means that spending on basic R&D, which is the future of Israeli innovation and the infrastructure on which the high-tech industry can thrive, is shrinking.

“To give a serious push to Israel high-tech, the Chief Scientist's Office needs to play a greater role in setting the direction for the economy,” says Keidar.”It must take chances wherever the private sector won’t, serving as a platform for cooperation between the business and academic sectors, in infrastructure research on major global technological trends, and generating joint ventures.”

“One of the proposed steps is examining the possibility for increased funding through regulatory breaks for investments by financial institutions,” says Keidar.

Tomer Appelbaum