Why Build a Factory When You Can Build an App?

Education Minister Shay Piron’s efforts to put vocational training back in schools has made Israeli manufacturers happy. Finally, somebody’s talking about real factories that make things and not the dreams of high-tech.

Up until the turn of the 21st century, manufacturers made up the strongest lobby in the country. Prime ministers consulted with them, and their professional association was headed by leading businessmen people like the late founder of Teva Pharmaceutical Industries, Eli Hurvitz, and the founder of textile manufacturer Delta Galil Industries, Dov Lautman.

The economic shifts in the past 13 years - the contraction of manufacturing and concomitant rise of high-tech and financial services, together with increasing globalization and the relaxation of import barriers – have decreased the influence of the Manufacturers Association of Israel. Now we hear from the employers’ organization mainly when the dollar weakens against the shekel or when interest rates rise.

The return to the public agenda of the issue of vocational education offers a good opportunity to discuss the current state of Israeli manufacturing and its potential. We can now go back to talking about important issues like productivity, output and innovation, after more than a decade that was dominated by concepts that are foreign to traditional industry, like startup, exit and options.

Let’s say Piron’s project goes well, and there’s a run of vocational training programs in schools. Let’s say that great technical training schools are built and a modern, prestigious ethos of manufacturing is created. Would that guarantee an Israeli manufacturing renaissance? Will we see a massive return to investing in factories and manufacturing equipment? Or will we perhaps discover that the moving force behind the Israeli economy and Israeli entrepreneurship is something besides manufacturing?

Some will see the discussion about returning to manufacturing as anachronistic, in a world in which production is something that happens in the Far East; they view innovation and sophisticated financial services as the issues that ought to concern developed Western economies. But five years of a serious crisis in Europe and the United States have brought talk of manufacturing and production back into fashion.

Last October the European Commission announced a plan to “reindustrialize” the continent in an effort to cope with the crisis that has hit Europe so hard. The plan aims to “reverse the shrinking role of industry” and increase the share of industrial enterprises from 16% of the gross domestic product of European Union countries to 20% of EU-wide GDP by 2020.

How? By investing in innovation and human capital, opening markets and improving wage conditions and access to funding sources.

Israel is far from being a manufacturing power. The share of manufacturing in GDP is 12.6%, down from 24.6% three decades ago. The decline is due, in part, to the relocation to countries with lower wages and other operating costs of textile plants and other low-skilled manufacturing industries. All this would be fine, if not for the fact not enough other industries have taken their place.

There are three ingredients necessary for high-quality industry: , you need three main elements: financial capital, human capital and intellectual capital (innovative entrepreneurship).

Israel has plenty of financial capital. Tens of billions of shekels in pension funds enter the local capital market each year, looking for the right place to be invested. Sometimes, in the absence of the right place, the money goes to less-right places, such as holding companies, leveraged buyouts and risky real estate ventures around the world. Capital is not Israeli industry’s problem, but yield on capital can be. Manufacturing requires the kind of long-term investment that doesn’t suit speculators or opportunistic investors. In financing for industry, slow and steady wins the race.

Technical training is supposed to take care of the human-capital part of the equation, turning out not only technicians, welders and electricians but also chemists, physicists, engineers and computer programmers. Israeli factories already suffer from a chronic shortage of around 20,000 people in these professions combined.

The failures of vocational education mentioned in last week’s article - being the default option for high-school students with low grades in outlying areas – don’t have to be an obstacle to revamping technical and professional training programs.

Instead of pushing 15-year-olds toward trades that don’t suit them, as a punishment for low grades in academic subjects, create advanced programs for older students that will require more effort and years of study and will give them a high-earning profession in a technological field.

The success of such a program in attracting students depends on choosing occupations that are expected to be in high demand in the future, and that are considered relatively high-status.

And that brings us to the third and most complex component needed for high-quality industry: innovative entrepreneurship. It is clear that Israel is already an innovative and entrepreneurial society, as can be seen in the relatively high number of patents issued and of startups (and successful exits) based here, as well as the accomplishments of the defense industry, the number of Israeli technology companies trading on Nasdaq and the number of Nobel prizes that have been awarded to Israelis.

While the buyouts of Israeli startups have enriched the national treasury - the state records these revenues as “export of software services.” But does this kind of innovation take the economy to a place where it can realize the potential for growth and for industry?

Individual entrepreneurs generally look not at unemployment rates but at their own ideas, and that’s how it should be. The government might be able to help entrepreneurs and use various incentives to guide them to fields that would benefit the country at large, but who says the government knows any better than the market the best place to put that extra money?

If we set aside governmental incentives and look solely at market incentives, we will discover that entrepreneurs, directors and investors need an unusually high yield in order to invest in industry. If we look at high-tech for comparison, we will see that despite a very high rate of failure for startups, the incentive to invest in them is still higher than it is for industry, due to foreign investment (venture capital funds, angel investors), the relatively low initial costs (a few friends and a few computers vs. a factory and production lines) and the relative speed with which it is possible to make an exit. It’s not uncommon for people to build high-tech companies in order to sell them off after a few years. It’s a sprint as opposed to the long-distance marathon of industry.

Let’s look at two examples from the past year. Stef and Eitan Wertheimer’s toolmaking company Iscar was founded in 1952. In 2006, more than half a century later, 80% of it was sold to Warren Buffett for $4 billion. He paid $2 billion a few months ago for the remaining 20%. The other side of the coin is Waze, the Israeli social mapping startup bought by Google for about $1 billion this year, a mere five years after it got off the ground.

It could be argued that each case is different and they can’t be compared, but entrepreneurs and investors alike cannot but help notice the numbers, which favor the sprint over the marathon. Why bother to build a factory, buy machines and find markets abroad if, in a fraction of the time it takes to develop a manufacturing business, you can invent a killer app without even getting your hands dirty?

Even the great saviors of traditional industry – like the risk-capital investment funds that have come to the rescue of quite a few foundering factories – operate in the relatively short time span of a few years, because they also need to show good returns. They bring money, new energy and renovation capabilities to factories, but only rarely do they really bring new possibilities. More often, it all ends with funding rounds and cosmetic changes on the way to liquidation.

All this raises many questions about the possibility of reindustrializing Israel, as the EU is trying to do in Europe. For it to succeed here, it’s not just high-school students who will need reeducation, but also entrepreneurs and individual and institutional investors. They must make sure that graduates will be able to find jobs using the skills they are acquiring. Then again, perhaps manufacturing is not where Israel’s future lies.

On a final note: There are two pressing issues that relate to both vocational training and the potential for Israel’s reindustrialization. The recent discoveries of huge offshore reserves of natural gas open up the possibility of cheap, clean and accessible energy that could be used to fuel heavy industry. The growing push to bring more ultra-Orthodox Jews into the country’s work force, meanwhile, will increase the need for more jobs and more spending on manufacturing capability.

There are interesting opportunities here, along with the concern that if they are missed Haredim will choose fields such as finance or the public sector rather than manufacturing. What is clear is that the issues of technical training and reindustrialization must be evaluated from all sides, and that the decisions must be made soon, and with the cooperation of all concerned parties. Decisions of this size, about the growth engines of the Israeli economy, cannot be left to the education minister alone.