Israel’s Office of the Chief Scientist has been called the “killer app” of Israel’s startup ecosystem. A new report sheds light on what it does
There are many answers to the question of what makes a startup ecosystem innovative. Is it density? Education? Availability of capital? One of the most contentious issues is whether government has a role to play in nurturing startup ecosystems beyond offering favorable tax incentives and getting out of the way.
In Israel, the government has played a far larger role than that, chiefly through the Office of the Chief Scientist, which uses its annual budget of $450 million to offer up to 85 percent of seed funding for close to 200 incubated companies a year as well as support massive R&D projects from larger companies. Startup Nation co-author Saul Singer calls the OCS the “killer app” of Israel’s startup scene, but others have said that the most successful companies are started with private capital anyway. Chief Scientist Avi Hasson for his part argues that the OCS addresses market failure – companies or projects that are beneficial to the economy in the long term but might not get off the ground without a little push.
Now the Office of the Chief Scientist has published its first annual Innovation Report. Unlike other innovation reports, say the Bloomberg Global Innovation Index, it does not cover sexy topics like startup rankings or explain the sources of creative genius. Instead, the report points to a number of market failures that require robust public intervention, and being a government document, is somewhat verbose. Here are some of the nuggets worth your attention.
2014 was a banner year
According to the report, 2014 was a peak year for Israeli hi-tech. About 700 Israeli companies raised $3.4 billion in venture capital funding, the highest amount of any year ever. Even Israel’s venture capital firms raised over $900 million.
There were 100 exits at a total valuation of $7 billon. Eighty-two companies were sold and 17 went public. The most prominent among these was Mobileye, which went public at a valuation of $1.02 billion, and Viber, which sold for $900 million.
But lest you become too sanguine, the Chief Scientist warns of some worrying bigger picture trends. From 2004-2007, there was an annual average growth of 13.2 percent in hi-tech production. But from 2007-2011, the growth rate was only 4 percent. Similarly, in 2013, the total number of people employed in hi-tech was 269,800, which is 8.9 percent of the workforce. But in 2008, they had comprised 10.7 percent.
The report claims that Israel’s hi-tech industry is actually two industries. There is the startup sector, which is thriving, and then there are mid- to large-size hi-tech companies, which are stagnating. The OCS says that its job is to provide incentives for startups to exit less quickly so they can grow into mid-size or large companies that employ more people.
Not enough engineers
Israel is suffering from a dearth of engineers and computer programmers. This was confirmed in the 2012 report by Professor Eugene Kandel, says the OCS. The average salary in hi-tech is 2.5 times higher than in the rest of the country, and the median salary for someone with a computer science degree is 23,739 shekels per month, a lofty sum indicating its high demand.
Meanwhile the number of high school graduates in a position to enter the field lags behind. In 2009, out of 118,000 18-year-olds, only 11,000 took mathematics at the highest level (5 yechidot). Only 6,600 of them passed with a grade over 85. In other words, only 5.6 percent of this age cohort is sufficiently skilled in mathematics to constitute a future possible work force in hi-tech. Of these, not all go into STEM subjects. The number of students who actually obtain degrees in electrical engineering, electronic engineering, software engineering, computer science and physics is 4,671 students per year. At the same time, there are 7,000 new jobs created each year in hi-tech.
The OCS suggests several possible solutions, including programs for outstanding Arab and haredi students (two populations that tend not to study STEM subjects at a high level) as well as encouraging educated Israelis living abroad to return to Israel.
Bringing back the brains
In 2010, the Israeli government created a program to try to bring back educated Israelis from abroad. In a 2011 study, there were 22,000 Israelis with academic degrees living abroad — that’s 3.6 percent of Israelis who have earned degrees since 1985. Even though this percentage is high, it is similar to that of similar sized countries like Finland and Ireland. In the same study, there were 2,500 doctors and PhDs living abroad — 9.4 percent of Israelis with those degrees.
Despite panicked media accounts of a brain drain, the report says the number of educated Israelis living abroad has not increased, but is stable. People with exact science degrees are more than twice as likely to stay abroad for more than three years than people with humanities degrees.
Life sciences and market failure
There are 1,100 life science companies in Israel compared to 200 at the end of the 1990s. Forty new companies are launched each year and within a few years, about a third of these companies achieve profitability. Life science companies are a pillar of Israeli exports, explains the report, but they constitute a market failure that requires government intervention. That’s because these products take a lot longer to develop than software products. As a result, financing them is high-risk. The government provides funds to help these medical devices market themselves, and provides funding for life sciences incubators as well as applied academic research.
Life science exports comprise 17.5 percent of all exports. In 2014, there was $8.5 billion worth of exports, a 4 percent rise over the previous year. This includes biotechnology, nanotechnology, new medicines, tiny medical devices for minimally invasive procedures, imaging devices, robotics, diagnosing and monitoring with mobile and cloud platforms, and medical software that combines computation and medicine. Medical devices are the most prominent aspect of the life sciences industry, representing two-thirds of the activity. In addition, blockbuster drugs developed in Israel have achieved tens of billions of dollars in sales.
Most of these exports are to Europe and the U.S., but the Israel Export Institute wants to expose its life sciences industry to markets like India, China, Brazil and Turkey as well as developed markets like Japan and South Korea. It’s important to note that there are a lot of obstacles involved in exporting Israeli life science products to east Asia, including translating medical content, a different business culture, and the fear that patents could be violated. The OCS recommends acquiring a local partner familiar with the market, regulations, competition, and prices.
Let’s get digital
Outside the hi-tech sector, most Israeli industry is inefficient and unproductive. As the Economist put it, “24 major conglomerates control nearly a quarter of the country’s 596 listed companies and more than two-thirds of the total market capitalisation of those firms. These groups have various vices, including high debt, poor focus and pyramid-style ownership structures that allow a handful of people at the top to control a large number of subordinate companies. Predictably, growth of their earnings per share has been dismal: 2% on average in the case of companies listed on the Tel Aviv Stock Exchange.”
The Office of the Chief Scientist is leading a program supporting R&D in traditional industries and has invested NIS 1.5 billion in these industries in the past few years. In particular, the OCS is helping 1,000 businesses in Israel’s south create e-commerce platforms as well as providing courses to SMBs on Internet marketing and helping them create websites for mobile.
In addition, the Office of the Chief Scientist is cooperating with Digital Israel, the bureau in charge of modernizing public services, which is beginning to lay down a fiber optic cable network in Israel, allowing homes and business to connect to the Internet at a speed of 1000 mbps. The chief scientist is also providing funding for companies that make public sector services, like education, healthcare, and public service, more efficient.
Ultimately, the report makes a strong case that no startup ecosystem is an island and that government policies affect the business scene in ways we are not even aware of. Considering the most innovative countries, including Israel, South Korea and Finland, have high levels of public expenditure in R&D, government intervention shouldn’t read as a dirty phrase in developing a robust startup scene.
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