Lavi Project Grounded, High-tech Takes Off

The effort for military self-sufficiency reached its limits in the 1980s,  when Israel tried to develop the Lavi jet fighter. The cost proved beyond the small country’s financial abilities and the project was abandoned. As a result, in the mid-eighties, hundreds of engineers with cutting-edge experience in aerodynamics, avionics, computers and electronics were released onto the private sector. The Lavi project's demise has been described as one of the greatest ever boosts to Israeli high-tech industry. 

Since the Lavi, Israeli defense industries have focused more on components, electronics, avionics and other systems that are installed on American or other platforms. Israel had arranged many reciprocal procurement agreements with leading aerospace and military manufacturers, which help sustain high-tech industries. The development of these auxiliary systems has also given Israeli high-tech industries an edge in civilian spin-offs in security, electronics, computers, software and the burgeoning Internet sectors.

Into space

Israel’s military imperative has not disappeared. Even in the era of the Oslo peace process, Israel keeps a constant guarded stance towards the region. In response to the Iraqi Scuds that hit Tel Aviv in the 1991 Gulf War Israel began development of the Arrow anti-missile missile. The Arrow program began as part of the US SDI (Star Wars) program, requiring considerable advances in electronics, computers and ballistics. The Arrow will soon be ready for operational deployment. In general, the search for better systems in the areas of weapons, intelligence gathering, command and control, translates to space exploration.

In the 1990s, Israel became only the eighth country in the world to develop and launch satellites, beginning with the Amos civilian communications satellite and followed by the Ofek military satellites and the Eros civilian photo-reconnaissance satellite. Israel now partners with NASA, the ESA and the Russian space program, building component and complete satellites for scientific and civilian uses.

In 2002, two of Israel’s six largest industrial companies by turnover were high-tech companies: Israel Aircraft Industries (IAI), Intel Electronics and pharmaceutical company Teva (Nasdaq: TEVA; TASE:TEVA). The largest exporters in terms of sales included high-tech companies Teva, IAI, Intel Electronics, and Vishay Inter-technology (Israel) with over $1 billion in exports each. 

Economic imperative

The economic necessity derives in part from its military counterpart. Israel's defense budget is inadequate for Israel to maintain military advantage. One solution for increasing capital is exporting.

Israel is both a highly successful defense and civilian high-tech exporter.Israel faces a new challenge: the global defense market is shrinking. Civilian applications software, communications, imaging and process control derived from military industries have therefore become increasingly important. For example, the need for better night-vision equipment led to local engineers becoming trained in the field of image processing and the establishment of two trailblazing Israeli high-tech companies: Scitex (Nasdaq: SCIX; TASE:SCIX), and Elscint. Because Israel is such a small market, export is essential for civilian products too, providing a further incentive to maintain technological excellence

, particularly in certain niche markets such as network security, in which CheckPoint (Nasdaq: CHKP) is a world leader; Mercury Interactive Corporation (Nasdaq: MERQ) is a leader in enterprise testing and performance management solutions; Amdocs (NYSE: DOX) is a leader in customer relations management, billing and order management solutions. 

Pharmaceuticals

In the 1990s, pharmaceuticals and medical devices became a growing high-tech sector. Teva has become a leading global generic drug maker, followed by Taro Pharmaceutical Industries (Nasdaq: TARO) and Agis Industries (TASE:AGIS). Medical device company Given Imaging (Nasdaq: GIVN) and biopharmaceutical companies such as Savient Pharmaceuticals (Nasdaq:SVNT) are becoming prominent players, listed on Nasdaq and European bourses.

Liberalization 

Israel has few natural resources. The aspiration of her population for a Western standard of living can only be satisfied through integration into the global market. Israel's transition from a State-dominated, centralized, protectionist economy to a free market means that traditional industries such as textiles are disappearing, losing out to low-cost overseas competition. How far and how fast this transition should go is a matter of debate but there is no doubt that high-tech, in which Israel enjoys a relative advantage, will be a mainstay of Israel's economic future. As Israel’s economy restructures from traditional industries for the local market to export-oriented high-tech, high-tech exports as a percentage of total exports has been steadily increasing, rising from 45% in 1995 to 57% in 2000.

Exports of electronics communications components, electronic components, medical equipment and software and IT products soared to over $13 billion in 2000. Although the onset of the high-tech crisis in late 2000 caused a sharp contraction in exports and production, electronics, communications, monitoring and control equipment and avionics are still key exports. Pharmaceuticals and medical devices and equipment are also becoming increasingly important. High-tech is still the key growth engine for the Israeli economy and a mark of its integration into the global economy.

Foreign Investment

An important aspect of Israel's integration into the world economy has been increasing inward investment, particularly in the high-tech industry. Companies like Cisco Systems, Motorola, Intel, IBM, Nortel, Microsoft, Mitsubishi, Deutsche Telekom and aviation and space companies have recognized that Israel is a pool of high-tech innovation they cannot afford to ignore. They have set up subsidiaries and research centers in Israel, invested in Israeli companies, technology incubators, and venture capital funds or found Israeli strategic partners.

Annual foreign investment in Israel grew from $400 million in 1992, to peak at $5.0 billion in 2000. Foreign investment subsequently contracted, due to the high-tech crisis, the global economic slowdown and political tensions in the Middle East, but is still substantial. Foreign venture capital investment grew, rising from $587 million in 1998 to a peak of $3.1 billion in 2000, before falling to $982 million in 2002, still higher than the level of five years before. Investment by Israeli venture capital funds followed the same pattern: peaking at $1.27 billion in 2000, but totaling only $481 million in 2002, including $62 million in foreign companies. (Sources: MonetyTree and IVC). The Bank of Israel reported that total foreign investment in Israel amounted to $2.6 billion in 2002, including $1.2 billion in direct foreign investment.

Start-up Country

With 3,000 start-ups the Global Competitiveness Report 2000 ranked Israel second, behind only the US, in the number of start-ups and first relative to population. The weight of start-ups for GDP was 3% in 2000, compared with 0.4% in 1997. The comparable figures for the US were 0.3% and 0.1%, respectively. Israel was highly ranked in terms of the number of engineers and education, but poorly in terms of physical infrastructure, a situation the government is trying to remedy.

Israel was ranked second in civilian R&D expenditure as a percentage of GDP, rising from 2.7% in 1994 to 4.2% in 1999. Total R&D expenditure in 2000 was $4.2 billion and NIS 23.9 billion in 2001. State expenditure on civilian R&D has been rising faster than GDP through the 1990s, mostly being invested in high-tech, but also agriculture, manufacturing and biotechnology.

Next Steps

In any discussion of the future of Israeli high-tech, the following points tend to emerge:

• The limiting factor on the sector's growth is a shortage of engineers and managers. Although training programs at universities, colleges and government and industry sponsored retraining courses have been expanding, in addition to attempts to expand the labor pool by tapping Haredi (ultra-orthodox) and other communities, demand continues to outstrip supply, even in the wake of the cutbacks due to the high-tech crisis that emerged mid-2000. Demand to allow the entry of foreign skilled engineers and programmers for the high-tech sector have abated but the issue may re-emerge when the industry recovers and if the Israeli labor pool remains insufficient.

• The industry needs to consolidate through company mergers.

• The government's role needs to be reviewed. Many argue that government support for civilian R&D is not sufficiently discriminating, resulting in financial and human resources becoming too thinly spread.

• Tax reform to ease mergers and acquisitions, better reward employees, and encourage foreign investment. Although progress has been made on these issues, stumbling blocks remain.

• New directions: Biotechnology and medical devices are seen as growing fields. While Israel is well placed to exploit it, with outstanding life sciences and medical research institutions, this will entail a departure from the military-industrial symbiosis which has done so much to sustain high-tech development. Nevertheless, Israel has a number of outstanding and growing start-ups and companies in these areas, including many new listings on Nasdaq and European exchanges. Israel is ranked third in the world in biotechnology start-ups. In 2000 there were 160 biotechnology and 400 medical device companies in Israel, compared with 25 in 1988, employing 4,000 people and generating $800 million in turnover. 20 companies are publicly traded, half in the US and half in Europe. Investment in biotechnology has been growing steadily, reaching a totaled $1.7 billion in 2000, including about $200 million in venture capital. There are 15 life sciences venture capital funds operating in Israel.