Last to First: Israel’s Economic Miracle

With the history of twentieth-century science and technology largely a saga of Jewish accomplishment, in retrospect it might seem foreordained that after World War II the rising Jewish nation in the Middle East would emerge not only as a financial power but also as a scientific and technological leader.

Yet surprisingly, for all the talk of deserts in bloom, the predictable miracle did not occur. Forty-some years on, Israel by 1990 was still mostly barren of technology and finance.

Apart from military breakthroughs, the scores of thousands of brilliant Jews assembled in Israel generated few significant companies or technologies, no significant financial institutions, and little important science.

U.S. states such as California or New York, Massachusetts or even New Jersey far excelled all the accomplishments of Israeli enterprise. Jews outside Israel far outperformed Jews in Israel.

Writing in 1990, Michael Porter in his famously definitive tome The Competitive Advantage of Nations mentioned Israel only once: “In Israel principal clusters [of innovation] are related to agriculture (crops, fertilizers, irrigation equipment, other specialized equipment and machinery) and defense.”

One measure of the creativity of an economy is its research-and-development activities. In general, public research is far less productive than private research. In its early years, Israel’s research effort was mostly public, devoted to defense, and was paltry by any standard.

As late as 1965, the ratio of research-and-development spending in Israel to its output of gross domestic product was under 1 percent, near the lowest in the entire Organization for Economic Cooperation and Development (OECD).

In the proportion of engineers among all its employees, at one-tenth of 1 percent, Israel ranked far behind the United States and even Sweden (each with between two and three times as many engineers per capita).

In the early years, wars and heavy defense burdens as well as an agrarian Socialist ideology provided an excuse for relatively poor economic and entrepreneurial performance.

As a Jewish country, Israel should have arisen rapidly after the war as a center of Jewish achievement. Instead, its leftist assumptions actually inclined it toward the Soviet model.

A team of American economic consultants in 1957 described a “lack of managerial and supervisory skill lack of experience in many fields and a lack of appreciation of the deficiencies. High labor costs reflected the high degree of job security [and] the absence of adequate incentive to or rewards for superior efficiency or performance. In part, high-wage rates represented an effort on the part of labor to capture an amount of product that the economy simply was not producing.

“The absence of competition was a result in part of the virtually complete protection from foreign competition afforded by import and exchange controls . In part, it was the result of a widespread practice operating ‘cartel’ agreements and other similar arrangements to prevent price and other competition and to restrict production .”

The economists concluded: “In fact, these arrangements reflected the reluctance of the society to penalize inefficiency or to put a premium on aggressive effort.”

Professor A. J. Meyer of the Harvard Center for Middle Eastern Studies in 1959 noted “uncertainty in the minds of many industrial producers [in Israel] that theirs is the ‘good’ occupation or that society really gives them credit – financially and in status – for their efforts.”

He cited “welfare state concepts [that] often dictate that incompetent workers stay on payrolls.” These Jews, as the American sage Midge Decter described them, “were coming into the country armed with their socialism and their ideologies of labor and a Jewish return to the soil.”

Imagine it, urban Socialists trying to reclaim their past glory and save themselves in a hostile world by returning to the soil in a desert.

Fleeing oppression in Europe, they buried their heads deeply into the sands of delusional ideologies. They created fatuous communal experiments called kibbutzim and put intellectuals to work with hoes and shovels for all the world like a voluntary version of Chairman Mao’s Cultural Revolution. In a truly menacing démarche of ideological madness, they attempted to abolish the family and private property.

They toured the centers of Western money and industry with tin cans in hand. They assigned close to a third of the economy to the ownership of Histadrut, a Socialist workers’ organization prone to threatening nationwide strikes, always “helpful” in a nascent and embattled country.

Under Histadrut pressure, they created minimum-wage levels that stifled employment for decades and propelled inflation, as much a phenomenon of depressed productivity as excessive credit, as high as 400 percent for a period of months in the first half of 1984. Then they imposed more controls on wages and prices and rents, making everything scarce.

In a general enthusiasm for public ownership of the means of production and finance, the government through the 1990s owned four major banks, 200 corporations, and much of the land. Stifling any private initiatives that might miss these sieves of socialism, Israel’s taxes rose to a confiscatory 56 percent of total earnings, close to the highest in the world.

Erecting barriers of bureaucracy, sentiment, and culture, Israeli leaders balked the entrepreneurs and inventors who gathered there, creating a country as inhospitable to Jewish genius as any anti-Semite could contrive.

Israel’s redemption came from unexpected directions. In the mid-1980s, Yitzhak Shamir’s Likud government, with Bibi Netanyahu as its Reaganite UN ambassador in New York, deployed tax-rate reductions that, if short of Reaganesque, increased the rewards of work and investment by some 30 percent and dramatically boosted economic growth and reduced inflation.

At least as important to Israel’s technology sector, however, was the fact that beginning in the late 1980s, the country committed itself to absorb close to a million immigrants, chiefly from the former Union of Soviet Socialist Republics (USSR).

Impelled by constant harassment from the U.S. government (which was responding to Senator Henry “Scoop” Jackson’s emancipation amendment attached to any U.S. legislation of interest to the USSR), the Soviet government finally agreed to a frontal lobotomy of its economy. Under Gorbachev, the USSR released the bulk of the Soviet Jews who, despite constant oppression, continued to supply most of the technical skills that kept the Soviet Union afloat.

This influx of Russian Jews into Israel represented a 25-percent population increase over a period of five years, a tsunami of new arrivals tantamount proportionately to the United States accepting the entire population of France. Largely barred in the USSR from owning land or business, many of them had honed their minds into keen instruments of algorithmic science, engineering, and mathematics.

At the same time as the flood of former-Soviet immigrants, a smaller but seminal wave of returnees arrived in Israel from such companies as IBM and Bell Laboratories, with a knowledge of Silicon Valley and an interest in opportunities in Israel. Capping off and capitalizing these catalytic outsiders were a generation of eminent American retirees, either making aliyah in the late 1980s and early 1990s or focusing on Israel after successful careers in U.S. business:

Morry Blumenfeld from General Electric; Ed Mlavsky from Tyco; Alan “Ace” Greenberg who helped raise Israel’s first venture-capital fund; physicist David Medved from Amoco; Yadin Kaufmann and Erel Margalit from U.S. venture-capital firms; biotech pioneer Martin Gerstel from ALZA Corporation; and even an eminent economist, Stanley Fischer from MIT, who became governor of the Bank of Israel.

Collectively these newcomers wielded billions of dollars of available capital, petawatts of imperious brainpower, a practiced disdain for bureaucratic pettifogs, and Olympian confidence in their own judgment and capabilities.

Mix the leadership of these dynamic capitalist retirees finding new birth in Israel with a million restive and insurgent Russians in a tiny Mediterranean land, and the reaction was economically incandescent. Throw in natural leadership from the irrepressible Natan Sharansky, who had faced down confinement in the Gulag and formed a new political party in Israel to mobilize his Russian compatriots, and the impact reverberated through the social and political order as well.

Such an influx could not be clamped or channeled, tapered or intimidated into the existing economic framework. To deal with this overwhelming transformation of the human capital of Israel entailed radical entrepreneurial creativity and initiative. It required a vast ventilation and revamp of the Israeli economy.

This recognition did not come naturally to the Israeli leaders or to the existing population. Labor Party chief Shimon Peres declared: “I’m for the market, but the market does not absorb immigrants. The market is indifferent. Absorption has to be done by people. When you fight a war, the market doesn’t fight. People do.”

The absorption of immigrants, however, is not analogous to a war, which may initially entail mobilization of existing resources and industrial capacity. Immigrants provide a challenge and an opportunity to create new resources and capabilities.

Many of the Russian newcomers commanded elite technical skills and scientific degrees. Such capabilities are best applied to innovation. Planned creativity and innovation are an oxymoron: creativity always comes as a surprise.

Until the early 1990s, Jews could succeed far more readily in the United States than in Israel. The U.S. was far freer and more favorable to creativity and excellence, and thus to Jewish achievement, than the state of Israel itself.

Nonetheless, under the pressure of immigration and the emerging guidance of market-savvy politicians led by Benjamin Netanyahu, Israel accomplished what was the most overwhelming transformation in the history of economics. In a decade, it went from being a nondescript laggard in the industrial world to become a luminous first.

Today, on a per-capita basis, Israel far leads the world in research and technological creativity.

Between the years 1991 and 2000, Israel’s annual venture-capital outlays, almost all private, rose nearly sixtyfold, from $58 million to $3.3 billion. From 100 venture-capitalized start-ups in 1991, Israel’s venture funds launched some 800 companies in 2000. Israel’s revenues in information technology rose from $1.6 billion in 1991 to $12.5 billion in 2000.

By 1999, Israel ranked second only to the United States in invested private equity capital as a share of GDP. With 70 percent of its growth attributable to high-tech ventures, by this measure Israel went in twenty years from last among all industrial countries to lead the world.

To a world transfixed by trillion-dollar bailouts of banker bureaucrats and crony capitalists, these numbers look small. But so it has always been. The same freedom and discipline that endow the seminal entrepreneurs of the era with mere hundreds of thousands or millions of dollars to start the companies that move the economy allow their stockholders and their children to accumulate hundreds of millions and billions.

The same forces and freedoms dictate as well that the resulting fortunes will disappear within a few generations. It is a rigid rule of capitalism that overfunded businesses, like overfunded banks, are disasters waiting to happen, while small sums in the hands of a few exceptional men can yield equally unexpected riches.

While the rest of the world slumped after the millennial telecom and dot-com crash, and Israel suffered an acute recession, Israeli venture capitalists strengthened Israel’s lead in technological enterprise.

During the first five years of the 21^st century, venture-capital outlays in Israel rivaled venture-capital outlays in all of the United States outside California, long the world’s paramount source and sump of entrepreneurial activity in high technology.

In 2006, Israel’s nearly eighty active venture funds raised $1.62 billion compared to $1.2 in 2005. The United States was the only country that raised more venture capital in 2006 than Israel, but in contrast, Israeli investments were at an earlier stage in their start-up development, making eventual returns higher.

Although much of Israel’s capital comes from the hugely greater American venture industry, Israeli companies are rapidly increasing their share.

A 2008 survey of the world’s venture capitalists by Deloitte & Touche, the accounting consultancy, showed that in six key fields – telecom, microchips, software, biopharmaceuticals, medical devices, and clean energy – Israel ranked second only to the United States in technological innovation. Germany, ten times larger, roughly tied Israel.

In 2008, Israel produced 483 venture-backed companies with just over $2 billion invested; Germany produces approximately a hundred venture-backed companies annually. With heavy government subsidies, Germany ranked decisively ahead of Israel in clean energy. In biopharma and medical devices Germany had a small edge in established companies, but Israel commanded some 1,500 biotech ventures, was well ahead in telecom, and clearly ahead also in microchips and software.

These valuations registered absolute performance. Adjusted for its population, Israel ranked massively ahead of all other countries – including the United States.

As it approached the end of the first decade of the new century, Israel was a global center of microchip, telecom, optics, software, biotech, and medical-devices research, the country’s development and entrepreneurship rivaled only by its partners in Silicon Valley.

As one prominent U.S. engineer put it, “When I became VP of business development for ROW (rest of the world), it was obvious that Israel is now the capital of the rest of the world.”