Venture capitalist George Gilder wrote this essay for City Journal. I’ve had first-hand experience with Israeli innovation. Gilder is spot on. Excerpt:
(…) My interest in Israeli innovation began in 1998, when I invited an Israeli physicist named David Medved to speak at the Gilder/Forbes Telecosm conference. Medved described the promise of â€œfree-space opticsâ€â€”what most of us call â€œlightâ€â€”for high-end communications among corporate buildings and campuses. He also spoke of air force experiments in Israel that used the still-higher frequencies and shorter waves of ultraviolet light for battlefield communications. Some of the most important explorations of electromagnetic technology, I realized, were happening in Israel.
Nearly a decade later, Medved introduced me to his son Jonathan, a pioneering Israeli venture capitalist. In his offices high over Jerusalem, the younger Medved told me the startling tale of Israelâ€™s rapid rise to worldwide preeminence in high technology. I had long known that Israel held laboratories and design centers for American microchip companies. I knew that, in a real sense, much American technology could reasonably bear the label ISRAEL INSIDE. I was familiar with a few prominent Israeli start-ups, such as the electric-car company launched by Wired cover boy Shai Agassi, which boldly bypassed the entire auto industry in redesigning the automobile from scratch, and Gavriel Iddanâ€™s company Given Imaging, with its digestible camera in a capsule for endoscopies and colonoscopies.
But what I learned in Jerusalem was that Israel was not only a site for research and outsourcing and the occasional conceptual coup, but the emerging world leader, outside the United States, in launching new companies and technologies. This tiny embattled country, smaller than most American states, is outperforming European and Asian Goliaths ten to 100 times larger. In a watershed moment for the country, Israel in 2007 passed Canada as the home of the most foreign companies on the technology-heavy NASDAQ index; it is now launching far more high-tech companies per year than any country in Europe.
To take one example among many, Israel is a prime source not only of free-space optics but also of another form of hidden light: ultra-wideband technology. This technology features wireless transmissions that are not, like cell-phone signals, millions of hertz wide at relatively high power, but billions of hertz wideâ€”gigahertzâ€”at power too low to be detected by ordinary antennas. The technology is typically used for mundane purposes, such as connecting personal computers and televisions wirelessly. But a firm called Camero, in Netanya, Israel, has invented an ingenious ultra-wideband device that enables counterterrorist fighters and police to see through walls and identify armed men and other threats within. An easily portable box about the size and weight of a laptop computer, Cameroâ€™s Xaver 400 could suffuse an urban battlefield with hidden light that would penetrate walls and bunkers and be detectable only by its users. Such inventions are changing the balance of power in urban guerrilla warfare, to the advantage of the civilized and the dismay of the barbarians.
But what changed in Israel that made this possible? Certainly Israel was not reckoned a force for innovation as late as the mid 1980s. Gilder argues that the new Israel gave up its welfare-state mentality:
How to explain this lassitude? For much of Israelâ€™s short history, the country has been a reactionary force, upholding a philosophy of victimization and socialist redistribution that could only impede its progress. In 1957, a team of American economic consultants found that Israelâ€™s â€œhigh labor costs . . . reflected the high degree of job security . . . [and] the absence of adequate incentive to or rewards for superior efficiency or performance.â€ This was partly a result, they added, of â€œvirtually complete protection from foreign competition.â€ Two years later, A. J. Meyer of the Harvard Center for Middle Eastern Studies noted â€œuncertainty in the minds of many [Israeli] industrial producers that theirs is the â€˜goodâ€™ occupation or that society really gives them creditâ€”financially and in statusâ€”for their efforts.â€ He also cited â€œwelfare state concepts [that] often dictate that incompetent workers stay on payrolls.â€
Many of Israelâ€™s Jews, as the writer Midge Decter described them, â€œwere coming into the country armed with their socialism and their ideologies of labor and a Jewish return to the soil.â€ 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! They created communal experimentsâ€”kibbutzimâ€”and put intellectuals to work with hoes and shovels, for all the world like a voluntary version of Chairman Maoâ€™s Cultural Revolution. In a truly menacing dÃ©marche of ideological madness, they attempted to abolish the family and private property.
Panicked, moreover, by the Jewish caricatures and stereotypes wielded by their enemies, they resolved to become mendicant nebbishesâ€”touring the centers of Western money and industry with tin cups in handâ€”rather than bankers and financiers. They assigned close to a third of the economy to the ownership of Histadrut, a socialist workersâ€™ organization prone to threatening nationwide strikes. Under Histadrut pressure, they instituted minimum wages that stifled employment and propelled inflation. Then they imposed more controls on wages, 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. Israelâ€™s taxes rose to a confiscatory 56 percent of total earnings, close to the highest in the world, stifling even those private initiatives that managed to pass through the countryâ€™s sieves of socialism. Erecting barriers of bureaucracy, sentiment, and culture, Israeli leaders balked the entrepreneurs and inventors who gathered there, creating a country inhospitable to Jewish genius.
Gilder says the game changer was the influx of Russians:
The influx of Soviet Jews into Israel represented a 25 percent population increase in ten years, a tsunami of new arrivals that would be equivalent to the entire population of France being accepted into the United States. Largely barred in the USSR from owning land or businesses, many of these Jews had honed their minds into keen instruments of algorithmic science, engineering, and mathematics. Most had wanted to come to America but were diverted to Israel by an agreement between Israel and the United States. Few knew Hebrew or saw a need for it. At best, they were ambivalent Zionists. But many were ferociously smart, fervently anti-Communist, and disdainful of their new countryâ€™s bizarre commitment to a socialist ethos that punished achievement.
But finance was still mired in the socialist past
(…)As the millennium dawned, Israel had failed to create a financial-services industry or to wrest control of much of Israelâ€™s capital from the hands of Histadrut.
The force driving the Israelis decisively out of their socialist slough into the modern world of finance was once again the ingenuity of Netanyahu. (…)
An Israeli supply-sider, Netanyahu faced the adamant opposition of Histadrut and its allies in the Knesset. To overcome the hostility to finance capitalism that had long hobbled the Israeli economy, Netanyahu enlisted vital help from President George W. Bush and his treasury secretary, John Snow. Netanyahu sought a sovereign loan guarantee that would give Israeli bonds the full faith and credit of the United States Treasury, so that despite intifadas and other perils, Israel could issue bonds on the same terms as the worldâ€™s leading economy. Not wanting the U.S. to appear a patsy, Snow refused to do the deal without a significant quid pro quo, stipulating that Netanyahu secure from the Knesset a series of major financial reforms.
First, Histadrut, which dominates the pension system in Israel, had to give up its direct line to the Israeli treasury, which had guaranteed it an inflation-adjusted 6 percent annual yield. This special arrangement would be phased out over a period of 20 years. Starting immediately with the first 5 percent of its holdings, Histadrut would need to begin finding other ways to invest its $300 million per month of cash flow. Somehow a financial industry would have to arise in Israel to handle this huge trove of funds. A second briar-patch reform demanded by Snow was the immediate privatization of Israelâ€™s state-owned industries, reducing the governmentâ€™s stake in these companies from an average of 60 percent ownership to minority ownerships of about 20 percent. Among the privatized ventures were oil refineries, nearly all the banks, the Bezeq telephone monopoly, and the national airline, El Al. The third key reform was the emancipation of the financial-services industry, complete with legalization of investment banks, international private equity funds, and performance fees for hedge funds. Eliminated were double taxes not merely on investments in Israel but also on international investment activities by Israelis. The Netanyahu-Snow agenda went into effect on January 1, 2005.
In under 25 yearsâ€”starting from those first modest tax reforms of the mid-1980sâ€”Israel has accomplished the most overwhelming transformation in the history of economics, from a nondescript laggard in the industrial world to a luminous first. Today, on a per-capita basis, Israel far leads the world in research and technological creativity. Between 1991 and 2000, even before the big reform of 2005, Israelâ€™s annual venture-capital outlays, nearly all private, rose nearly 60-fold, from $58 million to $3.3 billion; companies launched by Israeli venture funds rose from 100 to 800; and Israelâ€™s information-technology revenues rose from $1.6 billion to $12.5 billion. By 1999, Israel ranked second only to the United States in invested private-equity capital as a share of GDP. And it led the world in the share of its growth attributable to high-tech ventures: 70 percent.
(…) By 1999, Israel ranked second only to the United States in invested private-equity capital as a share of GDP. And it led the world in the share of its growth attributable to high-tech ventures: 70 percent.
(…) Venture capital is the most catalytic force in the world economy. In the United States, venture-backed companies produced nearly one-fifth of GDP in 2007.