6/19/18 Israel's Economy Soars- Leaves Challenges in its Wake

People who have not visited Tel Aviv in a number of years would hardly recognize the place. The number of skyscrapers going up in a city that a mere 40 years ago prided itself on having the single tallest building between India and Italy (the Shalom Towers that stood at 34-stories), is hard to visualize. Last week, a new 100-story tower has just been approved for construction. Furthermore, the number of commercial towers planned for completion over the course of the next few years will double the commercial space available in Tel Aviv.

All of this tremendous expansion is being fueled by an economy that has been growing rapidly. This week, the Israeli Central Bureau of Statistics revised the reported growth of the Israeli economy for the first quarter of 2018 upward to 4.5%. They revised the reported growth numbers upward for the last quarter of 2018, to a 4.5% annualized rate, as well. Israel is a member of the OECD, where the average rate of economic growth in 2017 was 2.5%. The growth rate of the economy in the United States last year was 2.3%.  

Last week, Prime Minister Netanyahu proudly announced that Israel’s per capita GDP (i.e., GDP divided by the population) had risen to $42,115 — ranking Israel 24th in the world for the per capita GDP, ahead of Japan and right behind the United Kingdom. In comparison, it should be noted that the US per capita GDP stands at $62,15, and the US ranks 9th. To understand the relative meaning of this growth, it should be mentioned that Israel’s GDP stood at $11,264 in 1990, while the US GDP stood at $23,954.

Israel’s economic expansion has been fueled by its rapid high-tech growth, incorporating both startups and other tech companies. 112 Israeli companies were purchased last year, for a total of $23 billion — this includes the massive purchase of Mobileye by Intel for $15.3 billion. To fill the other side of the ledger, $5.24 billion was invested into Israeli startups last year, up 9% from the year before. According to the OECD, Israel maintains the highest rate of investment from Venture Capital relative to GNP in the world, which currently stands at .38%; the second is the US with .34%. The average in the OECD is .05%.  

In addition to the success of the start-up sector, an added factor has been fueling Israeli growth, which is the actions of tech multinationals who have invested widely in Israel. Some landed in Israel due to acquisitions. Others, such as Intel, established its first R&D office in 1974. More than four decades later, Intel employs over 10,000 workers in Israel and has recently announced plans to invest an additional $6 billion in its semiconductor plant if Kiryat Gat. IBM began doing R&D with the Technion in 1972. Today, those initial tech companies have been joined by Google, Apple, Facebook, and now Amazon, who together with another 350 companies, all do R&D in Israel.   

According to Alon Ben-Tzur, CEO of Binat Communications, Israel’s high-tech sector did not suddenly develop, but rather, “It began to take off in the 1980s, thanks to Israel’s defense needs and the realization that to meet the needs of the Intelligence Corps, the Air Force, and other arms of the military, the country would have to invest in civilian technology companies.”

However, all of Israel’s present-day successes do not come without their own sets of challenges. With both multinationals and startups competing for the same talent pool, Israel’s high-tech industry is facing a severe labor shortage, Ben-Tzur asserts: “The shortage of labor is the single biggest obstacle to the continued growth of the country’s economy.”

The solution to the labor shortage has so far remained mostly elusive. Most of the top talent for the high-tech industry either come out of the technical unit of the Israeli Army or from the handful of Israeli universities with high-level computer science departments (often these graduates overlap). There are many programs underway to increase the pool of candidates for high-tech positions, including efforts to boost computer training in the Arab-Israeli and Ultra-Orthodox sectors. 

Efforts in the Arab-Israeli sector have yielded some encouraging results — though, with some of the best performing schools in the country being in that sector, combined with the large number of Israeli Arabs who attend Israeli universities, that favorable outcome is not a surprise. 

The Takwin Fund was created to invest in promising start-ups in the Arab-Israeli sector and to date, the fund has invested in eight startups. According to the fund’s CEO and managing partner Itzik Frid, 

“I counted last week and we have 12 Ph.D.s among our companies and 4 professors. Most of them and the majority of our technologies originated from the Technion. We are mainly invested in Nano-technology and deep algorithm research.”

 Despite some of the successes, more and more Israeli companies are looking overseas to Ukraine, Poland, and other places to find competent tech workers. At a recent tech conference I attended, it seemed that every second person I bumped into was from Eastern Europe looking to get subcontracting work.

The other challenge caused by Israel’s tremendous economic success has been the creation of two parallel economies. Salaries in the high-tech world are approximately twice that of average Israeli salaries. Housing is very expensive in Israel’s major cities — similar to the situation in the United States — unlike the US the cost of housing in peripheral cities in Israel also remains very high, (a problem the government has been unsuccessfully trying to address for the last seven years). The skyrocketing cost of housing has made the purchase of a home unaffordable for many in Israel. This together with large differentials in income is a major challenge.  Israel once had one of the smallest income gaps in the world. Today, the income disparity in Israel is one of the highest in the world, with only the US and Mexico having higher wealth disparities among the OECD.

In addition, Israel carries a sizable military burden, which remains one of the highest in the world — standing at $1,981 per person in the country. While Israel’s overall economy has grown so that the military budget has dropped from 8.9% of the GDP to 4.7% today — the burden per person has not changed, and with the possibility of war ever present, that onus is not expected to change any time soon.

Finally, it is impossible to accurately portray Israel’s economy, without writing about the other great disparity — i.e. the West Bank and Palestinian territories (located 30 miles from downtown Tel Aviv), where the per capita income in 2016 was under $2,000, (less than 5% of Israel’s per capita income). Finding a path to the elusive peace between Israel and Palestinians will also require finding a way to decrease this enormous gap in income.  

Despite all of the aforementioned successes, standing in Tel Aviv watching the skyline transform almost daily, there is a certain air of uncertainty. A fear that it might not be real, that it could all disappear. 

Could war break out with Gaza again? What about the very real fear of war with Iran that includes Hezbollah and their 100,000 missiles? Will Israel’s vaunted missile defense system be able to shoot down enough of those missiles so Tel Aviv would not be severely damaged?

What about BDS? Until now it has had no significant impact, but who knows what might happen in the future?

Tel Aviv’s nickname is “Silicon Wadi”. However, unlike Silicon Valley in California or Silicon Alley in New York, Israelis do not worry about “Amber Alert” notifications (kidnappings are almost unheard of here), but rather, “Red Alerts” for incoming missiles. And while American politics is far from settled at the moment, employees at Google, sitting in Palo Alto are unlikely to need to take off 30 days for military reserve duty or to be called for reserve duty at a moment’s notice.  

Ben-Tzur correctly stated that much of the origins of Israeli high-tech innovation came from Israel’s defense needs. However, as long as those defense needs remain front-and-center, and peace remains elusive, the Israeli economy will continue to confront challenges that no other high-tech center faces.