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DE RUEHTV #0653/01 0781347
ZNR UUUUU ZZH
R 191347Z MAR 09
FM AMEMBASSY TEL AVIV
TO RUEHC/SECSTATE WASHDC 1033
INFO RUCPDOC/USDOC WASHINGTON DC
RHEBAAA/DOE WASHDC
RUEHSS/OECD POSTS COLLECTIVE
RUEAIIA/CIA WASHDC
RUEHJM/AMCONSUL JERUSALEM 1685
RUEHAM/AMEMBASSY AMMAN 5675

UNCLAS TEL AVIV 000653 
 
SENSITIVE BUT UNCLASSIFIED 
SIPDIS 
 
DEPT FOR OES/STC, NEA/IPA and EEB/OIA 
USDOC FOR FCS - Wiegler and Loustaunau 
DOE FOR EERE - Chalk 
AMMAN FOR ESTH-Bhalla 
 
E.O. 12958: N/A 
TAGS: TSPL EINV ECON ENRG PINR IS
SUBJECT: Israel's Technology Sector: The Future at Risk 
 
------------------------ 
Introduction and Summary 
------------------------ 
¶1. (U) Israel's economy was fundamentally altered by the rise of a 
robust high-technology innovation sector over the past twenty years. 
 The key factors contributing to its formation were strong national 
intellectual capital resources, state-supported innovation programs 
in the defense and non-defense sectors that generated tangible and 
intangible spin-offs, and an abundance of private sector capital 
resources (much of it foreign) speculating on Israeli ingenuity 
under pressure.  The technology innovation sector now accounts for 
20 percent of industrial output, directly engages over 10 percent of 
the workforce, and is responsible for a large share of economic 
growth.  GOI ability to cultivate high-tech innovation growth and 
broaden it to other sectors was due to an effective national science 
policy, strong government investment in education, and fortuitous 
circumstances.  Israel's economic future is now intertwined with the 
health of this major component of the economy, but is increasingly 
at risk from an eroding education system, underinvestment in 
intellectual capital, and growing competition from lower-cost R&D 
centers.  Given the long lead-time education investments take to 
yield results, Israel's next government faces critical decisions 
with pivotal long-term consequences.  End Summary. 
 
------------------------ 
The Data and the History 
------------------------ 
¶2. (U) Israel's success in the global high technology innovation 
market is remarkable: After companies based in the United States and 
Canada, Israel has more NASDAQ-listed companies than any other 
country.  Israeli developers pioneered the technology that led to 
the internet, and several Israeli companies (Amdoxs, Comverse, 
Checkpoint) have become global names in their fields.  Many major 
high-tech corporations (Motorola, IBM, Phillips, Cisco, 
Microsoft...) have big R&D divisions based in Israel. Intel employs 
over 6,400 Israelis at its research center in Israel, one of only 
three such centers worldwide.  The technology innovation sector 
counting software, computer and IT components today accounts for 20 
percent of industrial output, directly engages over 10 percent of 
the workforce, and is responsible of a large share of Israel's 
economic growth.  High-tech industry exported $15 billion in 
products and services in 2006, accounting for nearly half of all 
export earnings.  Israel records the fourth greatest number of 
patents per capita in the world, and claims to have the world's 
highest percentage of broad-band internet connection per population 
(30%).  An analysis of global innovation centers in the Harvard 
Business Review of March 2009 ranked Israel third in the world, 
trailing only the US and Finland. 
 
¶3. (U) The country's success in high technology, including 
microelectronics, bioengineering, software development, and 
telecommunications, is more assumed than analyzed.  However, its 
advent was far from accidental.  Until the 1990s Israel's economy 
relied on agricultural exports, the diamond industry, and a small 
but growing arms and defense equipment export sector for revenue. 
These were heavily supplemented by a tourism industry - subject to 
the vagaries of regional political tensions - and direct assistance 
from the USG and the global Jewish diaspora through Israeli bonds 
and other investment vehicles.  During the 1990s, the advent of 
subcontracts to export civilian technology products forced companies 
to offer shares to the public in order to raise the funds for 
expanding production -- first in the small Tel Aviv capital market 
and later in New York.  This drew the attention of emerging market 
specialists, who recognized the potential of the country as a 
civilian technology producer. 
 
4 (U) What allowed Israel to make the transition from military 
technology innovation to civilian high-tech R&D was a fortunate 
combination of extraordinary intellectual capital resources, and a 
business culture that rewarded success against daring odds and did 
not punish failure.  This fostered an entrepreneurial culture that, 
according to a 2008 OECD study, has become a principal factor in 
Israel's innovation economy.  A 2007 global competitiveness survey 
ranked Israel first in terms of new business start-ups. 
 
A Well-Tuned Science Policy 
--------------------------- 
¶5. (U) The key ingredient that helped combine the intellectual 
resources and entrepreneurial business culture was a strong 
government science policy.  This was composed of (1) heavy 
investment in the country's human capital, particularly during the 
mandatory military service of both men and women, (2) facilitating 
the spin-off of ideas and highly-trained personnel from the military 
into the civilian sector and academia, and (3) using 
publicly-supported incubators and other mechanisms to channel 
venture capital to innovative applications, resulting in a very high 
rate of business start-ups. 
 
¶6. (U) Israel's intellectual capital derives from both official 
structures and cultural tradition.  Academic study has long been an 
esteemed Jewish cultural value, and Jewish history is filled with 
icons of learning.  Some attribute it to the minority status which 
often led to the persecution of Jews in diaspora society for 2000 
years - intellectual property, unlike physical property could never 
be confiscated by expulsion or edict.  Referring to themselves as 
"the people of the Book", Jewish tradition honors scholarship and 
the learned professions.  This high cultural value placed on study 
provided a good foundation for a knowledge-based economy.  Even 
before the state was created in 1948, Jews returning to British-held 
Palestine had made the country's educational institutions a 
priority, founding Hebrew University in 1918, with Albert Einstein 
delivering its first science lecture. Recognizing a dearth of civil 
engineers and architects to design and build a modern country, in 
1923 the Technion-Israel Institute of Technology was also founded by 
early Zionist leaders. 
 
Human Capital Paramount 
----------------------- 
¶7. (U) Government investment in the country's intellectual capital 
continues to play a critical role.  Israelis place a high priority 
on education, which as a sector accounts for 10 percent of GDP. 
Education is one of the key responsibilities of the government, 
taking about 9 percent share of Israel's domestic budget, some 28 
Billion NIS in 2008.  Israeli secondary and tertiary education 
received enormous investments from 1960 through 1990, as the country 
built four new universities, to supplement the four existing ones, 
and expanded its capacity to meet the demands of a doubling 
population.  Today, Israel has the third highest tertiary education 
attainment ratio in the world, after Norway and Canada. 
Significantly, nearly a quarter of all Israeli graduates are in the 
fields of science and engineering. 
 
¶8. (U) Government investment in intellectual capital is strikingly 
demonstrated in Israel's military training programs.  GOI military 
service is one of the unifying elements of Israeli society.  Between 
the ages of 18 and 22, men and women are expected to serve in the 
military (men for three years, women for two), and may remain on 
reserve duty for up to 20 years thereafter.  It is an equalizer in 
society, obliging both rich and poor, native-born and immigrant, to 
serve the state - the major exceptions being the ultra-orthodox 
Jewish sector, which is now under increasing pressure to serve, and 
the Arab sector, which is also being pressed to perform some type of 
national service.  Although it imposes a common obligation on 
Israelis, the GOI does not treat all recruits identically, using the 
opportunity to troll for the most academically talented youth and 
channel them into selective training programs. 
 
¶9. (U) The Talpiyot program is the most elite of these, selecting 50 
recruits per year for intensive three-year training in physics, 
computers and other sciences with an eye to cultivating tech-savvy 
 
officers for the Israeli military.  The graduates then serve six 
years in the military, not in combat but rather in roles tailored to 
meet the technological challenge of improving the Israel Defense 
Force's (IDF) effectiveness.  Spurred by the shock of heavy losses 
in the October 1973 Yom Kippur War, the Talpiyot program was 
established with the recognition that each IDF soldier must be equal 
to seven of the enemy if the country is going to meet the challenges 
presented by its more numerous enemies.  Since its creation thirty 
years ago, graduates of this program have contributed to Israeli 
security through innovations such as improved propulsion systems, 
better missile guidance systems, life-saving technologies such as 
drone aircraft and stronger vehicle construction.  Beyond Talpiyot, 
the IDF also offers a more general university education option to 
IDF soldiers in exchange for an extended service commitment, and 
offers an impressive array of technical training programs to 
cultivate the skills it needs to win wars, from piloting fighter 
aircraft to repairing engines to designing advanced 
telecommunications systems. 
 
¶10. (U) Although its primary mission was to create a techno-savvy 
future officer corps, the Talpiyot program's inadvertent secondary 
effect has been to feed a stream of high-powered engineers and 
innovators to the private sector.  After finishing military service, 
Talpiyot graduates are snapped up by technology firms.  Of the 
nerly 600 graduates over the life of the program, onl 25 have 
stayed in the IDF to attain its highestranks, while most move into 
commercial R&D and fund companies working on new technology.  These 
irms benefit from both the personnel and the ideasthey bring with 
them.  Anecdotal evidence points o a high percent of Israeli 
high-tech corporatios counting Talpiyot grads among their 
leadership  An added benefit is the Talpiyot alumni connection, 
that encourages communication and cross-fertilization of hatching 
ideas among young companies, avoiding the stove-piping that hinders 
creative problems solving. 
 
Channeling Capital Resources 
---------------------------- 
¶11. (U) A second key method through which GOI science policy fosters 
innovation is facilitating the spin-off of ideas from military and 
academia into the commercial world.  The government supports a 
series of incubator programs that help individuals with ideas 
develop them further into commercially viable applications. 
Principal among these is a program run by the Office of the Chief 
Scientist (OCS) of the Ministry of Industry, Trade and Labor, though 
other ministries have their own Chief Scientist offices with smaller 
research support budgets.  Since 1991 the Trade and Industry OCS has 
funded technological incubators in Information and Communication 
Technology, life sciences, medical devices, water technology, and 
clean-tech that support fledgling entrepreneurs trying to turn 
innovative ideas into exportable commercial products and viable 
business ventures.  These incubators provide physical premises, 
financial resources and professional and business guidance during 
the initial and most risk-prone phase of a start-up's business 
cycle.  The OCS claims that after a year or two with state support, 
over 60 percent of the 11,000 projects it has assisted have 
successfully attracted private investment, and 55 percent of 
assisted projects were still active in R&D three years after 
"graduating."  About 200 projects are currently in the program, 
which yields about 80 new start-up companies annually.  Over the 
life of the program the OCS has cumulatively invested over $500 
million, but has leveraged nearly $2.2 billion in private sector 
funds for these companies. 
 
¶12. (U) To fully draw on the potential from its investment in 
tertiary education, the GOI also encourages universities to assist 
their professoriate in converting new knowledge into marketable 
products.  This assistance usually takes the form of a separate 
company, with the university as the unique shareholder, which offers 
incubator-type assistance to the institution's researchers, both 
professors and students.  This assistance may include financial 
assistance, equity investment, and guidance on patent and copyright 
issues and business strategy.  These companies, such as Hebrew 
University's Yissum, Technion's Yazamut, Tel Aviv's Ramot, and the 
Weizmann Institution's Pamot, operate independently of their parent 
university, but channel their financial proceeds to the 
institutions.  Hebrew University claims such returns now account for 
about 10 percent of its R&D investment budget, and many of Israel's 
tertiary education institutions hope the licensing rights, 
inventions, and equity investments from their professors' and 
students' research will help cover the budget shortfalls of the 
future. 
 
¶13. (U) Leveraging the private sector's resources through initial 
public offerings evolved as another facet of official science 
policy.  In 1992, to help structure the emerging private venture 
capital market in Israel, the GOI created the Yozma Venture Capital 
Fund.  Yozma (which is Hebrew for "initiative") was the tool for 
organizing and expanding the first stages of Israel's young venture 
capital market.  One of Yozma's major purposes was to encourage 
local and foreign multinational investors to join forces in 
financing  young, high risk Israeli firms. These early venture 
capital investments combined financial means with post-military 
Talpiyot talent, and resulted in companies such as Elbit Vision 
Systems-EVS (Elron), Gilat Satellites (AAV), Logal (Veritas), and 
Mercury Interactive (Athena).  Cultivating and channeling capital to 
promising start-up companies was undertaken as a national policy, 
recognizing that fully utilizing Israel's intellectual capital can 
generate the exports, jobs and income of the future. 
 
¶14. (U) Between government investment, investments by Israeli 
venture capital firms, and existing private sector R&D budgets, 
Israel records the world's highest R&D intensity at 4.65 percent of 
GDP, over twice the OECD average of 2.26 percent. According to the 
2008 OECD Science, Technology and Industry Outlook, Israeli private 
sector R&D at 3.64 percent of GDP also outpaces all OECD countries. 
 
 
A Future at Risk 
---------------- 
¶15. (SBU) Despite its present image of strength, Israel's high-tech 
sector faces considerable challenges in maintaining its position in 
the future.  The education budget has been cut in recent years, both 
in nominal and relative terms, due to the need to rein in government 
expenditures.  This has aggravated a system already under strain, 
with the large impact on primary and secondary education visible in 
standardized test scores.  In the 1960s Israeli students scored 
among the top in the world in science and mathematics testing; in 
2006 Israeli pupils ranked 39th and 40th out of 57 countries in math 
and science.  Israeli middle and high school teachers were on strike 
for about two months in 2007 over working conditions and pay; they 
earn half of the average OECD teacher's pay, and have over 30 
students per class.  So many teachers have left the profession that 
the GOI, trying to capitalize on the global high-tech downturn, 
signed up 1,000 unemployed engineers for a course of study to turn 
them into science and math teachers.  Estimates of the need for new 
teachers to fill gaps and replace retirees in coming years range up 
to 10,000.  Critics say the Education Ministry is a dysfunctional 
bureaucracy grossly inefficient at utilizing its massive budget; 
ironically this led to further budget cuts by the Knesset, rather 
than a serious attempt to fix the administrative problems. The 
persistent under-investment in basic education may have long-term 
ramifications on the country's competitiveness. 
 
¶16. (SBU) Universities have also not been spared budget cuts, which 
have significantly reduced faculty size at most universities. 
Academic sources say one-third of all Israeli doctoral-level 
professors have chosen to teach abroad rather than accept the low 
salaries paid by the government-funded universities in Israel.  In 
2007-8 university professors and instructors went on strike for 
three months to protest low salaries and cuts in government support. 
 Tighter budgets also have resulted in less prepared entering 
students.  Without a stream of top-notch students from secondary 
schools, universities fear that scholastic standards will fall, and 
the brainpower to fuel Israel's high-tech economy into the future 
will not be there. 
 
¶17. (SBU) Another bad omen is a marginal drop in national R&D 
spending.  OCS support for R&D was cut back in 2007 and 2008. 
University R&D investment dropped almost 2 percent across 2006 and 
2007, as GOI funding for universities was cut back in the quest for 
a balanced national budget.  The global economic recession also has 
severely impacted donor contributions to and the endowments of 
Israeli universities, and struck simultaneously with the substantial 
damage to Jewish philanthropy caused by the Bernard Madoff scandal. 
The Technion, for example, lost $25 million directly, and the 
American Technion Society (its alumni and benefactor arm) lost $72 
million.  Because government support for the universities covers 
only faculty salaries and overhead, most research and capital 
construction costs must be covered by corporate and alumni 
donations.  As a consequence, numerous academic investment projects 
are being delayed or cancelled. 
 
¶18. (U) Coincident with the self-inflicted blows to its long-term 
innovative capacity, Israel faces the new and immediate challenge of 
growing foreign competition from new research centers in the 
developing world.  The capacity of India, China, and Brazil dwarfs 
that of Israel; over 800,000 engineers finished university in India 
and China in 2007, compared to only 8,000 in Israel.  The ability of 
competitors to throw huge numbers of developers into a project poses 
a daunting challenge to Israel.  Even smaller competitors like 
Singapore and Ireland are a threat, with their assured access to 
larger regional markets (China and the EU respectively), while 
Israel remains a virtual island.  Just as the global economic center 
of production may be shifting toward Asia, so Israeli analysts say 
the globe's R&D capacity may be shifting away from the West. 
Employment costs, a key component, may be half as high in Asia as in 
Israel.  Israelis also fear the strengthening of Israel's currency, 
the shekel, which in 2007-8 strengthened by 22 percent before 
falling back, and caused high-tech exporters a reported $690 million 
in lost orders during that period. 
 
¶19. (SBU) Although the new government of prime minister-designate 
Benjamin Netanyahu may not be able to control the international 
competition the country faces, it will need to acknowledge and act 
on the great pressures building up in Israel to fix an 
under-performing education system and promote national R&D 
competence.  Netanyahu's reputation as a serious financial manager - 
a legacy of what is widely considered to be his successful term as 
Finance Minister earlier in this decade -- may help him recognize 
the value of long-term investment in human capital and the 
short-term importance of pro-investor tax incentives to encourage 
competitiveness.  Without serious attention to strengthening 
Israel's commitment to science education and investment, the 
country's future as a locus of diverse high-technology innovation 
will be endangered. 
 
Cunningham