July 16, 2003

Big ideas for small countries

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What country is Ireland’s fastest growing trade partner, our exports to it having increased tenfold over the past decade?

One would logically think Britain, the United States or somewhere in Scandinavia or the EU. Maybe with all this talk about “enlargement” you could be forgiven for concluding Poland or Hungary.

In fact, Ireland’s most dynamic trade partner is Israel. The volume of trade between these countries has increased from £44 million in 1990 to £635 million in 2000. We import as much from the Israelis as we export to them. Some people argue that Ireland and Israel are in direct competition and, as the two fastest growing high-tech growth centres outside the US, are vying to be the second “Silicon Valley”.

When I visited Israel in the mid 90s, a debate was raging about whether or not a small country like Israel should be making itself attractive to American multinationals. In contrast, Ireland’s traditional policy has been to bring multinationals in at all costs.

Senior thinkers in the Israeli establishment did not believe Israel should give tax breaks (in this case for Intel) in order to build a Leixslip-type operation in Jerusalem. The debate continued for a few years until the pro-multi-national side won. Intel’s two biggest operations outside the US are in Israel and in Ireland.

That there was a debate underscored a profound difference between the Israeli and Irish policy makers.

Over the years, the Israeli army’s significant investment in military technology has created a sort of mini-university for the Israeli high-tech industry. The army acts like a conveyor belt, spilling out hundreds of graduates who are trained to use the most sophisticated military hardware and software. These people are the backbone of Israel’s civilian high-tech industry.

Given the presence of so many highly-qualified people, the Israeli establishment argued that to allow a few multinationals to pick and choose the brightest and best would be a monumental waste of resources.

It was argued that Israel would be better off setting up small, domestically-run, start-up companies with government finance. In addition, many couldn’t see why tax breaks were needed as long as the labour was smart and the infrastructure up to date.

Yet the pro-multinational faction won the debate and, copying the Irish model, a ten-year tax holiday was given, with part of the set-up costs being underwritten by the government. The swing factor in support of the multinationals was not the employment argument, rather it was deemed that having the big names operating in Israel would improve the country’s and the sector’s international business image. This improvement in the business climate would make it easier for smaller Israeli companies to attract venture capital finance from abroad.

Around the same time, the government unveiled the second part of its high-tech strategy: “technology greenhouses”. These greenhouses or incubators were set up in every medium-sized town in the country to help young start-up companies get their ideas off the ground. Recognising that the first few years are the most difficult, the government underwrites the initiative and gives technical and financial help to fledgling entrepreneurs so they can get to the stage where they can show their product to investors without having to give away all of the upside.

These greenhouses have been a roaring success, particularly for the immigrants who arrived from Russia in the early 1990s with loads of brains and no cash. Due mainly to the “incubators”, thousands of Israeli high-tech companies have reached second stage financing and many are listed on Nasdaq. Today, there are more Israeli companies listed on Nasdaq than from all the EU countries combined. There are over 2,000 relatively mature high-tech firms and 3,000 start-ups — the highest concentration outside Silicone Valley.

Which approach is best? The Israeli approach of fostering more domestic firms? Or the Irish approach of garnering the best quality multinational investment around?

One of the most successful Irish venture capitalists recently said he intended to make the Irish high-tech sector “more Israeli” meaning more entrepreneurial and, possibly, more financially savvy. However, in many ways Ireland and Israel are not that far from each other. Ireland has cultivated a mix of multinationals and indigenous companies, with many former employees going out on their own and supplying the multinationals.

Arguably, given the volatility of the Nasdaq since 2000, underexposure to the index has been a blessing here. The Israeli entrepreneur has to deal with the day-to-day roller coaster ride on Nasdaq, as well as the cut-throat competition in the real world.

Some key factors will determine which country becomes the second Silicon Valley. The Israelis are way ahead of the posse when it comes to education: 24 per cent of the workforce have university degrees (this rises to 40 per cent of the one million immigrants from the former Soviet Union).

It has the world’s highest proportion of scientists in its workforce (140 per 10,000 compared to Ireland which has 35 per 10,000). Israel spends close to 10 per cent of GDP on education; in Ireland the figure is just over 5 per cent.

In innovation, Israel ranks third in the world (behind the US and Japan) when it come to patents owned per head of population. While Ireland spends just 1.4 per cent of GDP on research and development, Israel spends twice that figure. With 54 per cent of Israeli households using PCs, Israel is up there with Scandinavia in terms of general computer competence.

On the downside for Israel is the Al-Aqsa intifada and Israel’s relationship with its neighbours. Up to now, the financial markets have been surprisingly stable.

At the first sign of trouble, money usually flees a country but the shekel has been strong and it is the Nasdaq rather than Nazareth which continues to exert the dominant influence on Israeli finance.

The international markets have concluded that whatever happens in the West Bank, the State of Israel itself is not threatened. However, having reached $2 billion last year, venture capital investment has slowed significantly and it is unlikely (in the short term, at least) that new and permanent direct investment will be made.

In this environment, a credit squeeze on Israel’s technology sector could be on the cards. Despite all the factors in their favour, development may be retarded because (as an Israeli once said) they “live in a bad neighbourhood”.

Back in the 1980s, due to the war in Lebanon and atrocious economic management, Israel experienced net emigration for the first time in its short history. Should the regional situation deteriorate, this may happen again.

Irrespective of what happens in the Middle East, Ireland should react to the competition from central European countries which would make ideal locations for multinationals exporting into the EU. Ireland must be more sophisticated in both production and innovation.

Perhaps we should mimic the Israelis and take a closer look at these “technology greenhouses”. There’s nothing wrong with imitation, after all that is what made Japan rich.