Israel was named one of the most innovative countries in the world in cleantech innovation in a study released Monday, with young Israeli companies leading the world in developing new ideas, methods and products for water reclamation, agricultural development, and energy production. Israel came in second on the first-ever Cleantech Global Innovation Index of 38 countries for its efforts in development and commercialization of environmental technologies, behind Denmark, which topped the study.

Clean technology, also called cleantech, refers to the intersection of business interests and investment with environmentally friendly products and services that use alternative energy sources, water purification methods, and the like.

The study was conducted by the Cleantech Group, which represents thousands of investors and companies in the cleantech industry (the company says it represents companies with $3 trillion in assets), and the World Wildlife Fund. The countries were evaluated on 15 indicators related to the creation and commercialization of cleantech start-ups, companies and ideas, with an index measuring each country’s relative potential to produce entrepreneurial start-up companies and commercialize technology innovations over the next 10 years.

Israel came in second on the index, the report said, because “it leads the pack in its capacity to produce new innovative cleantech companies” — meaning there are more innovative cleantech companies per capita developing new technologies in Israel than in much larger countries like the US, Canada, Germany, France, Japan, and many others (most of the countries listed in the study are OECD members). Two factors kept Israel out of the top spot: Israel’s small domestic market, and a lack of government support for cleantech development.

“Israel places second on the overall index, primarily due to its very high score for evidence of emerging cleantech innovation,” the report said. But Israel comes in second on the index instead of first because “the country lacks a cleantech-supportive government policy.” However, the dearth of state money is somewhat made up by VC activity, with venture funds and angels funding many small, promising projects, the report added.

Israeli companies also lead in patent activity. As an example of Israeli innovation, the report cited a company called TaKaDu, which develops software-based technologies to detect and prevent leaks in commercial water systems (TaKaDu was named Cleantech’s Company of the Year in 2011, and was one of the Wall Street Journal’s top innovation award winners last year as well). “Israel is especially strong in water innovation, driven by the serious water scarcity that affects the region and supported by Mekorot, the highly innovative water utility that regularly partners with local cleantech start-ups,” the report said.

Although Israelis have developed many great ideas, not enough have been implemented at home. “Israel’s success in giving birth to cleantech companies is not matched by its performance on the evidence of commercialized cleantech innovation factor — the country places 14th,” the report said, adding that “this is likely due to the limited domestic market in Israel as well as a scarcity of local expansion capital.” Most of Israel’s ideas are actually being implemented abroad, benefitting the entire world – but not Israelis.

With a little effort, though, Israel could duplicate the experience of Denmark, the top country on the index. “Denmark places first on the overall index, despite a quite average score for general innovation drivers. Denmark’s top score for cleantech drivers is primarily founded on strong government policy and public R&D spending.” Israel, which leads in innovation, should strengthen government cleantech policy, and implement some of its ideas at home, the report adds.