A new reality

By the end of the twentieth century, Israel was second only to Canada in the number of companies traded on the NASDAQ and second to none in the number of startup companies per capita. The companies that were established and operated within Israel attracted more venture capital dollar per capita than in any other country in the world (and they were third in the world in absolute terms). Venture capital was drawn to invest in these new technologies, new ideas, and new applications that were being created at a rate of over 50 new companies per day. Israel was nicknamed “the land of milk and start-ups” (The Economist), “The Startup Nation” (Dan Senor and Saul Singer), and “Silicon Wadi” (playing on the Arabic word for valley).

The rise of Israeli technology companies and their participation on the global stage was a result of unique characteristics and events that took place in the twenty years that preceded the turn of the century. As I have been describing, the massive immigration that followed the fall of the Soviet Union expanded the country’s population by over twenty percent within a less than a five-year period. The immigrants that came to Israel were highly skilled, exceptionally educated, and eager to succeed in their new country. A series of government initiatives encouraged the US venture capital industry to expand their operations within the country. A newly liberated telecom industry, with massive military investment behind it, led to the development of cutting edge technologies and applications. And a series of trade agreements allowed Israeli companies to compete in US and European markets. All of these events and government policies helped to develop and shape Israeli industry in a unique way. Today, Israel technology has become the gold standard for innovation and excellence in the fields of communication, software, and security. The characteristics of today’s Israeli economy, its innovative solutions, its reliance on Intellectual Property (IP) creations, and its entrepreneurial and global reach is very much the result of these events and the environment in which Israeli companies and its people grew up and operate in.

Today, Israel technology has become the gold standard for innovation and excellence in the fields of communication, software, and security

While Israel transformed into the “Startup Nation,” other economies developed in different ways. During the 1990s, India underwent a series of reforms and investments in infrastructure. Although still considered lacking in the development of electricity, water, roads, and rail infrastructure, all of these areas were heavily invested in. During the Internet bubble that led up to 2000, heavy investments in undersea fiber optic cables connected Asia to the rest of the world. The fall that followed the economic boom resulted in the auction of cheap fiber optic cables at one-tenth of their original price, which in turn led to widely available low-cost communications infrastructure. All of these investments and events, not to mention a swell of available talent, resulted in India becoming almost overnight the center for outsourcing. The country began to host everything from call centers to basic R&D activities, and during the decade that followed, the Indian economy grew at admirable two-digit rates. Yet the engines of the Indian economy geared down after some time. Investments in infrastructure there have declined, reforms have stopped, and red-tape-bureaucracy has returned. High inflation combined with a new shortage of talent has resulted in a salary hike that reduced the country’s main source of competitive advantage. Ten years later, foreign direct investments are halved (as of 2011) and the country’s GDP growth rate has dropped by thirty percent (1990–2000 compared to 2000–2010).

Like India, the engines that drove Israeli economic growth could not work forever and could not increase their overall output. Despite continuing startup activity, Israel has yet to produce the giants of Silicon Valley. Companies on the scale of Apple, Google, Cisco, AMD, and Intel have not emerged from the Israeli Silicon Wadi, nor have companies half their size. Israel has also not been able to duplicate the success of its communication and security sectors in other industries and sectors. Despite investments in biotechnology, nanotechnology, and other industries, there has yet to emerge an industry with the same success characteristics as the ones that drove the Israeli success of the late 1990s.

Most countries around the world would trade for Israel’s economic structure, innovation, and entrepreneurial spirit in a heartbeat. Yet not being able to reproduce its success across industries and not being able to transform companies into large, sustainable ones has taken a heavy economic toll. Small companies may have a reputation for being quicker to react to events and more innovative, but this reputation has little basis in reality and no economic data to support it. By comparison, large companies generally enjoy higher productivity and create more IP. They enjoy ‘economy of scale’ and for that reason are able to produce more products per dollar spent. In Europe, manufacturing companies with 250 or more workers are 30–40% more productive (per employee) than ‘micro’ firms with fewer than ten employees. Size also creates more room for innovation. Large companies that have developed a collaborative environment are able to encourage innovation, which generally emerges at the intersections of functions and disciplines. In addition large companies that sustain innovative cultures provide their employees more resources to try out new things and are also more tolerant of failures, which is another big part of innovation. Innovation is not about one great idea, but rather lots of bad ideas to experiment with and learn from. Big companies are able to commit to the investments that are necessary for innovation and to go through processes of trial-and-error. Big companies are able to tackle big problems. It is easier for an engineer at a large multinational to devote himself completely to a problem when he isn’t also being asked to help fix the CEO’s computer. In addition to being more productive and innovative, large companies offer better wages and create more jobs. The opposite notion that startup companies create more jobs has little statistical support. While it is true that a new company creates new jobs, mostly because it didn’t exist before, statistical data show that, after one year, larger companies create more jobs and at a faster rate than smaller ones.

The demographic characteristics of a nation’s businesses are of utmost important for its economy. The recent financial crisis has demonstrated that economies based on small and micro businesses are less resilient to external shocks. In countries such as Greece, Spain, Portugal, and Ireland, the lack of resilience of these companies created a domino effect that has led to a long and painful recovery.

Despite this economic data, policymakers worldwide have developed a fixation on small companies. Today a large part of policymakers’ initiatives are geared toward supporting such companies. The lesson from the last two decades of economic downturn is that what matters most is economic growth, regardless of size. Growth matters because it enables resilience in the event of economic shock.

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The direction in which an economy is headed, and the economic characteristics of a country depend mostly on its government and the stature of its political leaders. One of the major problems with the capitalist system is that politicians often have a hard time finding their places within it. Although we are now living in different times, a large part of the political leadership that is active today was raised under President Reagan’s notion of the role of government and business. As he put it, “The nine most terrifying words in the English language are: ‘I’m from the government and I’m here to help’ (August 12, 1986).” Political leaders brought up in such an environment may find it hard to understand their proper role in government.

Regardless of one’s political position, most should agree to the notion that governments should develop, adjust, monitor, and re-develop the frameworks that set the environment for other players to develop and prosper

Regardless of one’s political position, most should agree to the notion that governments should develop, adjust, monitor, and re-develop the frameworks that set the environment for other players (e.g., for-profit organizations) to develop and prosper. They should interfere at times, and they should intervene when things are getting out of control. However, the focus of their actions should be on the boundaries and conditions that would best allow economic players to access what they need. They should adjust the environment to best suit the players within their borders, and monitor the climate in order to understand where and when investments are needed and to re-develop new frameworks, hopefully before the old ones become irrelevant and crises emerge. All of this work should be carried out with one aim in mind — improving citizens’ quality of life.

The reason both the Indian and the Israeli economies slowed is because the policies that originally nourished these economies, the policies that allowed them to evolve, did not evolve with the systems that they created. These economies changed both because of their own internal growth and because of external factors and challenges that they faced. Looking forward, policies that support growth should focus on providing businesses with tools that will allow companies within their sphere to operate, innovate, and compete in an ever-evolving and ever-changing world.

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Uri Goldberg (photo credit: courtesy)

Uri Goldberg (photo credit: courtesy)

Uri Goldberg is a management expert, specializing in serving governments and corporations on strategy, innovations and economic development issues. He worked with McKinsey& Co., where he directed key consulting projects for Fortune 500 companies as well as governments in Asia, Europe and the Middle East. His analytical pieces have been presented and reviewed at the World Economic Forum.

Uri also served as foreign policy aide to Israeli President Shimon Peres in his former capacity as vice prime minister.

He currently resides in Tel-Aviv, Israel.

What’s Next for the Startup Nation? by Uri Goldberg: Order now from Amazon