Despite minimal progress in the Middle East peace process, Israel has succeeded over the past 15 years in making itself an attractive suitor for growing U.S. high-tech firms. By offering substantial government subsidies, Israel has lured many foreign companies, most recently 3Com, Cisco Systems, Computer Associates, Hewlett-Packard, Rockwell International, Analog Devices, and LSI Logic, to establish R&D and design centers in the country's own version of Silicon Valley--a 60-mile-long strip of land stretching from Tel Aviv through Herzliyya to Netanya and winding up in the port city of Haifa.
The foreign aid campsBy most measures, the subsidies have produced greater-than-expected results: foreign investment grew from $366 million in 1991 to top the $2 billion mark in 1995, according to the World Markets Research Center, and the technology industry in Israel is now booming, consisting of about 1,200 local and international companies, reports the Office of the Chief Scientist in the Ministry of Industry and Trade. That figure represents a fivefold increase over the last 15 years. But although the Israeli government certainly doesn't want to turn away additional foreign investment, some of the country's high-tech industry leaders now oppose the policy of subsidizing foreign high-tech companies. While critics agree the policy was successful in stimulating the development of a technology industry, they say it is now strong enough to grow on its own and that the subsidies are actually stifling local startups. Government funds, they argue, should be reallocated toward helping local companies establish roots in the increasingly competitive market.
Israel is perhaps the only geographical region that has created anything close to a Silicon Valley replica. Of the technology businesses in Israel, 800 are locally based private companies and 100 are traded on foreign stock exchanges. Many of these companies have achieved notable success in the United States. VocalTec, for example, an Internet telephony company, went public on Nasdaq (VOCLF) in February 1996 at $19. Its stock price has since dropped to $13, but the company reported revenues of $3.4 million for the second quarter of this year, an increase of 87 percent over the same quarter of the previous year. In June 1996, Check Point Software Technologies, a developer of enterprise firewalls, went public (Nasdaq: CHKPF) at an offering price of $14. The stock now trades at $23.75, and, at $17.3 million, the company's second-quarter revenues are up 134.6 percent from the same quarter the previous year. In August the Israeli government recognized Check Point with the Prime Minister's Award for Computer Software. And Finjan Software, the only company making security software designed to preapprove Internet executables, recently established a U.S. subsidiary and made our list of the top 100 technology companies (see "That's Good Java").
Still, Efi Arazi, the founder of Scitex and Electronics for Imaging--digital printing companies that went public in 1983 (Nasdaq: SCIXF) and 1992 (Nasdaq: EFII), respectively--and one of the most successful technology pioneers in Israel, says the policy of subsidizing foreign companies is crippling the continued growth of the Israeli market. "Foreign R&D centers offer no added value or economic benefit to the country and only make the shortage of engineers worse," he says. Yehoshua Gleitman, a former chief scientist of the Industry and Trade Ministry, agrees, repeating that foreign companies should not receive support from the Office of the Chief Scientist because it is the primary dispenser of government subsidies to early-stage Israeli startups.
A 38 percent carrotIsrael's Ministry of Industry and Trade began inviting American businesses to establish R&D centers and manufacturing facilities in Israel in the early '80s. At that time, the government correctly assumed that if it lured a core group of major microelectronics companies to Israel, the country's fledgling high-tech industry could develop a dependable backbone and achieve international credibility. The policy made foreign high-tech companies eligible for government grants covering 38 percent of the cost of new R&D facilities.Intel, IBM, KLA, Motorola, and National Semiconductor bucked prevailing perceptions--that Israel was embroiled in a warlike situation and thus not suitable for investment--and set up chip design centers in Tel Aviv, Jerusalem, and Haifa. Today, Israel is home to more offshore R&D centers of U.S. high-tech companies than any other country.
The debate over Israel's high-tech policy stems from the 1994 request by Intel for $450 million over a ten-year period to build a semiconductor fab. Intel's Israeli plant is scheduled to be thefirst outside the United States capable of making microprocessors with lines as small as 0.25 micron. The plans also are unusual in that most foreign high-tech firms in Israel limit their operations to R&D. Intel says it plans to begin manufacturing microprocessors in Israel in the second half of 1998 and to start making flash memory chips six months later (although nothing in the company's agreement with the Israeli government obligates it to do so).
In late 1996, when the Israeli business press revealed exactly how much the deal was going to cost Israeli taxpayers, an outcry arose. The industry and trade minister at the time, Micha Harish, countered that the huge grant to Intel would benefit the country's technological infrastructure by creating spin-offs and bringing Israel new microelectronics technology, which it desperately needed.
Subsidies begin at homeIn May of this year, Israel's state comptroller, Miriam Ben-Porat, released a report lambasting the government's decision to allocate funds to Intel. "The plant is due to cost Israel between $202 million and $231 million to build, according to conservative estimates," Ms. Ben-Porat wrote. "Intel stands to gain at least $1.12 billion to $1.32 billion from the plant.It is not clear what Israel will gain other than additional jobs."
The Intel deal prompted an onslaught of subsidy requests from other companies, among them Motorola, which announced plans for a $1 billion facility. Intel's and Motorola's requests alone would have eaten up almost $800 million, or 75 percent of the entire 1996 budget for industrial subsidies, and yet Motorola's request is still under consideration.
Critics of the foreign subsidy policy also allege that companies have learned to abuse it. Although no fraud has been documented, some locals have accused grant recipients of deliberately inflating investment projections, so that Israel's grant ultimately accounts for much more than 38 percent of the final investment.
Barry Chamish, a correspondent in Israel for several European and U.S. high-tech trade publications,contends that the Israeli technology industry has dire needs that the subsidies simply cannot remedy: specifically, more engineers and more sophisticated marketing and management techniques. "The state of Israeli high tech would be much better off," he says, "if the government allocated the money for subsidies to the establishment of a first-class business school so that Israelis could study computers and learn about business in a combined degree."
In the past few years, the booming local high-tech industry and the stampede of foreign firms hiring Israeli computer experts have caused a huge inflation in salaries. Experienced software and hardware engineers are earning $50,000 to $60,000 a year, compared with the $35,000 that a top-level project head was paid in 1992. At the recent annual conference of the Israel Manufacturers Association, Industry and Trade Minister Natan Sharansky said that studies by his ministry predict a shortfall of 7,000 engineers by the year 2000 unless radical measures for recruiting and training are implemented immediately. By the turn of the century, he estimates, some 29,000 graduate-trained engineers will be needed to staff Israeli companies.
"Israeli startups are having a difficult time hiring qualified personnel because of the extreme rise in the cost of computer engineers in the last few years," says Amir Friedman, general manager of Connect One Messaging Solutions, a startup that develops Internet connectivity productsfor OEM distribution. "Startups like our company can't afford the high cost of training that foreign firms can provide," Mr. Friedman complains. "So we are unable to hire the most qualified people, and, as a result, we experience delays in our development schedules."
Indeed, recent figures indicate that the labor shortage may be taking a toll on the Israeli economy. According to Dun & Bradstreet, the growth rate of Israeli high-tech companies dropped 6 percent in 1996, from 32 percent to 26 percent. The survey cited high interest rates and the engineer shortage as chief reasons for the slowdown.
High-tech carpetbaggersAnother shortcoming of the subsidy policy is that many foreign companies do not go on to set up manufacturing plants after their R&D facilities because other countries offer lower labor costs. "Israel should reconsider the benefits it gives to foreign companies, since international firms that establish local R&D centers do not create a significant number of jobs or generate sizable proceeds for the local economy," says Giora Yaron, former managing director of National Semiconductor's Israeli R&D center. "For every dollar a U.S. high-tech company invests in a local R&D center, it generates $10 elsewhere. These companies end up removing their assets as well as the intellectual property created by Israeli engineers."
The history of new manufacturing facilities in Israel supports Mr. Yaron's argument: Intel's proposed fab would be the first new one in nearly ten years. But Shahar Meidan, foreign investment consultant for the Ministry of Industry and Trade, disagrees, saying that R&D centers are the beginning of the road, not the end, for foreign companies in Israel. "No one is going to come and set up a semiconductor plant out of the blue," he says. "It all starts with R&D."
Clearly, subsidies are at least partly responsible for the present high-tech boom in Israel. But the government's venture capital initiative--which provided financing for 40 percent, or a maximum of $8 million, of the cost of raising a VC fund--was also instrumental. Today there are reportedly 35 VC funds in Israel, with at least $1 billion under management, up from just a single fund in 1992. The program was discontinued recently because the government decided there was no longer any need to subsidize the industry.
Many local high-tech activists wish the government would do the same with foreign subsidies. With the growth of VC funds and of the high-tech industry itself, critics feel that the policy of aiding multinationals to build the industry has run its course.
Joel Bainerman is a freelance writer living in Israel. Write to him at isratech@netvision.net.il.