An Overview of the Israeli Economy: Challenges, Opportunities, and R&D Innovation

1. An Overview of the Israeli Economy Prof. Manuel Trajtenberg • Head of the National Economic Council • The Prime Minister’s Office, Israel • May 2008

2. Background • Economic Policy • Challenges and Opportunities • R&D and Innovation

3. A Brief Economic History – 60 Years of Growth

4. Current Economic Performance – Robust Growth, Low Inflation GDP Growth (% per annum) % Israel Average (4.2%) OECD Average (3.2%) Inflation rate Source: Central Bureau of Statistics and Ministry of Finance Projections

5. The Current Account Current Account Deficit/Surplus as % of GDP Sources: Central Bureau of Statistics and the Bank of Israel

6. Background • Economic Policy • Challenges and Opportunities • R&D and Innovation

7. Fiscal Policy: Government Expenditure & Budget Deficits General Government Expenditure (% of GDP) Government Budget Deficit (% of GDP) Deficit Ceilings Source: Bank of Israel and Ministry of Finance Projections

8. Public Debt as % of GDP % Source: Bank of Israel and Ministry of Finance Projections

9. Tax Burden Average tax rate on personal income Corporate tax rate 2002 2007 2010 Monthly income, NIS, 2007 prices Source: Ministry of Finance

10. Recent Reforms & Privatizations Tax Reforms Pension Fund Reforms Bank Leumi Discount Bank Domestic Government Bonds Reforms Capital Market Reforms Bezeq (telecom corp) Oil Refinery Ashdod & Haifa El Al Israel Airlines, Ltd Investment in Infrastructure Sea Ports Structural Reform ZIM (Israel navigation corp)

11. Background • Economic Policy • Challenges and Opportunities • R&D and Innovation

12. The Snapshot on the Israel’s Challenges • Israel’s highly heterogeneous society, with a tremendous range of different • backgrounds • cultures • religions • Exposed to the rigors of the global economy • Challenged by its geo-political situation

13. In the Global Environment: A massive influx of new players in advanced R&D, challenging Israel’s standing in this field. Geo-political instability. Domestic Issues: A high incidence of poverty, particularly among the ultra-orthodox and the minorities. High inequality – (Gini Index of 0.38). Socio Economic Agenda 2008 – 2010 Main problems and challenges

14. From Challenge to Action: the Current Agenda • Increase employment, reduce poverty. • Reinvigorate the education system, expand and upgrade its pool of human capital • Refocus innovation and R&D in the incipient scientific and technological frontiers • Improve Governance, reduce frictions within its governing bodies • Pursue further structural reforms, investments in infrastructure.

15. Socio Economic Agenda 2008 – 2010 Quantitative Targets and Main Policy Tools Negative Income Tax Innovation in Traditional & Services Sectors • The employment target:“increase the employment rate to the OECD average” (2)The poverty reduction target: “increase the income of the lowest quintile by more than the per capita growth rate. ” From Welfare to Work programs Reduce the Number of Foreign Workers Enhanced enforcement of the Labor Law Ultra-Orthodox and Minorities Targeted Tools

16. Background • Economic Policy • Challenges and Opportunities • R&D and Innovation

17. Background(1970’s): Israel had little resources, but highly skilled manpower, scientific prowess – how to mobilize them for growth? Strategic Decision: Jump-start a “science-based” sector by providing broad financial support, and making up for market failures. Hallmark of policies: “Neutrality”: respond to market demand/signals, do not “pick winners.” Dynamic/Innovative: create new and varied support programs according to evolving needs; avoid “self-perpetuating” programs. Background and Features of Policies

18. Matching grants to commercial R&D projects - criteria: innovativeness, tech and commercial feasibility. “Magnet” Program for support of generic R&D consortia: corporations + academia; longer term, higher support. Examples: Nano Functional Materials, Streaming Media Messaging, Digital Printing. Technological “Incubators” Program: from innovative ideas to start-ups. “Yozma” Program 1993-97: Jump-started the Venture Capital Industry – success, hence discontinued Main R&D-Support Programs in Israel

19. ICT growth since 1990: ~ 15% per year ~ 4,000 high tech companies, most of them start-ups. 2nd largest VC market after the US The most foreign IPO’s in Nasdaq World’s fourth in US patents per capita Major innovations: ICQ, disk-on-key, Centrino chip, advanced firewalls, GPS software, Pill-camera, etc.; R&D/GDP= 4.6%(world highest) Silicon Miracles from the Holy Land:Highlights of Israel’s High Tech Sector

20. Entrepreneurship, Israeli style High-quality human capital, technical skills Government support for commercial R&D. Venture Capital, local and US-based Very open economy, strong ties with the global main players The Ingredients of Israel’s “Silicon Miracle”

21. Wide disparity between thriving High Tech and rest of the economy: HighT grew 5 times as fast! Low productivity of non-tradables, non-ICT sectors – a “dual economy”. Rising socio-economic inequality, in part consequence of dual economy: concern in itself, and narrowing future pool of human capital. But Israel’s Silicon miracle not for all

22. Innovations mainly for exports, some spillovers internal, but benefits realized mostly abroad. not much “Wal-Mart effect” in Israel 2. Gov. supports mostly product rather than process innovations; hence little R&D in traditional industries, services. 3. VC-backed startups: must exit, mostly by selling off to US-based corporations – who benefits? Israel: powerhouse in generating innovations, but not quite in benefiting from them. Why? Innovate here, benefit elsewhere…

23. Cannot have economy-wide growth by relying just on one fast-growing sector (ICT), Need to encourage and channel innovativeness also to non-High Tech sectors 2. Cannot have sustained growth with widening socio-economic gaps : Need policies of inclusion, of expanding the pool of human capital. Some lessons from the Israeli experience