Is the State of Israel worthy of its description as “the startup nation”? The initial answer is surely “yes” – Israel is a world leader in terms of the number and quality of its startups. However, another question arises: is Israel the Startup Nation or is it just the Tel Aviv metropolitan area that can justifiably make this claim, and not the country as a whole?

This chapter seeks to examine this question – not only with regard to startup companies, but also in regard to the entire Israeli innovation system. It will propose a practical agenda with a dual goal: optimal use of the innovation resources that exist beyond the Tel Aviv metropolis for the benefit of the Israeli innovation system, and innovation-inclined economic growth throughout the country. We believe in a plan of action that will benefit both the Israeli innovation system Tel Aviv and the areas in the eographical periphery. However, this requires implementable solutions that consider the market forces acting on national innovation systems, that are adapted for each individual region. For example, an attempt to duplicate Rothschild Boulevard’s high- tech activity in the Galilee or the negev may fail, or worse, come at the expense of successful practical solutions better suited to these areas.

Geographical Specialization in Israel and its Ramifications

When examining the geographical distribution of the various economic sectors in Israel, we must distinguish between results that are the consequence of economic forces at work in Israel and wishful thinking. The premise we must accept is that high-tech companies tend to concentrate in certain geographical areas, frequently in urban metropolises. The most prominent example of this is San Francisco although other centers such as London, Beijing and Berlin have followed suit in recent years. This phenomenon has many advantages, both for the companies themselves and for the regional economy. The companies inspire each other with technological knowledge, exchange skilled human capital, and attract investors. The trend has grown over the past decade, for reasons that include increasing technological complexity necessitating greater collaboration, and because of the increasing attraction of workers to vibrant urban areas. ¹Katz, B. and Wagner, J. (2014). The Rise of Innovation Districts: A New Geography of Innovation in AmericaIn practice, today, more than 50% of venture capital investment in the world is concentrated in only ten urban metropolises.²Florida, R. (Oct 3, 2017). Venture Capital Remains Highly Concentrated in Just Few Cities. Citylab   

The other side of the coin is that the area in which they are concentrated benefits from accelerated growth and high-quality employment. As these regions develop, they become a powerful magnet, attracting most of the “talent”, investors and entrepreneurs. While they serve as an economic growth engines, attracting innovation resources may harm the potential growth and quality employment in other areas. This dynamic can also have negative ramifications for the national economy by potentially increasing disparities and leading to an under-utilization of skilled workers who, for various reasons, are unable to work in these centers.

similar “centralization” trend in high-tech also exists in Israel: more than 60% of all high- tech jobs in Israel are located in the Tel Aviv and central regions, and as Diagram no. 1 illustrates, approximately 77% of the companies operate in this area. Diagram no. 2 reveals that this trend has even intensified in recent years with the growth in high-tech employment in Tel Aviv constituting approximately 70% of the total increase in this sector in Israel.³CBS Data, Labor Force Survey, High-tech sectors excluding communications sector

Source: Startup nation Central and CBS Data, Personnel Survey (excluding the communication sector)

As mentioned above, this trend is not surprising. Access to skilled human capital is decisive for high-tech companies and they therefore tend to locate themselves at the center of innovation activity. Other considerations, such as the high cost of office space in city centers are of only secondary importance for them, because of the relatively small office space required per employee. This is in contrast to other sectors such as manufacturing and agriculture that generally require large space, occasionally even far from population centers.
It is not surprising therefore that approximately half the jobs in mass manufacturing industries and about 80% of all farmed agricultural land is located in the north and south of Israel.⁴CBS Data, Annual Yearbook 2017, Table 20.12, excluding high-tech, and the Ministry of Agriculture & Rural Development, Agricultural and Rural Planning Policy Paper (2015) The high availability and low cost of land in these areas lead to specialization in mass manufacturing, agriculture and food, and as will be presented below, we believe that these advantages should be leveraged and strengthened by connecting them to Israel’s advanced innovation system.

Although the geographical distribution described here is based on economic logic and relative regional advantages, it creates several economic and social challenges for the Israeli economy. The first of these challenges is a significant productivity disparity between the country’s periphery and center that is reflected in salaries which are approximately 35% lower than the average in central Israel.⁵National Insurance Institute Data. Only a small part of this disparity is offset by lower living costs in the periphery – according to National Economic Council analysis, expenses in the periphery are lower by approx. 300-1000 shekels per month than expenses in central Israel , ⁶The National Economic Council in the Prime Minister’s Office, 2018. Towards 2040 – A Metropolitan View of Economic Development 32% of this disparity can be explained by the difference between the different sectors i.e., by the fact that the high-tech sectors, which are concentrated in the center of the country, are characterized by high productivity compared to the average in developed countries, whereas the mass manufacturing and agriculture sectors, concentrated in the periphery, are typified by lower productivity.

A further challenge arises in light of the shortage of skilled high-tech workers. As we mentioned in the “High-Tech in Israel 2018” chapter, there are an estimated 15,000 unfilled jobs in the high- tech industry. Due to the concentration of high-tech in the center of the country, skilled workers living in the periphery have lower access to high-tech employment. Consequently, the Israeli high-tech industry fails to fully utilize the human capital potential in the periphery.⁷It should be pointed out that this estimation relies on the assumption that there are people living in the periphery with high-tech skills who fail to find quality employment in the field – an assumption that still requires empirical confirmation. An indication to this appears later in this chapter        

A Strategy for an Innovation-driven Economy in the Periphery

The challenges described above lie at the foundation of a strategy formulated by the Innovation Authority that is aimed at promoting an innovation-inclined economy in the periphery areas and serve as a clear guiding light for the Authority: a successful policy is beneficial, both for the local economy in the periphery, and the innovation system as a whole. 

This policy was not created in a vacuum. For years, the Chief Scientist’s Bureau in the Ministry of Economy, from which the Innovation Authority was born, endeavored in a number of ways, to promote technological innovation in the periphery. Firstly, companies from all sectors located in the periphery8 received increased grants. Secondly, as part of the Technological Incubators Program, incubators operated, and still operate today, in a range of peripheral areas. Furthermore, large high-tech companies that established development centers in the periphery received special benefits. Approximately a third of the Authority’s annual grants budget was allocated in recent years to R&D activity in the periphery – a total of about half a billion shekels ($140 million) a year.

The need to formulate an updated and comprehensive strategy for innovation in the periphery arose from the very outset of the Innovation Authority’s operation. The Knesset, with the legislation that founded the Authority, placed explicit emphasis on promoting technological innovation in the periphery as one of the Authority’s central policy objectives.⁸The Encouragement of Industrial Research and Development Law, 5744-1984, Clause 1 Accordingly, throughout 2018, we conducted an in-depth examination of policy alternatives for promoting technological innovation in the periphery regions, while considering prior experience in Israel, in other countries, and a current situation report. In addition, we conducted a comprehensive field study among a range of relevant local entities: local authorities, innovation centers, higher education institutions, entrepreneurs and companies.

The study clearly revealed that a national policy for promoting an innovation-inclined economy in periphery areas must be based primarily on regional competitive advantages. In other words, effort should be made to strengthen the local center of gravity of economic activity in the periphery – specifically, mass manufacturing, agriculture and food processing – by encouraging technological innovation and entrepreneurship. The study also found that quality high-tech employment should be made more available to periphery residents – both in order to increase wages and productivity in the periphery, and as a solution for the shortage of human capital in the high-tech industry. Accordingly, the Innovation Authority’s strategy to promote technological innovation in the periphery is based on four central objectives:   

1. Promoting Technological Innovation in the Manufacturing Industry and in the Agriculture and Food Sectors in the Periphery

The manufacturing industry in Israel in general has suffered from under-investment in technological innovation for many years. Among the variety of causes for this were a lack of financing solutions, only loose affiliations with technology and research players, a shortage of technicians, difficulty in allocating managerial resources, and the lack of a sufficient knowledge infrastructure for implementing innovative technologies.⁹Ministry of Economy and Industry (2018). National Strategic Plan for Advanced Manufacturing in Industry

On the other hand, the agriculture and food processing sector in Israel has always been typified by development and adoption of advanced technologies.¹⁰For example, according to the OECD, Israel is the world leader in recycling wastewater for agricultural use and sustainable agricultural production in arid areas. Source: OECD (2010). Review of Agricultural Policy: Israel However the challenges facing it today, particularly lower than average productivity compared to other developed countries, expected population growth, and the need for more efficient water use – require increased investment in innovation and its implementation in agricultural production. In its survey of agricultural policy in Israel, the OECD points out that extensive investment in research and development and the transfer of knowledge between R&D bodies and farmers will ensure a future increase in the productivity of this sector.¹¹Ibid  

Peripheral areas in all countries are characterized by low accessibility to skilled personnel, financing and knowledge networks. This hinders the capability of companies operating in these regions to implement,¹²Ibid thereby magnifying the obstacles to investment in innovation in the manufacturing, agriculture and food processing sectors in Israel. Removing obstacles to technological innovation in these sectors is the key to promoting an innovation-inclined economy in the periphery.

The Innovation Authority is already providing approximately 120 million shekels (approximately $34 million) a year for support of technological innovation in the manufacturing industry. In order to focus efforts on companies located in the periphery, the Authority will primarily strive to increase their participation in the various incentive programs. In particular, the Authority will operate the Preparatory R&D Program – aimed at aiding companies without prior experience in technological innovation processes and companies in need of focusing and direction in their R&D activity – at a number of focal points throughout the periphery. The Authority will also cooperate with the clusters of local authorities that are forming in the negev and the Galilee to market and provide access to incentive programs for manufacturing companies in the periphery.

The Authority will simultaneously endeavor to encourage technological collaboration between industrial, agricultural, and food processing companies and hi-tech companies, technology entrepreneurs and applied research institutions. The Authority will actively promote the appropriate incentive programs and assist in creating connections between the different entities.

2. Encouraging Local Entrepreneurship in the Periphery with a Link to Regional Anchors

Most of the technological entrepreneurship in Israel is concentrated in the center of the country: the overwhelming majority of venture capital funds in Israel are located in the center, and 77% of all startup companies are located in the Tel Aviv and central regions (see Diagram 1).

The low presence of technological entrepreneurship in periphery areas severely reduces the possibilities for local entrepreneurs in these areas . The development of technology entrepreneurship communities in the periphery

will assist local entrepreneurs to realize their potential, will strengthen the connection of local industrial, agricultural and food companies to technological innovation, will contribute to the development of high-quality local employment, and will improve the overall quality of life.

Furthermore, studies show a positive correlation between direct exposure of children to technological innovation activity in one’s home area and the probability of engaging in innovation as adults.¹³Lost Einsteins – Innovation and Opportunity in America, Chetty, R. (2017) Increasing exposure to technological innovation among children and youth in the periphery will therefore help them realize their high-tech entrepreneurial and employment potential in the future. naturally, at the same time, teenagers in the periphery should be encouraged to acquire sciences, engineering and mathematics skills at their high school and university – a goal towards which several government departments are working on.¹⁴Especially the Planning and Budgeting Committee (PBC), the Ministry of Education, and the Ministry for the Development of the Periphery, the Negev and the Galilee

The Innovation Authority will therefore encourage local entrepreneurship in the periphery, with special emphasis on an affiliation with regional anchors such as academic institutions and centers of industry, agriculture, and food, via

These incubators will promote the establishment of local startup companies by local entrepreneurs while connecting them to the needs of local industrial, agricultural, and food companies and to regional applied research centers. The incubators will thus contribute towards the development of a local innovation ecosystem. 

3. Creating Connections Between Human Capital in the Periphery and the Leading High-Tech Companies

In recent years, the high-tech industry in Israel has suffered from a shortage of engineers and programmers that is threatening to cause a slump in its growth. Alongside government efforts to increase the supply of human capital to high-tech, the Israeli industry must vary the sources of human capital to which it turns. Previous innovation reports dealt extensively with the potential human capital sources among women, Arabs, Haredim and older workers. 

is yet another group the potential of which remains unfulfilled, in this case due to the concentration of high-tech in the center of the country.

Many of those possessing high-tech academic education are interested in living in the Galilee or the negev for proximity to family, for quality of life or other reasons. Data gathered in the Chief Economist’s Bureau at the Ministry of Finance reveals that more than half the students of science and engineering studies returned after graduation to live as adults in the area in which they grew up (See Diagram 3). Furthermore, approximately only a quarter of science and engineering graduates who grew up in the Israeli peripheral areas move to live in the center as adults .¹⁵Both universities and academic collegesIt should be pointed out that the tendency to remain in the same area throughout their lives is especially strong among the Arab population. 

Source: Chief Economist in the Ministry of Finance’s Adaptation of Administrative Data 

Due to the concentration of high-tech activity in central Israel, science and engineering graduates living in the periphery may have difficulty finding employment to suits their skills. Although there are some focal points of high-tech activity in the north and the south, the labor market in these areas is a “thin” market. A thin market is characterized by a small number of “buyers and sellers” – in this case employers and workers – and by an equally low number of employment transactions. This fact leads to employers having difficulty in finding suitable employees and difficulty for workers in finding suitable work or professional advancement. In other words, the upshot is unrealized potential of human capital for the industry and a compromise regarding employment on the part of the workers.

Great importance is placed therefore on the development and enhancement of the high- tech labor market in the peripheral areas. In order to achieve this objective, the Authority will provide incentives to innovative high-tech companies interested in increasing their scope of search for potential employees to open branches in the periphery, while supporting necessary training and adjustments via a specially designated program (See box below).¹⁶Based on a sample of people born between 1975-1985. This may be an undervaluation because of possible unreported residential address changes Because experience teaches us that excellence and innovation are key to the growth of sustainable activity in the periphery, the program will emphasize the establishment of local anchors of technological excellence, based on local “talents”, with the intention that these will grow and become prominent and independent centers of the companies’ activities.

4. Strengthening the High-Tech Ecosystem in the Large Cities: Haifa, Jerusalem and Beersheba

Haifa, Jerusalem and Beersheba already have in place the essential foundations for a high-tech ecosystem, yet their full potential has not been realized: Research universities with strengths in exact sciences and engineering (the Technion, Ben-Gurion University and the Hebrew University), university and research hospitals (Rambam, Hadassah and Soroka), technological entrepreneurship, and R&D centers of large multination corporations. Haifa is especially characterized by a high level of multi-national R&D centers that are responsible for approximately one quarter of total multinational corporations’ R&D expenditure in Israel.¹⁷Amendment to Benefit Track No. 15 – Assistance for R&D centers of large corporations in the periphery Leading high-tech companies such as Mobileye and OrCam have established themselves in Jerusalem and dozens of startups are already operating in Beersheba where the national Cyber Directorate (a civilian cyber and cyber security center) has been founded.

These cities, already functioning as regional employment centers also have a critical mass of government and municipal activity supplying a supportive environment for high- tech activity, such as allocation of suitable facilities, municipal innovation, investment in education and mass transportation. Furthermore, most of the country’s regions are located within a 50-kilometer radius of these cities,¹⁸CBS Data, R&D survey, 2015 they are connected or will soon be connected by high-speed rail to Tel Aviv,¹⁹(Except for the ‘Galilee Finger’ the Golan, and the Southern Negev) and they already constitute regional employment centers.²⁰Already today, the three cities serve as a regional employment center: 350,000 salaried employees work in the Jerusalem area, 240,000 in the Haifa District, 200,000 in the Beersheba District (2017)

nevertheless, none of the above cities have a complete high-tech ecosystem. In order to realize the potential of Haifa, Jerusalem and Beersheba as high-tech employment centers for the peripheral areas, the Innovation Authority will strive towards establishing a high- tech ecosystem in these three cities. To this end, the Authority will promote technological entrepreneurship, will bolster cooperation between players from academia, IDF technology units and industry, and will develop crucial R&D infrastructures for Israeli industry as a whole in these cities while collaborating with the three city municipalities. This will naturally be alongside the ongoing support of existing R&D projects in these cities.

Already in 2018 a new program for encouraging technological entrepreneurship in Haifa was approved by the Authority’s council. Its goal is to promote technological innovation and to increase the number of high-tech companies in Haifa with an emphasis on the “Lower City” borough. The program will include the establishment of hubs and accelerators and the activation of programs to encourage entrepreneurship, and to connect between the different players in the municipal ecosystem. The program will be run by a body selected in a competitive procedure and will receive funding of 25 million shekels (approximately $6.9 million) from the Innovation Authority for an operating period of 4 years. During 2019, an innovation laboratory in the field of Fin-Sec (Cyber-Financial Technology) will be opened in Beersheba in cooperation with the national Cyber Security Authority and the Ministry of Finance; it will aim to leverage Beersheba’s cyber assets, such as the existing Cyber Directorate for ecosystem development. At the same time, the Authority will conduct an in-depth examination of the cyber assets and the obstacles to the development of a complete ecosystem in Jerusalem and Beersheba, on the basis of which it will formulate broad plans of action.