At the same time as the flood of Soviet immigrants, a smaller but seminal wave of Americans arrived in Israel from major U.S. corporations, with knowledge of Silicon Valley and an interest in opportunities in Israel. Among them were GE’s Morry Blumenfeld, Tyco’s Ed Mlavsky, venture pioneer Alan “Ace” Greenberg, U.S. venturers Yadin Kaufmann and Erel Margalit, biotech pioneer Martin Gerstel, and even an eminent economist Stanley Fischer of MIT, who became governor of the Bank of Israel. Collectively these newcomers to Israel wielded billions of dollars of available capital, petawatts of impressive brainpower, a well-honed ability to bypass bureaucratic pettifogs, and an Olympian confidence in their own judgment and capabilities.
Mix the leadership of these dynamic capitalists with a million restive and insurgent former Soviet Jews, and the reaction was economically incandescent. Throw in natural leadership from the irrepressible Natan Sharansky, who had faced down years of abusive confinement in the Gulag, and the impact reverberated through the social and political order as well. Sharansky formed a new conservative political party in Israel to mobilize his former Russian compatriots.
This influx of Russians could not be clamped or channeled, tapered or intimidated into the existing economic framework. As Israeli financier Tal Keinan remarks, “they could not all work for Intel.” Today, immigrants from the former Soviet Union constitute fully half of Israel’s high-tech workers.
Despite the dramatic progress of the 1990s, at the dawn of the new millennium, Israel still lacked a financial sector capable of propelling the nation into the globally dominant role it stands poised to fill today. To get there would take one more great reform.
Like the launch of a new technology, the successful allocation of capital is an elegant expression of the law of capitalism (from the latin word “caput” for head) that mind rules matter. Jews throughout history have excelled in this most intellectual of capitalist endeavors. And yet Israel until recently had virtually no investment houses, deep capital markets, or venture capital. With performance fees barred, hedge funds were essentially illegal. “All my Jewish friends were making their money at Goldman Sachs, while Israel’s finance was dominated by a heavily subsidized labor union,” recalls Keinan.
In the mid-1980s, Yitzhak Shamir’s Likud government, with Benjamin Netanyahu as its ambassador to the United Nations, did cut taxes — increasing the rewards of work and investment by some 30 percent, dramatically boosting economic growth, and reducing inflation. As prime minister in the 1990s, Netanyahu also ushered in dramatic deregulation, along with tax cuts that brought in floods of new revenue. Further spurring local entrepreneurs was the Yozma program in 1993, which waived double taxation on foreign venture-capital investments in Israel and put up a matching fund of $100 million from the government. Demand for the money became so intense that the government hiked the amount and doubled the matching-funds requirement, but private infusions swamped the government incentives. Nevertheless, throughout the early 1990s, much of the money powering Israel’s technological ascent came from the Israeli government or from American technology companies. As the millennium dawned, Israel had failed to create a financial-services industry or to wrest control of much of Israel’s capital from the hands of Histadrut.
The force driving the Israelis decisively out of their socialist past into the modern world of finance was the ingenuity of Netanyahu. As finance minister, Netanyahu used Israel’s financial crisis of 2003 and 2004, precipitated by the latest campaign of Palestinian terror, as a lever to transform Israel’s economy from a largely socialized domain dependent on foreign finance into one of the world’s most open and flourishing financial systems. In the process, he created what his occasional advisor Keinan today calls “the greatest opportunity in our lifetimes.”
An Israeli supply-sider, Netanyahu faced the adamant opposition of Histadrut and its allies in the Knesset. To overcome the hostility to finance capitalism that had long hobbled the Israeli economy, Netanyahu enlisted vital help from President George W. Bush and his treasury secretary, John Snow. Netanyahu sought a sovereign loan guarantee that would give Israeli bonds the full faith and credit of the United States Treasury, so that despite intifadas and other perils, Israel could issue bonds on the same terms as the world’s leading economy. Not wanting the U.S. to appear a patsy, Snow refused to do the deal without a significant quid pro quo, stipulating that Netanyahu secure from the Knesset a series of major financial reforms.
First, Histadrut, which dominates the pension system in Israel, had to give up its direct line to the Israeli treasury, which had guaranteed it an inflation-adjusted 6 percent annual yield. This special arrangement would be phased out over a period of 20 years. Starting immediately with the first 5 percent of its holdings, Histadrut was required to begin finding other ways to invest its $300 million per month of cash flow. Somehow a financial industry would have to arise in Israel to handle this huge trove of funds.
A second briar-patch reform demanded by Snow was the immediate privatization of Israel’s state-owned industries, reducing the government’s majority ownership stakes in these companies from an average of 60 percent to minority ownerships of about 2 0 percent. Among the privatized ventures were oil refineries, nearly all banks, the Bezeq telephone monopoly, and the national airline, El Al.
The third key reform was the emancipation of the financial-services industry, complete with the full legalization of investment banks, international private equity funds, and performance fees for hedge funds. Eliminated were double taxes not merely on investments in Israel but also on international investment activities by Israelis. The Netanyahu-Snow agenda went into effect on January 1, 2005.
In fewer than 25 years — starting from those first modest tax reforms of the mid-1980s — Israel has accomplished the most overwhelming transformation in the history of economics, from a nondescript laggard in the industrial world to a luminous first. Today, on a per capita basis, Israel far leads the world in research and technological creativity. Between 1991 and 2000, even before the major reform of 2005, Israel’s annual venture-capital outlays, nearly all private, rose some 60-fold, from $58 million to $3.3 billion; companies launched by Israeli venture funds rose from 100 to 800; and Israel’s information-technology revenues rose from $1.6 billion to $12.5 billion. By 1999, Israel ranked second only to the United States in invested private-equity capital as a share of GDP. And it led the world in the share of its growth attributable to high-tech ventures: an astonishing 70 percent.
Even a year or two later — while the rest of the world slumped after the millennial telecom and dot-com crash — Israel’s venture capitalists strengthened their country’s lead in technological enterprise. During the first five years of the 21st century, venture-capital outlays in Israel rivaled venture-capital outlays in all of the United States excepting California, long the world’s paramount source of entrepreneurial activity in high technology.
Today, Israel’s tech supremacy grows ever greater. A 2008 survey of the world’s venture capitalists by Deloitte & Touche showed that in six key fields — telecom, microchips, software, biopharmaceuticals, medical devices, and clean energy — Israel ranked second only to the United States in technological innovation. Germany, ten times larger, roughly tied Israel. In 2008, Israel produced 483 venture-backed companies with just over $2 billion invested; Germany produces approximately 100 venture-backed companies annually. The rankings registered absolute performance, but adjusted for its population, Israel comes in far ahead of all other countries.