Israel, the ‘start-up nation’, is in the throes of a decade-long tech boom that now allows the country to boast the world’s highest number of start-ups and amount of venture capital (VC) per capita.
At the centre of this success story is Tel Aviv and its surrounding neighbourhoods, known as ‘Silicon Wadi’, where more than 50 tech unicorns (privately held start-ups with a valuation of more than $1bn) have originated in recent years, such as DriveNets and Wiz.
A golden decade of development in Israel
The Israeli economy has witnessed impressive growth over the past ten years, despite the unresolved political instability caused by the Israel-Palestine conflict. This expansion has been fuelled by high-value-added manufacturing and services sectors, especially in tech and communications. Of these, Tel Aviv has been the main beneficiary.
For several decades, the demands of Israel’s powerful military have driven technology development through public and private investment. This is why research and development (R&D) is a huge part of the country’s economy and is far above the OECD average.
It is little surprise, therefore, that overall foreign direct investment (FDI) to Israel has risen very strongly since the turn of the millennium (see below chart) and ranks among the world’s most popular destinations for investors. The country now boasts some 400 multinationals, about 140 of them from Europe and a significant majority of which have opened Israeli research centres – multinationals account for half of all Israeli R&D expenditure.
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For example, US chipmaker Intel has set up several multibillion-dollar advanced manufacturing and R&D facilities across the country, employing some 15,000 people. Chipmakers such as Intel have brought more capital to the country than other greenfield foreign direct investors, while investors from the software and IT service sectors have seen the highest number of projects, according to fDi Markets.
Meanwhile, funding for start-ups has been on the rise too, with VC money hitting about $1bn from 2010 until 2015, $2bn in 2016 and $4.1bn in 2019. The hottest tech sector in the country remains cybersecurity, followed by fintech, mobility, digital health, consumer tech and gaming.
In short, foreign investors are highly important to the Israeli economy. Inward FDI flows accounted for 22.4% of Israel’s gross fixed capital formation (net investment) in 2019, according to the UN Conference on Trade and Development, compared with an international average of 7%.
How Tel Aviv resisted a pandemic
Israel has weathered Covid-19 with aplomb, which is why it has the highest vaccination rate in the world. This has been a big win for the entire economy, especially Tel Aviv’s.
As a result, the country saw strong foreign direct investment in 2020, despite global figures falling by 42%. Meanwhile, start-ups in Israel raised record levels of investment and produced 19 initial public offerings in 2020.
“In Israel, several sectors are witnessing increased activity as a result of Covid-19, including healthcare, enterprise software for remote working, cybersecurity and e-commerce. Foreign investment remained strong in the second quarter of 2020, reaching 52% of the total investment volume,” according to a report by Santander Trade, a provider of international market information. Similarly, private equity remained robust in the first half of 2020, posting its best first-half deal and volume figures in more than a decade.
Covid-19 has boosted all things digital, a boon for Israel. It is not surprising, therefore, that a whopping 16 Israeli companies became unicorns in 2020 (about 10% of new entries globally) and that another seven joined them in the first quarter of 2021.
A shortage of talent to meet the huge demand
Despite Tel Aviv’s rapid population growth, tech talent in the city is not keeping pace with the industry's phenomenal rise. In fact, Israel is short of about 15,000 software engineers, meaning the little talent that is available is very expensive.
To put the aforementioned figure into context, there are 300,000 tech workers in Israel, almost half of whom are working on or facilitating R&D.
The Israeli government has taken several steps to lure foreign talent to the country. In 2015, it launched a unique visa programme that made it easier for foreign nationals to move there. Four years later, a new government programme eased immigration rules and provided incentives for foreign start-up companies. The country is also working to tempt multinationals to shift intellectual property to Israel by providing attractive tax benefits.
Tel Aviv’s famous beaches, liberal environment and nightlife are also strong attractions for young talent.
On the downside, however, Israel’s very welcoming posture towards FDI has been dented by the recent establishment of an advisory committee assessing the national security implications of foreign investment. That’s in line with a global trend that has caused consternation for investors, especially from China (a country that has vastly increased its investment to Israel in recent years). Another deterrent is the fact that Tel Aviv suffers from a housing shortage, while the recent violence with Palestine is hardly an incentive for people to move to Israel.
In short, Tel Aviv’s rapid success as a global hotspot for tech companies has created pressing concerns that must be addressed. If not, the country’s phenomenal growth runs the risk of plateauing.
This article is part of Investment Monitor’s Future of Middle Eastern Cities series. Other articles in the series are: