Start-up Nation

by Dan Senor, Saul Singer

  During this stage of Israel’s development, private entrepreneurs may not have been essential because the largest and most pressing needs of the economy were obvious. But the system broke down as the economy became more complex. According to Israeli economist Yakir Plessner, once the government saturated the economy with big infrastructure spending, only entrepreneurs could be counted on to drive growth; only they could find “the niches of relative advantage.”15

  The transition from central development to a private entrepreneurial economy should have occurred in the mid-1960s. The twenty-year period from 1946 through 1966, when most of the large-scale infrastructure investments had been made, was coming to an end. In 1966, with no more frothy investment targets, Israel experienced for the first time nearly zero economic growth. This should have convinced Israel’s government to open the economy to private enterprise. But instead, needed reforms were staved off by the Six-Day War. Within one week of June 6, 1967, Israel had captured the West Bank, Gaza Strip, Sinai Peninsula, and Golan Heights. Collectively, the territory was equal to more than three times the size of Israel.

  Suddenly the Israeli government was once again busy with new large-scale infrastructure projects. And since the IDF needed to establish positions in the new territories, massive spending was necessary for defense installations, border security, and other costly infrastructure. It was another giant economic “stimulus” program. As a result, from 1967 to 1968, investment in construction equipment alone increased by 725 percent. The timing of the war reinforced the worst instincts of Israel’s central planners.

  Israel’s “Lost Decade”

  Still, Israel’s economy was living on borrowed time. Another war six years later, the Yom Kippur War of 1973, did not yield the same economic boost. Israel suffered heavy casualties (three thousand fatalities and many more wounded) and enormous damage to its infrastructure. Forced to mobilize large numbers of reserves, the IDF pulled most of the labor force out of the economy for up to six months. The effect of such a massive and protracted call-up was jarring, paralyzing companies and even entire industries. Business activity came to a halt.

  In any normal economic environment, private incomes among domestic workers would have experienced a corresponding decline. But in Israel they did not. Instead of allowing salaries to fall, the government artificially propped them up through a vehicle that resulted in extremely high levels of public debt. In order to try to offset the ballooning debt, every tax rate—including on capital investment—was raised. Short-term and high-priced debt was used to finance the deficit, which in turn increased interest payments.

  All this coincided with a decline in net immigration. New immigrants have always been a key source of Israel’s economic vitality. There had been a net gain of nearly one hundred thousand new Israelis between 1972 and 1973. But the number was down to fourteen thousand in 1974 and almost zero in 1975.

  What made recovery especially unlikely—if not impossible—was the government’s monopoly of the capital market. As the Bank of Israel itself described it at the time, “The government’s involvement transcends anything that is known in politically free countries.” The government set the terms and interest rate for every loan and debt instrument for consumer and business credit. Commercial banks and pensions were forced to use most of their deposits to purchase nonnegotiable government bonds or to finance private-sector loans for projects that had been earmarked by the government.16

  This was the condition of Israel’s economy during what is often described by economists as Israel’s “lost decade,” from the mid-1970s through the mid-1980s. Today, Intel’s decision to search for scarce engineers in Israel seems like an obvious move. But the Israel that Intel found in 1974 was nothing like what it is today. While it may no longer have resembled an expanse of sand, swamps, and malaria, visitors during the 1970s might have been excused for thinking they had landed in a third-world country.

  Israeli universities and Israel’s engineering talent were by this time fairly advanced, but much of the country’s infrastructure was antiquated. The airport was small, quaint, and shabby. It had a Soviet-style utilitarian feel as one arrived and entered immigration. There was no major road that could pass for a real highway. Television reception was shoddy, but it hardly mattered since there was only a single government-owned station broadcasting in Hebrew, along with a couple of Arabic channels that, with a powerful enough antenna, one could pick up from Jordan or Lebanon.

  Not everyone had a telephone at home, and not because they all had cell phones, which didn’t exist yet. The reason was that phone lines were still being slowly rationed out by a government ministry, and it took a long time to get one. Supermarkets, unlike the small food marts common in neighborhoods, were a novelty, and they did not carry many international products. Major international retail chains were nonexistent. If you needed something from abroad, you had to go yourself, or ask a visitor to bring it back for you. High customs duties—many of them protectionist attempts to coddle local producers—made most imports prohibitively expensive.

  The cars on the road were a bland bunch—some produced in Israel (these became the butt of jokes, much like locally produced Russian cars did in Russia) and a motley assortment of the cheapest models of mostly Subaru and Citroën, the two companies brave or desperate enough to defy the Arab boycott. The banking system and the government’s financial regulations were as antiquated as the auto industry. It was illegal to change dollars anywhere except at banks, which charged government-set exchange rates. Even holding an overseas bank account was illegal.

  The overall mood was dour. The euphoria that had come with the stunning 1967 victory—which some likened to first receiving a death-row pardon and then winning the lottery—quickly dissipated after the 1973 Yom Kippur War and was replaced with a renewed sense of insecurity, isolation, and, perhaps worst of all, tragic blunder. The mighty Israeli army had been utterly surprised and badly bloodied. It was scarce consolation that, in military terms, Israel had won the war. Israelis felt that their political and military leadership had badly failed them.

  A public commission of inquiry was appointed; this led to the removal of the IDF’s chief of staff, its chief of intelligence, and other senior security officials. Though the commission exonerated her, Prime Minister Golda Meir took responsibility for what was seen as a fiasco and resigned a month after the release of the commission’s report. But her successor, Yitzhak Rabin, was forced to resign from his first stint as prime minister when, in 1977, it was revealed that his wife had a foreign bank account.

  As late as the early 1980s, Israel also suffered from hyperinflation: going to the supermarket meant spending thousands of almost worthless shekels. Inflation rose from 13 percent in 1971 to 111 percent in 1979. Some of this was due to rising oil prices at this time. But Israeli inflation continued to skyrocket beyond other countries’, rising to 133 percent in 1980 and to 445 percent in 1984, and appeared to be on its way to a four-digit figure within a year or two.17

  People would hoard phone tokens, since their value didn’t change as their price rose sharply, and would rush to buy basic items in advance of expected price hikes. According to a joke of that time, it was better to take a taxi from Tel Aviv to Jerusalem than a bus, since you could pay the taxi at the end of the ride, when the shekel would be worth less.

  A main reason for the hyperinflation was, ironically, one of the measures the government had taken for years to cope with inflation: indexing. Most of the economy—wages, prices, rents—were linked to the Consumer Price Index, a measure of inflation. Indexing seemed to protect the public from feeling the effects of inflation, since their incomes rose with their expenses. But indexing ultimately fed an inflationary spiral.

  Path to Recovery?

  In this context, it is especially striking that Intel set up shop in Israel in the 1970s. An even greater mystery, however, is how Israel transformed itself from this somewhat provincial and isolated state to a thriving and technologically s
ophisticated country three decades later. Today, visitors to Israel arrive in an airport that is often far more slickly modern than the one they departed from. Unlimited numbers of new phone lines can be set up with only a few hours’ notice, BlackBerrys never lose reception, and wireless Internet is as close as the nearest coffee shop. Wireless access is so abundant that during the 2006 Lebanon war, Israelis were busy comparing what kind of Internet service worked best in their bomb shelters. Israelis have more cell phones per capita than anywhere else in the world. Most kids above the age of ten have a cell phone, as well as a computer in their bedroom. The streets are full of late-model cars, ranging from Hummers to European Smart cars that take up less than half of a scarce parking spot.

  “Looking for a few good programmers?” CNNMoney.com recently asked in a feature listing Tel Aviv among the “best places to do business in the wired world.” “So are IBM, Intel, Texas Instruments, and other tech giants, which have flocked to Israel for its tech savvy. . . . The best place to close a deal is at Yoezer Wine Bar, with its extensive selection of varietals and deliciously doused beef bourguignon.”18 In 1990, though, there wasn’t a single chain of coffee shops, and probably not a single wine bar, decent sushi restaurant, McDonald’s, Ikea, or major foreign fashion outlet in all of Israel. The first Israeli McDonald’s opened in 1993, three years after the chain’s largest restaurant opened in Moscow, and twenty-two years after the first McDonald’s in Sydney, Australia. Now McDonald’s has approximately 150 restaurants in Israel, about twice as many per capita as there are in Spain, Italy, or South Korea.19

  The second-phase turnaround began after 1990. Up to that point, the economy had a limited capacity to capitalize on the entrepreneurial talent that the culture and the military had inculcated. And further stifling the private sector was the extended period of hyperinflation, which was not addressed until 1985, when then finance minister Shimon Peres led a stabilization plan developed by U.S. Secretary of State George Shultz and IMF economist Stanley Fischer. The plan dramatically cut public debt, limited spending, began privatizations, and reformed the government’s role in the capital markets. But this didn’t yet generate for Israel a private and dynamic entrepreneurial economy.

  For the economy to truly take off, it required three additional factors: a new wave of immigration, a new war, and a new venture capital industry.

  CHAPTER 7

  Immigration

  The Google Guys’ Challenge

  Immigrants are not averse to starting over. They are, by definition, risk takers. A nation of immigrants is a nation of entrepreneurs.

  —GIDI GRINSTEIN

  IN 1984 SHLOMO (NEGUSE) MOLLA left his small village in northern Ethiopia with seventeen of his friends, determined to walk to Israel. He was sixteen years old. Macha, the remote village where Molla grew up, had virtually no connection to the modern world—no running water, no electricity, and no phone lines. In addition to the brutal famine that plagued the country, the Ethiopian Jews lived under a repressive anti-Semitic regime, a satellite of the former Soviet Union.

  “We always dreamed of coming to Israel,” said Molla, who was raised in a Jewish and Zionist home. He and his friends planned to walk north—from Ethiopia to Sudan, Sudan to Egypt and through the Sinai Desert, and from Sinai to Israel’s southern metropolis, Beersheba; after that, they would continue on to Jerusalem.1

  Molla’s father sold a cow in order to pay a guide two dollars to show the boys the way on the first leg of their journey. They walked barefoot day and night, with few rest stops, trekking through the desert and into the jungle of northern Ethiopia. There they encountered wild tigers and snakes before being held up by a band of muggers, who took their food and money. Yet Molla and his friends continued, walking nearly five hundred miles in one week to Ethiopia’s northern border.

  When they crossed into Sudan, they were chased by Sudanese border guards. Molla’s best friend was shot and killed, and the rest of the boys were bound, tortured, and thrown in jail. After ninety- one days, they were released to the Gedaref refugee camp in Sudan, where Molla was approached by a white man who spoke crypti-cally but clearly seemed well-informed. “I know who you are and I know where you want to go,” he told the teenager. “I am here to help.” This was only the second time in Molla’s life that he had seen a white person. The man returned the next day, loaded the boys onto a truck, and drove across the desert for five hours, until they reached a remote airstrip.

  There, they were pushed inside an airplane along with hundreds of other Ethiopians. This was part of a secret Israeli government effort; the 1984 airlift mission, called Operation Moses, brought more than eight thousand Ethiopian Jews to Israel.2 Their average age was fourteen. The day after their arrival, they were all given full Israeli citizenship. The New Republic’s Leon Wieseltier wrote at the time that Operation Moses clarified “a classic meaning of Zionism: there must exist a state for which Jews need no visas.”3

  Today Molla is an elected member of Israel’s parliament, the Knesset; he is only the second Ethiopian to be elected to this office. “While it was just a four-hour flight, it felt like there was a gap of four hundred years between Ethiopia and Israel,” Molla told us.

  Coming from an antiquated agrarian community, nearly all the Ethiopians who immigrated to Israel didn’t know how to read or write, even in Amharic, their mother tongue. “We didn’t have cars. We didn’t have industry. We didn’t have supermarkets. We didn’t have banks,” Molla recalled of his life in Ethiopia.

  Operation Moses was followed seven years later by Operation Solomon, in which 14,500 Ethiopian Jews were airlifted to Israel. This effort involved thirty-four Israeli Air Force and El Al transport aircraft and one Ethiopian plane. The entire series of transport operations occurred over a thirty-six-hour period.

  “Inside Flight 9, the armrests between the seats were raised,” the New York Times reported at the time. “Five, six or seven Ethiopians including children crowded happily into each three-seat row. None of them had ever been on an airplane before and probably did not even know that the seating was unusual.”4

  Another flight from Ethiopia set a world record: 1,122 passengers on a single El Al 747. Planners had expected to fill the aircraft with 760 passengers, but because the passengers were so thin, hundreds more were squeezed in. Two babies were born during the flight. Many of the passengers arrived barefoot and with no belongings. By the end of the decade, Israel had absorbed some forty thousand Ethiopian immigrants.

  The Ethiopian immigration wave has proven to be an enormous economic burden for Israel. Nearly half of Ethiopian adults age twenty-five to fifty-four are unemployed, and a majority of Ethiopian Israelis are on government welfare. Molla expects that even with Israel’s robust and well-funded immigrant-absorption programs, the Ethiopian community will not be fully integrated and self-sufficient for at least a decade.

  “Given the context of where they came from not so long ago, this will take time,” Molla told us. The experience of Ethiopian immigrants contrasts sharply with that of immigrants from the former Soviet Union, most of whom arrived at roughly the same time as Operation Solomon, and who have been a boon to the Israeli economy. The success story of this wave can be found in places like the Shevach-Mofet high school.

  The students had been waiting for some time, with the kind of anticipation usually reserved for rock stars. Then the moment arrived. The two Americans entered through a back door, shaking off the press and other groupies. This was their only stop in Israel, aside from the prime minister’s office.

  The Google founders strode into the hall, and the crowd roared. The students could not believe their eyes. “Sergey Brin and Larry Page . . . in our high school!” one of the students proudly recalled. What had brought the world’s most famous tech duo to this Israeli high school, of all places?

  The answer came as soon as Sergey Brin spoke. “Ladies and gentlemen, girls and boys,” he said in Russian, his choice of language prompting spontaneous applause. “I emig
rated from Russia when I was six,” Brin continued. “I went to the United States. Similar to you, I have standard Russian-Jewish parents. My dad is a math professor. They have a certain attitude about studies. And I think I can relate that here, because I was told that your school recently got seven out of the top ten places in a math competition throughout all Israel.”

  This time the students clapped for their own achievement. “But what I have to say,” Brin continued, cutting through the applause, “is what my father would say—‘What about the other three? ’ ”5

  Most of the students at the Shevach-Mofet school were, like Brin, second-generation Russian Jews. Shevach-Mofet is located in an industrial area in south Tel Aviv, the poorer part of town, and was for years notoriously one of the roughest schools in the city.

  We learned about the history of the school from Natan Sharansky, the most famous former Soviet Jewish immigrant in Israel. He spent fourteen years in Soviet prisons and labor camps while fighting for the right to emigrate and was the best-known “refusenik,” as the Soviet Jews who were refused permission to emigrate were called. He rose to become Israel’s deputy prime minister a few years after he was freed from the Soviet Union. He joked to us that in Israel’s Russian immigrant party, which he founded soon after his arrival, politicians believe they should mirror his own experience: go to prison first and then get into politics, not the other way around.

  “The name of the school—Shevach—means ‘praise,’ ” Sharansky told us in his home in Jerusalem. It was the second high school to open in Tel Aviv, when the city was brand-new, in 1946. It was one of the schools where the new generation of native Israelis went. But in the early 1960s, “the authorities started to experiment with integration, a bit like in America,” he explained. “The government said we can’t have sabra schools, we must bring in the immigrants from Morocco, Yemen, Eastern Europe—let’s have a mix.”6