As the local hi-tech ecosystem fails to attract foreign investors, Netanyahu is looking to make the country a leader in artificial intelligence
Recent reports have sounded alarm bells for Israel’s vibrant hi-tech ecosystem, once hailed as a global leader. But as the hi-tech sector flounders, leading voices – including that of Prime Minister Benjamin Netanyahu – have singled out artificial intelligence, and Israel’s role in its global development, as a potential bastion of hope.
It is seen not only as a promising technological frontier but also as a potential savior for Israel’s position on the global stage. The allure of AI lies in its transformative power, its capacity to reshape industries, enhance productivity, and drive economic growth. Within this landscape of uncertainty, Israel’s role in AI’s global development assumes a pivotal significance.
Troubling numbers
During the peak of 2021, Israeli companies saw a remarkable influx of investments, outpacing the US and Europe. However, this has since reversed, with Israel experiencing a steeper decline, particularly between 2022 and 2023.A report from the Start-Up Nation Policy Institute (SNPI) published on Sunday uncovered unsettling statistics regarding Israeli hi-tech’s performance, with a 20% decrease in investments between Q2 and Q3 of 2023, coupled with a staggering 50% drop in the number of deals between July and September.
While the exact reasons for this decline vary, it is evident that the number of active investors has significantly decreased. Both local and foreign investors have reduced their activity in Israel, with active Israeli funds dropping by a third between 2022 and 2023 and foreign ones decreasing by over 40%.
Investor activity’s downward trend is also evident in the decline of new unicorn companies and mega funding rounds ($100 million or more) in 2023. Only one unicorn emerged this year, and of the 11 companies that secured mega rounds, only three had Israeli headquarters, while the majority were based in the US or the UK.
SNPI’s report is only one of several in recent weeks that indicate an overall slowdown within the economy, and namely in the hi-tech ecosystem, which represented 18.1% of the country’s GDP in 2022, making it the largest contributor to the economy.
Experts have indicated a handful of causes for the trouble facing the economy, many of which were flagged months ago as potential dangers and are now beginning to rear their heads.
Are investors getting cold feet?
The hi-tech turmoil gripping Israel’s once-thriving ecosystem is the result of several challenges that have converged to cause trouble for the industry’s prosperity.
Among them, two key issues stand out as primary contributors to this crisis:
The judicial reform (or overhaul, if you’d prefer)
One of the central issues highlighted in the Start-Up Nation Policy Institute’s report, as well as by experts and economists around the world and throughout Israel, is the controversy surrounding the government’s judicial reform plan to severely limit the authority of the Supreme Court.
A major lack of consensus on legislative changes – both within the government and among the public – has eroded trust between the hi-tech industry and the government, adding a layer of unpredictability to the business environment.
Much of the investment in this sector comes from foreign investors attracted by Israel’s renowned innovation. However, by undermining the judicial authority of the court, Israel runs the risk of scaring off investors who would prefer to put their money into more stable investment environments.
Experts have warned against the move for months. Over the past several months, each of the world’s leading global credit rating agencies – namely Moody’s, S&P, Fitch, and Morgan Stanley – have explicitly highlighted the government’s intention to undermine the authority of the Supreme Court as a risk to foreign investors. Credit score decreases followed suit and seem to have now culminated in a tangible and worrying lack of foreign investor participation.
“As nearly all of Israel’s academic economists, myself included, have been saying since this government rolled out its proposed judicial coup legislation, the result will be similar to aiming a flame-thrower at our economy (and hi-tech, our economic locomotive, in particular), our health system, and the general fabric holding together Israeli society and our army,” said Prof. Dan Ben-David, head of the Shoresh Institution for Socioeconomic Research and an economist at Tel Aviv University, following the release of a Finance Ministry report showing a 60% decrease in foreign investments back in Q1.
“What we are currently witnessing is only the initial damage resulting from the major uncertainty that the government policies are sowing. The long-run effects – if what they’re doing will be able to grow and mature – will be no less than catastrophic for Israel’s future,” he said.
Global economic factors
While on the local side, the judicial reform is playing a big role in current economic troubles, the fortunes of Israel’s hi-tech sector are also intrinsically linked to the global economy. The recent global economic slowdown has had a ripple effect on the industry, affecting investor confidence and capital availability. The decline in investments in Israeli start-ups is, in part, a reflection of this broader economic context.
Put briefly, the global economy has been slowing down for several years due to factors like the Ukraine war, energy crisis, inflation, supply chain disruptions, and rising interest rates. The US and Europe, hit hard by the slowdown, are now showing signs of recovery. Factors aiding the recovery include the reopening of the Chinese economy, improved supply chains, government stimulus, and falling energy prices.
Israel, however, has lagged significantly in its ability to pull out of the decline. “Hi-tech has been doing badly worldwide this past year, but hi-tech in Israel has been hit worse than in the majority of other countries,” said Ben-David in response to SNPI’s latest report. “This is particularly evident in the parting of ways between the stock markets in leading economies and the Israeli stock market that had been completely in sync until the recent elections.”
The global economy issue has made a significant shift in preferences among investors everywhere. As partner at leading US VC fund Harmonix Ventures, Krish Ramadurai put it to the Post earlier this week: “It used to be that you could get cash with just an idea. But now investors want to see if companies actually have a business model and can make money.”
The combination of local and global issues have compounded on each other, leaving Israel in a complicated position that seems to be getting out of hand. In its report, SNPI acknowledged that, while it might have done the trick before, even an immediate and clear statement on halting the judicial reform might not be an instant remedy for the crisis. There is a genuine concern that investors and entrepreneurs may remain cautious, awaiting concrete actions from the government.
The organization concluded by urging the government to take a series of actions, chief among which is to present a clear and budgeted plan to save the Israeli hi-tech sector – and a key part of that plan needs to relate to Israel’s global position in artificial intelligence development.
Can AI mitigate the damage?
Amid the turbulence in Israel’s hi-tech landscape, there is hope that artificial intelligence could play a significant role in mitigating the damage. Besides the SNPI’s recommendation, Netanyahu himself has highlighted the importance of Israel becoming an international AI leader.
“For several months now, I have been formulating a national plan. Soon I will appoint a project manager on the subject and I will also submit the national plan to the government and the public,” he said last Thursday, adding that his goal is to turn the “State of Israel into the No. 3 country in the world in this field.”
Developing any national plan is a daunting task, no less creating one that deals with a rapidly developing technology. In his efforts to formulate this plan, Netanyahu has tapped one of the nation’s leading minds in terms of technological strategy.
The godfather of Israeli cyber
Prof. Isaac Ben-Israel, the director of the Blavatnik Interdisciplinary Cyber Research Center at Tel Aviv University and a retired major-general in the IDF, has been at the forefront of initiatives aimed at revitalizing Israel’s technological prowess for many years.
Among his current efforts are two ongoing yearly conferences – CyberWeek and AI Week. The soonest instance of these events, AI Week 2024, is a three-day conference from the Blavatnik Interdisciplinary Cyber Research Center and Tel Aviv Center for AI and Data Science at Tel Aviv University, which is slated for February next year.
In 1999, Ben-Israel wrote a letter to the prime minister urging him to invest in Israel’s development of cybersecurity. Years later, he was asked by Netanyahu to create a cybersecurity plan to prepare Israel for the coming years. The plan that Ben-Israel submitted in 2011, known as the National Cyber Initiative, laid the foundation for Israel’s cyber revolution during the past decade.
Following that plan’s success, Ben-Israel and Prof. Eviatar Matania co-authored the “National Initiative For Secured Intelligent Systems,” a plan that aims to harness the potential of AI for national security and innovation. While it was completed in 2019, political changes led to a freeze in budget allocation. However, recent developments have seen interest resurge.
“We submitted a plan on how to make Israel one of the top five countries in the world in artificial intelligence to Prime Minister Netanyahu in June 2019, two months after he failed to get reelected,” Ben-Israel recalled during a conversation with the Post.
“In the – what is it now, four years? – since then, no government has seriously dealt with neither AI nor any other technology, because until recently the government had no approved budget, and of course, you can’t touch a national plan without a budget.”
Even then, moving forward with the national AI plan wasn’t a priority to the current government.
“They put all the money into more important issues, like yeshivas,” Ben-Israel cynically noted. However, now that the vise has tightened and AI development strategy has become an urgent issue, Netanyahu has reached out to Ben-Israel and Matania. “He understands, very well, the potential of AI for the economy, as well as its security.”
A good plan could do good work
It’s going to take some problem-solving to get the AI plan moving.
“First of all you need a huge budget. It’s not huge for a country, relatively, but currently I don’t know where – or whom – he’s going to take it from within his coalition,” Ben-Israel explained. “And then he needs to appoint some kind of management in his office to run it, which is another coalition problem.”
Assuming the prime minister can figure out those issues, Ben-Israel is certain that AI can do some serious work for Israel’s economy.
“Of course, it has potential. One of the most significant income sources of Israel’s economy is cyber technology, which didn’t exist practically 10 years ago. By doing the right thing, we became one of the top five countries in cybersecurity,” he said. “There’s no reason why we couldn’t repeat the same with AI – and the economic potential of AI is at least 10 times bigger, if not more, than the cyber market.”
That said, Ben-Israel acknowledged that the economic issues facing Israel’s economy are serious, and can’t necessarily be solved in one fell swoop.
“We haven’t really recovered the way the US has, and this is directly because of the judicial reform. Not necessarily because investors don’t like investing in Israel, but they’re waiting. They don’t like to invest in places which don’t have clear rules of the game, and a clear future, so they wait,” he said. “Some, even most of the damage can be recovered, but not all of it, because a lot of Israel’s entrepreneurs have already gone abroad to establish their tech – especially AI – companies. That’s very difficult to repair; but it’s not too late to repair most, maybe 90%, of the damage.”
Looking on with bated breath
Israel’s hi-tech ecosystem is at a critical juncture. While challenges persist, the adoption of practical and strategic AI initiatives hold remarkable potential for Israel’s future. If they’re implemented properly, and quickly enough, the resilience and adaptability that have defined Israel’s hi-tech sector for decades may once again shine through, bolstered by the power of artificial intelligence.If not, buckle up.