Review of Start-Up Nation

Philip Greenspun's Weblog 2014-01-06

I’m wondering if there should be a genre on Amazon of “Jew-pride” books. If so, Start-up Nation: The Story of Israel’s Economic Miracle should be first in the category. The book meets all of the rigorous standards of business bestsellers, which is to say that it is mostly anecdotes.

The book opens rather unfortunately, celebrating the achievements of Better Place. Given that Arab countries surrounding Israel won’t allow Israeli cars on their roads, it is basically impossible to drive farther than a person would within the state of New Jersey. So it was practical to set up a network of battery-swapping stations. Better Place would own the batteries, relieving consumers of the burden of having to pay for them up front and also from having to worry about battery condition deteriorating. The batteries could be charged at times that were most efficient for the Israeli electric grid. You had a group of consumers not necessarily enthusiastic about contributing to the demand for oil that has been funding wars and terrorism against Israel (e.g., the Saudi government paying the families of suicide bombers or the Iraqi government, back in Saddam’s day, doing the same (CBS News)). Better Place managed to secure a partnership with Renault to make the vehicles that would accept the batteries. It looked like a great idea when the book was printed… but by now we know how it worked out (investors left with a $700 million hole in their pockets, though unlike similar greentech companies in the U.S., these seem to have been private investors rather than taxpayers).

Lesson 1: Start-ups are risky, even when Israeli!

The authors claim that the success of a handful of companies has changed societal norms:

Most importantly, launching a start-up or going into high tech has become the most respected and “normal” thing for an ambitious young Israeli to do. Like the stereotypical Jewish mother, an Israeli mother might be satisfied with a child who becomes a doctor or a lawyer, but she will be at least as proud of her son or daughter “the entrepreneur.” What in most countries is somewhat exceptional in Israel has become an almost standard career track, despite the fact that everyone knows that, even in Israel, the chances of success for start-ups are low. It’s okay to try and to fail. Success is best, but failure is not a stigma; it’s an important experience for your résumé.

[I asked a married-with-kids friend who is a computer scientist in Israel "If a mom had to choose, would she be happier to see the new graduate going to medical school or into a startup?" and he responded "For sure, go to Medical School!"]

The most confusing thing about the book is that in several places the authors throw rocks at Singapore. The authors claim that having compulsory military service and existential threats to the country as a whole are conducive to economic success, citing Israel, South Korea, and Singapore as examples. But Singapore is supposedly woefully deficient in start-ups compared to Israel:

Although Singapore’s military is modeled after the IDF—the testing ground for many of Israel’s entrepreneurs—the “Asian Tiger” has failed to incubate start-ups. Why? It’s not that Singapore’s growth hasn’t been impressive. Real per capita GDP, at over U.S. $35,000, is one of the highest in the world, and real GDP growth has averaged 8 percent annually since the nation’s founding. But its growth story notwithstanding, Singapore’s leaders have failed to keep up in a world that puts a high premium on a trio of attributes historically alien to Singapore’s culture: initiative, risk-taking, and agility…

I’m not sure where they are getting their data on Singapore’s failure to keep up. The CIA Factbook says that Singapore has a GDP per capital (purchase-power adjusted) of $61,400. This is almost double Israel’s, at $32,800. If that is failure, where can we get some?

[The authors are not alone in their tender concern for the wealthy Singaporeans sweating peacefully next to their koi ponds and bonsai: "As the New York Times’ Thomas Friedman put it, 'I would much rather have Israel’s problems, which are mostly financial, mostly about governance, and mostly about infrastructure, rather than Singapore’s problem because Singapore’s problem is culture-bound.'"]

The authors note that a planned economy worked well in the 1950s when Israel needed to build out basic infrastructure:

Israel’s economic performance occurred in part because of the government’s meddling, and not just in spite of it. During the early stages of development in any primitive economy, there are easily identifiable opportunities for large-scale investment: roads, water systems, factories, ports, electrical grids, and housing construction. Israel’s massive investment in these projects—such as the National Water Carrier, which piped water from the Sea of Galilee in the north to the parched Negev in the south—stimulated high-velocity growth. Rapid housing development on kibbutzim, for example, generated growth in the construction and utilities industries. But it is important not to generalize: many developing countries engaged in large infrastructure projects waste vast amounts of government funds due to corruption and government inefficiencies.

The authors go on to point out that this centrally planned economy worked only because of an unusual lack of corruption (Israel didn’t have any big companies lobbying for special benefits back in the 1950s and, in any case, the place is so small that ordinary citizens would have howled in protest at sweetheart deals for the connected). Anyway, the command-and-control economy stalled out and resulted in inflation rates above 400 percent in the 1970s:

… 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.” 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.  …

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.

The last paragraph is cautionary for the U.S. as the government gradually assumes a larger role in the U.S. economy (see this chart for the growth from about 20 percent of GDP after World War II to nearly 40 percent now). A lot of government expenditures are indexed to the inflation rate, notably pensions, Social Security payments, etc. If inflation takes hold here, it may not be as easy to stop as it was in the past.

Like the U.S., Israel does not seek out educated immigrants. There is no Australian/Canadian/NZ-style point system that favors the educated and/or skilled. Anyone with a connection to Judaism can immigrate. Israel spends lavishly on integrating immigrants into its society, with a wide range of welfare programs targeted specifically at immigrants. How has it worked out?

… 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. Their average age was fourteen. The day after their arrival, they were all given full Israeli citizenship. .. 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.

But then Israel picked up a batch of immigrants from Russia, who showed up with fantastic technical educations:

Between 1990 and 2000, eight hundred thousand citizens of the former Soviet Union immigrated to Israel; the first half million poured in over the course of just a three-year period. All together, it amounted to adding about a fifth of Israel’s population by the end of the 1990s. The U.S. equivalent would be a flood of sixty-two million immigrants and refugees coming to America over the next decade.

It seems that these Russians may in fact be the secret to Israel’s recent economic success:

Walk into an Israeli technology start-up or a big R&D center in Israel today and you’ll likely overhear workers speaking Russian. The drive for excellence that pervades Shevach-Mofet, and that is so prevalent among this wave of immigrants, ripples throughout Israel’s technology sector.

If so, that is hardly replicable for other countries, few of whom would welcome 800,000 Jews as immigrants (the authors note that “Even after World War II ended and the Holocaust became widely known, Western countries were still unwilling to welcome surviving Jews. The Canadian government captured the mood of many governments when one of its officials declared, ‘None is too many!’”).

One good thing about the book is that the authors interview people who have invested in Israel to ask “Why were you crazy enough to put your money at risk in a war zone?” It does seem reasonable for an investor to ask “What happens to my money when the Iranians finish their nuclear weapons and decide to test them out over Israel?” Warren Buffet’s subordinates shared his perspective with the authors:

Buffett spent fifty-two hours touring Iscar, the machine-tool company he’d purchased for $4.5 billion, and Israel, the country he had heard so much about. “You think of people walking those steps 2,000 years ago,” he said of his visit to Jerusalem, “and then you look at the Iscar factory on a mountaintop, supplying 61 countries—whether it’s Korea or the United States or Europe or you name it. It’s pretty remarkable. I don’t think you can really find that kind of combination of the past and the future, in such close proximity, virtually any place in the world.”

Buffett’s view, she told us, is that if Iscar’s facilities are bombed, it can go build another plant. The plant does not represent the value of the company. It the talent of the employees and management, the international base of loyal customers, and the brand that constitute Iscar’s value. So missiles, even if they can destroy factories, do not, in Buffett’s eyes, represent catastrophic risk.

Israel is a relatively crummy place to do business, according to the Heritage Foundation (link). The government chews up 45 percent of GDP, for example, compared to 17 percent in Singapore (the failed state, according to the authors of this book, because they are not cranking out as many iPhone apps!). But it used to be even crummier:

… in 2003, [finance minister at the time] Netanyahu cut tax rates, transfer payments, public employee wages, and four thousand government jobs. He also privatized major symbols of the remaining government influence on the economy—such as the national airline, El Al, and the national telecommunications company, Bezeq—and instituted financial-sector reforms. “In the sense that he tackled the stifling role of government in our economy, Bibi was not a reformer but a revolutionary. A reform happens when you change the policy of the government; a revolution happens when you change the mind-set of a country. I think that Bibi was able to change the mind-set,” said Ron Dermer, who served as an adviser to four Israeli ministers of finance, including Netanyahu.18 Netanyahu told us, “I explained to people that the private economy was like a thin man carrying a fat man—the government—on its back. While my reforms sparked massive nationwide strikes by labor unions, my characterization of the economy struck a chord. Anyone who had tried to start a [nontech] business in Israel could relate.”19 Netanyahu’s reforms gained increasing public support as the economy began to pull out of its rut. At the same time, a package of banking-sector reforms pushed through by Netanyahu began to take effect. These reforms launched the phaseout of the government’s bonds that had guaranteed about 6 percent annual return. Up until that point, asset managers for Israeli pensions and life insurance funds simply invested in the Israeli guaranteed bonds. The pension and life insurance funds “could meet their commitments to beneficiaries just by buying the earmarked bonds. So that’s exactly what they did—they didn’t invest in anything else,” Keinan told us. “Because of these bonds, there was no incentive for Israeli institutional investors to invest in any private investment fund.”

And it is sliding back into crumminess due to the fact that a growing number of Israelis prefer to collect Welfare rather than work:

This underutilization brings us to what we believe is the biggest threat to Israel’s continued economic growth: low participation in the economy. A little over half of Israel’s workforce contributes to the economy in a productive way, compared to a 65 percent rate in the United States. The low Israeli workforce participation rate is chiefly attributable to two minority communities: haredim, or ultra-Orthodox Jews, and Israeli Arabs. Among mainstream Israeli Jewish civilians aged twenty-five to sixty-four, to take one metric, 84 percent of men and 75 percent of women are employed. Among Arab women and haredi men, these percentages are almost flipped: 79 percent and 73 percent, respectively, are not employed.

(Of course, the U.S. labor force participation rate is also shrinking currently (see this Washington Post analysis).

The book also tries to explain why Arab countries, similarly situated to Israel but far wealthier due to oil, have not been successful in producing start-up companies, despite some special enterprise zones in places such as Dubai and despite collaborations with a lot of top American universities.

[according to McKinsey & Company], Arab governments have been consumed with the number of teachers and investments in infrastructure—buildings and now computers—in hopes of improving their students’ performance. But the results of the recent Trends in International Mathematics and Science Study ranked Saudi students forty-third out of forty-five (Saudi Arabia was even behind Botswana, which was forty-second).19 While the average student-teacher ratio in the GCC is 12 to 1—one of the world’s lowest, comparing favorably with an average of 17 to 1 in OECD countries—it has had no real positive effect. Unfortunately, international evidence suggests that low student-teacher ratios correlate poorly with strong student performance and are far less important than the quality of the teachers. But the education ministries in most Arab countries do not measure teacher performance. Inputs are easier to measure, through a methodology of standardization.

Celebrating student-teacher ratios without measuring teacher performance? I don’t think we need to go to Saudi Arabia to find a situation like that!

The authors interview Shimon Peres, President of Israel at the time (sort of a ceremonial job in a parliamentary democracy). He shows that politicians everywhere are attracted to the lure of central planning:

[Peres] previewed what his message would be for Israel’s entrepreneurs and policymakers in the coming years: “Leave the old industries. There are going to be five new industries. Tremendous—new forms of energy, water, biotechnology, teaching devices—there’s a shortage of teachers—and homeland security to defend against terrorism.”

The authors celebrate the military and three years of compulsory military service as a boon to Israel. They point out that when Israelis go to college they get more out of it because they are older. This is something that hasn’t been lost on American colleges. Harvard, for example, often requires applicants to spend a “gap year” doing something other than attending a full-time school before starting college at age 19. It is hard to imagine, however, that the supposed benefits of military service are worth taking three years out of everyone’s life. And is this replicable for other countries? Suppose that French drafted everyone from age 18-21 and made them practice all kinds of elaborate military techniques. Given that there is no credible threat from Germany anymore, would people take it seriously?

The authors end on an optimistic note, quoting the Economist magazine regarding the Collapse of 2008: “Israel was one of the ‘last countries to enter recession and among the earliest to exit.’ Indeed, Israel had only one quarter of negative growth, and has since been leading all other OECD countries in GDP growth.” And what about the shift of economic activity to Asia?

In the next few years, we may see China leapfrog American leadership in whole industries, such as the development and manufacture of electric cars and the batteries to power them. India is also becoming a science and technology powerhouse. China and India also have the advantage of access to their own rapidly growing markets that are being jealously eyed by the developed world. None of this is bad for Israel; in fact it represents a major opportunity. Just as Israeli start-ups and development centers have played a critical role for tech giants such as Google, Microsoft, IBM, Intel, and Cisco, Israeli companies could be ideal partners for Chinese and Indian companies—including start-ups—looking to innovate and globalize.

Suppose that there were a much simpler explanation for all of this? How about the following:

  • Israel is not home to a lot of huge successful international companies. There is nothing comparable to Samsung in Israel (Samsung is 10X the size of Teva, Israel’s biggest company)
  • The Arab Boycott of Israel prevents the development of successful regional companies.
  • Israel got lucky when a lot of Russian Jews wanted to migrate and were not able to get into the U.S. or Western Europe (see my Israel article from 2003).
  • These Russians and their well-educated children couldn’t find good jobs in a big company, so they started a lot of new companies in hopes of selling their labor (by selling the companies) to U.S. and Western Europe without moving physically to those countries.

If this is the correct explanation then there is pretty much nothing that can be learned from the success of some Israeli start-ups. You have smart well-educated people who are blocked for political and practical reasons from moving somewhere else. There are practical and political impediments to Israeli companies growing huge, which creates a relatively more favorable environment for small companies.

[The book contains some factual errors that call the whole project into question. The authors talk about the Ayalon Institute, a secret underground bullet factory. The equipment came from Poland. The "factory" was smaller than the average American SUV driver's McMansion "great room".  Apparently there are no fact-checkers at Reed Elsevier because they didn't do a Google search to check the authors' assertions: "One factory was literally hidden underground, beneath a kibbutz laundry; the machines were kept running to mask the banging noise from below. This factory, built with war-surplus tools smuggled from the United States, was producing hundreds of machine guns daily by 1948. "]