2016 ISRAEL INNOVATION AUTHORITY REPORT PRESENTED TO PRIME MINISTER AND
MINISTER OF ECONOMY AND INDUSTRY, BENJAMIN NETANYAHU
Prime Minister Told Chairman of the Israel Innovation Authority:

“Israel is a country that has prized and continues to prize innovation. We
have made enormous achievements, but must not rest on our laurels, we must
continue to climb higher. We have had some very good proposals in order to
continue ascending, some of them budgetary, and we will assess them in the
2-year budget. Some of them demand a far greater perspective regarding the
key means of fostering innovation – human capital – and this is an issue we
will discuss further. I thank you for this. Continue your important work.”

Avi Hasson, Chairman of the Israel innovation Authority and Chief Scientist
at the Israeli Ministry of Economy and Industry: “We are at a crossroads: in
order to make a leap forward, we need efficient and growth-focused policy
with a significant rise in the resources allocated towards Israeli
innovation. Thanks to the extensive activity in Israel over the past two
decades, we have accomplished extraordinary achievements, but it looks like
the ‘seven good years’ are over and that we are approaching our glass
ceiling. We must look at this point in time as an opportunity to make a leap
forward from a position of strength. If we do not take the appropriate
measures now, they will be forced upon us in a few years from a position of
weakness and after a lot of potential has been squandered. If we are wise
enough to enact the necessary policy changes, there is a good chance we can
succeed in renewing Israeli hi-tech’s rapid growth, and increase
innovation-fueled growth in the economy in general.”

JERUSALEM. June 29th, 2016 – In the annual report submitted on Wednesday,
June 22nd by the Israel Innovation Authority to the Prime Minister of the
State of Israel, the Authority (formerly the Office of the Chief Scientist)
presented an extensive analysis regarding the state of the country’s hi-tech
industry and its projection for future trends in 2016-17, as well as a
series of recommendations for the benefit of Israel’s decision makers.

Hasson is also set to present the government with his ‘Making a Leap’
program, comprised of a detailed list of urgent actions needed to be taken
in order to rejuvenate the hi-tech ecosystem and maintain its leading global
position.

Along with its analysis of the impressive achievements of Israeli hi-tech
this year, including record-high exits ($8B) and capital raises ($4.4B), the
report brings to light several important issues that demand immediate
solutions by the government:

Creating new tools in order to support the new needs of Israel's maturing
innovation ecosystem, specifically those of growth companies.

The issue of skilled, available personnel is the main obstacle for growth
and competitiveness in the Israeli hi-tech ecosystem.

The challenge of global competitiveness as exemplified by the shifts in the
ranking of the Israeli hi-tech industry vis-à-vis the global industry –
according to several global indices.

The significant decline over the past few years in government expenditure on
R&D as a percentage of GDP.

The immediate need to prepare to implement the OECD’s BEPS guidelines.

The need to prioritize manufacturing in order to implement innovation and
increase work productivity.

Preparation to seize the opportunity that rests in China’s five-year plan
and the expected liberalization of the Chinese economy.

Concrete actions needed to position Israel as a center for the development
and implementation of groundbreaking technologies: competitive programs with
high levels of support for groundbreaking R&D, improving the communication
and flow of knowledge between all parties with an interest in the innovation
ecosystem (academia, industry, government and civil society), advancing
regulation for groundbreaking technologies (e.g.: autonomous cars, robotics,
Bitcoin, crowdfunding, smart cities), incentivizing the participation of
Israeli companies in industrial programs in Europe, and more.

. Israeli industry is maturing: In 2015, several positive trends continued
in Israeli hi-tech, characterized by impressive achievements: Israeli
companies raised $4.4 billion and achieved exits worth $8 billion. The scope
of hi-tech fundraising (693 deals) and the net addition of companies to this
sector (some 700) are at an all-time high. The overall picture reflects
stability compared to previous years. This maturing trend highlights the
need for updated policies in order to realize the potential of the Israeli
innovation ecosystem and contribute to its significant leap forward.

Several significant data points that reflect this change:

The Israeli hi-tech industry is entering its third decade in the
international consciousness. The experience gained is proving itself – e.g.
increased growth from startups developing into more mature companies. For
the first time ever, the income of 30 Israeli startups grew by two-digit
percentage points over the past three years.

Significant growth in the number of experienced entrepreneurs active in the
Israeli economy – 25% of all entrepreneurs in Israel in 2015 are veteran
entrepreneurs who have at least two initiatives under their belt, as
compared to 16% in 2010. This trend helps established companies grow at a
faster pace.

The average exit has increased by more than 100% over the past five years –
from $31 million in 2010 to $75 million in 2015 – this is another testament
to the maturing of the industry, as expressed in acquisitions or IPOs at a
more mature, developed stage of the companies.

·With the industry maturing and the increased aspiration for independent
growth, the need arises for a paradigm shift regarding the way hi-tech
activity in Israel is funded – Until today, the most typical avenues of
funding relied on equity. Now, with a more diverse mix of companies in the
industry with new needs – like that of growth capital – new funding tools
are being created to answer those needs. Over the past few years, new
avenues of funding have been developed in Israel, such as bank loans. The
relative share of debt investments in hi-tech is still small, constituting
only 0.25% of the overall credit given by the banking system over the past
year – NIS 2.25B out of NIS 900B. Nevertheless, this funding avenue is
expected to grow significantly in the coming years. The Authority is
examining tools that would help banks develop this avenue. Among other
possibilities, the Authority is considering giving guarantees for growth
loans to hi-tech companies.

B. The issue of skilled, available personnel is the main obstacle for growth
and competitiveness in the hi-tech ecosystem in Israel – According to
preliminary estimates, the Israeli innovation industry will lack more than
10,000 engineers and programmers in the coming decade. The Israeli
government must take immediate action to increase the number of students who
acquire relevant education for the hi-tech industry. The effect of such
activity is not immediate and may take up to a decade to bear fruit, and
therefore immediate action is necessary. This must be a combined,
inter-ministerial effort designated as a national goal and with immediate
implementation. Lack of skilled human resources is a central obstacle for
growth, both for startups as well as for more established Israeli technology
companies. An ongoing shortage in the number of engineers has been the
result of a decline in the share of Israelis graduating in the sciences
(from 13% of all graduates in 2004 to 8.7% in 2014). This is specifically
relevant in computer science, math, and statistics where there has been a
decline from some 3,000 graduates in 2004 to 2,250 in 2014. This issue is
now being addressed more comprehensively by the government through several
key programs that have been presented recently in the government’s weekly
meeting: the “Five Units” plan, led by the Ministry of Education, as well as
other programs led by the Council for Higher Education and the Planning and
Budgeting Committee, and human capital related programs led by the Israeli
Ministry of Economy and Industry and others.

C. The shifting position of the Israeli hi-tech industry vis-à-vis the
global industry – Israel is seeing its position as a leader of innovation in
the international arena erode – many countries are now waving the flag of
innovation as a national goal. Over the past year alone, Australia and
Canada launched wide-scale national innovation programs that include a
series of significant steps inspired by the “Israeli model.” Developed
countries across the globe are investing more and more resources in research
and development. After many years of leadership, Israel in 2014 lost its
leading position among developed countries for national expenditures on
civilian R&D (as a percentage of GDP). The annual investment has remained
static over the last decade, while other countries like South Korea have
expanded such investment significantly. Another noteworthy challenge is the
ease of doing business in Israel, as measured by two international indices
(the Global Innovation Index and the section devoted to innovation in the
Global Competitiveness Index published by the World Economic Forum), which
show that Israel’s position is deteriorating compared to the rest of the
world. According to parameters like the number of days it takes to start a
business, the number of procedures necessary to start a business, the ease
of getting credit and the ease of paying taxes, Israel has dropped in the
ratings compared to the previous year.

D. A significant drop over the years in government expenditure for R&D as a
percentage of GDP, from 0.8% in 2002 to 0.52% in 2015 – This essentially
means that the government’s ability to influence and invest in public
infrastructure, needed for developing industry and increasing
competitiveness, is shrinking. In the coming years, there will be a need for
an additional annual investment of at least NIS 450 million in order to
close the gap. The State of Israel should legislate government expenditures
on national innovation as a fixed percentage of the state’s budget or,
alternately, of GDP.

E. Preparation for the OECD’s BEPS guidelines (Base Erosion and Profit
Shifting): The new set of guidelines dealing with the matter of tax planning
by multinational corporations (MNCs) can significantly influence the Israeli
technology sector and the overall economy. Currently, there is significant
activity from the more than 300 R&D centers belonging to MNCs in Israel,
which for the most part pay taxes abroad on the products they develop in
Israel. The implementation of the new BEPS guidelines will insert new
considerations into the MNCs’ strategic planning, which in turn may affect
their high volume of activity in Israel. A comprehensive government response
is currently being formulated, spearheaded by the Israeli Ministry of
Finance. The program will include recommendations for the appropriate
government response in order to produce the best economic results for
Israel, given the new situation.

F. Promoting the local manufacturing industry will be a central goal of the
Israel Innovation Authority in the coming years: The state of traditional
industry in Israel has been slowly eroding over the past few years and is in
need of a serious change in direction, specifically, implementing
technological innovation within production processes. This crucial change is
based on the understanding that ensuring sustainable competitiveness in this
industry depends on its level of technological innovation. Traditional
industries are saturated in human capital but suffer from low productivity:
even though 56% of industry employees are in traditional industries, these
are responsible for only 38% of the gross added value in industry overall
and only 22% of industrial exports. While hi-tech industries compete
globally and boost exports on an annual basis, traditional industries export
at low volumes and their scope is not growing over time.

Increasing innovation in manufacturing industries will be one of the main
challenges for the Israeli economy in the coming years – a crucial step
towards increasing productivity, wages and employment, and towards helping a
significant part of the economy cope with growing competition from abroad.

G. The share of employees from the Arab sector working in R&D grew fourfold
in seven years: Whereas employees from the Arab sector constituted only 0.5%
of all R&D employees in hi-tech in 2008 (350 people), in 2015 their share
increased to 2% of all R&D sector employees. These 2,700 employees are part
of 16,200 members of the Arab community working in the hi-tech industry,
5.7% of all those working in this sector. Despite these still small numbers,
there is a positive trend of employees from the Arab sector integrating into
the technology sector. This positive trend should be supported via several
significant steps – including preparing students for professions in demand,
increasing assistance during academic studies and preparing graduates for
entering the job market. These efforts will help minimize the economic gaps
between sectors of society and help decrease the shortage of skilled
personnel in the hi-tech industry.

H. China is undergoing significant change, transforming from a leading
manufacturing country to a leader in innovation – this opportunity should be
fully embraced. Economic relations and technological cooperation between
Israel and China continues to grow. Despite this generally positive trend,
this is still only the tip of the iceberg regarding the potential for
economic relations with this global giant. Over the past few years, a
significant shift in consciousness is taking place amongst Israeli
companies. Many companies that used to be active only in Western markets are
looking eastward in order to search for opportunities to expand activities
in the Chinese market. Chinese involvement in the local industry has grown
both in terms of investments and strategic cooperation. Chinese investors
are also partnering in Israeli companies’ fundraising efforts – since 2012,
more than 30 investors have come from China and Hong Kong. In light of China’s
five-year plan and the expected liberalization of the Chinese economy
regarding currency, capital markets and ease of investing outside the
mainland, the year 2016 has many opportunities in store for Israeli
companies in various technological fields, beginning with improving air
quality, water and food safety through cooperation in the fields of IoT, big
data and mobile. China’s economic clout and its future avenues of growth
necessitate every Israeli company looking for opportunities in the global
market to examine how to enter the Chinese market. The Israel Innovation
Authority and additional government agencies are ready to help companies
looking to penetrate the Chinese market.

I. There is an extensive need for government support in the development of
robotics in Israel: Israel excels in developing each of the different
building blocks of the robotics industry, but the potential for combining
these building blocks to create infrastructure for the development and
expansion of finished products in the robotics field has yet to be realized.
The Israeli robotics industry is small in scope but its reputation is
global. Many Israeli companies in this field are sophisticated global
leaders, growing at double digit rates per annum while exporting the lion’s
share of their products. Nevertheless, obstacles like lack of engineers with
interdisciplinary capabilities, a rise in the level of complexity in
producing robots, funding difficulties in light of the long development
cycles and growing global competition have made it hard for companies to
join the ranks of leading companies and countries in this field. Among the
steps being considered to support this industry: state support for a
consortium of companies aiming at creating advanced robotic capabilities
with commercial potential, involving a diverse range of players with
complementary technological capabilities. In addition, the Authority is in
the process of finding foreign entities (states or corporations) interested
in cooperating with the Israeli ecosystem. This and other activities are
critical to realizing this industry’s potential and ensuring that Israel
will not only avoid missing the next technological revolution but will be
among the countries leading it.

Chairman of the Israel Innovation Authority and Chief Scientist at the
Israeli Ministry of Economy and Industry, Avi Hasson said: “Our annual
report points to a series of obstacles and challenges faced by the Israeli
economy: a shortage of quality personnel; the significant drop in the
percentage of government expenditure on R&D as part of GDP; increasing
competition from abroad; and the low participation of sectors of the
population and industrial branches in the Israeli hi-tech ecosystem.
Nevertheless, we do enjoy many advantages and opportunities: a more mature
industrial sector, the technological innovation revolution in China, new tax
instructions from the OECD for global corporations, new sectors of the
population entering the innovation market and more. The Israeli
technological industry’s promising results in 2015 and over the past few
years in general are quite encouraging. Still, these companies’ ongoing
success makes it that much more difficult to notice the deeper issues
threatening Israel’s competitiveness and constitute a genuine obstacle for
the industry’s long term success, as economists from the Bank of Israel and
the Finance Ministry have recently pointed out. The main challenges facing
us, especially the shortage of skilled workers and the freeze in government
expenditure on R&D, are also related to the long term infrastructure reforms
necessary for the continued development of the Israeli innovation industry.
Some of these become apparent when comparing Israel’s performance with other
leading countries competing on technological innovation, especially as these
countries increase their expenditure on R&D and innovation. The Israeli
innovation industry is at a critical juncture – will it tread in place due
to increased competition or renew its growth? Are we moving towards another
leap forward ahead of other countries, breaking our own glass ceiling via
forward thinking, or are we plodding towards mediocrity? The actions we take
in the coming years will decide. If we are able to allocate more resources
towards technological innovation and expand its influence on the entire
economy, we can better prepare the Israeli innovation industry for its next
leap forward. The very establishment of the Israel Innovation Authority
signals the importance the Israeli government attaches to the hi-tech
industry and to creating the right tools for its development. The Authority
will work towards reprioritizing public funding towards building the
necessary infrastructure for innovation and towards creating the optimal
conditions for another leap forward by the Israeli industry and economy.”