Start-Up Nation - The Story of Israel's Economic Miracle Part 1

Start-Up Nation_ The Story of Israel's Economic Miracle.

by Dan Senor and Saul Singer.

AUTHORS' NOTE

This is a book about innovation and entrepreneurs.h.i.+p, and how one small country, Israel, came to embody both.

This is not a book about technology, even though we feature many high-tech companies. While we are fascinated by technology and its impact on the modern age, our focus is the ecosystem that generates radically new business ideas.

This book is part exploration, part argument, and part storytelling. The reader might expect the book to be organized chronologically, around companies, or according to the various key elements that we have identified in Israel's model for innovation. These organizational blueprints tempted us, but we ultimately rejected them all in favor of a more mosaiclike approach.

We examine history and culture, and use selected stories of companies to try to understand where all of this creative energy came from and the forms in which it is expressed. We have interviewed economists and studied their perspectives, but we come at our subject as students of history, business, and geopolitics. One of us (Dan) has a background in business and government, the other (Saul) in government and journalism. Dan lives in New York and has studied in Israel and lived, worked, and traveled in the Arab world; Saul grew up in the United States and now lives in Jerusalem.

Dan has invested in Israeli companies. None of these companies are profiled in this book, but some people Dan has invested with are. We will note this where appropriate.

While our admiration for the untold story of what Israel has accomplished economically was a big part of what motivated us to write this book, we do cover areas where Israel has fallen behind. We also examine threats to Israel's continued success-most of which will likely surprise the reader, since they do not relate to those that generally preoccupy the international press.

We delve briefly into two other areas: why American innovation industries have not taken better advantage of the entrepreneurial talent offered by those with U.S. military training and experience, in contrast to the practice in the Israeli economy; and why the Arab world is having difficulty in fostering entrepreneurs.h.i.+p. These subjects deserve in-depth treatment beyond the scope of this book; entire books could be written about each.

Finally, if there is one story that has been largely missed despite the extensive media coverage of Israel, it is that key economic metrics demonstrate that Israel represents the greatest concentration of innovation and entrepreneurs.h.i.+p in the world today.

This book is our attempt to explain that phenomenon.

Israel. 20032009 Koret Communications Ltd. www.koret.com. Reprinted by permission.

Israel and the region. 20032009 Koret Communications Ltd. www.koret.com. Reprinted by permission.

Introduction.

Nice speech, but what are you going to do?

-s.h.i.+MON P PERES to S to SHAI A AGa.s.sI.

THE TWO MEN MADE AN ODD COUPLE as they sat, waiting, in an elegant suite in the Sheraton Seehof, high up in the Swiss Alps. There was no time to cut the tension with small talk; they just exchanged nervous glances. The older man, more than twice the age of the younger and not one to become easily discouraged, was the calmer of the two. The younger man normally exuded the self-confidence that comes with being the smartest person in the room, but repeated rejections had begun to foster doubt in his mind: Would he really be able to pull off reinventing three megaindustries? He was anxious for the next meeting to begin. as they sat, waiting, in an elegant suite in the Sheraton Seehof, high up in the Swiss Alps. There was no time to cut the tension with small talk; they just exchanged nervous glances. The older man, more than twice the age of the younger and not one to become easily discouraged, was the calmer of the two. The younger man normally exuded the self-confidence that comes with being the smartest person in the room, but repeated rejections had begun to foster doubt in his mind: Would he really be able to pull off reinventing three megaindustries? He was anxious for the next meeting to begin.

It was not clear why the older man was subjecting himself to this kind of ha.s.sle and to the risk of humiliation. He was the world's most famous living Israeli, an erudite two-time prime minister and n.o.bel Prize winner. At eighty-three years old, s.h.i.+mon Peres certainly did not need another adventure.

Just securing these meetings had been a challenge. s.h.i.+mon Peres was a perennial fixture at the annual Davos World Economic Forum. For the press, waiting to see whether this or that Arab potentate would shake Peres's hand was an easy source of drama at what was otherwise a dressed-up business conference. He was one of the famous leaders CEOs typically wanted to meet.

So when Peres invited the CEOs of the world's five largest carmakers to meet with him, he expected that they would show up. But it was early 2007, the global financial crisis was not yet on the horizon, the auto industry was not feeling the pressure it would a year later, and the American Big Three-GM, Ford, and Chrysler-didn't bother to respond. Another top automaker had arrived, but he'd spent the entire twenty-five minutes explaining that Peres's idea would never work. He wasn't interested in hearing about the Israeli leader's utopian scheme to switch the world over to fully electric vehicles, and even if he had been, he wouldn't dream of launching it in a tiny country like Israel. "Look, I've read Shai's paper," the auto executive told Peres, referring to the white paper Peres had sent with the invitation. "He's fantasizing. There is no car like that. We've tried it, and it can't be built." He went on to explain that hybrid cars were the only realistic solution.

Shai Aga.s.si was the younger man making the pitch alongside Peres. At the time, Aga.s.si was an executive at SAP, the largest enterprise software company in the world. Aga.s.si had joined the German tech giant in 2000, after it bought his Israeli start-up, TopTier Software, for $400 million. The sale had proved that though the tech bubble had just burst, some Israeli companies could still garner precrash values.

Aga.s.si founded TopTier when he was twenty-four. Fifteen years later, he headed two SAP subsidiaries, was the youngest and only non-German member of SAP's board, and had been short-listed for CEO. Even if he missed the ring at thirty-nine, he could be pretty confident that someday it would be his.

Yet here Aga.s.si was, with the next president of Israel, trying to instruct an auto executive on the future of the auto industry. Even he was beginning to wonder if this entire idea was preposterous, especially since it had begun as nothing more than a thought experiment.

At what Aga.s.si calls "Baby Davos"-the Forum for Young Leaders-two years before, he had taken seriously a challenge to the group to come up with a way to make the world a "better place" by 2030. Most partic.i.p.ants proposed tweaks to their businesses. Aga.s.si came up with an idea so ambitious that most people thought him naive. "I decided that the most important thing to do was to figure out how to take a single country off of oil," he told us.

Aga.s.si believed that if just one country was able to become completely oil-independent, the world would follow. The first step was to find a way to run cars without oil.

This alone was not a revolutionary insight.

He explored some exotic technologies for powering cars, such as hydrogen fuel cells, but they all seemed like they would forever be ten years away. So Aga.s.si decided to focus on the simplest system of all: battery-powered electric vehicles. The concept was one that had been rejected in the past as too limiting and expensive, but Aga.s.si thought he had a solution to make the electric car not just viable for consumers but preferable. If electric cars could be as cheap, convenient, and powerful as gas cars, who wouldn't want one?

Something about coming from an embattled sliver of a country-home to just one one-thousandth of the world's population-makes Israelis skeptical of conventional explanations about what is possible. If the essence of the Israeli condition, as Peres later told us, was to be "dissatisfied," then Aga.s.si typified Israel's national ethos.

But if not for Peres, even Aga.s.si might not have dared to pursue his own idea. After hearing Aga.s.si make his pitch for oil independence, Peres called him and said, "Nice speech, but what are you going to do do?"1 Until that point, Aga.s.si says, he "was merely solving a puzzle"-the problem was still just a thought experiment. But Peres put the challenge before him in clear terms: "Can you really do it? Is there anything more important than getting the world off oil? Who will do it if you don't?" And finally, Peres added, "What can I do to help?"2 Peres was serious about helping. Just after Christmas 2006 and into the first few days of 2007, he orchestrated for Aga.s.si a whirlwind of more than fifty meetings with Israel's top industry and government leaders, including the prime minister. "Each morning, we would meet at his office and I would debrief him on the previous day's meetings, and he'd get on the phone and begin scheduling the next day's meetings," Aga.s.si told us. "These are appointments I could never have gotten without Peres."

Peres also sent letters to the five biggest automakers, along with Aga.s.si's concept paper, which was how they found themselves in a Swiss hotel room, waiting on what was likely to be their last chance. "Up until that first meeting," Aga.s.si said, "Peres had only heard about the concept from me, a software guy. What did I know? But he took a risk on me." The Davos meetings were the first time Peres had personally tested the idea on people who actually worked in the auto industry. And the first industry executive they'd met had not only shot down the idea but spent most of the meeting trying to talk Peres out of pursuing it. Aga.s.si was mortified. "I had completely embarra.s.sed this international statesman," he said. "I made him look like he did not know what he was talking about."

But now their second appointment was about to begin. Carlos Ghosn, the CEO of Renault and Nissan, had a reputation in the business world as a premier turnaround artist. Born in Brazil to Lebanese parents, he is famous in j.a.pan for taking charge of Nissan, which was suffering ma.s.sive losses, and in two years turning a profit. The grateful j.a.panese reciprocated by basing a comic-book series on his life.

Peres began to speak so softly that Ghosn could barely hear him, but Aga.s.si was astounded. After the pounding they had just received in the previous meeting, Aga.s.si expected that Peres might say something like, "Shai has this crazy idea about building an electric grid. I'll let him explain it, and you can tell him what you think." But rather than pulling back, Peres grew even more energetic than before in making the pitch, and more forceful.

Oil is finished, he said; it may still be coming out of the ground, but the world doesn't want it anymore. More importantly, Peres told Ghosn, it is financing international terrorism and instability. "We don't need to defend against incoming Katyusha rockets," he pointed out, "if we can figure out how to cut off the funding that launches them in the first place."

Then Peres tried to preempt the argument that the technology alternative just didn't exist yet. He knew that all the big car companies were flirting with a bizarre crop of electric mutations-hybrids, plug-in hybrids, tiny electric vehicles-but none of them heralded a new era in motor vehicle technology.

Just then, again about five minutes into Peres's pitch, the visitor stopped him. "Look, Mr. Peres," Ghosn said, "I read Shai's paper"-Aga.s.si and Peres tried not to wince, but they felt they knew where this meeting was heading-"and he is absolutely right. We are exactly on the same page. We think the future is electric. We have the car, and we think we have the battery."

Peres was almost caught speechless. Just minutes ago they'd received an impa.s.sioned lecture on why the fully electric car would never work and why hybrids were the way to go. But Peres and Aga.s.si knew that hybrids were a road to nowhere. What's the point of a car with two separate power plants? Existing hybrids cost a fortune and increase fuel efficiency by only 20 percent. They wouldn't get countries off oil. In Peres and Aga.s.si's view, hybrids were like treating a gunshot wound with a Band-aid.

But they had never heard all this from an actual carmaker. Peres couldn't help blurting out, "So what do you think of hybrids?"

"I think they make no sense," Ghosn said confidently. "A hybrid is like a mermaid: if you want a fish, you get a woman; if you want a woman, you get a fish."

The laughter from Peres and Aga.s.si was genuine, mixed with a large dose of relief. Had they found a true partner for their vision? Now it was Ghosn's turn to be worried. Though he was optimistic, all the cla.s.sic obstacles to electric vehicles still remained: the batteries were too expensive, they had a range less than half that of a tank of gas, and they took hours to recharge. So long as consumers were being asked to pay a premium in price and convenience, clean cars would remain a niche market.

Peres said that he'd had all the same misgivings, until he had met Aga.s.si. This was Aga.s.si's cue to explain how all these liabilities could be addressed using existing technology, not some miracle battery that wouldn't be available for decades.

Ghosn's attention s.h.i.+fted from Peres to Aga.s.si, who dove right in.

Aga.s.si explained his idea, as simple as it was radical: electric cars seemed seemed expensive only because batteries were expensive. But selling the car with the battery is like trying to sell gas cars with enough gasoline to run them for several years. When you factor in operating costs, electric cars are actually much cheaper-seven cents a mile for electric (including both the battery and the electricity to charge it) compared to ten cents a mile for gas, a.s.suming gas costs $2.50 a gallon. If the price of gas is as high as $4.00 per gallon, this cost gap becomes a chasm. But what if you didn't have to pay for the battery when you bought the car and-as with any other fuel-spread the cost of the battery over the life of the car? Electric cars could become at least as cheap as gasoline cars, and the cost of the battery expensive only because batteries were expensive. But selling the car with the battery is like trying to sell gas cars with enough gasoline to run them for several years. When you factor in operating costs, electric cars are actually much cheaper-seven cents a mile for electric (including both the battery and the electricity to charge it) compared to ten cents a mile for gas, a.s.suming gas costs $2.50 a gallon. If the price of gas is as high as $4.00 per gallon, this cost gap becomes a chasm. But what if you didn't have to pay for the battery when you bought the car and-as with any other fuel-spread the cost of the battery over the life of the car? Electric cars could become at least as cheap as gasoline cars, and the cost of the battery with with the electricity to charge it would be significantly cheaper than what people were used to paying at the pump. Suddenly, the economics of the electric car would turn upside down. Furthermore, over the long run, this already sizable electric cost advantage would be certain to increase as batteries became cheaper. the electricity to charge it would be significantly cheaper than what people were used to paying at the pump. Suddenly, the economics of the electric car would turn upside down. Furthermore, over the long run, this already sizable electric cost advantage would be certain to increase as batteries became cheaper.

Overcoming the price barrier was the biggest breakthrough, but it wasn't sufficient for electric vehicles to become, as Aga.s.si called it, the "Car 2.0" that would replace the transportation model introduced by Henry Ford almost a century ago. A five-minute fill-up will last a gas car three hundred miles. How, Ghosn wondered, can an electric car compete with that?

Aga.s.si's solution was infrastructure: wire thousands of parking spots, build battery swap stations, and coordinate it all over a new "smart grid." In most cases, charging the car at home and the office would easily be enough to get you through the day. On longer drives, you could pull into a swap station and be off with a fully charged battery in the time it takes to fill a tank of gas. He'd recruited a former Israeli army general-a man skilled at managing complex military logistics-to become the company's local Israeli CEO and lead the planning for the grid and the national network of charging/parking spots.

The key to the model would be that consumers would own their cars, but Aga.s.si's start-up, called Better Place, would own the batteries. "Here's how it works," he later explained. "Think cell phones. You go to a cell provider. If you want, you can pay full price for a phone and make no commitment. But most people commit for two or three years and get a subsidized or free phone. They end up paying for the phone as they pay for their minutes of air time."3 Electric vehicles, Aga.s.si explained, could work the same way: Better Place would be like a cellular provider. You would walk in to a car dealer, sign up for a plan based on miles instead of minutes, and get an electric car. But the buyer wouldn't own the car battery; Better Place would. So the company could spread the cost of the battery-and the car, too-over four or more years. For the price consumers are used to paying each month for gas, they could pay for the battery and the electricity needed to run it. "You get to go completely green for less than it costs to buy and run a gas car," Aga.s.si said.

Aga.s.si picked up where Peres had left off on another question: Why start with Israel, of all places? The first reason was size, he told Ghosn. Israel was the perfect "beta" country for electric cars. Not only was it small but, due to the hostility of its neighbors, it was a sealed "transportation island." Because Israelis could not drive beyond their national borders, their driving distances were always within one of the world's smallest national s.p.a.ces. This limited the number of battery swap stations Better Place would have to build in the early phase. By isolating Israel, Aga.s.si told us with an impish smile, Israel's adversaries had actually created the perfect laboratory to test ideas.

Second, Israelis understand not only the financial and environmental costs of being dependent on oil but also the security costs of pumping money into the coffers of less-than-savory regimes. Third, Israelis are natural early adopters-they were recently number one in the world in time spent on the Internet and have a cell phone penetration of 125 percent, meaning lots of people have more than one.

No less importantly, Aga.s.si knew that in Israel he would find the resources he needed to tackle the tricky software challenge of creating a "smart grid" that could direct cars to open charging spots and manage the charging of millions of cars without overloading the system. Israel, the country with the highest concentration of engineers and research and development spending in the world, was a natural place to attempt this. Aga.s.si actually wanted to go even further. After all, if Intel could ma.s.s-produce its most sophisticated chips in Israel, why couldn't Renault-Nissan build cars there? Ghosn's response was that it would work only if they could produce at least fifty thousand cars a year. Peres didn't blink, and committed to an annual production of one hundred thousand cars. Ghosn was on board, provided Peres could make good on his promise.

Aga.s.si was caught between three possible commitments. He needed a country, a car company, and the money, but to get any one of them he first needed the other two. For example, when Peres and Aga.s.si had gone to then prime minister Ehud Olmert to secure his commitment to make Israel the first country to free itself from oil, the premier had set two conditions: Aga.s.si had to sign on a top-five carmaker and raise the $200 million needed to develop the smart grid, turning half a million parking s.p.a.ces into charging spots, and building swap stations. Now Aga.s.si had the carmaker, and it was time to fulfill Olmert's second condition: money.

Still, Aga.s.si had heard enough to believe that his idea could take off. Stunning the tech world, he quit his job at SAP to found Better Place. (It took four conversations to convince the SAP management that he was serious about quitting.) But investors around the globe were not jumping at a plan that involved reimagining some of the largest, most powerful industries in the world: cars, oil, and electricity. Plus, since the cars were useless without the infrastructure, the charging grid would have to be developed and deployed before before the cars were released in significant numbers. That meant spending most of the $200 million to wire the entire country up front-an enormous capital expenditure that would make investors' heads spin. Ever since the tech bubble had burst in 2000, venture capitalists were much less venturesome; no one wanted to spend tons of money up front, well before the first dollar of revenue showed up. the cars were released in significant numbers. That meant spending most of the $200 million to wire the entire country up front-an enormous capital expenditure that would make investors' heads spin. Ever since the tech bubble had burst in 2000, venture capitalists were much less venturesome; no one wanted to spend tons of money up front, well before the first dollar of revenue showed up.

Except for one investor, that is-Israeli billionaire Idan Ofer, who had just made the largest ever Israeli investment in China by buying a major stake in the Chinese car manufacturer Chery Automobile. Six months before, Ofer had also bought an oil refinery. So he knew a thing or two about the auto and oil industries. When Mike Granoff, an early American investor in Better Place, suggested tapping Ofer, Aga.s.si said, "Why would he help me put him out of his two newest businesses?" But Aga.s.si had nothing to lose.

Forty-five minutes into their meeting, Ofer told Aga.s.si he was in for $100 million. He later increased his stake by another $30 million and told his Chinese auto team he wanted it to build electric cars.

Aga.s.si raised the $200 million, making Better Place the fifth-largest start-up in history.4 With Israel in place as the first test case, others were quick to follow. As of this writing, Denmark, Australia, the San Francis...o...b..y Area, Hawaii, and Ontario-Canada's most populous province-have all announced that they will join the Better Place plan. Better Place was the only foreign company asked to compete in developing an electric vehicle system for j.a.pan, a highly unusual step for the historically protectionist j.a.panese government. With Israel in place as the first test case, others were quick to follow. As of this writing, Denmark, Australia, the San Francis...o...b..y Area, Hawaii, and Ontario-Canada's most populous province-have all announced that they will join the Better Place plan. Better Place was the only foreign company asked to compete in developing an electric vehicle system for j.a.pan, a highly unusual step for the historically protectionist j.a.panese government.

Among the many skeptics is Thomas Weber, the Mercedes research and development chief. He said that in 1972 his company had actually built an electric bus with a swappable battery, called the LE 306, and discovered that changing a battery could cause electrocution or fire.

Better Place's answer has been a working battery swap station. Using one is like pulling into a car wash. Only, once the driver pulls in, a large rectangular metal plate-much like the lifts at the back end of moving trucks-rises up from underneath the car. The car then retracts the thick two-inch metal hooks securing the enormous blue battery, releasing it so it rests on the plate. The plate moves back down, drops the spent battery in a charging station, picks up a full battery, and lifts it into place under the car. Total time for the completed automated swap: sixty-five seconds.

Aga.s.si is proud of how his team solved the engineering problem of precisely, instantly, and reliably releasing a battery that weighs hundreds of pounds. They employed the same hooks used to hold five-hundred-pound bombs in place on air force bombers. There was no room for error in a bomb-release mechanism; the battery would be just as secure, yet removable, in electric cars.

If it succeeds, the global impact of Better Place on economics, politics, and the environment might well transcend that of the most important technology companies in the world. And the idea will have spread from Israel throughout the world.

Companies like Better Place and entrepreneurs like Shai Aga.s.si don't appear every day. Yet a glance at Israel shows why it is not so surprising that, as Boston's Battery Ventures investor Scott Tobin predicted, "the next big idea will come from Israel."5 Technology companies and global investors are beating a path to Israel and finding unique combinations of audacity, creativity, and drive everywhere they look. Which may explain why, in addition to boasting the highest density of start-ups in the world (a total of 3,850 start-ups, one for every 1,844 Israelis),6 more Israeli companies are listed on the NASDAQ exchange than all companies from the entire European continent. more Israeli companies are listed on the NASDAQ exchange than all companies from the entire European continent.

And it's not just the New York stock exchanges that have been drawn to Israel, but also the most critical and fungible measure of technological promise: venture capital.

In 2008, per capita venture capital investments in Israel were 2.5 times greater than in the United States, more than 30 times greater than in Europe, 80 times greater than in China, and 350 times greater than in India. Comparing absolute numbers, Israel-a country of just 7.1 million people-attracted close to $2 billion in venture capital, as much as flowed to the United Kingdom's 61 million citizens or to the 145 million people living in Germany and France combined.7 And Israel is the only country to experience a meaningful increase in venture capital from 2007 to 2008, as figure I.1 shows. And Israel is the only country to experience a meaningful increase in venture capital from 2007 to 2008, as figure I.1 shows.8

Figure I.1. Sources: Sources: Dow Jones, VentureSource; Thomson Reuters; U.S. Central Intelligence Agency, Dow Jones, VentureSource; Thomson Reuters; U.S. Central Intelligence Agency, World Fact Book World Fact Book, 2007, 2008.

After the United States, Israel has more companies listed on the NASDAQ than any other country in the world, including India, China, Korea, Singapore, and Ireland, as figure I.2 shows. And, as figure I.3 makes clear, Israel is the world leader in the percentage of the economy that is spent on research and development.

Figure I.2. Source: Source: NASDAQ, NASDAQ, http://www.nasdaq.com/asp/ NonUsOutput.asp, May 2009.

Figure I.3. Source: Source: UNDP (United Nations Development Programme) Report, 2007/2008. UNDP (United Nations Development Programme) Report, 2007/2008.

Israel's economy has also grown faster than the average for the developed economies of the world in most years since 1995, as a chart on page 14 14 ill.u.s.trates (figure I.4). ill.u.s.trates (figure I.4).

Even the wars Israel has repeatedly fought have not slowed the country down. During the six years following 2000, Israel was. .h.i.t not just by the bursting of the global tech bubble but by the most intense period of terrorist attacks in its history and by the second Lebanon war. Yet Israel's share of the global venture capital market did not drop-it doubled doubled, from 15 percent to 31 percent. And the Tel Aviv stock exchange was higher on the last day of the Lebanon war than on the first, as it was after the three-week military operation in the Gaza Strip in 2009.

Figure I.4. Sources: Sources: "Miracles and Mirages," "Miracles and Mirages," Economist Economist, April 13, 2008; "GDP Growth Rates by Country and Region, 19702007," Swivel, http://www.swivel.com/data_columns/spreadsheet/2085677.

The Israeli economic story becomes even more curious when one considers the nation's dire state just a little over a half century ago. Shai Aga.s.si's family immigrated to Israel from Iraq in 1950, two years after Israel's founding. The Aga.s.sis were part of a flood of a million refugees fleeing as a wave of violent pogroms swept the Arab world after the State of Israel's founding. At the time, the fledgling Jewish state simultaneously faced two seemingly insurmountable challenges: fighting an existential war for independence and absorbing ma.s.ses of refugees from postwar Europe and the surrounding Arab countries.

Israel's population doubled in the first two years of its existence. Over the next seven years, the country grew by another third. Two out of three Israelis were new arrivals. Right off the boat, many refugees were given a gun they had no idea how to use and sent to fight. Some of those who had survived n.a.z.i concentration camps fell in battle even before their names could be recorded. Proportionately, more Israelis died in the war for Israel's establishment than Americans in both world wars combined.

Those who survived had to struggle to thrive in a stagnant economy. "Everything was rationed," complained one new arrival. "We had coupon books, one egg a week, long lines."9 The average standard of living for Israelis was comparable to that of Americans in the 1800s. The average standard of living for Israelis was comparable to that of Americans in the 1800s.10 How, then, did this "start-up" state not only survive but morph from a besieged backwater to a high-tech powerhouse that has achieved fiftyfold economic growth in sixty years? How did a community of penniless refugees transform a land that Mark Twain described as a "desolate country . . . a silent, mournful expanse," How, then, did this "start-up" state not only survive but morph from a besieged backwater to a high-tech powerhouse that has achieved fiftyfold economic growth in sixty years? How did a community of penniless refugees transform a land that Mark Twain described as a "desolate country . . . a silent, mournful expanse,"11 into one of the most dynamic entrepreneurial economies in the world? into one of the most dynamic entrepreneurial economies in the world?

The fact that this question has been treated only in piecemeal fas.h.i.+on is unbelievable to Israeli political economist Gidi Grinstein: "Look, we doubled our economic situation relative to America while multiplying our population fivefold and fighting three wars. This is totally unmatched in the economic history of the world." And, he told us, the Israeli entrepreneur continues to perform in unimaginable ways.12 While the Holy Land has for centuries attracted pilgrims, lately it has been flooded by seekers of a different sort. Google's CEO and chairman, Eric Schmidt, told us that the United States is the number one place in the world for entrepreneurs, but "after the U.S., Israel is the best." Microsoft's Steve Ballmer has called Microsoft "an Israeli company as much as an American company" because of the size and centrality of its Israeli teams.13 Warren Buffett, the apostle of risk aversion, broke his decades-long record of not buying any foreign company with the purchase of an Israeli company-for $4.5 billion-just as Israel began to fight the 2006 Lebanon war. Warren Buffett, the apostle of risk aversion, broke his decades-long record of not buying any foreign company with the purchase of an Israeli company-for $4.5 billion-just as Israel began to fight the 2006 Lebanon war.

It is impossible for major technology companies to ignore Israel, and most haven't; almost half of the world's top technology companies have bought start-ups or opened research and development centers in Israel. Cisco alone has acquired nine Israeli companies and is looking to buy more.14 "In two days in Israel, I saw more opportunities than in a year in the rest of the world," said Paul Smith, senior vice president of Philips Medical.15 Gary Shainberg, British Telecom's VP for technology and innovation, told us, "There are more new innovative ideas, as opposed to recycled ideas-or old ideas repackaged in a new box-coming out of Israel than there are out in [Silicon] Valley now. And it doesn't slow during global economic downturns." Gary Shainberg, British Telecom's VP for technology and innovation, told us, "There are more new innovative ideas, as opposed to recycled ideas-or old ideas repackaged in a new box-coming out of Israel than there are out in [Silicon] Valley now. And it doesn't slow during global economic downturns."16 Though Israel's technology story is becoming more widely known, those exposed to it for the first time are invariably baffled. As an NBC Universal vice president sent to scout for Israeli digital media companies wondered, "Why is all this happening in Israel? I've never seen so much chaos and so much innovation all in one tiny place."17 That is the mystery this book aims to solve. Why Israel and not elsewhere?

One explanation is that adversity, like necessity, breeds inventiveness. Other small and threatened countries, such as South Korea, Singapore, and Taiwan, can also boast growth records that are as impressive as Israel's. But none of them have produced an entrepreneurial culture-not to mention an array of start-ups-that compares with Israel's.

Some people conjecture that there is something specifically Jewish at work. The notion that Jews are "smart" has become deeply embedded in the Western psyche. We saw this ourselves; when we told people we were writing a book about why Israel is so innovative, many reacted by saying, "It's simple-Jews are smart, so it's no surprise that Israel is innovative." But pinning Israel's success on a stereotype obscures more than it reveals.

For starters, the idea of a unitary Jewishness-whether genetic or cultural-would seem to have little applicability to a nation that, though small, is among the most heterogeneous in the world. Israel's tiny population is made up of some seventy different nationalities. A Jewish refugee from Iraq and one from Poland or Ethiopia did not share a language, education, culture, or history-at least not for the two previous millennia. As Irish economist David McWilliams explains, "Israel is quite the opposite of a uni-dimensional, Jewish country. . . . It is a monotheistic melting pot of a diaspora that brought back with it the culture, language and customs of the four corners of the earth."18 While a common prayer book and a shared legacy of persecution count for something, it was far from clear that this disparate group could form a functioning country at all, let alone one that would excel at-of all things-teamwork and innovation.

Indeed, Israel's secret seems to lie in something more than just the talent of individuals. There are lots of places with talented people, certainly with many times the number of engineers that Israel has to offer. Singaporean students, for example, lead the world in science and mathematics test scores. Multinationals have set up shop in places like India and Ireland, too. "But we don't set up our mission critical work in those countries," an American executive from eBay told us. "Google, Cisco, Microsoft, Intel, eBay . . . the list goes on. The best-kept secret is that we all live and die by the work of our Israeli teams. It's much more than just outsourcing call centers to India or setting up IT services in Ireland. What we do in Israel is unlike what we do anywhere else in the world."19 Another commonly cited factor in Israel's success is the country's military and defense industry, which has produced successful spin-off companies. This is part of the answer, but it does not explain why other countries that have conscription and large militaries do not see a similar impact on their private sectors. Pointing to the military just s.h.i.+fts the question: What is it about the Israeli military that seems to foster entrepreneurs.h.i.+p? And even with the influence of the military, why is it that defense, counterterrorism, and homeland security companies today represent less than 5 percent of Israel's gross domestic product?

The answer, we contend, must be broader and deeper. It must lie in the stories of individual entrepreneurs like Shai Aga.s.si, which are emblematic of the state itself. As we will show, it is a story not just of talent but of tenacity, of insatiable questioning of authority, of determined informality, combined with a unique att.i.tude toward failure, teamwork, mission, risk, and cross-disciplinary creativity. Israel is replete with such stories. But Israelis themselves have been too busy building their start-ups to step back and try to st.i.tch together how it happened and what others-governments, large companies, and start-up entrepreneurs-can learn from their experience.

It would be hard to imagine a time when understanding the story of Israel's economic miracle could be more relevant. While the United States continues to be rated the world's most compet.i.tive economy, there is a widespread sense that something fundamental has gone wrong.

Even before the global financial crisis that began in 2008, observers of the innovation race were sounding alarms. "India and China are a tsunami about to overwhelm us," predicted Stanford Research Inst.i.tute's Curtis Carlson. He forecasts that America's information technology, service, and medical-devices industries are about to be lost, costing "millions of jobs . . . like in the 1980s when the j.a.panese surged ahead." The only way out, says Carlson, is "to learn the tools of innovation" and forge entirely new, knowledge-based industries in energy, biotechnology, and other science-based sectors.20 "We are rapidly becoming the fat, complacent Detroit of nations," says former Harvard Business School professor John Kao. "We are . . . milking aging cows on the verge of going dry . . . [and] losing our collective sense of purpose along with our fire, ambition, and determination to achieve."21 The economic downturn has only sharpened the focus on innovation. The financial crisis, after all, was triggered by the collapse of real estate prices, which had been inflated by reckless bank lending and cheap credit. In other words, global prosperity had rested on a speculative bubble, not on the productivity increases that economists agree are the foundation of sustainable economic growth.

According to the pioneering work of n.o.bel Prize winner Robert Solow, technological innovation is the ultimate source of productivity and growth.22 It's the only proven way for economies to consistently get ahead-especially innovation born by start-up companies. Recent Census Bureau data show that most of the net employment gains in the United States between 1980 and 2005 came from firms younger than five years old. Without start-ups, the average annual net employment growth rate would actually have been negative. Economist Carl Schramm, president of the Kauffman Foundation, which a.n.a.lyzes entrepreneurial economics, told us that "for the United States to survive and continue its economic leaders.h.i.+p in the world, we must see entrepreneurs.h.i.+p as our central comparative advantage. Nothing else can give us the necessary leverage." It's the only proven way for economies to consistently get ahead-especially innovation born by start-up companies. Recent Census Bureau data show that most of the net employment gains in the United States between 1980 and 2005 came from firms younger than five years old. Without start-ups, the average annual net employment growth rate would actually have been negative. Economist Carl Schramm, president of the Kauffman Foundation, which a.n.a.lyzes entrepreneurial economics, told us that "for the United States to survive and continue its economic leaders.h.i.+p in the world, we must see entrepreneurs.h.i.+p as our central comparative advantage. Nothing else can give us the necessary leverage."23 It is true that there are many models of entrepreneurs.h.i.+p, including microentrepreneurs.h.i.+p (the launching of household businesses) and the establishment of small companies that fill a niche and never grow beyond it. But Israel specializes in high-growth entrepreneurs.h.i.+p-start-ups that wind up transforming entire global industries. High-growth entrepreneurs.h.i.+p is distinct in that it uses specialized talent-from engineers and scientists to business managers and marketers-to commercialize a radically innovative idea.

This is not to suggest that Israelis are immune from the universally high failure rate of start-ups. But Israeli culture and regulations reflect a unique att.i.tude to failure, one that has managed to repeatedly bring failed entrepreneurs back into the system to constructively use their experience to try again, rather than leave them permanently stigmatized and marginalized.

As a recent report by the Monitor Group, a global management consulting firm, described it, "When [entrepreneurs] succeed, they revolutionize markets. When they fail, they still [keep] inc.u.mbents under constant compet.i.tive pressure and thus stimulate progress." And the Monitor study shows that entrepreneurs.h.i.+p is the main engine for economies to "evolve and regenerate."24 The question has become, as a BusinessWeek BusinessWeek cover put it, "Can America Invent Its Way Back?" cover put it, "Can America Invent Its Way Back?"25 The magazine observed that "beneath the gloom, economists and business leaders across the political spectrum are slowly coming to an agreement: Innovation is the best-and maybe the only-way the U.S. can get out of its economic hole." The magazine observed that "beneath the gloom, economists and business leaders across the political spectrum are slowly coming to an agreement: Innovation is the best-and maybe the only-way the U.S. can get out of its economic hole."

In a world seeking the key to innovation, Israel is a natural place to look. The West needs innovation; Israel's got it. Understanding where this entrepreneurial energy comes from, where it's going, how to sustain it, and how other countries can learn from the quintessential start-up nation is a critical task for our times.

PART I.

The Little Nation That Could