Chapter 3. Business environment and framework conditions in Israel1

This chapter examines the framework conditions influencing SME and entrepreneurship development in Israel. It covers macroeconomic conditions, product market regulations and the ease of doing business, human resources, the innovation system, access to finance, business taxation and foreign direct investment. Israel has experienced strong economic growth in recent years thanks to major assets such as high rates of participation in tertiary education, strong R&D expenditure, well-developed equity finance, and favourable business taxation. This has offered favourable conditions for Israel’s successful high-technology entrepreneurial ecosystem. Nonetheless, improvements can still be made to framework conditions for SME and entrepreneurship development more generally, including addressing barriers to product market competition, inadequate vocational skills and training, limited access to loan finance, limited support for non-R&D based innovation and limited FDI‐SME linkages. Tackling these issues can help reduce the dualism of the Israeli economy between an internationally advanced high-technology sector and a lagging traditional manufacturing and services sector.

Macroeconomic conditions

GDP growth

SMEs and entrepreneurship have benefited from the strong growth of the Israeli economy in recent years in terms of growing market and other opportunities. Israel’s GDP growth rates were positive throughout the decade 2003-13, despite the global recession, although they have recently slowed (Figure 3.1). OECD estimates set them at 3.2% and 3.5% for 2014 and 2015.2 The economy appears to be close to potential and there are relatively few areas of spare capacity (OECD, 2013a). As a result, GDP growth in the future will have to stem more and more from increased productivity, which is a challenge for SME and entrepreneurship policy as well as other government policy areas.

Labour market trends

As a result of sustained recent economic growth, labour market performance has reached record highs. In 2013, Israel outperformed the OECD average on the labour market participation rate, the employment rate and the unemployment rate. Israel’s labour force participation rate and employment rate are close to 70%, whereas the unemployment rate stood at approximately 6% in 2013 (Figure 3.2).

Figure 3.3 shows employment rates by population group in Israel for men and women. It shows that although the general context is one of high labour utilisation, there are two particular segments of the population – Ultraorthodox Jewish men and Arab Israeli women – whose participation in the labour market is significantly below that of the total population. In addition, there is a smaller gap between the Arab Israeli male participation rate and that of all males than between the participation rate of Ultraorthodox Jewish women and that of all females. The support offered to these groups to increase their labour market participation could include encouragement for self-employment in the formal sector.

Growing labour market participation and job creation in new and small enterprises have been facilitated by a flexible labour market. OECD employment protection legislation (EPL) indicators show the Israeli labour market to be less rigid than the OECD average with respect to both regulations on dismissals against regular workers and regulations on temporary contracts (Figure 3.4). This is likely to make new and small business owners less reluctant to hire workers in periods of economic expansion for fear of being unable to reduce their labour force when the economy slows down.

Wages growth has significantly trailed GDP growth and labour productivity growth (GDP per hour worked) in Israel in recent years (Figure 3.5),3 which suggests that wage moderation has played a role in helping SMEs to create jobs. At the same time, wage inequality in Israel is the second-highest in the OECD after the United States, calling for increased policy attention to improve the quality of low-end jobs, including in SMEs and micro firms in non-high-technology sectors of the economy.

Labour productivity

Israel’s labour productivity growth has not kept pace with the Euro area, the OECD area or the United States (Figure 3.6) over the last fifteen years. Further measures are needed to address this productivity gap, which would include facilitating business entry and dynamism and increasing productivity in established SMEs and micro firms in traditional sectors, where productivity levels are low. Productivity growth in established SMEs is primarily supported through technology development, notably through the incentives of the Law for the Encouragement of Capital Investment. However, the incentives of this Law are mainly used by larger and R&D-based SMEs, whereas fostering productivity in existing non-high-technology SMEs is likely to require a different set of policies that include, among others, business management skills upgrading and improved integration in national and global supply chains.

Monetary and fiscal policy

The Bank of Israel has undertaken a long series of interest-rate cuts that brought the base rate to a historic low of 0.1% in June 2016. This policy aims to boost investment as the economy starts to show some signs of slowdown and to reduce the appreciation of the national currency thus mitigating a recent decline in exports. These measures should maintain a positive climate for SME investment and market access. Although there are no signs of inflationary pressures in the economy, with the significant exception of the housing market, it will be important to continue gradual adjustment of interest rates to prevent potential inflationary shocks that could harm the ability of SMEs to invest or export.

Israel has a “small government” approach to fiscal policy, where low taxation is coupled with low government spending.4 There has been slow fiscal consolidation in the last ten years, during which public debt has fallen by one-fifth in relation to GDP, from 98% in 2004 to 79% in 2014. The government deficit has been low, although the global economic crisis led it to increase to between 3.5% and 6% of GDP during the period 2009-14. With renewed growth and a reduced government deficit, there should be room for moderate fiscal expenditures on SME and entrepreneurship policy.

Product market regulations and the ease of doing business

Competitive product markets support the productivity-enhancing role of entrepreneurship in the economy. Israel trails only Turkey in the overall restrictiveness of its product market regulations, based on the OECD Product Market Regulation (PMR) index (Figure 1.7, reproduced below). In particular, Israel lags behind most other OECD countries in all three main areas covered by this index: state control of the economy, barriers to entrepreneurship and barriers to trade and investment.

Progress in reducing regulatory burdens has also been slow in relation to other OECD countries, despite some recent pro-competition reforms such as the new Concentration Law and the new powers granted to the Israel Anti-trust Authority that have not yet generated their full intended benefits. More generally, this also suggests the importance of reviewing regulations and their impact on SMEs and entrepreneurship, something which the SMBA has started to do mainly through an informal process of consultation with private-sector business associations and chambers of commerce. In the future, the use of more standard regulatory impact assessment methodologies such as the Standard Cost Model would enable the SMBA to assess the impact of new regulations on SMEs in a more rigorous way.5

A disaggregated analysis of the PMR index shows that Israel lags behind most OECD countries in each of the three covered areas (Figure 3.7). Progress in reducing regulatory burdens has also been slow in relation to other OECD countries. This suggests the importance of reviewing regulations and their impact on SMEs and entrepreneurship.

The World Bank’s Doing Business Survey offers results substantially in line with those of the OECD PMR index (Table 3.1). The most problematic areas identified by this survey are those which involve licenses and permits, such as obtaining a construction permit, registering property or getting electricity for a new business premise. Similarly, the survey highlights the complexity of the tax and judicial systems for businesses. On the other hand, “starting a business” in Israel is no more difficult than across most OECD countries; in fact, setting up a limited company in Israel takes the same number of procedures but slightly more time than the OECD high-income country average (Table 3.2).6

Table 3.1. Israel’s profile in the World Bank’s Doing Business Survey, 2016
Rank and distance to the frontier (DTF)
	Rank	Distance to the frontier (%)
Starting a business	56	90.55
Dealing with construction permits	96	68.2
Getting electricity	91	68.96
Registering property	127	52.84
Getting credit	42	65
Protecting minority investors	8	73.33
Paying taxes	103	71.65
Trading across borders	58	82.85
Enforcing contracts	77	59.78
Resolving insolvency	29	72.47
Note: Countries are ranked from 1-189. The distance to frontier (DTF) measures the distance of Israel to the leading country in the respective topic. An economy’s distance to frontier is indicated on a scale from 0 to 100, where 0 represents the lowest performance and 100 the frontier.
Source: The World Bank’s Doing Business database, www.doingbusiness.org/data/exploreeconomies/israel.
https://doi.org/10.1787/888933421859

Table 3.2. Starting a business in Israel, 2016
Number of procedures, number of days and cost
	Israel	OECD high-income
Procedures (number)	5	4.7
Time (days)	13	8.3
Cost (% of income per capita)	3.4	3.2
Note: The World Bank definition of “OECD high-income” includes all 34 OECD countries, except Mexico and Turkey, which in the World-Bank income classification fall under the upper-middle income category. Further information on the definitions of procedures, time and cost is available in the World Bank’s Doing Business website: www.doingbusiness.org/data/exploreeconomies/israel#starting-a-business.
Source: The World Bank’s Doing Business database, www.doingbusiness.org/data/exploreeconomies/israel.
https://doi.org/10.1787/888933421868

In order to improve market competition, the Israeli government passed a new Concentration Law in December 2013. This will oblige industrial conglomerates to separate their financial and non-financial branches and make more difficult the use of corporate pyramid structures by which one public company can retain control of another by holding minority shares. This measure can be expected to facilitate business entry and SME development among other benefits. However, the law will be implemented over six years, which may reduce its immediate impact and expose it to the risk of future changes.

The government has also strengthened the functions of the Israeli Anti-trust Authority (IAA). In food retailing, for example, the IAA has encouraged price transparency by publicising “exclusivity agreements” between suppliers and retailers, while in network services small electricity and gas suppliers have been allowed to connect to the national grid and sell energy services to the market. Nonetheless, there is a risk that other existing rules prevent prices from dropping in the immediate future, such as guaranteed producer prices in agriculture (OECD, 2013a), while state-owned companies are still core producers and distributors of electricity and gas in Israel, leading to higher utility costs for SMEs. More generally, the approach of the IAA has been to propose solutions to restore competition in markets where this is at risk, whereas greater powers, including the ability to impose financial sanctions on wrongdoers, would help the IAA to undertake its task more effectively (OECD, 2011a).

A complex license and permit system, largely managed at the local level by municipalities, is another major regulatory barrier to entrepreneurship and SME development in Israel. Approximately 40% of companies need a license in Israel, but one-quarter of them does not have one. Key problems include lack of information to businesses about the process to follow to obtain the permit, long delays in receiving a response, and poor standardisation of procedures across different municipalities. To tackle these problems a law has been proposed, but not yet approved, that aims to harmonise license requirements across the country, make it more difficult for municipalities to add extra local requirements on top of the national ones, and reduce delays to obtain licenses especially in trades that pose no environmental risks. As part of its SME advocacy function, SMBA could help identify difficulties in permits and licenses and encourage their simplification with the relevant authorities. Digitalisation is another approach that many OECD governments have pursued to modernise their business license and permit system that could also be applied in Israel (see Box 3.1).

Box 3.1. The Canadian online service for business permit and licensing

Description of the approach

BizPaL is an online government service, launched in 2005, for streamlining business permit and licensing procedures and reducing the amount of red-tape for new entrepreneurs and SMEs (www.bizpal.ca). BizPaL receives CAD 3 million annually (EUR 2.1 million) in federal funding to support its maintenance, continued expansion and service improvements. Through BizPaL, the three levels of government work collaboratively to help SMEs comply with government requirements. To date, over 34 federal departments/agencies and all 12 provinces/territories are participating in BizPaL together with about 700 municipalities.

Accessing BizPaL allows SMEs and entrepreneurs to identify which permits and licenses they require and how to obtain them. From the website, they select the business activities they plan to undertake (and in which sectors) and BizPaL automatically generates a list of all required permits and licenses from all levels of government (federal, provincial/territorial and municipal), along with basic information on each with links to the specific government sites where the entrepreneur can learn more and, in some cases, apply online. By using this portal, less time is needed to search for information about which permits and licenses are needed, which also improves business planning because entrepreneurs are able to “get it right the first time”.

In developing the BizPaL tool, the federal government (Innovation, Science and Economic Development Canada, or ISED Canada) was responsible for securing the participation of provincial/territorial governments, which were responsible for securing the participation of municipal governments. ISED Canada manages the project but each jurisdiction is responsible for maintaining its own data within the system. BizPaL data is housed in a central database. Information is entered into this database using the BizPaL Administration Module, a secure web-based application. The database contains the permit and license information from all participating jurisdictions and the questions that link a business activity to the permit or license required for that activity.

BizPaL receives CAD 3 million annually (EUR 2.1 million) in federal funding to support its maintenance, continued expansion and service improvements.

Factors for success

Success was dependent on three main factors:

Establishing a national coordinating body (a role assumed by ISED Canada) to provide a secretariat function to support the partnership and oversee the technology infrastructure, and a Steering Committee consisting of federal, provincial/territorial and local governments, which cemented the partnership approach.
Providing training and technical support, business process mapping tools and other assistance to federal, provincial/territorial, and municipal partners so they could participate in BizPal.
Recognition and endorsement of the project by the Canadian Federation of Independent Business, the largest SME membership association in Canada.

Obstacles and responses

It was more difficult than initially expected to bring municipalities into the project, especially those in smaller and more remote locations, because they lacked staff and capacity to participate. When the project was piloted in 2006, only 13 municipalities were part of the project. Two years later, 454 had joined and another 136 were in the process of joining. Together, this represented 16% of the 3647 municipalities Canada. The BizPal team realised that their target objectives for municipality participation were too ambitious and that much more intensive involvement with municipalities was needed to bring them on board. For example, provincial/territorial governments had to spend considerably more time process uploading information on behalf of the local governments than they had originally thought.

Moreover, the awareness of the BizPal service among SMEs was low, even two years after launch. BizPal therefore undertook a national marketing campaign to increase awareness and interest among potential users. The specific objectives of the marketing campaign were to improve client awareness and usage of the BizPaL service and increase BizPaL recognition through cohesive and consistent marketing communication, activities and messaging, which included ads and banners on search engines.

Finally, there was uncertainty with respect to securing ongoing resources from federal and provincial governments, which was alleviated by the decision by the federal government to allocate CAD 3 million annually to the BizPal project as part of A-base funding.

Relevance for Israel

Complexities in obtaining business licenses and permits are a significant obstacle for SMEs and entrepreneurs in Israel.

Implementing a BiZPal-like online portal in Israel would reduce learning costs for SMEs and entrepreneurs and increase transparency of municipal requirements. It would provide an important complement to the reforms currently underway to expedite the licensing process and would also be in line with the “Digital Israel” Initiative, which includes a transition towards e-government services.

Sources for further information

The website can be consulted and reviewed at: www.bizpal.ca.
Further information can be obtained from the Small Business Policy Branch, ISED Canada, Ottawa, Canada (+1 613 954 5489).
Reference can also be made to the evaluation report on the BizPal project, “Evaluation of Industry Canada’s BizPaL Service” (2011), available online at: www.ic.gc.ca/eic/site/ae-ve.nsf/eng/h_03356.html/.

Human resources

Tertiary education

During the last twenty-five years, the proportion of people enrolled in tertiary education (expressed as a percentage of the total population of the five-year age group following on from secondary school leaving) has nearly doubled, from 34% in 1990 to 66% in 2015. As a result, in 2014, 48.5% of the Israelis aged 15-64 had received tertiary-level education, a proportion second only to Canada among OECD countries and 16 percentage points above the OECD average (Figure 3.8). These high skills are a major asset of the Israeli economy and help support SME and entrepreneurship activity by increasing labour productivity in SMEs and by improving the growth-orientation of entrepreneurs.

At the same time there is a skills mismatch in the economy, and many highly-educated workers are under-employed in low-productivity jobs. This implies a need to improve the bridging process between the supply of graduates from the university system and the demand for graduates in existing SMEs. Options for intervention in these areas include increasing employer participation in curriculum design and increasing placements offered to higher education students in SMEs in order to increase the probability of matching the student to an employment that requires their skills. In addition, it implies a need for consultancy and advice to SMEs that upgrades their management and working practices so that they can make better use of the skills that graduates offer.

Secondary education

Secondary education completion rates in Israel are above the OECD average (87% vs. 84%). However, results from the OECD Programme for International Student Assessment (PISA) survey reveal an under-performance in the learning outcomes of Israeli upper-secondary students (aged 15 years) in maths and science compared with the OECD average (Figure 1.8 reproduced below). Israeli students also perform poorly in financial literacy skills, which are particularly relevant for those who will undertake an entrepreneurial career in the future (nearly one-quarter of Israeli students are in the two lowest performance brackets). Furthermore, certain segments of the population such as Arab Israelis and Ultraorthodox Jews perform particularly poorly in secondary education, which has negative consequences on their ability to enrol in university and on their career prospects. Only 12% of Arab Israelis enrol in university, while Ultraorthodox Jewish students tend to attend religious schools which lack a strong curriculum in secular subjects such as mathematics and foreign languages.

Strengthening core skills achievement and participation by under-represented groups in secondary education will be important to improving the quality of labour available to SMEs. In addition, secondary schools need greater support to build educational links with local enterprises, such as for short-term work placements, company visits and case study exercises related to real-world business problems.

The vocational education and training school system

Adult VET is primarily available through a nationwide system of occupational certifications delivered by local technical colleges and covering more than 100 different professions with approximately 70 000 people qualifying each year (MOITAL, 2012). Both the Ministry of Economy and Industry and the Ministry of Education are involved, which operate two distinct VET school systems.

The Ministry of Education is responsible for the vast bulk of schools (around 1 700), which are divided along religious and ethnic lines (schools for secular Jews, religious Jews, Ultraorthodox Jews and Arab Israelis). Some 60% of students in these schools work towards the high-school graduation certificate, i.e. the Bagrut certificate. The other 40% (around 137 000 students) follow a technical and vocational route, which is divided into three tracks: science and engineering (around 46 000 students); technical studies (around 49 000 students); and vocational studies (around 42 000 students) (European Training Foundation, 2014). Numbers in the VET school system have been on the decline since the peak of the 1980 when 53% of all high school students were enrolled in the VET system (Natanzon and Levi, 2010).

The Ministry of Education VET school system is implemented through a range of partner organisations, the most notable being the ORT (the Society for Trades and Agricultural Labour) and AMAL Educational Network. The ORT manages a network of 205 schools, 16 of which are vocational high-schools, with approximately 100 000 students and 7 500 staff across Israel. AMAL is a smaller network of 128 schools with an enrolment of around 40 000 students. In total, about 40% of vocational students are enrolled in ORT and AMAL programmes (European Training Foundation, 2014). There is some involvement from business support organisations such as the Manufacturer’s Association of Israel on the identification of training needs and design of curricula, while municipalities also play an important role in the system by providing additional funding and helping to tailor national curricula in ways that meet local needs.

The Ministry of Economy and Industry operates around 70 schools, attended by about 13 000 students (Yair et al., 2013; European Training Foundation, 2014). The major programme addresses upper-secondary-level students who take practical courses of three-to-four years during which, depending on the year of the curriculum, they spend one or two days practising in an enterprise with the rest of the time spent in traditional classroom activities. These schools absorb 60% of the drop-outs from the schools of the Ministry of Education. The emphasis is therefore on reintegrating students back into society through a curriculum that is more vocationally orientated. In particular, three options are offered:

“industrial schools”, where students mainly work with large firms or the Israeli Defence Force and receive a mix of practical and vocational training;
“apprenticeship schools”, where students primarily work with small firms and study between one and three days per week; and
“work groups/courses”, which are designed for students who are neither studying nor working elsewhere.

The fact that Israel operates two parallel VET school systems is associated with a number of problems. Yair et al. (2013) identify a number of examples of duplicated VET provision. For example, within the Ministry of Economy, MAHAT (the National Institute for Technical Training) accredits colleges and set examinations. In parallel, the Ministry of Education and the Science and Technology Administration oversee separate programmes. Another challenge is that VET students are often stigmatised, reflecting the wider association between vocational education and poor social outcomes (Neuman and Ziderman, 1999; 2003). For example, VET students often do not take enough credits to matriculate, which stymies their ability to progress onto higher education. This magnifies the cultural stigma associated with VET and makes it difficult for SMEs to attract talented individuals. Despite attempts to challenge the stigma (see Box 3.2), one disadvantage of not having a visible and well-defined VET pathway structure in schools and colleges (e.g. TAFE institutions in Australia, community colleges in the US, Fachschulen in Germany) is that it is difficult for SME employers to trust that VET schools are likely to produce high quality students to meet their needs. Employer engagement is further impeded by the fact that there is no common system and framework of qualifications between the various ministries involved in VET in schools.

Box 3.2. The Zur Lavon Training Centre, Israel

Founded by the philanthropist, Stef Wertheimer, the Zur Lavon training centre delivers a range of vocational education programmes that aim to offer both Jewish Israelis and Arab Israelis the opportunity to develop key workforce skills. One strand of this training is working in with other stakeholders (the local municipality, the Ministry of Economy, and the Israel Defence Forces) to provide vocational education to upper secondary students in the Negev and the Galilee. This training mixes vocational, academic and soft skill development to build professional skills. Another activity of the center is to train post-secondary students in plastic injection and metal casting. This course last around 10 months (1 430 hours) and leads to a nationally-accredited certificate. In addition, working with the Ministry of the Economy and with the state of Baden-Wurttemberg in Germany, the center also offers a teachers training programme that leads to “the Kammer” which is a nationally recognised qualification for those who wish to be professional instructors. The training lasts eighteen months with the first half being class room based with the second half being a mix of work and study based training.

Source: www.zur.co.il.

The Ministry of Economy and Industry also offers manual and non-manual VET to the unemployed or those with low skill levels. These courses typically run for between 3 and 11 months and give practical and theoretical training delivered by external providers. Training vouchers are also available for young unemployed individuals. The two main programmes in this area are “On the Job Training in Industry” (OJT) and “A Class in the Workplace”.

The OJT is a scheme where a group of 3-10 new employees participates in a “work-and-study” programme of three months in a company under the responsibility of an in-house instructor. The government pays part of the salary of the new employees (NIS 2 000 per month) and of the instructor (NIS 3 000 per month) on condition that those who complete the programme remain in the company payroll for at least one year. “A Class in the Workplace” is an apprenticeship scheme which gives practical training, backed up by theoretical training in the workplace or in a training institution. Employers are expected to hire or find employment for 65% of those that graduate from the programme. These programmes are usually for unemployed young adults (28-35 year olds) referred by the public employment service, while employers are large companies or larger SMEs who are asked to place the new recruit in the payroll in change of reimbursement of training costs and a wage subsidy.

While survey evidence suggests that some of the programmes (i.e. the voucher scheme) produce good outcomes (MOITAL, 2012), one general limitation consists in the very small number of participants: 7 846 (1.7% of all jobseekers) altogether for the OJT and “A Class in the Workplace” and 1 449 (0.3% of jobseekers) for the voucher programme (figures for 2011). These modest numbers possibly reflect Israel’s low spending on active labour market policy, i.e. 0.3% of its GDP, half of the OECD average.

Small-scale sector-specific training is also available in Israel through the Ministry of Tourism (accredited courses in tour guiding), the Ministry of Immigrant Absorption (e.g. targeting Ethiopian immigrants) and the Israeli Defence Forces (IDF), which offer vocational training to a small number of people who are allowed to postpone conscription for two years and then to enter the army in technology-orientated positions.

A significant weakness affecting the ability of Israel’s VET school system to supply SMEs with entry workers with intermediate technical skills is that the training provided often lacks close relevance to SME needs. Only around 4% of VET students receive training with employers during their studies (Musset et al., 2014), a much lower proportion than in other OECD countries such as the Netherlands, where about one-third of the study-time of VET students is spent with employers (OECD, 2015b). This leads both to a lack of integration of classroom activities with practice in enterprises and limited opportunities for students to link up with potential employers.

In addition, the design of VET curricula has insufficient input from SMEs. Although organisations such as government ministries, the Israel Defence Forces, Histradut (Israel’s trade union federation), the Manufacturing Association and education providers such as AMAT and ORT are all involved in VET design, there is weak formal involvement by SMEs and their trade bodies, and no systematic partnership arrangement to engage industry bodies in the design of VET curricula. To reduce duplication and to ensure a more seamless transition into employment, there is a need for a strategic steering body capable of auditing, mapping and strategically planning VET provision so that it is more responsive to the present and future skill needs of the economy. This will necessitate the rationalisation of the current system where there are large numbers of providers chasing a relatively small number – by international standards – of students. Developing synergies will ease the current fragmentation and make it easier for SME employers to identify and support vocational pathways for their employees.

Formal partnerships with industry bodies are common in other OECD countries such as Switzerland or Germany where employers, ministries and employee representatives work together to determine the national skill strategy and could help to improve the relevance of VET schools to SME skill needs in Israel. An example is the Employer Ownership of Skills pilot programme in the United Kingdom, which asked SMEs to come forward with their own ideas about the training programmes that are needed (see Box 3.3). The risk of a skill mismatch between VET supply and industry demands is exacerbated by the lack of a robust labour market information system in Israel that could help identify skill needs and plan training (ETF, 2014).

Box 3.3. The Employer Ownership of Skills Pilot, United Kingdom

Description of the approach

Despite rising funding and uptake of VET in the United Kingdom over the last 10 years, the UK Commission for Employment and Skills (UKCES) – a publicly-funded, industry-led organisation with a mission to provide strategic leadership for UK employment and skills development – identified a need for greater employer ownership of skills if VET were to have a long-term sustainable footing.

UKCES set out five principles for VET design, underlining the importance of greater employer involvement:

VET should be employer-owned not government-led.
There should be a single market for skills development. In the UK, as in other OECD countries, there is substantial private sector provision of VET. In parallel, there is a public sector market, which is orientated towards qualification attainment. One downside of these parallel markets is that that many publicly-funded colleges follow state funding incentives rather than business needs.
Employer-led partnerships should design skills solutions to ensure that workforce development is relevant and practical.
There should be a shift from public grant provision to a system in which employers determine incentives and investments.
Public funding should be transparent, simple and less bureaucratic.

To support these principles, UKCES developed the Employment Ownership of Skills (EOS) pilot programme. With GBP 340 million of co-investment funds available over four years, the EOS invited employers, including SMEs, to come forward with innovative employer-led training and recruitment programmes, sensitive to local, regional and sectoral labour market needs.

This was organized through an open call for proposals. The EOS did not define the skills or delivery mechanisms. Instead, it suggested that employers may consider different VET pathways involving delivery of VET to:

regional industrial clusters;
large-small firm supply chains;
partnerships that involve employers currently not investing in skills; or
networks of SMEs working with local training providers and other stakeholders.

The EOS also asked employers to come forward with new curriculum models and qualifications that would meet future employer needs in their sector or region. By providing an impetus to employer-owned VET, the aim has been to incentivise public sector education colleges to shift away from focusing on government VET targets to become more responsive to business needs.

In the first round of the open competition for EOS co-investment funding, out of 269 bids, 35 employer-led projects won funding. One of these was a consortium bid led by AJ Woods Engineering, an SME that provides shore-based facilities for the construction of wind farms. Concerned with the difficulty of obtaining skilled workers in the locality, AJ Woods successfully bid to EOS to work with other SMEs and further education providers to develop a programme of skills development, shared work experience and support for new entrants to the sector. A bid led by PwC, the professional service practice, was also successful. It involved PwC working with both large and small firms seeking to recruit and upskill professional services (e.g. payroll, project management, legal and tax issues) personnel to manage their access to government funding, provide training or arrange suitable training for them.

Factors for success

This pilot has a number of attractive features that may help contribute to success:

the funding is contestable, enabling policy-makers to direct funding to the best value and innovative projects;
employers have the opportunity to shape training to present and expected future labour market needs;
the supply of potential training providers may increase due to the ability to work with employers to put forward training bids;
greater employer contributions may be secured for VET, thereby increasing the potential for sustainable private sector funding and leadership of VET.

Obstacles and responses

The EOS pilot faces a number of challenges. For example, because of public money involved, administrative demands to comply with audit requirements may deter SMEs from applying, either on their own or with other businesses. In addition, for SME employees, the skills and qualifications obtained through the programmes, particularly if they are not portable, may be too specific, thereby inhibiting the willingness of workers to take up the training. Similarly, because employers may be unwilling or unable to fully fund the long-term sustainability of the vocational training, the need for public funding may be on-going. One objective of the second round of the pilot was to address these types of issues.

Relevance for Israel

The EOS pilot shows that there are mechanisms available to shift from government-led to business-owned VET. This type of approach could help Israel to develop vocational training that is more practical and relevant to its SMEs in the future.

Source: UKCES (2011, 2013, 2014).

It is also important to upgrade and support the VET teaching profession. Under both the Ministry of Economy and Education frameworks, VET teachers are required to have practical industry experience before they can teach. However, particularly for Ministry of Education teachers, this requirement is not always followed (MOITAL, 2012). In-service training to upskill teachers is also not mandatory. Alongside a more integrated qualification system for employees, there is a need for a unified system that supports the ongoing professional development of VET teachers. For example, Ireland offers a number of pedagogical qualifications for further education and training teachers and trainers at various levels of the National Framework of Qualifications. Furthermore, a professional development strategy is currently under development which is aimed at all practitioners in the further education and training sector. The implementation of this strategy will provide a unified system for the ongoing pedagogical, subject matter and employer liaison development of further education and training personnel.

Measures that could help address the issue of the relevance of VET school training to SMEs therefore include increasing the share of credit-generating and quality-controlled work-based learning (including apprenticeships, work placements and internships) in SMEs as part of the VET school studies, introducing formal partnership programmes to involve SMEs in the design of VET school curricula, developing a better labour market information system to better identify industry skill needs, and introducing certification of training standards in VET schools.

A further approach to improving the supply of “middle skills” to Israeli SMEs through the formal education system could involve the development of “associate degree” qualifications through VET schools. Associate degrees are typically two-year programmes offered by tertiary education institutions which offer a more practical and applied curriculum. The two years of coursework can often be taken by students either on a full-time or part-time basis, for example students could take the associate degree over four years attending courses for half a day a week during that period. Associate degrees provide a higher level of education than secondary school diplomas but lower than bachelor’s degree programmes. This type of qualification has become common in some other OECD countries. For example, in the United States, 10% of workers have an associate degree, which usually implies two years of full-time coursework (Carnevale et al., 2012). Other countries have also expanded associate degree provision such as Japan (the Jun-gakushi) and France (the Brevet de technicien supérieur/Diplôme universitaire de technologie) (Varghese and Püttmann, 2011).

Entrepreneurial culture and skills

The formal education system can play a significant role in strengthening enterprise culture and increasing people’s abilities to exploit business opportunities. However, in Israel only 13% of adults in 2012 reported that their school education promoted entrepreneurial attitudes, in contrast to 22% in the EU27 and even higher figures in countries such as Brazil (57%), Norway (41%) and the United States (27%). Israelis were also less likely to report that their education helped them to understand the role of entrepreneurs in society (13% compared with 20% in the EU27) or equipped them with the skills needed to run a business (12% compared with 18% in the EU27) (European Commission, 2012). Furthermore, only 28% of 18-34 year old Israelis reported that they have the skills and knowledge required to set up a business, compared with 40% in the EU (GEM/YBI, 2013).

Some of Israel’s eight universities and more than 70 government and non-government funded colleges have entrepreneurship education initiatives. In particular, the Technion, the Hebrew University of Jerusalem, Tel Aviv University, and the University of Haifa all have dedicated entrepreneurship centres offering courses and modules on entrepreneurship for students from across the institution (see Box 3.4). Others offer various undergraduate and postgraduate modules to certain parts of the student population. For example, the Shamoon College of Engineering runs the Engineer-Entrepreneur programme, which provides engineering undergraduates with an interest in starting businesses with dedicated entrepreneurship teaching modules and business coaching and encourages them to mentor the entrepreneurial aspirations of secondary-level students (Yemini and Haddad, 2010). However, entrepreneurship in Higher Education Institutions (HEIs) is usually taught as an elective rather than a compulsory module, is often only available to postgraduate business school students, and tends to focus mainly on technology-orientated businesses (Almor and Heilbrunn, 2014).

Box 3.4. The Bronica Entrepreneurship Centre at Technion, Israel

The Bronica Entrepreneurship Centre is the central point of contact for entrepreneurship at Technion University. It offers a wide range of support both for its own students and those from other HEIs. For its own students, the Centre offers an undergraduate minor in entrepreneurship, a range of entrepreneurship modules, a dedicated MBA in entrepreneurship, a summer school programme, and mentoring, consultancy and alumni support for its present and former students. It has also set up the Dream Factory; an idea-generation scheme that encourages student teams to find novel and innovative solutions to real-world business problems submitted by companies.

The Centre is also responsible for implementing the national BizTEC Entrepreneurship Challenge start-up competition. This has been running since 2004, and is open to all Israeli HEI students. Out of the hundreds of applications that the competition attracts every year, up to 30 teams are selected to attend a dedicated workshop programme supported by faculty and outside professionals. The next stage sees up to 8 of these teams going forward to the business accelerator stage where they receive more intensive assistance from faculty, outside professionals and a dedicated mentor from a relevant field. Five of the teams can win financial assistance and the opportunity to represent Israel in the international Intel Challenge Europe competition.

The Centre offers lessons for other HEIs seeking to develop entrepreneurship education. The ‘one-stop shop’ service provided by the Centre makes it easier for students at the Technion to find out about entrepreneurial support. In addition, the BizTEC competition offers a means to support students in entrepreneurial ventures through an integrated package of workshops, one-to-one mentoring advice and financial support.

Source: yazamut.technion.ac.il.

There are also examples of good practice in entrepreneurship education at the primary (see Box 3.5) and secondary education levels in Israel, such as the Network for Teaching Entrepreneurship. Junior Achievement Young Enterprise Europe (JA-YE Europe) is also active in Israel through the Young Entrepreneurs Israel association. The JA-YE Europe Company Programme supports teams of 15-18 year old students to form mini-corporations under the guidance of an education advisor for schools and youth centres and a volunteer business mentor. It also offers an access course to the Company Programme through a 6-hour teaching programme for 14-15 year olds. However, the JA-YE Europe programmes available and the numbers of participants in Israel are more limited than in many other countries, although they have grown significantly since 2013 (JA-Worldwide, 2014).

Box 3.5. The Misgave Elementary School, Israel

Misgave Elementary School provides an example of how entrepreneurship skills can be embedded within the conventional primary school curriculum. Led by the school management team, the school initially piloted the viability of embedding entrepreneurship teaching. Having demonstrated the potential, the Ministry of Education committed extra resources and a mentor to work with the school. All teachers were also offered the opportunity to participate in workshops to build their understanding of the ways in which entrepreneurship could be taught. The school also worked with the local municipality, parents and representatives from industry to establish its entrepreneurship teaching.

Within the school’s “entrepreneurial centres”, students participated in a weekly two-hour entrepreneurship course embedded within subjects such as mathematics, science, English, ecology, the arts, and community involvement. Students were also asked to use creative techniques, work in teams and follow their ideas through into their implementation. Grade 5 and 6 students had the opportunity to mentor younger students in the entrepreneurial centres while Grade 2 pupils had a weekly creativity lesson. At the end of the school year, products developed by the students (e.g. a bracelet to avoid harassment between students, herbal ice-cream, user-friendly refuse disposal) were presented and sold at a school fair.

Source: Heilbrunn, S. (2010), “Advancing entrepreneurship in an elementary school: A case study”, International Education Studies, 3(2), page 174.

Despite these examples of good practice in entrepreneurship education in Israel, its patchy nature is a concern, when considering the limited numbers of institutions offering programmes and the limited numbers of students able to access them. A national entrepreneurship education strategy in Israel would help to expand these actions and give them better foundations in terms of funding, inclusion in the curriculum, and teaching training and support.

Some OECD countries have introduced dedicated national strategies for entrepreneurship education that could act as models for Israel, such as Belgium, Denmark, Estonia, Finland, Norway, Spain and Sweden, while several others explicitly set out entrepreneurship education actions as part of broader education policy documents or economic and employment policy documents (European Commission/EACEA/Eurydice, 2016; European Commission, 2014). Typically, these strategies set out definitions of entrepreneurship education, the entrepreneurship education and practical entrepreneurship experiences to be delivered in the curriculum, the teaching and support methods to be used, the arrangements for training entrepreneurship teachers, and the arrangements promoting school networking and sharing of good practice. The strategy may also set out the funding arrangements to be used. As an example, the Nordic countries have espoused an “enterprise for all students” vision that sets objectives and targets for increasing the proportions of students graduating with a practical understanding of entrepreneurship (Box 3.6).

Box 3.6. From ABC to Ph.D. – The Nordic approach to entrepreneurship education

Description of the approach

Having an integrated and holistic approach to entrepreneurship education is crucial for enhancing entrepreneurial culture and skills. Nordic countries (Finland, Sweden, Denmark and Norway) have developed such an approach which rests on three pillars:

Long-term and cross-ministerial co-operation. Each of the four Nordic countries have developed national strategies for supporting entrepreneurship education in schools, colleges and universities: Strategy for Education and Training in Entrepreneurship (Denmark), Entrepreneurship in Education and Training (Norway), Strategy for Entrepreneurship (Sweden), Guidelines for Entrepreneurship Education (Finland). Close collaboration between employers, education providers and economic development agencies has been an essential part of the development of these strategies. In Finland, for example, 18 key stakeholders were involved in developing the strategy, such as ministries, business support providers, unions, enterprise agencies and universities.
Developing an integrated entrepreneurship education pathway. Nordic countries have worked extensively with the suite of core programmes offered by the NGO Junior Achievement-Young Enterprise, which seek to build economic awareness in primary pupils (‘our community’); financial literacy (‘economics for success’) and understanding of entrepreneurship (‘it’s my business’) in lower-secondary school pupils; experimentation with starting and running a business (‘company programme’) in upper-secondary school students; and starting a business (‘start up programme’) in post-secondary school students. These have been adapted to meet the specific needs of particular Nordic countries. For example, Denmark now has a suite of four main programmes. ‘Project Edison’ encourages sixth and seventh grade students to develop a new product that they will showcase at a local school fair. If their idea proves successful, they go on to compete at a national fair. The aim of the project is to develop their creativity and innovation abilities. Danish eighth to tenth grade pupils can progress from this to the ‘Next Level’ programme, where they are asked to work on a self-set or teacher-set problem, identify a potential solution and test out its economic, social or environmental value. At older ages, students can participate in the JA-YE company and start up programmes.
Supporting entrepreneurial teaching. There is now an increased understanding that perhaps the most effective forms of entrepreneurial teaching require teachers to act more as facilitators than lecturers (European Commission, 2008). To achieve a shift in pedagogic practices, Nordic countries have increasingly developed supportive learning materials. One such example is Framtids Frön (Future Seeds), which offers Swedish primary and secondary school teachers resources and support to develop creativity, curiosity, problem solving and entrepreneurial skills. Nordic countries have also found that partnering SMEs with educational institutions is critical in increasing the relevance and applicability of entrepreneurship education. Involving SMEs is more likely to ensure that the learning is practice-based and gives students the opportunity to understand the challenges faced in running and working in a small firm. Support for teacher training in entrepreneurship has also been boosted. For example, as part of its action plan, Norway expanded its funding of teacher training and university courses in entrepreneurship education and has sought to extend the engagement of education providers with the private sector.

Success Factors

One key success factor underlying the development of entrepreneurship education in Nordic countries has been the adoption of a long-term strategy, backed up by periodic action plans. While incentivising educators, firms and students to become more involved in entrepreneurship education, Nordic countries have also sought to adopt a flexible ‘bottom-up’ approach that tailors entrepreneurship education to meet the needs of individual countries and regions.

Alongside this, there has been a commitment to monitoring and evaluating programmes. For example Young Enterprise Denmark (2012) embarked on a longitudinal evaluation of its programmes, which showed that young secondary students on its programmes were more likely to be favourably orientated towards entrepreneurship.

Long-term cultural change has also been achieved in some cases. For example, the number of Finns who believe that their school education equips them with the skills to be an entrepreneur increased from 44% in 2009, when the national entrepreneurship education strategy was introduced, to 55% in 2012 (European Commission, 2012).

Obstacles and responses

Despite the commitment to entrepreneurship education from ABC to PhD, Nordic countries still have to negotiate a number of barriers. One issue is embedding entrepreneurship education as a cross-curricula transversal subject. There is also the perennial issue of extending business engagement and ensuring that initial and continuing teacher education supports entrepreneurial education. There is also a need for the traditional education system to better accredit the experiential learning gained from entrepreneurial education. One way of potentially achieving this is the further development of the “entrepreneurial skills pass” (http://entrepreneurialskillspass.eu/). This is an EU initiative that combines practical experiential learning with an on-line exam, providing students with a valuable complementary qualification to traditional academic qualifications.

Relevance for Israel

Israel has no long term national strategic or action plan to support entrepreneurship education. Whilst Israelis may feel that entrepreneurship is desirable, many of them believe that they lack the necessary skills to create and run a business. There is a need for clear incentives for teachers, employers and entrepreneurs to become stakeholders in developing student entrepreneurial competencies. The Nordic experience shows how to develop a strategy in a way that involves the relevant stakeholders, to introduce appropriate practical entrepreneurial experiences and to support teachers in entrepreneurship teaching. It also shows that it is possible to rapidly reduce the gap between entrepreneurial aspirations and skill attainments.

In Israel, a national entrepreneurship education strategy could be designed, co‐ordinated and supported by a national steering committee on entrepreneurship education, which could include representatives from the relevant ministries (e.g. the Ministry of Education and the Ministry of Economy and Industry), stakeholders (e.g. the teaching profession, business support organisations, NGOs and other delivery partners) and entrepreneurs’ organisations.

In parallel, the Israeli government could introduce an online web portal offering guidelines, information and teaching resources for entrepreneurship education. This portal could link to the online OECD-European Commission HEInnovate guiding framework for HEIs and Entrepreneurship360 guidance for entrepreneurship in schools and vocational education and training institutions. The former contains a detailed step-by-step approach alongside model action plans to help tertiary education institutions foster entrepreneurial mindsets and entrepreneurship. Policy can support these endeavours by offering specific awards and incentives to support the development of entrepreneurship education and work with student entrepreneurship clubs and societies across university campuses. Moreover, whilst there are examples of Israeli higher education institutions offering strong technology orientated entrepreneurship education and skills development, there is a need to broaden cross campus collaboration and involve other entrepreneurship facing disciplines (e.g. design, creative professions) as this closer collaboration is more likely to promote learning and innovation (Harrington and Douglas, 2005).

The government could also boost arrangements for initial and continuing teacher training in entrepreneurship. For example, in France prospective and qualified entrepreneurship teachers have the opportunity to participate in company internships, allowing for closer collaboration between schools and enterprises, while in Flanders (Belgium), the regional development agency has developed a website for teachers with lesson plans to develop entrepreneurial competencies (www.competento.be).

There is also a need to actively involve entrepreneurs in drafting entrepreneurship education guidelines and curricula and in providing education and practical training. One way of achieving this is to have an entrepreneur-in-residence in schools. This is prevalent in many universities internationally. For example, the Berkeley Center for Entrepreneurship & Innovation at New York University has an entrepreneurship-in-residence programme to support and develop the business ideas of students and staff. This could be adapted to schools and colleges, working alongside activities such as company visits, guest talks by entrepreneurs, enterprise days and weeks and case studies of role models. To support SME-school linkages, a brokerage service could be offered, similar to that organised by the Ministry of Finance and Economics of Baden-Württemberg and the chamber of commerce. This initiative partners schools with local SMEs, resulting in 95% of general education secondary schools developing links with firms.

The innovation system

Israel has a well-developed innovation system, which receives public support in various ways. The government makes significant investments in human capital infrastructure; contributes substantial funds for research; offers tax incentives to encourage multinational corporations to establish R&D activities in Israel (e.g. Intel, Hewlett Packard, Microsoft, Google, etc.); has supported the establishment of a major venture capital industry targeting high-technology start-ups; and runs a range of government programmes in support of technological innovation (Frenkel and Maital, 2012; OECD, 2012). Additional contributing factors have been the government’s liberal immigration policy able to integrate thousands of Jewish immigrants into the economy and capitalise on their scientific and technical expertise as well as the military support for R&D investment which has stimulated private-sector company spin-offs in cyber-security, electronics, computers, software, communications, imaging, and process control (Frenkel and Maital, 2011).

This impression of a healthy innovation system is backed up by Israel’s strong performance on most of the main indicators of the innovation system compared with other OECD countries. The number of researchers in relation to total employment is the highest among OECD countries, 17.5% compared to an OECD simple average of 8.5% (Figure 3.9). Gross domestic expenditure on R&D (GERD) amounts to 3.9% of GDP, which is the second-highest value in the OECD area only behind Korea. Business enterprises undertake 83% of total R&D spending (Figure 53), the highest value among OECD countries. Private sector firms are also active supporters of university R&D; 6.8% of higher education R&D is financed by industry, compared to 5.8% for the overall OECD area. This strong business involvement in R&D is very significant for Israel’s innovation capacity, given the proximity of business R&D to commercialisation opportunities compared with government and higher education R&D spending.7

The internationalisation of the Israeli R&D system is also very well developed, which can be expected to contribute to the quality of innovation through global knowledge flows. As indicated in Figure 3.10, 54% of business R&D is funded directly from abroad and 65% is undertaken by domestic companies affiliated to multinational enterprises. These are both very high values in the OECD context, and reflect the importance of foreign-backed R&D centres in ICT-related sectors in Israel.

On the other hand BERD is relatively narrowly based in terms of its sectors and origins. The share of BERD undertaken by firms in the services industry is 70% in Israel, which exceeds any other OECD country (Figure 3.11). One-half of this R&D is carried out in dedicated R&D centres, which are mostly affiliated to foreign multinational enterprises and mostly found in ICT. This sector alone accounts for 48% of Israel’s BERD and 1.7% of Israel’s GDP (OECD, 2015c). Clearly, the share of manufacturing R&D is correspondingly low (27%), which is not necessarily a concern given the high rate of services R&D and its potential to impact on manufacturing. However, Figure 3.12 shows that business R&D in manufacturing is heavily weighted towards high and medium-high R&D-intensity sectors (90%), highlighting the challenge of broadening technological innovation activities towards low technology manufacturing sectors in Israel.

Israel’s innovation performance in terms of revealed technological advantage (RTA) is also strongly concentrated by sector, as measured by patents in different technology fields. This shows that Israel enjoys a world technological leadership in computer technology and has strong specialisations in other ICT-related domains such as telecommunications and basic communications (Figure 3.13). The ICT specialisation of Israel’s technological innovation has declined, as ICT-related patents have fallen from 53% to 39% of the national total during the 2010s (OECD, 2013c). At the same time, the RTA has grown in medical technologies and biotechnologies, which also have multiple potential industry applications and hold the promise of fuelling further growth. Notwithstanding the emergence of these two new sectoral innovation advantages, the strong concentration of RTA raises the question of how to diversify the innovation success of Israel’s ICT to other sectors.

The Israeli government provides generous support to business R&D. The volume of direct government funding of business R&D as a share of GDP is one of the largest of OECD countries (Figure 3.14), alongside which there are also generous tax breaks to R&D-active firms. However, the support is currently strongly weighted to R&D-intensive firms, particularly in ICT and biotechnologies. Non-high-technology industries conduct only 10% of industrial R&D, compared with one-quarter in other developed nations (Bank of Israel, 2014).

Indeed, as shown in Figure 3.15, only 13.5% of Israeli SMEs with innovation activity declare having received public support, far below the OECD average of 29%. Some degree of concentration in government support is justified to reward excellence in innovation, especially when public resources are scarce. Spreading innovation support to more small enterprises would help to narrow the wide productivity gaps that exist between sectors and business size classes, both broadening the drivers of economic growth and helping respond to high levels of inequality in Israel. This conclusion was also reached by a government committee established in 2007 to “Examine Means to Strengthen Peripheral Areas and Low Technology Industries” (i.e. the Makov Committee). This Committee recommended greater investment in R&D in traditional industries to close the gap between better and poorer performing regions and industries and suggested that a combination of R&D subsidies and increased supply of engineers would lead to higher levels of R&D investment and productivity in traditional industries (Bank of Israel, 2014).

Access to finance

Debt finance

The G20/OECD High-Level Principles on SME Financing (2015) call for measures to strengthen SME access to traditional bank financing. This is very relevant in the case of Israel, where one of the important constraints on SME development is difficulties in accessing bank credit. Israeli SME owners report credit, financing and cash flow problems to present the most significant barriers to the development of their businesses (Adalya Economic Consulting, 2011). Approximately 30% report that they cannot raise the funds needed for their everyday activities and over one-half are unable to attract financing to develop or expand their operations. For more than one-half of SMEs that do succeed in raising most of the funds needed for daily operations, amounts are insufficient for development and expansion. The problems are exacerbated for new businesses, which find it nearly impossible to receive bank credit.8

The perceptions of SME managers are paralleled in the data on credit volumes. In relation to national GDP Israel’s SME credit was 41% in 2014, which is lower than in countries such as Italy and France where business ownership is widespread, but higher than in countries such as the United States, Canada and the United Kingdom where companies tend to rely less on bank credit to finance cash-flow requirements (Figure 3.16).9 Furthermore, bank deposits of small firms are larger than the credit they receive, while credit for medium-sized firms is 30% greater than their deposits and credit for large firms is 65% greater than their deposits (OECD, 2014).

The terms of bank credit for SMEs are also relatively unfavourable. The interest rate spread between SMEs and large firms is quite large, standing at 1.44% in 2014 (OECD, 2016). Furthermore, although Israel’s Central Bank does not collect data on loan maturity, it appears that small business credit is also often of short duration, which makes it difficult to use bank lending for long-term capital investment.

The situation has nonetheless been improving for SMEs, at least in terms of credit volumes (Table 3.3). The volume of SME loans increased by 3.4% per year in Israel during the period 2007-2014, compared to an average annual inflation rate over the same period of 2%. There has, therefore, been a real increase in SME lending. This has been associated with a rise in the proportion of SME lending out of total business lending from 41% in 2007 to 47% in 2014. The expansion in SME lending has occurred without harming the solidity of the banking sector, which has a capital adequacy ratio of 14%, two percentage points above the target set by the Bank of Israel following the implementation of the Basel II Agreement on banking laws and regulations. Furthermore, the contribution of small business lending to the total net profits of commercial banks has been growing in parallel to increased credit provision to this business segment (Bank of Israel, 2012).

Table 3.3. Outstanding business loans in Israel, 2007-14
New Israeli Sheqel (NIS) billions
	2007	2008	2009	2010	2011	2012	2013	2014
SMEs	169.3	171.2	161.6	173.8	177.7	187.0	186.7	211.9
All businesses	413.9	460.9	425.2	438.9	458.6	450.4	445.7	447.9
Note: The definition of SME lending is not related to the size of the firm which receives the credit but to the amount of bank lending. Each of the five major banks of Israel uses slightly different definitions, but small business lending is always up to between NIS 6 and 10 million, medium business lending between up to NIS 40 and 100 million, and large business lending from between above NIS 40 and 100 million.
Source: OECD (2016), Financing SMEs and Entrepreneurs 2016: An OECD Scoreboard, OECD Publishing, Paris.
https://doi.org/10.1787/888933421872

The continuing difficulties in accessing finance for SMEs in Israel take place against the backdrop of a concentration of the banking system, which reduces the incentives of banks to seek out SME borrowers and to increase their choice of financial products. The two largest commercial banks (Bank Leumi and Bank Hapoalim) issue 60% of total bank credit in Israel and the five major banks together provide 95% of total bank credit in the country. Moreover, most banks are part of wider company groups where financial activities co-exist with non-financial activities, creating opportunities for distortion in the allocation of resources and systemic risk in the case of weaknesses in other branches of the group (OECD, 2011b). Competition is held back by restrictive regulations such as on procedures to change banks, establishment of new bank and non-bank financial institutions, and sharing of credit information on customers.

As pointed out in the G20/OECD High-Level Principles on SME Financing, the absence of positive credit information is often a compounding problem, calling for improved transparency in SME finance markets. There is room for improvement in this area in Israel. The Israel Credit Data Services Law (5762-2002) rules that positive credit information on individuals can only be disclosed subject to their approval, unlike for example the United States, where positive credit information can be revealed as long as an individual does not expressly opt out. This means that only negative credit information is disseminated in Israel, which reduces the chances for SMEs with good credit history to obtain bank credit.

To address competition issues in the banking sector, the Israeli government and the Bank of Israel established in 2011 an inter-ministerial “Committee to Increase the Competitiveness of the Banking Sector”, chaired by the Supervisor of the Banking Sector at the Bank of Israel and including representatives of the Ministry of Finance, Ministry of Justice, Antitrust Authority and National Economic Council. This Committee formulated a number of recommendations, some of which have already been implemented. In particular, the administrative procedures for customers to change bank have become slimmer, banking fees have been trimmed, information asymmetries have been curtailed through client reports which banks prepare for their customers showing their full assets and liabilities, and the legal framework for credit unions and online banking has been set up.

On the other hand, other recommendations are still on hold. For example, the Committee advised that institutional players such as insurance companies and pension funds be more involved in household credit and small businesses credit through closer cooperation with lending institutions; non-banking financial institutions (NBFIs) be subject to the same interest-rate ceiling as banks, on the assumption that the existing lower ceiling for NBFIs has prevented their correct pricing of credit risk; and that lending institutions deal with small businesses with turnover up to NIS 5 million as retail customers rather than as business customers, resulting in lower banking fees. Implementation of these recommendations should contribute to improving SME access to finance. In addition, the entry of additional large operators is probably needed in order to create significant competitive pressure on the main incumbents. In this respect, some efforts have been made to attract foreign banks into the Israeli market, but so far with limited success.

Equity finance

The G20/OECD High-Level Principles on SME financing also call for actions to enable SMEs to diversify their financing. Equity investment is one of the key financing instruments cited by the Principles alongside traditional debt, standing alongside asset-based finance, alternative debt, and hybrid instruments (see also OECD, 2015d). In relation to GDP, Israel has the largest venture capital market in the OECD area (Figure 1.10 reproduced below). Furthermore, unlike most other OECD countries, and notably the United States, Israel’s venture capital industry is very much focused on seed, start-up and early-stage investments. By 2013, there were 70 venture capital funds in Israel, with a substantial stock of investment in the country’s high-technology sector. Of these there were 8 recently-established “micro venture capital funds” managing almost USD 124 million. These are funds with less than USD 30 million, which generally invest small amounts and focus on early stage companies. Venture capital is therefore a major and dynamic component of the high-technology entrepreneurship success story of Israel.

The development of Israel’s venture capital industry dates back to the mid-1990s when lifting of government restrictions on access to foreign capital led many high-technology SMEs to issue private equity abroad. The government also intervened proactively through the establishment of Israel’s first venture capital fund, YOZMA. In addition, the government offers tax incentives for venture capital investors. Foreign investors, in particular, receive tax breaks for investments in Israel-based venture capital funds or direct investments in research-intensive Israeli companies.

There are nevertheless some concerns for Israel’s domestic venture capital industry, since domestic investment is a relatively small and declining share of total venture capital investments. Of the 70 venture capital funds in Israel, fifteen are branches of international funds while the remaining fifty-five are local funds which only work in Israel. A large share of venture capital investments in Israel are from non-domestic sources; two-thirds of total venture capital investments came from international funds during 2007-12, while only one‐third came from domestic funds (Table 3.4). Potential regulatory barriers to the participation of domestic institutional investors in venture capital deals should be investigated in an attempt to increase the flow of funds to domestic venture capital companies.

Table 3.4. Venture capital investments in Israel, by origins of the fund, 2007-12
USD million and percentage values
	2007	2008	2009	2010	2011	2012
Total investment (USD million)	1 759	2 076	1 122	1 262	2 136	1 924
of which from domestic VC funds (USD million)	678	780	410	371	638	516
of which from domestic VC funds (%)	39	38	37	29	30	27
Source: Israeli Venture Capital Research Centre, (2013), The IVC 2013 Yearbook: Israel High-Tech, Venture Capital, Startup and Private Equity Directory, www.ivc-online.com/upload/IVC2014/learnmore/pdfs/View_Sample_2013.pdf.
https://doi.org/10.1787/888933421881

Furthermore, venture capital is heavily focused on high-technology enterprises. Government could help rebalance the supply of venture capital to include high-potential firms in more traditional industries through the provision of preferential tax incentives for private investors and venture capital funds that invest in traditional sectors.

The Israeli government has also sought to stimulate smaller scale seed financing through tax incentives for business angel investment. By 2011, however, business angel investments had totalled only NIS 100 million and involved only 60 companies. This appears to reflect overly-stringent eligibility criteria for investment incentives, such as an obligation to maintain shares in the start-up companies for at least three years. The government has therefore proposed new rules for those who invest in start-ups that are less than three years old, have turnover that does not exceed NIS 1.5 million and require investments of up to NIS 3 million.10

In this new legal framework, fiscal incentives are generous by providing up to NIS 5 million of personal income tax deduction over the three years of the required minimum period of investment, which is therefore kept unchanged compared to the previous law. However, eligibility rules appear still somewhat rigid, for example with respect to the definition of eligible company, which can only be one in which R&D represent at least 70% of the expenses of the company, with at least 75% of these expenditures being incurred in Israel, and in which the revenues of the company do not exceed 50% of R&D expenditure.11

Taxation affecting small business

The Israeli government introduced a number of tax rate increases following the social protests of 2011 against high living costs and social disparities in the country. Personal income tax rates, which directly affect the self-employed and unincorporated businesses, were increased by 1% or 2% depending on the income bracket; the corporate income tax rate was raised from 25% to 26.5%; and the value-added tax (VAT) from 16% to 18%.

Despite these increases, personal income taxation levels remain favourable to business in Israel. The average personal income tax rate is low by international standards (Figure 3.17). Moreover, existing tax credits combined with a low basic tax rate (i.e. 10% on the first NIS 63 600 earned) means that average wage earners pay little or no income tax.12 Social security contributions are also low. Israel’s rate of social security contributions is 7% up to 60% of the average wage and 18.5% on earnings above the 60% threshold. Overall, this makes the country’s aggregate tax wedge on employment one of the lightest in the OECD area, although mandatory contributions to private-sector pension funds increase the effective tax wedge (OECD, 2013a). In addition, Israel has run an Earned Income Tax Credit (EITC) since 2011 which helps the transition from welfare to work of low-income earners, including through self-employment. However, the Israeli EITC scheme absorbs only 0.02% of national GDP, compared with 0.4% and 0.5% of GDP in the United States and the United Kingdom (OECD, 2013a). There is therefore scope for expanding the EITC scheme in Israel, with the aim of strengthening social inclusion and reducing informality in the economy.

Formalisation can also be pursed from the demand-side of informal labour, for example through tax deductions and voucher schemes targeted to sectors where informality is widespread. Vouchers, for example, typically include a state wage subsidy whereby the employer only pays a part of the worker’s salary, with the goal to cut the incentive to resort to informal labour arrangements (OECD/European Commission, 2015). An example is Denmark’s Home-Job Plan, whose objective was to encourage formalisation in the sector of home-based personal services (Box 3.7).

Box 3.7. Denmark’s Home-Job Plan

Description of the approach

The Home-Job Plan provided tax deductions to consumers of personal and household services in the sectors of cleaning, indoor and outdoor house maintenance, gardening and babysitting. Its aim was to reduce the supply of informal labour in those sectors, but also more generally to create new jobs in construction and encourage the installation of environmental-friendly solutions in Danish households.

The programme ran as a pilot project from June 2011 to the end of 2013 with a budget of DKK 1 billion (EUR 134 million) in 2011 and DK 1.75 billion (EUR 234 million) in 2012 and 2013. It offered tax deductions of 15% over the costs incurred for buying the eligible services for each household member aged above 18 years old and up to a ceiling of DKK 15 000 (EUR 2 000) per person per year. The programme was not renewed in 2014.

The operational rules were simple. The buyer of the service had to inform the tax authority of the cost of the service and the name of the entrepreneur. The tax authority would then deduct the incurred costs from the calculation of the personal income subject to personal income tax. In more than 95% of cases the form was completed online.

The tax deduction has been widely used and its budget resources have quickly ran out each year. In 2011, for example, about 270 000 people used the tax incentive, mostly for house maintenance and repair where informal self-employment is prevalent. The average reported cost for tax deduction was DKK 9 800 (EUR 1 315), while total deductions amounted to DKK 2.7 billion (EUR 362 million). The measure was considered useful both by consumers and construction business associations. The main criticism concerned the ceiling for deductible costs (EUR 2 000), which was considered low compared with similar policies in other countries (e.g. EUR 6 600 in Sweden).

Factors for success

Budget outlays have quickly dried up every year, suggesting that this measure met a real demand from both consumers and the targeted industries. Moreover, programmes offering small tax deductions, such as Denmark’s Home-Job Plan, need to be managed in a simple way to attract users and keep overheads low. Administering a voucher scheme online is generally the best way to keep costs low, although there might be a risk of excluding from the scheme the low-educated and older people. Moreover, similar interventions are better targeted at sectors where informality is known to be widespread to increase the additionality of the measure.

Obstacles and responses

With fixed-term tax incentives, such as vouchers, there is always the risk that informal arrangements kicks in again once employers and workers are no longer eligible to them. At the same time, the smaller the subsidy offered by the government (i.e. the percentage of the salary covered by the government), the higher the risk that the measure proves ineffective by either not attracting sufficient interest in the employers or by subsiding work which would have taken place in the formal sector anyway (i.e. limited additionality). Finally, if the targeted sector has a strong presence of illegal foreign workers which have no access to a government-backed voucher scheme, a similar measure may unintendedly push further down their wages by lowering the price below which employers have a convenience to resort to informal labour. The final outcome can, therefore, be the further marginalisation of illegal foreign workers.

It appears, therefore, important that similar measures have adequate resources to make a dent on informality. At the same time, these measures should be short-term, being second-best compared to structural reforms which reduce taxation and social security contributions more generally. Finally, in countries or sectors where there are large numbers of illegal foreign workers, this policy may bring the unintended consequence of further marginalising these workers.

Relevance for Israel

Israel has a high rate of informality, which voucher schemes such as Denmark’s Home-Job Plan can help reduce, with positive effects on reduced income disparity across the society. Israel also does not have a large proportion of illegal foreign workers, which should prevent the unintended consequences of the measure mentioned above. Together with a more generous earned income tax credit, vouchers could be part of a wider business formalisation strategy in Israel.

Israel’s combined corporate tax rate, at 25%, is relatively high by international standards (Figure 3.18). However, the government offers generous corporate tax breaks to foreign investors, exporters and R&D-based companies through the Law for the Encouragement of Capital Investment. For example, companies with at least 25% of taxable revenues from exports to countries at least 14 million residents are eligible for a corporate income tax rate of 16%, or 9% if they are located in a priority regional development area (i.e. the North and the South of the country). Similarly, large R&D-intensive companies are eligible for a corporate income tax rate of 8% (5% in priority areas) provided that they meet certain requirements for investment in productive equipment and employment creation. This wide system of tax concessions helps to make Israel a business-friendly environment although there is a risk that the support may not be sufficiently effective in generating incremental activity (OECD, 2013a). In addition, the tax incentives are strongly weighted towards large enterprises and the high-technology and export-oriented businesses, leaving few resources to encourage the activity of SMEs in traditional sectors of the economy through direct government programmes such as in access to finance, training and business management consulting.

Foreign Direct Investment

Inward foreign direct investment (FDI) brings to host economies improved access to best practice technologies and international markets for the SMEs in their supply chains. In addition, FDI affiliates may generate company spinoffs, thus fostering high-impact entrepreneurship. Clearly these benefits depend both on the successful attraction of FDI ventures into the country and on the development of local supply chains by these firms.

Israel’s performance in FDI attraction is relatively strong, amounting to 4% of GDP in 2015 (Figure 3.19). FDI inflows suffered a set-back following the global recession, but they are now on the path to recovering their pre-crisis levels. Overall, in the period 2005-15, FDI inflows grew at an annual average of 27% (Figure 3.20).

Israel’s strong performance in FDI attraction is the result of major assets such as a highly-educated labour force, cutting-edge R&D capabilities and favourable taxation. For example, the Law for the Encouragement of Capital Investment, which offers generous R&D incentives and employment grants, has long been targeted to foreign-owned firms. Although this law is also now open to Israeli exporter companies, it continues to be mostly used by foreign large establishments.

On the other hand, while inward FDI has a strong positive impact on Israel’s high‐technology economy, its potential to stimulate SME development more widely across the economy is limited by a strong sectoral bias towards ICT and, in particular, ICT R&D centres. Of the 489 foreign affiliates operating in Israel at the end of 2009, 286 were R&D centres affiliated to ICT multinationals such as Intel, Google and Microsoft. As a result, the potential trickle-down of supply contracts and technology transfer to domestic SMEs in other sectors is limited. A more diversified FDI attraction strategy coupled with increased emphasis on supply chain development could help spread the benefits of FDI more widely in the economy.

Moreover, most individual FDI deals in Israel are of relatively small size. For example, in 2009, only nine deals exceeded USD 100 million (Aahroni, 2009). Besides the establishment of R&D centres, these deals often involve the acquisition of domestic high-technology start-ups. Some of these promising start-ups may, however, be sold prematurely before they could have been able to generate stronger benefits for the national economy through higher wages, more knowledge spill-overs and increased managerial learning opportunities.

Conclusions and policy recommendations

Recent SME and entrepreneurship development in Israel has benefitted from strong economic growth, macroeconomic stability, a flexible labour market and relatively low taxation. Administrative burdens to business start-up are also fairly low. There are nonetheless a number of areas in which framework conditions for SMEs and entrepreneurship could be improved in Israel.

Small businesses still face difficulties in obtaining business licenses and permits. A Regulatory Impact Assessment process has recently been introduced under the responsibility of SMBA to help ensure that new legislation does not add to the overall regulatory burden on SMEs, but investment has to be made in full implementation of this process. Product market regulation is also relatively tight in Israel, leading to difficulties for new firms to enter certain markets. The Concentration Law of 2013 and recent decisions to strengthen the functions of the Anti-Trust Authority should help open up markets, but again attention will have to be paid to their full implementation.

Another challenge is to more fully exploit the potential of entrepreneurship education to strengthen the culture of entrepreneurship across the Israeli population. Whilst there are several good practice entrepreneurship education initiatives in Israel, at various levels of education, there is not yet a national entrepreneurship education strategy that could spread these initiatives more widely and offer support in terms of curriculum development and incentives, training trainers and offering pedagogical materials.

There are also a number of areas in which existing framework conditions favour high-technology entrepreneurship more than typical SMEs, contributing to a dualism between a high-income, high-productivity high-technology economy and a low-income, low-productivity traditional SME economy.

First, business R&D spending is strong in Israel, and this leads to successful patenting and research commercialisation. However, innovation policy support is mainly oriented to large companies and R&D-intensive companies, whereas greater attention to non-high-technology sectors of the economy would help spread the benefits of R&D and innovation among more people, with expected positive consequences on social inclusion.

Second, Israel enjoys one of the highest rates of workforce with tertiary education, and this helps explain, among other things, strong FDI attraction in high-technology sectors. However, the performance of upper-secondary students in the OECD PISA tests in numeracy and literacy skills is disappointing, suggesting that those who do not continue on with tertiary education may lack some basic skills to succeed in the labour market. In addition, there are weaknesses in the VET system regarding the quality of learning outcomes, training and trainer standards, and the relevance of technical education to SMEs.

Third, while the venture capital industry is actively engaged in financing start-ups and the early stages of business growth, notwithstanding some gaps in business angel finance, credit market conditions are not always the most favourable to the host of small enterprises whose sector or business model does not fit the requirements of equity financers. In particular, limited credit information and lack of competition in the banking sector are two major barriers to better access to credit for SMEs.

Fourth, Israel draws sizeable foreign direct investments. However, FDI inflows are again mostly concentrated in high-technology sectors, especially ICT. Stronger FDI inflows in non-high-technology sectors would enhance competition in the economy and bring benefits to wider segments of the society. In addition, a substantial share of inward FDI is in the form of acquisitions of innovative start-ups. There may be a case for strengthening support for the early-stage development of Israeli start-ups in order to postpone acquisitions until greater benefits have been generated for the Israeli economy in terms of wealth and managerial learning.

Given these considerations, the following recommendations are offered to improve Israel’s business environment and framework conditions:

Key recommendations on business environment and framework conditions for SMEs and entrepreneurship

Strengthen product market competition by rapid implementation of the 2013 Concentration Law and granting more powers to the Anti-Trust Authority, including the ability to apply financial sanctions to companies abusing their market power.
Simplify the business licensing and permit system through increased monitoring by SMBA of difficulties SMEs and entrepreneurs face with permits and licenses and communication to the relevant authorities, digitalisation of the business license and permit system, and creation of a national online portal that provides comprehensive information on licensing and permit requirements across the country.
Strengthen Regulatory Impact Assessment (RIA) of new legislation affecting SMEs and entrepreneurship by SMBA by replacing informal consultations with business associations with more rigorous RIA methodologies such as the Standard Cost Model.
Improve bridging between the supply of higher education graduates and their employment in SMEs by increasing SME participation in curriculum design, teaching and student placements, and providing support for upgrading productivity and management practices in SMEs to increase their demand for higher skilled workers.
Strengthen the capacity of the Vocational Education and Training (VET) system to supply appropriately skilled workers to SMEs by increasing the share of work-based learning in SMEs (including apprenticeships, work placements and internships) as part of VET studies, experimenting with new approaches to involving employers in VET programme design and take up, experimenting with “associate degree” qualifications, developing a better labour market information system to identify industry skill needs, and promoting national training standards for VET teaching. This could all be part of a national VET strategy jointly designed by the government and industry leaders.
Introduce a national entrepreneurship education strategy that makes entrepreneurship a mandatory and integral part of the curriculum. To support this effort, develop steering documents (e.g. curricula and syllabi) and evaluation plans, provide training and incentives to entrepreneurship teachers, and develop an online web portal offering guidelines, information and teaching resources for entrepreneurship education.
Broaden the targeting of government expenditures on business innovation to cover more non-R&D expenditures and support greater numbers of SMEs, including in low-technology manufacturing.
Reinforce competition in the banking sector by offering training to qualified financial or economic organisations interested in setting up credit unions and by fully implementing the recommendations of the National Committee to Increase the Competitiveness of the Banking Sector (in particular easing access to loans by very small businesses by applying regulations for retail loans rather than business loans).
Amend regulations to enable disclosure of positive credit history information for entrepreneurs and support credit bureaus in building credit rating information through standardised computation methodologies and disclosure requirements.
Investigate potential regulatory barriers to domestic institutional investors taking part in the venture capital market and consider tax incentives for investors making equity investments in in firms outside of high-technology sectors.
Encourage business formalisation through both demand- and supply-side strategies, such as wider availability of the earned income tax credit and voucher schemes in sectors where informality is widespread.
Develop an FDI attraction strategy that goes beyond high-technology sectors and supports the development of business linkages between FDI affiliates and SME suppliers.

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Notes

← 1. The statistical data for Israel are supplied by and under the responsibility of the relevant Israeli authorities. The use of such data by the OECD is without prejudice to the status of the Golan Heights, East Jerusalem and Israeli settlements in the West Bank under the terms of international law.

This document and any map included herein are without prejudice to the status of or sovereignty over any territory, to the delimitation of international frontiers and boundaries and to the name of any territory, city or area.

← 2. After abstracting from the impact of new offshore gas fields, OECD growth rate projections for 2014 and 2015 are at 2.5% per year.

← 3. This trend has not been uncommon elsewhere in the OECD area; in the last twenty years, on a yearly basis, wages increased by only 1.5% in the United Kingdom, 1.0% in the United States and 0.6% in Germany, far below their respective annual GDP growth rates.

← 4. In 2011, Israel’s civilian spending was 31% of GDP compared with an OECD average of 44% (OECD, 2013a).

← 5. In the Standard Cost Model (SCM), administrative burdens are calculated on the basis of the average cost of the required administrative activity (Price) multiplied by the total number of activities performed per year (Quantity). The European Commission, for example, estimates the “price” by multiplying a tariff (based on average labour cost per hour including overheads) and the time required per action, while the “quantity” is calculated as the frequency of required actions multiplied by the number of entities concerned. For further information, http://ec.europa.eu/smart-regulation/refit/admin_burden/scm_en.htm.

← 6. The OECD high-income average is a World Bank country income category which includes all OECD countries except Mexico and Turkey.

← 7. Data refer to 2014 and are based on the OECD Main Science and Technology Indicator Database.

← 8. Results based on a survey of SMEs by Adalya Economic Consulting in 2011 (Adalya Economic Consulting, 2011, p. 18).

← 9. Data on SME credit in relation to GDP are not strictly comparable because of the different definitions of SME loans in use in different OECD countries.

← 10. See “Israel to expand tax breaks to boost investment in start-ups”, www.reuters.com/article/2014/07/16/israel-taxbreaks-tech-idUSL6N0PR3DI20140716.

← 11. Information retrieved from: www.jpost.com/Business/Commentary/Your-taxes-Angel-Law-amendment-proposals-375536.

← 12. The average wage in Israel is approximately NIS 110 000.