The Economist: Israeli tech sector is under strain from the continuing conflict

Soon after Hamas attacked on October 7 last year, around a third of workers at Elsight, an Israeli maker of drone communications systems, were called up to fight in Gaza.

A similar exodus took place across Israel’s mighty tech sector, which accounts for over half of the country’s exports, a fifth of GDP — and a fifth of the reservists in the Israel Defence Forces.

Under the circumstances, Israel’s tech sector has proved to be remarkably resilient.

Venture capital funding stalled when the war began, slumping to $2.1b in the last three months of 2023, the worst quarter in five years. But it has since recovered.

Israel’s tech industry is accustomed to conflict — it emerged relatively unscathed from shorter bouts of fighting in 2006 and 2014 — and many firms benefited from a surge in defence contracts both at home and abroad over the past year.

Nonetheless, Israel’s widest and longest war in decades may leave lasting scars if it is not resolved soon.

Israel’s tech prowess dates back decades. The government has long sought to boost industrial R&D through grants, fund-matching arrangements and schemes such as the Magnet Program, which brings together companies and universities to develop technologies.

Supportive government policy has drawn private capital into the high-tech industry, says Avi Hasson, a former chief scientist of the country.

The upshot is that Israel spends more on research and development, relative to GDP, than any other country, and more than double the average among members of the OECD.

Israeli tech has also been helped by close ties to the country’s military, which has not only been a buyer of its whizzy products but also a supplier of entrepreneurs.

For instance, former members of Unit 8200, the IDF’s renowned signals intelligence group, have gone on to found many prominent cybersecurity firms, including Wiz, which Google unsuccessfully tried to buy for $23b in July, and Palo Alto Networks.

These ties help explain why Israeli tech centres rely less on things like mobile apps and more on cutting-edge innovations that may come out of, or be useful for, the military.

Increased defence spending over the past year, both at home and abroad, thus offers one explanation for the resilience of many Israeli tech firms.

Elsight has morphed into a defence-focused firm: it now makes over half its revenue from military contracts, up from less than 5 per cent before October 7, according to Yoav Amitai, its boss.

XTEND, an Israeli firm that makes software to inspect buildings and other infrastructure using drones and robots, has been signing contracts with the IDF. It raised $40m in VC funding in May.

Israeli tech firms in other buzzy areas of tech have also continued to do well. The country’s 460 or so cybersecurity firms are in high demand from companies looking to up their defences.

Earlier this year Nvidia, a chip behemoth, spent $1b on two Israeli artificial-intelligence startups, Deci and Run:ai.

Medical technology is another bright spot. In August Johnson & Johnson, an American pharmaceutical giant, announced it would purchase V-WAVE, an Israeli maker of heart implants, for up to $1.7b.

In July Alcon, a Swiss eye-care company, bought Belkin Vision, an Israeli start-up that develops laser-based technologies for glaucoma.

Yet other tech firms are increasingly showing signs of strain. Those in consumer-facing areas have been hit harder by the conflict.

Last month One Zero, an Israeli fintech firm, announced it would fire 6 per cent of its workers after a deal with Generali, an Italian financial-services group, to establish a digital bank in Italy was put on hold. In a letter to employees Gal Bar Dea, One Zero’s boss, blamed “uncertainty around the war situation”.

Aleph Farms, a start-up developing lab-grown meat, laid off a third of its staff in June.

Even in areas of tech that have done better, bosses note that the war is undermining morale and productivity.

What is more, foreign tech businesses such as Dropbox, an American cloud-storage company, and Verily, a biotech firm owned by Google, have been shutting operations in Israel. That is a problem for the wider economy.

At the end of September Moody’s, a rating agency, downgraded Israel’s government bonds by two notches, pointing to “high uncertainty around the high-tech sector’s capacity to keep growing”. About a quarter of the government’s tax take comes from tech companies and their employees. The longer the conflict continues, the worse the damage.