It's Not (Just) the Culture, Stupid: 4 Reasons Why Israel's Economy Is So Strong

And chutzpah is probably part of it. But early on, so was the helping hand of government. Thanks partly to investments in military research and its well-educated population, Israel had some of the key ingredients for a high-tech boom by the early 1990s. But it lacked an important catalyst: investors. As Glenn Yago, senior director at the Milken Institute's Israel Center, told me, there was virtually no venture capital scene in Israel to speak of. Rather, the economy was still dominated by state-backed behemoths. "Basically, it was a kind of crony capitalism," he said. 

That began to change with the Yozma program, a $100 million state-owned venture capital fund that opened for business in 1993. Some of the money was invested directly in startups. But more importantly, the program convinced foreign venture capitalists to create funds in Israel by lowering their taxes and promising to match part of the money they raised from investors. In doing so, it set in motion a virtuous cycle that created a thriving, independent venture capital market that was backing hundreds of startups a year by 2000, as shown in the graph below, adapted from a paper by Israeli researcher Gil Avnimelech. With the market up and running, the government privatized Yozma in 1998.

Israeli_Tech_Startups.PNG

As George Gilder wrote in City Journal, it took a final, massive round of deregulation under Prime Minister Benjamin Netanyahu in 2005 before Israel would have a full-fledged financial services industry. But Israel pulled off a remarkable feat by cleverly growing a financial ecosystem for its tech entrepreneurs from scratch. 

THEY MAY HAVE THE WORLD'S SMARTEST CENTRAL BANKER

There are a host of reasons Israel managed to escape the worst of the global financial crisis and its awful aftermath. For one, it managed to properly implement something close to a classic Keynesian spending policy, cutting its deficit during the good times before the meltdown, then letting it grow when the economy went south. 

But the country also has a not-so-secret weapon: Stanley Fischer, the Zambian-born, U.S. educated head of the Bank of Israel. A former MIT professor, chief economist at the World Bank, deputy managing director at the International Monetary Fund, and vice chairman at Citigroup, Fischer was not an Israeli citizen when he was recruited to manage the country's monetary policy. He was an import. But since taking the helm in 2005, he's managed to keep the country's currency relatively stable against a fluctuating dollar -- key for their exports -- while steering the economy towards consistent growth. 

In a much discussed blog post, Evan Soltas pointed out that this growth may have been the product of a controversial strategy known as "nominal GDP targeting," where a central bank picks an annual growth figure, and tries to hit it whether through inflation, or by expanding the real economy. The idea is to prevent private debts from crashing the economy by making sure incomes steadily rise, even if real growth slows down a bit. 

As Soltas' graphs below show, Israel's real GDP and inflation have moved in opposite directions, while its nominal GDP has hovered right around 6.5 percent per year. 

Israel_Soltas_Graphs.PNG

This is a strategy that many, including The Atlantic's Matt O'Brien, have hoped the Fed would pursue to rev up our own economy. But as of now, that seems like a remote possibility.  

MORE THAN CULTURE

So in a sense, Romney had a point. Culture has been a big factor in Israel's success. Its openness to immigrants and the ingenuity of its entrepreneurs have played a role in its economic renaissance. But unless you lump your feelings about about government spending as a percentage of GDP, public-private partnerships, and NGDP targeting under the header of culture - and who knows, you might - then that's only part of the explanation. Rather, Israel's government has gotten better over time at learning when it needs to get out of the way and knowing when it needs to step in and lend the private economy a hand, when it needs to tackle a problem like inflation and when a little bit could be good for growth. It's figured out how to be flexible. That's a lesson some of our own policy makers could probably use, too.

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Jordan Weissmann is a senior associate editor at The Atlantic.

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