SIEPR Policy paper No. 00-40
Israel’s Silicon Wadi: The Forces Behind Cluster Formation
Catherine de Fontenay and Erran Carmel
June 2001

By the end of the 1990s Israel had formed one of the world’s most successful high-technology clusters. The core of the Israeli cluster is based on the Information and Communication Technologies (ICT) industry consisting of software, data communications, electro-optics, hardware design, and internet technologies, which together generated $15 billion in export revenues in 2000. Two different sources account for the success of the cluster: one, long-term advantages that Israel possesses in ICT, and two, short-run exogenous factors that hastened the formation of the cluster during the 1990s, and produced strong cluster effects. Israel’s long-term comparative advantage is based on its endowments of production factors for labor-based high technology: A stock of (initially) underemployed high-skilled labor, a stock of research knowledge in some specific areas within ICT such as data security, and an abundance of relevant entrepreneurial and organizational skills. In addition, the government has introduced provisions that reduced costs and increased reliability such as support for industrial research. In the short run, the Internet and telecommunications boom of the 1990s had a tremendous impact on the success of Israeli firms, as the stock of knowledge in Israel (particularly from the military) was highly suited to tackling certain aspects of the Internet and telecommunications. New government policies also stimulated the formation and growth of firms. The presence of many more firms led to cluster effects, defined as positive benefits from the presence of other firms, independently of other location characteristics. Cluster effects include: professional networks with other ICT firms in Israel and firms founded by Israelis abroad (these networks existed previously but have become more valuable); and specialized services in areas such as venture capital (as there are now over 100 funds), executive recruiting, legal and management consulting. Our analysis suggests that cluster effects have been particularly useful in overcoming difficulties that Israeli firms faced in accessing markets, because of distance from final markets (which are primarily in the US) and inexperience.

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