How the VC Industry Transformed an Economy: Evidence from Two Decades of Israeli High-Tech Sector

Abstract

We question the impact of the Venture Capital industry on its hosting economy. This area is rarely explored because 90% of the VC investments are in the US and other large economies, wherein the impact of the VC is too small to be measured. Israel presents a unique case in which the activity of the VC industry over two decades (1993-2012) made the Israeli an exporter not only of High-tech hardware and software but also of intangible assets such as patents knowhow and expertise.

In the knowledge-based world, ideas are an important driver for growth and development. It takes a long time to turn ideas into actual cash flows. The VC industry provides an excellent example for an industry that is based on the ability to bring together ideas and high risk capital in a process that generates value. Of particular interest is the case where the entrepreneurs reside in one country and the investors reside in another country. In this paper we show that in this case there are two types of benefits; the benefits to the entrepreneurs and the investors, and the benefits to the country where the investment takes place. The first type of benefits depends on the success of the young innovative technology firms. The second type of benefits depends on the total flow of high-risk capital from the country of the investors to the country where the investment takes place. The two main components of the second macro benefit are the wages of the local high skilled and other workers; and the tax that they pay. Israel is a good example for a country that benefits substantially from the import of high-risk capital, primarily from the US, via venture capital fund. We use hand-picked database to estimate the total benefit to the Israeli economy from the investment of venture capital funds, which are funded by foreign high-risk capital.

Our main result is a direct empirical measure showing that the benefits to the Israeli economy from the wage bill which is generated by the VC investment is at least ten-times larger than the direct benefits from the successful start-ups only. This result can be translated into an optimal governmental policy of incentives that are set to keep cost-benefit efficient success rate.

Keywords: Venture Capital Investment, Start-Ups, Economic Growth

JEL Classification: O32, O47, G18, G24