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Contents 1 Conclusion: Comparing Choices and Consequences in Rapid Innovation–Based Industrialization 1.1 Dealing with the "King Kongs": The Politics of MNC-Focused Policies 1.2 Facilitating Industrial R&D: The Politics of the State as a Researcher 1.3 Financing and Resources: Going Local or Going Global? 2 Notes

[edit] Conclusion: Comparing Choices and Consequences in Rapid Innovation–Based Industrialization

Choice: the act of choosing: SELECTION; power of choosing: OPTION
Consequence: something produced by a cause or necessarily following from a set of conditions
—Merriam-Webster’s Collegiate Dictionary, eleventh edition

This book has been motivated by two puzzles. First, what is the role of the state in the development of rapid innovation–based industries in lessdeveloped economies, under the conditions of intensified globalization and fragmented production? Second, does the IT industry’s very different development paths—in particular in Israel, Ireland, and Taiwan—suggest that multiple developmental choices are available to emerging economies?

The study shows that emerging economies do have the ability to craft and select different paths in nurturing the growth of successful rapid innovation– based industries. Thus the argument of this book: that real choices for economic development exist. In the empirical chapters I elaborated on how diverse S&T industrial policies distinctly shaped the development of each IT industry. In so doing, I have dispelled theories that solely attribute the explanatory power either to the timing of industrialization or to specific states’ structures. The stories of Israel, Ireland, and Taiwan suggest that four factors are crucial in order for a state to spur RIB industrial development.

First, the state needs to actively engage with industry to solve the fundamental market failure in industrial R&D. Otherwise, the inherent characteristics of industrial R&D—its indivisibility, inappropriability, and high uncertainties, all of which are accentuated in the case of emerging economies with their lack of technological capabilities and finance—would lead private investors to allocate suboptimal amounts of resources to research.

Second, state action is also of crucial importance because the innovation process itself is an inherently collective endeavor. As such, innovation is iterative and cooperative in nature; therefore, there is a significant role for public actors in facilitating, enhancing, and maintaining innovative activities. Third, the state must actively link the local industry with global markets, both production networks and financial markets.

Lastly, in each specific industrial sector, the state and industry need to be able to manage constant change. State actions and policies that prove successful in early stages of the industry’s development might prove harmful in later stages. Specifically, the development agencies need to be able to manage the political reality of their own diminishing importance as the industry grows.

The theoretical framework presented in the first chapter offers a specific understanding of the different consequences and final outcomes of the diverse choices taken by Israel, Ireland, and Taiwan. First, our theory argues that specific industrial R&D, dynamic economic capabilities, and business models are more suitable for certain stages of the production process. Secondly, the analysis of the dynamics of production-stage specialization and economies of scale and scope indicates that industrial systems specializing in specific stages of production tend, if successful, with time and effort, to become ever more competitive and innovative in these specific stages. Consequently, to understand the different evolutionary processes of rapid innovation–based industrial growth we must (a) comprehend how industrial R&D and dynamic economic capabilities are created, improved, and maintained in each of our cases, (b) follow the growing utilization of certain business models in each of our cases, and (c) understand the development of specific relationships that the local industry has with the global industrial and financial markets.

In short, our framework has motivated us to a specific analysis of how different behavior and structure of the state influences the development of the IT industry’s R&D capabilities in each of our cases, by looking at a few critical domains:

• Domain one: state decisions on necessary R&D skill acquirement.
• Domain two: state decisions on the degree of control it attempts to have on the technological development path of the industry, including decisions of how, and whom, to finance. These decisions affect both the R&D resources available to the industry and the scope of R&D activities.
• Domain three: state efforts to build the early local leading companies, and state decisions concerning the involvement of foreign firms and investors within its national borders, as well as decisions concerning whether to enhance specific relationships between local and foreign companies outside the state’s national borders. These decisions shape the resources, and the particular feedback and information the industry gets from its main customers, as well as the diffusion and development of specific innovative capabilities.

Accordingly, private firms in the high-technology industry of emerging economies would have more limited R&D capabilities if the state tried to control the industrial R&D development path, encompassed the R&D conducting agents within its structure, supplied only limited resources, refrained from urging foreign companies to conduct R&D activities within its borders, and limited the involvement of foreigners as financiers. Throughout the three empirical chapters, this framework proved to be effective in enabling us to comprehend how the particular choices of the three states led to the specific industrial outcomes in each case. Moreover, unlike other theoretical frameworks, our framework proved helpful in understanding not only successes and failures but also the specific strengths and weaknesses of each industry. In short, the theory helps not only in explaining results at the aggregate level but also in comprehending the true nuances and consequences of the choices made and the actions taken. Consequently, by showing the plurality of actions and choices that emerging economies have in order to develop their RIB industries, and by analyzing their particular consequences, both positive and negative, I have in this study emphasized the importance of politics—the process of crafting, debating, deciding, and acting on different alternatives.

In this concluding chapter I take a more comparative approach to this last point and show how political debates, on both the national and sectoral levels, influenced key decisions about the critical variables of our framework. I present detailed comparisons on three issues: MNCs, R&D market failures, and venture financing. Together, these examples strengthen our arguments not only on how we should reformulate our thinking on rapid innovation–based industrial development but on the role of politics at both the national and sectoral levels in defining the very diverse economic growth paths emerging economies can, and should, follow.

[edit] Dealing with the "King Kongs": The Politics of MNC-Focused Policies

One of the critical factors in understanding the diverse development paths of the IT industries in Israel, Ireland, and Taiwan is the different ways in which the state has linked the local industry with the global industry. Nowhere are these differences more apparent than in the diverse policies that the three countries employed with regard to MNCs. This is also a crucial political choice as decisions with regard to MNCs (a) are about the nationality of the ownership of local production, and hence about the level of dependency on the international system and markets that the local economy is willing to sustain, and (b) intimately attest to the national perception of the local industry’s current and potential capabilities as well as status. Therefore various policies followed by the three countries reflect the diversity of their national identities as well as their perception of the world system.

Looking at the political context in which these policies developed, we find that in 1950 Ireland was a country brought to the brink of poverty by two decades of extreme nationalistic-autarkic industrial and economic policy, aimed at severing its dependence on the United Kingdom. In this political situation, job creation became the national mission, and a significant social backlash spread against the ideals of national economic independence and industrial isolation. Consequently, local industry was thoroughly discredited and its capabilities and motives were suspect. The fact that the IDA’s MNC-focused policies were quickly perceived as effective in large-scale job creation, even as local industry continued its downward spiral, strengthened this political atmosphere. Only by understanding the sociopolitical context in which Ireland’s first industrial policies evolved can we understand why, until very recently, the main aim of Irish S&T and industrial policies was to maximize inward FDI and bring more MNCs to open labor-intensive manufacturing facilities in Ireland, and why the local industry, specifically the IT industry, was treated indifferently and its leaders regarded with doubt.

On the other hand, we have Taiwan, a state that, while much more willing to create dependencies on international markets than its neighbors in north Asia, Japan and South Korea, was much keener than Ireland to see the nationality of the ownership of a significant percentage of the Taiwanese industry stay Taiwanese (Fuller 2002). Taiwan, in the context of its growing political isolation, was actively trying to link its local industry as a strategic supplier and partner to the world’s leading MNCs. However, to accomplish this vision, Taiwan still needed to create a critical mass of local industry, specifically locally owned, in the context of a political system distrusting the concentration of power in big multidivisional conglomerates, and within a financial system designed to prevent the use of large-scale long-term debt. Only by taking account of these political constraints and wishes can we understand why the Taiwanese state at the same time tried to lure MNCs into Taiwan, employing tactics similar to Ireland’s, and pressure these MNCs to source a significant percentage of their components locally, as well as to transfer to Taiwanese companies the necessary know-how to manufacture them.

Lastly, Israel conceptualized its economic future in terms not of job creation but of the creation of a science-based industry. Hence the policy goal was to maximize a certain set of activities and to build an industry whose main activities in Israel would be the creation and development of new products and technologies. Moreover, in the political context in which Israel has operated since 1967, under the Arab embargo, cooperation with MNCs was perceived as a significant international achievement, especially when these MNCs could be persuaded to locate activities of strategic importance in Israel. This is especially true since the vision of a science-based industry, unlike the Taiwanese industrial vision, does not inherently necessitate national ownership of the organization conducting these activities.

Looking at the behavior of American IT MNCs in the three preceding chapters, we saw that these diverse national policies translated into marked differences in the ways in which MNCs linked with the Israeli, Irish, and Taiwanese industries, as well as in the activities the MNCs located in the three countries. In contrast with the way American IT MNCs have been operating in Ireland and Taiwan, in Israel many if not all of the MNCs’ first activity was to open R&D centers, or to buy Israeli NTBFs and transform them into R&D centers, moving only later, if at all, to manufacturing activities. These diverse MNC behaviors translated into the different outputs MNCs supplied to the local industrial system, and the different inputs they sourced from it. Accordingly, these differences translated to different incentives for capabilities development, as well as different resources and opportunities available in pursuing them for the local IT industry.

Two examples of the different paths pursued by two leading MNCs, Intel and 3Com, in Israel and Ireland serve as a way to highlight these differences and their impact. In 1974 Dov Frohman, a senior Israeli researcher in Intel’s California headquarters, decided to return to Israel and accept a professorship in the School for Applied Physics at the Hebrew University of Jerusalem.^[1] As Intel wanted to retain the services of Frohman, the company agreed to open its first design and development center outside the United States in Israel, with five employees.^[2] In doing so, Intel pioneered a mode by which many MNCs started operations in Israel.^[3] Over the years, the Intel center was highly successful and continuously enlarged its R&D activities. By 2002 it encompassed seven centers. In 1985 Intel Israel also pioneered the first movement of Intel toward silicon chip fabrication activities outside the United States when the first Intel fab in Israel started operations in Jerusalem. In 1999 Intel started the operation of its second fab in Israel. In 2000, following the acquisition by Intel of two companies with major R&D centers in Israel, DSPC and Dialogic Israel, Intel’s R&D activities evolved into two more product platforms. Beyond these, the activities in Israel of Intel Capital, Intel’s venture capital arm, are the most comprehensive in terms of investment outside the United States. During 2002–2003, Intel Capital was the most active foreign investor in Israel.

Throughout the years, Intel Israel R&D has been responsible for some critical components in Intel’s global strategy, including the 8088 (IBM’s famous choice as a CPU for its first PC) and the Pentium MMX technology. In 2000 Intel Israel had revenues of $2 billion (USD) and employed four thousand people; as of 2002 Intel Israel was responsible for the development of the next generation’s laptop-oriented CPUs, 3G mobile network products, and a few other critical components of Intel’s global R&D strategy, such as the development of the latest technologies for optoelectronic chips manufacturing.

In 1989 Intel decided to start manufacturing operations in Ireland. The main reason behind Intel’s decision to locate in Ireland was the company’s fear of an imminent creation of “Fortress Europe” by the EC (now EU) in 1992. A year after the first box assembly operation began, Intel decided to open a full-scale fab, making Ireland the only other place apart from Israel with an Intel fab at the time. Within a few years, Intel realized that Fortress Europe was not an imminent danger and the box assembly line was closed. However, fabrication activities continued. Moreover, local management, spurred by the shock of the closing and helped by an Israeli who became the fab developer and manager, and using his experience in Israel, started lowprofile R&D activities aimed at the creation of a center of excellence in specific technologies in Ireland. Intel Ireland also managed to lobby Intel headquarters to create a special position for Intel Capital in Ireland, which started operations in 2001 and has already invested in a few local start-ups.^[4]

3Com’s involvement in Israel enlightens the second and newer route used by MNCs starting operation in Israel. In 1994, 3Com bought NiceCom, an Israeli company that developed local area network asynchronous transfer mode (ATM) switches.^[5] NiceCom was then transformed into the NiceCom division inside 3Com, responsible for the development of all ATM technology in 3Com, which enlarged its Israeli NiceCom R&D center through a few more M&As and ended with a critical mass of three hundred people in Herzelia. At the end of the 1990s 3Com became a large, complex company and suffered from growing financial difficulties. As a result, 3Com started a process in which it spun off, among others, Palm, its handheld division; its modem division under the old U.S. Robotics brand (another company with an R&D center in Israel, which 3Com had acquired); and, in February 2000, Atrica, a new Israeli start-up developing urban optical networks and headed by none other than the old NiceCom executive team. As of 2004 Atrica had inherited all of 3Com’s R&D activities in Israel and has been considered one of Israel’s most promising start-ups, managing by the beginning of 2005 to secure more than $160 million in investment. Moreover, the former CEO and now chairman of 3Com and CEO and chairman of Palm, Eric Benhamou, serves as Atrica’s chairman.

For reasons similar to Intel’s Fortress Europe strategy, 3Com started its Irish operation in 1992 by opening a plant in Dublin. Over the years, the Dublin operation became the best in quality and yields, and 3Com opened a small R&D center in Dublin. Even as 3Com was reeling from eighteen months of downsizing in 2002, the Irish R&D center was still operative when all others were closed or spun off, and although 3Com has outsourced all of its manufacturing activities, mainly to Flextronics, and closed down all of its other plants worldwide, the Irish plant was the last to close. According to 3Com, the reasons behind this decision have been a mix of the high quality and yields for the Dublin plant, the Irish tax regime, the fact that Ireland is part of the EU, the excellent infrastructure for European deliveries around Dublin, and the excellent relationship with the Irish government.^[6]

Thus the stories of Intel and 3Com exemplify the very different ways in which their national IT industries are embedded in the MNCs’ global production network. Israel has always been first and foremost a location for highlevel R&D activities, while Ireland was mainly deemed a strategic location for manufacturing. These different relationships brought leading American MNCs to locate very different activities in each location, creating very different relationships with, demands from, economic incentives for, and opportunity structures and resource availability for the local IT industry.

[edit] Facilitating Industrial R&D: The Politics of the State as a Researcher

A second critical component in understanding the different development paths of the Israeli, Irish, and Taiwanese IT industries involves the ways in which the three states devised different solutions to the problem of industrial R&D market failure. Of particular importance is the question of the location of the R&D-generating agents within the industrial system, public versus private. In all three countries this debate was intimately connected to the national perception of capabilities, status, and identity, as well as to the politics and the bureaucratic structure of knowledge. Taiwan and Israel are the two cases between which a deeper comparison is most revealing.

Looking at Israel in 1968, with a total of 886 R&D workers with academic degrees in the whole civilian industrial sector, one might wonder how the Katchalski Committee came to the conclusion that the growth of sciencebased industry should be the core of Israel’s S&T industrial policy goals. However, even more interesting, and easily forgotten, is the fact that the committee’s recommendations, which were transformed to specific policies, viewed state-run public research institutions as the main vehicle for this socioeconomic transformation. Hence, between 1968 and 1973, Israel undertook major steps toward following a development path similar to Taiwan’s. Nonetheless, by 1974 the reliance on public research institutions was quickly curtailed, and the system refocused around a policy regime viewing private companies as the main agents for industrial R&D and technological development. Thus two questions arise: why did Israel, unlike Taiwan, choose to change course? And what enabled Israel to do so with such speed and without any significant political backlash?

The answers to these two questions are intimately related to these two countries’ different politics of technological knowledge, perceptions of national identity, state-industry relations, and the political-bureaucratic structures of power. First, let us look at the question of each country’s political context of state-industry relations and the politics of technological knowledge. In Taiwan the ruling party, the KMT, while viewing the growth of private industry as the ultimate end, at the same time mistrusted private entrepreneurs and their motives and was actively pursuing policies to prevent the growth of competing centers of power (Cheng 1993, Fields 1995, Gold 1986, Hong 1997, Wade 1990, Wu 2001). In Israel, on the other hand, the ruling Labor Party actively tried to grow a strong private industry and was pursuing policies to limit the power of the public and semipublic sectors (Levi-Faur 1998, 2001). Accordingly, if at the starting point in both societies the existing infrastructure of industrial R&D consisted mainly of public research institutions, in the political context of Taiwan such a system would have offered an optimal solution to competing political goals. In Israel, on the other hand, a system focusing on public research institutions not only clashed with the ultimate goal of building private science-based industry, and hence an industry with significant R&D capabilities, but also clashed with the political-economic goal of the ruling Labor Party to strengthen the private sector at the expense of the public sector.

However, at least as important in facilitating the Israeli course change were the different politics of knowledge in the two states. Here the bureaucratic structure of knowledge and power, as well as the perception and structure of the academic system, was of key importance. In Taiwan the decision to create ITRI and later III was the personal undertaking of two prominent KMT leaders, Y. S. Sun and K. T. Li. As a consequence, the two public research institutions were under the direct patronage of two leading politician-bureaucrats who had direct interest in their continuous development. From the mid-1970s onward, K. T. Li devoted his career and considerable power to the development of the Taiwanese IT industry through ITRI and III.

In addition, the high echelons of the Taiwanese bureaucracy consisted of engineers. Therefore, the view of a state deeply involved in charting the technological development of its industry and locating the R&D agents within the state structure was accepted not only as natural but also as politically prudent, and helped to directly enhance the power and status of the two patrons of ITRI and III. Lastly, during that period, the university system in Taiwan was thoroughly controlled by the KMT, with virtually all the professors and administrators nominated by the KMT and members of stature in the party. Academic freedom was not a widely held value, and the goals of academic research were intimately tied to the national aims of improving Taiwan’s economic and political power.

In Israel, the situation was almost directly opposite. No leading politician had any direct interest in Israel’s public research institutions. The political leaders who decided the fate of Israel’s S&T industrial policies did not possess Ph.D. degrees, nor did they personally undertake the development of the IT industry. S&T industrial policy in Israel was always deemed to be a professional domain. Values of academic freedom and “pure” basic research were strong. Until the late 1970s developing the research capability of strictly academic institutions was a high national priority, sometimes even higher than national security and the growth of the defense industry. A case in point is the story of the transfer of a whole department to the Weizmann Institute of Science from RAFAEL, the public research institution for the development of armaments. This was done in order to enhance the national academic research infrastructure, and against the wishes of RAFAEL, which invested significant resources into the development of this department and viewed it as critical to its future R&D plans (Mardor 1981, pp. 113–117).^[7]

Consequently, after the 1973 war, when the government of Israel decided to give higher priority to the development of industrial R&D and science-based industry by recruiting a prominent and strong-willed professional, Itzhak Yaakov, to head the OCS, he was given the power to transform it into an active agency, and had authority to formulate and implement policies. Coming from within the military, and possessing strong international connections and education, Yaakov was ideologically opposed to public research institutions. In an interview he concluded:

My second guiding principle was that a state cannot guide the industry. The state cannot come and say from now on we will develop engines for helicopters; this is a complete dead-end. Successful industrial R&D comes from the people themselves. Therefore the problem of the state is to give the entrepreneurs who think they know what they are doing the ability to do so. The key to understand is that we cannot control the consumers; accordingly good ideas have to come from the market, not from the state. These are the reasons why in my second year I decided to cut the budget of the public research institutes by 70 percent and transfer the finance directly to industry. (interview, September 28, 2000)

The different national political contexts, the ideologies of development and science, political patronage for the public research institutes, and the bureaucratic structure of power were the main reasons why in Israel, once Yaakov decided to dismantle the public research institution-based S&T industrial policy, he could do so in matters of days, while in Taiwan, this option was not even considered.

These decisions have had decisive long-term consequences on the development path of the IT industries in Israel and Taiwan. In Israel, the focus on the enhancement of technological cutting-edge R&D activities of private firms has propelled IT companies to develop capabilities that facilitated novel products innovation based on the latest technologies, the newest technologies themselves, or new applications of these technologies, and has led Israel’s IT industry into its position as a supplier of new technologies to the global IT industry’s production networks. Nonetheless, the source of the industry’s Achilles’ heel is also the state’s almost exclusive focus on promoting private firms to conduct R&D activities and follow business models based on new innovations. Because the development of management and business skills has lagged, many Israeli companies have difficulties in maintaining enduring success.

In Taiwan the decision to utilize public research institutions–based S&T industrial policy led to the development of an industrial innovation system with strong division of labor between industry and public research institutions. This pattern limits the development of R&D capabilities of private firms by motivating these firms to concentrate more on the development part of the R&D. In this system it is the public research institutions that decide which R&D projects should be pursued, conduct nearly all R&D, and only then diffuse the results to private industry; accordingly, the development of core R&D capabilities is concentrated within the public sector. Thus in Taiwan, specifically because of its institutional system, the industry successfully developed advanced capabilities in second-generation, process, and manufacturing innovation, but not in new-product development. While this system propelled Taiwan to unprecedented success in the IT hardware sector, it is an open question as to whether Taiwan can change this system so that it can move to original, new-product R&D activities in the future.

[edit] Financing and Resources: Going Local or Going Global?

A third critical variable in the diverse development paths of the IT industries in Israel, Ireland, and Taiwan has been the connection of industry with the global financial markets. In all three countries, key decisions by the state were taken as part of policy initiatives to create local VC industries. These were again decisions that are closely linked to questions about the ownership and the long-term embeddedness of the industry within the national context. On the one hand, a tight relationship with the global investing community and financial markets gives the industry an opening to an immensely rich supply of skills, resources, and capital. On the other hand, this same linking transfers a large portion of the ownership of local industry into foreign hands, and this same dependency on foreign financial markets weakens the industry’s national linkages. Moreover, the more connected the industry is to the global financial markets, the more the fruits of the local IT industry’s success are redistributed to foreign investors who are not as inclined as local investors to reinvest their gains in the national economy. Lastly, national governments have more power to influence the behavior of local financiers. Hence, while from the point of view of overall industrial development, linking the IT industry with experienced foreign VCs might be preferred, governments might favor working with local institutions and individuals.

In each of our cases, the developmental agencies followed very different VC creation policies. A large percentage of these differences can indeed be explained by the different conceptualizations by policy makers of the VC industry itself. In Chapters 2–4 I showed the distinction between two VC creation policy styles: one that sees VC creation as a problem of a missing pool of capital, and a second that sees VC as a distinct industry with specific skills and capabilities (Avnimelech and Teubal 2003a, 2006a, 2006b). This distinction explains much of the outcome in terms of VC behavior. Nevertheless, this distinction obscures the intense political nature of these policies, specifically since, in the case of emerging economies, a decision to treat VC as a distinct industry strongly suggests a need to tightly connect the local with the global VC industry and financial markets.

In Taiwan the VC industry was, like many other initiatives, the brainchild of the leading technocrat-politician K. T. Li. Impressed by the U.S. VC industry in the early 1980s, Li viewed the VC industry mainly as a supplier of a dedicated pool of capital. In the Taiwanese political context, Li considered it essential that the main investors in the industry would be Taiwanese. In 1983, under his influence, VCs were allowed to register as companies rather than as limited partnerships. The main vehicle to channel capital to these newly formed companies was a tax credit of 20 percent to shareholders in VC firms. This tax incentive remained in place until 2000 and was the main reason behind the extensive amount of finance channeled specifically to VCs. It is not surprising that in this political context many of the early VCs were financial subsidiaries of different KMT investment vehicles. For the most part, the VC industry in Taiwan remains captive to various investors, both financial and industrial. The VCs themselves lack extensive industry experience and are mainly recruited from those with financial background. Taiwan’s VC industry, operating under the regulations that force VCs to be registered as companies, also continued to be extremely local. As of 2004, according to the Taiwanese VC association, foreign capital still amounted to less than 7 percent.^[8]

In Israel the political and industrial contexts were almost the opposite. By the beginning of the 1990s, not only was the IT industry already relatively well embedded in the American financial markets, with a cumulative number of about a dozen companies already listed on NASDAQ, but the first private VCs also appeared, and foreign financiers were their main investors. The OCS took the lead after a first failed attempt, Inbal, which was headed by the Ministry of Finance, to spur a local VC industry with an organizational form similar to Taiwan’s: VCs as publicly listed holding companies on the Tel Aviv Stock Exchange. Unlike Taiwan or Ireland, the OCS linked VC policy and made it an integral part of its overall reconfiguration program for the hightechnology industrial environment in the early 1990s. In this political context, we can understand why Yozma, as the VC creation initiative was known, was conceptualized the way it was.

In the early 1990s the OCS used the political window of opportunity created by the massive waves of immigration from the former Soviet Union to launch a series of policy initiatives. Each of these three initiatives was part of an overall program to fix what the OCS analyzed as areas of persistent weakness with Israel’s RIB industries: extremely early seed investment, skills and finance in the more mature market-penetration stage of firms’ development, and advanced generic R&D capabilities. Thus the creation of the VC industry was conceptualized not solely as a problem of financing but as part of a systemic weakness of missing capabilities. It is in this context, with the already deep embeddedness of the Israeli industry within the American financial markets, and only after the failure of the Inbal program to create a locally financed VC industry, that we can understand the advancement of the Yozma program. In particular, it conceptualized VC as an industry with skills that were lacking in Israel, and it made a deliberate political attempt to increase both the field of investors and their clients, as well as to tie the Israeli IT industry more fully with the global financial markets.

In Ireland, the one rarely talked about but quite striking political constraint, in the period when the IT-focused VC initiative materialized in the second half of the 1990s, was the recent reorganization of the developmental agencies and the sharp division of labor between their two domains and clientele. On one side of the divide was IDA Ireland, whose domain comprised MNCs and all FDI inflows into Ireland. On the other side was the newly structured Enterprise Ireland, out to prove itself with a domain comprising local industry and all local enterprise and investment. VC policy, under other political circumstances a bridge with which to connect FDI inflows with local enterprise development, fell within the domain of EI and was led by the NSD.

Hence, even with the declared aim of the NSD VC initiative to embed the Irish IT industry more intimately with the global markets and to aid Irish companies in their pursuit of foreign success, and even with the acknowledged political goal of increasing the circle of financiers in Ireland, which was deemed too narrow, the political institutional constraints limited the NSD to seek established local financial institutions as partners for its VC program. Accordingly, the NSD, utilizing EU funds, opted on the one side to enforce the organizational form of limited partnerships, similar to Israel and in imitation of the United States, but on the other side specifically chose only Irish institutions as its partners.^[9] The institutional division between the IDA and EI is also becoming an artificial obstacle with the growing interest of the MNCs in the Irish IT industry. Consequently, many managers of MNCs and their VC arms find that their “natural” political interlocutors are located within the IDA. However, the proper interlocutors for issues of Irish IT industrial development are all situated in EI.

All the very different VC creation policy initiatives of Ireland, Israel, and Taiwan have been exceptionally successful. However, all three have had very different outcomes in terms of the VC industries created, and in terms of the tremendously different relationships between the local IT industry and foreign markets they nurtured.

In Taiwan the creation and rapid growth of this VC industry has helped the Taiwanese IT industry, in particular the hardware industry, to evolve as it did. Taiwanese VCs are both much more conservative than their U.S. counterparts and also much less capable of giving added value in running a true R&D-based young venture. The VC industry in Taiwan prefers to invest in companies with the more established business models of second-generation innovation or OEM-ODM. Moreover, as virtually all of its financings are Taiwanese, and as the VCs are registered Taiwanese companies, the Taiwanese VCs are under no pressure to seek financial exits in foreign financial markets. Hence, not only does the Taiwanese VC industry strengthen the linkage of the Taiwanese IT industry within Taiwan, but it also defuses some of the need it otherwise might have had to embed itself more tightly into the global financial markets. Thus it seems as if the political goal of keeping the Taiwanese industry Taiwanese has been achieved, though only at the price of a less sophisticated and much more conservative VC industry.

In Israel, on the other hand, the VC industry that rapidly grew in the late 1990s is better seen as an extension of the American financial markets and VC community than as a purely Israeli industry. Almost all of the financing of the industry is foreign, with the share of local investors actually diminishing after the dot-com crash on NASDAQ. Most of the biggest funds not only have offices in the United States and Europe but also have general partners who are experienced American and European VCs. Most of the VCs have industry experience and operate very similarly to Silicon Valley VCs. Even more important, with the finance and the organizational modes coming from the United States, Israeli VCs are seeking foreign financial exits. Thus the linkage of the IT industry with the rest of the Israeli economy is severely weakened, while its embeddedness in the global financial markets is growing. In addition, the need to seek foreign exits and the diffusion of the Silicon Valley VC model limit the Israeli IT industry to employ, almost exclusively, novel R&D-based models. Lastly, with the investors of the VC industry mostly being foreign institutions, most of their profits are transferred back to the investors, and hence, out of the Israeli economy, with, relative to Taiwan, only a small fraction of the capital staying within Israel. The existence of such a VC industry is thus both positive and negative. For example, only with such intimate connections to foreign capital markets could Atrica, the spin-off of 3Com’s Israeli R&D center, raise more than $160 million to support novel R&D activities, a sum that is alone larger than the combined capital managed by the biggest Irish VC companies. However, Atrica’s CEO is no longer Israeli, the HQ is no longer in Israel, and the financial gains of Atrica’s success, if and when they arrive, will be mostly enjoyed by foreigners.

In Ireland the VC industry seems to be stuck in the middle. On the one hand the industry tries to imitate the American model and employ a hands-on value-added investment-and-management policy. On the other hand, most of its finance, and hence its connections, are with Irish financial institutions, and the VCs’ background is mainly in the financial and management-consulting industry. Therefore the Irish VCs’ ability to add value and to link their companies to foreign financial markets is limited. Indeed, with the Irish government being the single biggest source of funds, the VC industry is keener to be seen as helping the growth of the Irish IT industry. However, apart from a short period in the end of the 1990s, the VCs’ apparent influence vis-à-vis the sums under the industry’s management has actually declined. Nonetheless, the creation of a growing VC industry in Ireland has changed the rules of the game. Unlike in the past, a pure R&D business model is no longer seen as a taboo. Moreover, the strong connection of the VC industry to Ireland, in a very similar way to the case of Taiwan, aids in defusing some of the pressure of Irish IT firms to embed themselves more strongly in foreign markets at the expense of their “Irishness.” With a VC industry flush with capital it is also plausible to expect that once the global IT industry shows signs of substantial improvement, Irish IT NTBFs can hope to raise significant amounts of finance for R&D. Nonetheless, as of 2006, not only had the rapid growth of the Irish VC industry not transformed the shape and size of the Irish IT industry, but the existence of the VC industry and the attention it had gained from the state might actually have hurt the ability of NTBFs to commence operations in the short run.

The premise of this book is that—with the extensive and rapid changes of industries, the international system, and the nature of industrial production itself—there is a need to establish a framework to analyze the role of the state in rapid innovation–based industrial development. Since the early days of the late-development theory, research on industrial production, innovation, and economic growth has diverged. Hence we no longer have a coherent body of literature capable of answering the questions that motivate this study. Accordingly, in the first chapter I developed a new theoretical framework by debating and building upon the work of three schools of thought—late development, systems of innovation, and globalization, particularly the globalization of production networks. I then used this framework to analyze the role of the state in the development of the IT industry in Israel, Ireland, and Taiwan. This inquiry was conducted in order to answer three questions: first, what are the roles of the state in RIB industrial development in emerging economies? Second, do states and societies have choices in their economic development strategies? And third, how does globalization, especially the radical transformation of production, influence the development opportunities of peripheral economies?

Our analysis of the development of the IT industries in Israel, Ireland, and Taiwan yielded the following answers.

First, there is a significant role for the state in creating and sustaining rapid innovation–based industrial development. This role, however, is not fixed. Emerging economies have many different choices in their efforts to develop RIB industries. Each of these choices has major consequences for the developmental path of each industry. This is particularly true with regard to industrial and innovational capabilities, and the ways in which each of these national industries is embedded into the global product networks and financial markets. For this reason, while globalization might limit the scope of state capabilities to develop their national industries in the strong development state method used by South Korea or Japan, globalization, especially the growing fragmentation of production, opens numerous new entry points for rapid innovation– based industries in emerging economies.

As a consequence, the role of the state in RIB industrial development has significantly changed. First, the state needs to actively engage in the fostering of industrial R&D and innovation. In so doing, the state is devising different solutions to (a) the inherent industrial R&D market failure, which is heightened in the case of emerging economies, and (b) the need to start a collective— that is to say, a community—effort to foster innovation, which stems from the fact that innovation by its very nature is an iterative and social endeavor. However, precisely because of this, and because long-term strategic planning is less feasible in rapid innovation–based industries where technology itself or its latest application are the products, the state cannot assume a position of central planning and command. Rather, the state role is more limited to that of creating capabilities, spurring specific activities, and motivating private enterprises for sustained efforts in RIB industries.

A second finding is that the proper level of analysis of states’ rapid innovation– based industrial development efforts should be in the specific industrial sector level and at the level of particular state agencies, not solely in the national level. States can both fail and succeed in their RIB industrialization efforts in different sectors. Furthermore, many times sectoral, not national, policies have more direct influence on industrial development. This is especially true as, in contrast with the traditional Weberian ideals, our view of the state bureaucracy is of a fragmented and flexible civil service deeply embedded in various industrial sectors. For this reason, we should no longer view the state as a monolithic whole. Thus a crucial factor in understanding industrial success is to comprehend the political processes of state-industry co-evolution at both the national and sectoral levels.

Another crucial role of the state is to link its local burgeoning rapid innovation– based industry with global markets, to both production networks and financial markets, and both inside and outside its national borders. Our theory allowed us to explain why in the case of Taiwan a hardware industry developed that excels in second-generation innovation and high-level design-and-manufacturing services, as well as in the supplying of components. This occurred because in Taiwan the state (a) located the R&D-conducting agents mostly within its own structure, (b) is intimately involved in decisions about the technological development path of the industry, (c) has been aiming specifically at developing companies that excel as ODM-OEMs, as well as actively trying to foster OEM-ODM relationships between local companies and MNCs, and (d) has been striving to limit the relationship of Taiwanese NTBFs to Taiwanese financial institutions.

In the case of Israel an IT industry developed that excels in novel product innovation and new technology creation, specifically because the state (a) focused on motivating private firms to innovate and refrained from targeting specific technological development paths, instead focusing on fostering a specific set of activities, R&D, (b) has been actively helping in the creation of particular relationships between local companies and MNCs where Israeli firms focus on new-product R&D, (c) has had an FDI-focused industrial policy whose sole goal was to motivate MNCs to open R&D subsidiaries in Israel, and (d) has been vigorously trying to tie the local companies as closely as it can with foreign financial institutions. Nevertheless, the Israeli IT industry lacks several managerial skills and is not highly tied to Israel and the rest of the Israeli economy.

In Ireland an IT industry developed that excels in developing software products of mid-level sophistication, usually offering applications of novel technologies in new markets and industries, rarely developing the new technologies itself. This happen because the state (a) focused on job creation for many years, attempting to bring MNCs to open large-scale manufacturing facilities in Ireland and paying much less attention to the creation of the local IT industry, (b) was not actively trying to embed these MNCs with the local industry, (c) was for a long time not channeling many resources for industrial R&D activities, and since then has been concentrating on the software industry, taking less notice of the hardware industry, and (d) while not specifically dissuading local industry from deeply interacting with the global financial institutions, was, nevertheless, growing an Irish-owned vastly state-dependent VC industry.

The most important conclusion of this book is that states and societies still have real choices with regard to developing their own rapid innovation–based industries. Moreover, each set of choices has particular consequences that can be at least partly foreseen. These lessons, however, should be divided in two.

On the political economy side, there are a few important points to remember. First, in all three cases the financial investments by the state have been minuscule, especially in comparison to what the same government invested in other more traditional industries, or what other governments, many times less successfully, invested in their IT industries. The second point to remember is that the development of RIB industries is not a one-time effort. In Israel, Ireland, and Taiwan, sustained efforts by the state continued for a couple of decades before a true economic transformation occurred. Consequently, the third point to remember is that what allowed Israel, Ireland, and Taiwan to sustain their efforts has been the institutionalization of their S&T and innovation policies. Hence one lesson to be learned by emerging economies is that long sustained efforts with relatively minor financial investment are probably more transformative than short-term costly efforts done with a big political fanfare. Nonetheless, this lesson only heightens one of our main arguments: it is critical to manage the political process of industry-state co-evolution, especially the changing, and usually diminishing, role of the state.

The second set of lessons to be learned is directly related to our theoretical framework. Looking at their international and internal socioeconomicpolitical situation and defining their particular economic goals, emerging economies, while they can never know exactly what products and technologies their industries will develop, can use this framework to map what kind of capabilities, business models, and relationships with the global production networks their industry will have. By deciding how and where to locate the main R&D conducting agents, nurturing particular relationships with leading MNCs both inside and outside their borders, and influencing the role of foreign financiers and financial markets, emerging economies can partly shape the development path of their rapid innovation industries. Specifically, state actions influence two key domains: (a) what kind, and to what degree, private industry develops original R&D capabilities, and (b) what entry points, and hence what kind of inputs and relationships, their industry has with global production networks. Furthermore, each one of these choices also affects the economic distribution of success and its sustainability. For example, while many might see Israel, with its wide array of innovational capabilities and the success of its companies on NASDAQ, as the optimum of success, it is sobering to remember that whereas Taiwan and Ireland have managed to a great degree to achieve economic growth and equality, in Israel inequality has been growing rapidly, and it is not clear whether a large percentage of the Israeli society has ever enjoyed any of the fruits of the IT industry’s impressive success.

The final message of this study is a positive one: less-developed states and societies still have extensive opportunities to improve their economic wellbeing and spur rapid innovation–based industrial development. Moreover, there is more than one model to follow in order to achieve success. Israel, Ireland, and Taiwan have demonstrated that there are at least three, and probably more, development paths that other countries can follow. Moreover, our theoretical framework has shown the feasibility of developing models that would help us to predict the industrial outcomes in both capabilities development and the social distribution of success of different choice sets. For that reason this book constitutes a step in a research continuum that will grant us greater understanding of the politics and outcomes of rapid innovation–based industrial development.

[edit] Notes

1. ↑ In 1971, shortly after joining Intel in 1969 and after the first 1k-bit DRAM was released, Dov Frohman invented the UVEPROM, an electrically programmable memory that holds the programmed values until erased by intense ultraviolet light. Frohman invented, developed, designed, and fabricated the first UVEPROM.
2. ↑ One must note, though, that opening a small SC design center is not as capital-intensive a high-risk decision as is opening a fabrication facility; total investment in the Israeli center was $300,000 (1974 terms).
3. ↑ Over the years, Israeli senior R&D managers in other American MNCs have followed this pattern and returned to Israel to open R&D operations for their MNCs. National Semi-Conductors and KLA are two prominent examples.
4. ↑ The history of Intel in Ireland and Israel is based on interviews with five executives of Intel and Intel Capital in Israel and Ireland and email communication with Dov Frohman. See also Dror 2002; Tania Hershman, “Tech New Promised Land,” Wired, January 17, 2000, also available online, http://www.wired.com/news/infostructure/0,1377,33537,00.html; and Intel Israel and Intel Ireland Web sites: http://www.intel.com/il/ and http://www.intel.com/ireland/.
5. ↑ Asynchronous transfer mode is an international standard for cell relay in which multiple service types (such as voice, video, and data) are conveyed in fixed-length (fifty-three-byte) cells. This makes ATM a fast data transmission protocol, as fixed-length cells allow cell processing to occur in hardware, thereby reducing transit delays.
6. ↑ Interview with Eric Benhamou, former CEO and chairman of 3Com, 1990–2000, and current chairman of 3Com and chairman and CEO of Palm, February 13, 2002.
7. ↑ Indeed, the social status of academia in Israel was so high in these early years that RAFAEL viewed it as critical to win a political battle to grant its R&D employees recognition as academic personnel, giving them wage agreements and career patterns less typical of engineers than of university professors (Mardor 1981, pp. 88–92).
8. ↑ Interview with Taiwan’s VC association secretary general, November 3, 2003.
9. ↑ Interview with EI VC program official, March 7, 2002.

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