Concern over the impact of widely opposed judicial reforms on Israel’s tech ecosystem appear to have been vindicated, with the critical sector of the economy, accounting for more than half of the country’s exports, witnessing a substantial fall in investment.

Israeli tech companies drew $1.7bn (NIS6.21bn) in investment in the first three months of 2023, just 25% of the corresponding figure in 2022, according to independent think tank the Start-Up Nation Policy Institute (SNPI). It suggests the fall has been influenced by the global economic downturn and turmoil surrounding Israel’s highly controversial judicial overhaul plans.

“While it is impossible to separate the two effects – the ongoing global recession and the domestic unrest – the combination severely jeopardises the future of Israel’s high-tech sector,” the institute said.

Critics round on government reforms

The country’s entrepreneurs have been among the most vocal critics of the right-wing government’s intention to limit the powers of the Supreme Court, which many believe will undermine democracy. Hundreds of thousands of Israelis have demonstrated against the move, prompting a suspension of the legislative process.

Prime Minister Benjamin Netanyahu has agreed to talks with the opposition on the reforms, but there appears to be little hope of him making significant concessions. Some opponents of the proposed laws suspect the talks are only aimed at taking the heat out of the protests. If the government decides to go through with the plans, there is likely to be more disruption to the economy, with the Bank of Israel warning of big hits to its gross domestic product (GDP) growth. Credit rating downgrades are also a possibility.

Netanyahu and his allies regard the Supreme Court as exercising too much influence over the state, but critics maintain the reforms as they stand are excessive and dangerous. In granting the government powers to appoint judges and limit their ability to strike down legislation, the plans will neuter the court, protesters argue. In a country with no formal constitution or second chamber, an independent judiciary provides important checks and balances on government power.

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Israel’s tech leadership called into question

Israel remains a leading regional technology hub, despite the global economic downturn, which resulted in substantial layoffs in the country in 2022. However, those working in the sector fear investors will look elsewhere if the rule of law is undermined, given the business uncertainty and reputational risks that could create. Anxiety over investment will have been heightened by the collapse of Silicon Valley Bank, which played a key role in the Israeli start-up ecosystem.

“The high-tech sector needs stability, needs the rules of the game to be clear, needs a certainty that… they will have the court to go to” otherwise investors would be reluctant to commit funds, said Karnit Flug, a former governor of the Bank of Israel, now a vice-president at the Israel Democracy Institute, reported Reuters.

That should be of concern to the authorities given that the sector is such a vital part of the economy, employing more than 10% of the workforce and accounting for 15% of GDP. Officials are keen to see Israeli tech prosper, but with government expenditure on R&D the lowest in the OECD, companies are very dependent on private funds to fuel growth.

Worryingly, the Start Up Nation Policy Institute identified only 112 venture capital investment rounds in the first three months of 2023 – more than 60% less than the corresponding figure in 2022. Moreover, of the $1.7bn raised in the first quarter of 2023 – the lowest level since 2018 – 40% was invested in just three start-ups.

The harmful impact of the proposed judicial reforms on Israeli democracy could, said the SNPI, “irreversibly shake the foundations of [the] Israeli high-tech ecosystem” by making its workforce less willing to continue operating in the country. The fear within the sector is that disaffected entrepreneurs may join the thousands who over the years have left for Silicon Valley and Europe.

A recent industry survey showed that 90% of entrepreneurs and executives of tech companies would incorporate outside Israel if they had to relaunch their operations today. Since the judicial overhaul process began, many new start-ups are said to have incorporated in the US, not Israel. Several companies have already shifted funds overseas and there are signs some healthtech companies are moving intellectual property abroad. The impressive rise of the Israeli tech industry, and its central role in the national economy, led to the country being dubbed the ‘start-up nation’. The judicial overhaul plans may weaken its status as an entrepreneurial powerhouse, however. Investors, on whom the tech ecosystem depends, have signalled their concern, underlining the economic damage the reforms could wreak.