Israel’s Semiconductor Revolution and China factor

Divya Malhotra and Balasubramanian C

Israel has been at the heart of the semiconductor Research and Development ecosystem since the 1970s. In 1963, American engineer Charlie Sporck started outsourcing semiconductor chip production to Hong Kong. This had two consequences: most US chipmakers quickly turned to East and Southeast Asia as their primary locations for semiconductor fabrication. Simultaneously, there was a rise in demand for specialized research facilities. This is where Israel stepped in and rose to prominence in the field of semiconductor research.

Source: UKRI (2024)

Semiconductors, the building blocks of modern electronics, are indispensable to technological breakthroughs and innovations. Israel’s semiconductor sector had a humble beginning in 1964 when Motorola opened its first research and development facility for two-way radio communications equipment. A decade later, Intel Corporation established its research and development unit outside the US in Haifa. Since then, Israel made significant strides in the field of semiconductors. In 1979, after five years of operations in Israel, Intel Israel manufactured the world’s first IBM personal computer with an 8088 CPU running the Microsoft operating system. It was a breakthrough for Intel and also drew attention to Israel’s R&D culture.

The timing was interesting. From the 1960s till the Oslo Accords of the 1990s, Israel was embroiled in conflicts with its Arab neighbors. The country also endured stagflation and diplomatic isolation. However, this instability did not deter its march towards its tech boom.

Jewish History and Rise of Israel’s High-Tech Industry: Israel’s success in the sector has its roots in Jewish history. Historically, the Jewish people never had a nation-state. They were extradited and deported many times. The destruction of the Second Temple in 70 AD by Roman forces was a major turning point in Jewish history. They wandered far and wide, from “the academies of Babylon to the bustling streets of medieval Spain and the cold expanses of Eastern Europe”. Their wandering journey across Asia, Africa, and Europe lasted for about 2,000 years. Over centuries, the Jewish diaspora realized the importance of investing in human capital because, unlike material possessions, it is portable and cannot be confiscated. These values became the biggest strength of the newly-founded nation of Israel in 1948.

Israel is a country of immigrants. From 1949 till the 1990s, hundreds of thousands of Jews from around the world undertook ‘Aliyah’ and moved back to their biblical homeland in Israel. Israel benefited greatly from the abundance of scientific and technological know-how that Jewish immigrants, particularly those from affluent nations and the former Soviet Union, brought with them. These immigrants included many exceptional engineers and researchers, who played a crucial role in the development of Israel’s high-tech industry. In their book Start-up Nation, Senor and Singer argued that Israel’s success in the high-tech sector might be attributed to its endurance towards adversity. Like necessity, adversity also fosters creativity and innovation, often described by the Yiddish word Chutzpah!

Even though the Jewish people had a country they could finally call home, Israel was heavily dependent on other countries for military aid and support in its conflicts with the Arabs. However, this changed in 1967. Before the six-day war in June that year, Israel was subject to an arms embargo by the French President. Up until that point, France had provided the Israeli military with cutting-edge arms, including the Mirage fighter planes.

The French arms embargo pushed Israel closer to the US and more importantly, it compelled “Israel’s leadership to understand that the state could not rely on anyone but itself,” as Yaakov Katz, editor-in-chief of the Jerusalem Post, noted in 2017. It would have to establish autonomous capacities for research, development, and production if it were to endure—not just for weaponry, but for everything.

Dawn of Chip Kingdom: The Israeli hi-tech revolution, including the birth of the semiconductor industry, began in the 1970s, because of this clarion call for autonomy. While American chip firms had outsourced their semiconductor research to Israel long back, renowned semiconductor firms from South Korea, China, and Japan also started moving their R&D operations to Israel after 2000. Currently, Israel has five semiconductor fabrication plants (Fabs): two are owned by Tower Semiconductor, an Israeli company, while three are owned by Intel. It has about 200 semiconductor companies and about 30,000 chip engineers in a population of less than 10 million. The 2020 global ranking based on the number of semiconductor startups ranked Israel second after the US. As of 2021, Israel has at least 37 international corporations working in the semiconductor sector.

Most Israeli semiconductor firms prioritize technical development over profitability. This makes Israel’s semiconductor ecosystem unique and lucrative. The core of Israel’s semiconductor sector has always been chip design. Statistics show that about 8 percent of the world’s skill pool for chip design and R&D firms is located in Israel, giving the country the title of “Chip kingdom“.

The Israeli semiconductor experts are known for their passion for invention and spirit of entrepreneurship. This is demonstrated by their success in starting their own semiconductor firms. After making breakthroughs in specific industries, the entrepreneurs sell their ventures to large corporations, and then reinvest their capital in new ventures. These cyclical investments ensure that the country’s innovation quotient does not stagnate.

Israeli entrepreneur Inbal Arieli explains that the spirit of entrepreneurship is deeply ingrained in Israelis. They are raised in a culture that supports creative thinking, encourages risk taking and rewards “Chutzpah” right from childhood. Secondly, there is a large military capital in Israel’s startup ecosystem because most of the new ventures are started by veterans after completing their military service. The hi-tech sector in Israel has therefore benefitted immensely from the military training, discipline and social network cultivated during service.

The micro-culture of risk-taking can prosper and flourish at a macro-level only with adequate funding support. Semiconductors are a “high-risk, high-return” requiring huge capital investments. This makes it difficult for a semiconductor company to survive since there is limited margin for error and even a small mistake might result in failure and loss of invested capital. This is where venture capital (VC) plays a crucial role. Israel’s capital, Tel Aviv, has become a center for startup and venture capital activity.

Israeli venture funding hit USD 10.8 billion in 2021, with 28 times the US per capita investment in venture capital. Moreover, Israel also subsidizes its semiconductor industry, similar to Taiwan, South Korea, and Japan. This underscores Israel’s position in the global semiconductor industry and demonstrates its active involvement in industrial policies aimed at supporting and advancing its semiconductor sector. All these factors collectively explain the rise of Israel as a semiconductor powerhouse. At least 16% of Israel’s high-tech exports are comprised of semiconductors.  Interestingly, China  is the largest consumer of Israeli semiconductors.

China Factor: China’s dependence on Israel for semiconductors must be understood against the backdrop of Beijing’s Made in China (MIC) 2025 vision plan. In May 2015, State Council announced MIC 2025 as a roadmap for transforming China into a global leader in high-tech manufacturing which required huge investments in the semiconductor sector. Following the announcement, Chinese companies embarked on an unprecedented buying spree of assets along the semiconductor supply chain in North America and Europe. However, the West grew apprehensive of transfer of dual-use semiconductor technology to China and imposed restrictions on firms involved in technology-transfers to China. Meanwhile, Beijing began to invest more in Israeli businesses, hoping to tap into Israel’s small domestic market and ease of access vis-a-vis United States and Europe. Israel therefore stepped up as a crucial partner in China’s semiconductor ambitions.

In 2018, Israel shipped USD 2.6 billion worth of semiconductors to China. Israel’s semiconductor exports to China increased by 80% that year, notwithstanding the intensifying tensions between the US and China. This was primarily due to Intel’s growing shipments to China from its recently upgraded Israeli plant. In fact, China is now Israel’s second-largest trading partner country, and 56% of Israel’s exports to the eastern nation are semiconductors.

Israel is integral to Chinese goals to enhance its domestic high-tech sector, largely due to its reputation as a “start-up nation” and a conducive R&D ecosystem. During Netanyahu’s visit to Beijing in March 2017, he and Xi Jinping announced the establishment of a “comprehensive partnership” for innovation. This partnership includes “closer exchanges among young technological personnel” as well as a “global technology transfer center.” Since 2018, China continues to be the leading destination for Israeli semiconductor exports since 2018.

How Israel manages to balance its interests by walking a tightrope between China and the United States is rather intriguing. In December 2021, the US and Israeli officials held discussions to address these concerns, emphasizing the need for a united front against China. The Biden administration has pressured Israel to align more closely with the US, creating a dilemma for Israel as it balances its business ties with China against its strategic alliance with the US.

Washington has often expressed its discomfort with Israel-China cooperation in technology exchange. In May 2020, U.S. Secretary of State Mike Pompeo, during a state visit to Israel, told his Israeli counterparts to cut off Chinese investment, especially in technology transfers. In July 2022, Joe Biden, during his first visit to Israel, pushed Tel-Aviv to cut Beijing off from a crucial source of advanced technology. However, Israel has been unenthusiastic about changing its policy. Israel is aware that economic disengagement with Beijing would be unfavorable for the Israeli economy, given the size of the Chinese economy. In July 2024, the US blocked Chinese access to advanced chips and the equipment to make them, citing security concerns, and urged its allies to follow suit. This has again put Beijing’s love affair with Tel Aviv’s tech in a tight spot.

*The article is co-authored with Balasubramanian Chandrasekhar. He specializes in China. Currently he is a Senior Research Officer at the Centre for National Security Studies, Bengaluru (India) and heads the ‘Strategic Studies Programme’ at the Centre.