Can Startups Put Globe's Young Unemployed to Work?

The globe is awash in unemployed young people. This demographic time bomb is spurring revolution in the streets of Middle Eastern capitals and creating what looks like a lost generation in Japan. With big companies reluctant to hire, their best hope for work could be start-ups. And ironically enough, Israel may offer valuable lessons to its Arab neighbors on that key job creating process.

It is startling to examine the evidence of youth unemployment around the world. According to BusinessWeek, there are 78 million unemployed youth globally. About 24% of youth in the Middle East and North Africa are unemployed and with the exception of South and East Asia -- they have single digit youth unemployment -- the rest of the world's youth unemployment rate is in the high teens. Young people are almost three times more likely than adults to be out of work.

Youth's failure to ignite covers many countries and goes by different names, reports BusinessWeek:

• Britain's NEETs: "not in education, employment, or training;"
• Japan's freeters: a combination of the English freelance and the German Arbeiter (worker);
• Spain's mileuristas: so-called because they earn at most 1,000 euros a month;
• Tunisia's hittistes, "French-Arabic slang for those who lean against the wall;"
• Egypt's shabab atileen or unemployed youths; and 
• U.S. boomerang kids live with their parents. Here, 18% of 16- to 24-year-olds were unemployed in December 2010, nearly double the overall unemployment rate. Graduating in a recession results in an initial wage loss of 6% to 7% and 15 years later, these grads make 2.5% less than average according to Yale economist Lisa Kahn.

If large companies needed enough people, they might be the logical place to look for employing these youth. But after attending college, many of them either lack the skills that companies need or there are simply more of them than the companies need. After all, in the U.S., companies finished a record year in 2010 with $1.66 trillion in profits and nearly $2 trillion in cash. Meanwhile, in the final quarter of 2010, wages fell 1.5% as productivity rose rapidly at 2.6% and unemployment remained a stubbornly high 9.4%.

This leaves start-ups as a possible solution. One example of a program that teaches young people to create them is in Miami. As BusinessWeek reports, in 2008 the University of Miami started an entrepreneurship program called Launch Pad -- following which its graduates started 45 companies including Coral Morphologic, that collects and raises corals for sale to aquarium owners and Audimated, a music website that allows fans to profit by promoting their favorite musicians.

Can Israel's Arab Neighbors Benefit From Its Start-Up Success

While this sounds good, it's unclear whether such programs would create nearly enough start-ups and jobs to keep those 78 million unemployed youth busy. One model that my co-author, Srini Rangan and I discussed in our book, Capital Rising: How Global Capital Flows Are Changing Business Systems All Over the World, is Israel, whose ability to spur entrepreneurial innovation vastly exceeds its size.

How so? According to Dan Senor, co-author of Start-up Nation, Israel has 7.1 million people but the number of Israeli companies listed on the NASDAQ far exceeds its relative population. For example, in 2009 India had three companies listed. Japan had six, Canada had 48 Israel had 63. Israel has received as much foreign venture capital as the much larger Britain -- $2 billion in foreign venture capital invested there in 2008 alone. And Israel had the highest density of start-ups in the world 3,850 – the equivalent of one start-up for every 1,844 Israelis. Moreover, during the last few decades, Israel’s high-tech innovations have spread around the world.

How did Israel accomplish this feat? It was certainly not because its geographical neighbors welcomed it with open arms. Instead Israel took its many physical limitations and overcame them with the spirit of its people. After all an Arab nation boycott made regional trade impossible and it had very few natural resources. And yet thanks to the way it managed its human capital – Israel became an innovation hub.

Israel’s entrepreneurial success depends on the people it attracts and how it harnesses their skills. Since Israel is besieged by enemies, all its citizens serve in the military which creates social networks and leadership training. Furthermore, Israel’s culture of critique, fostered by centuries of Jewish tradition, encourages a spirit of relentless improvement. Moreover, an open immigration policy for Jews restocks Israel's population with motivated people. The result is a business climate that embraces risk and spurs the growth of good ideas.

Many examples of Israel’s most successful start-ups spring from the application of its human capital to the gap between demand and supply. For example, drip irrigation was invented when a farmer in the Negev desert noticed one of his trees flourishing despite drought conditions. When he discovered a leaky underwater pipe, he had a moment of creative inspiration, developing a technology that spread around the world.

Israel’s success at building a start-up nation suggests four important implications for policymakers in nations with high youth unemployment:

• Focus on policies that close the most important gaps between demand and supply. Rather than wallow in the misery of being surrounded by enemies with no significant natural resources, Israeli policymakers recognized that with their backs against the wall, they would need to adapt in order to survive. Israel needed food and water to feed its people and healthy industries to provide jobs and tax revenues. And Israel found a way to use the one resource it had – human capital – to close the gap between those needs and its ability to supply them.
• Manage human capital in a way that rewards innovation. Israel could have taken a hard line against bringing in new people since they certainly imposed a cost on its scarce resources – particularly before those immigrants could contribute to the economy. Instead Israel chose to welcome the immigrants while requiring them to serve in its military as a way to defend the country and forge a unique culture. Moreover, Israel placed a high value on risk taking and pushing good ideas from all sources. Its valuable human capital attracted the venture capital Israel needed to build these ideas into viable companies.
• Locate activities where they will yield the greatest corporate advantage. To maximize local employment, Israel could have required that Israeli companies perform all their activities – such as R&D, manufacturing, marketing, and logistics -- in Israel. But Israeli policymakers saw such limitations as short-sighted. Instead, they encouraged entrepreneurs to locate activities where they could generate the most global growth. As a result, many Israeli companies located their R&D in Israel and Silicon Valley while starting marketing and manufacturing outposts in their largest markets – such as the United States or China. Such global value chains enabled Israeli entrepreneurs to develop new products and sell them around the world.
• Push companies to adopt the corporate governance standards needed to list their shares in the deepest global capital markets. Finally, Israel’s high rate of listings on the NASDAQ illustrates the importance that its policymakers placed on high standards of corporate governance. By encouraging the flow of global venture capital into Israel, its policymakers also realized that the companies receiving that capital would need to meet the governance standards of the securities exchanges where the VCs would aspire to an IPO. Israel’s decision to permit such capital flows pushed its start-ups to adopt the highest standards of corporate governance.

It would indeed be ironic if its Arab neighbors adopted Israel's ideas for putting its young people to work. While it might be natural to conclude that the gap between the two is unbridgeable, it's worth noting that in the 1970s, Israel's socialist economy stagnated under the weight of inflation but during the 1980s and 1990s, it transformed itself into a Start-up Nation.

Israel's metamorphosis suggests that its ideas just might make a big enough difference to channel some of the youthful energy of these unemployed workers from angry protests into successful start-ups.