IN A PATCH of desert until recently frequented only by passing camels, workers in a computer lab examine new “smart” appliances: a slow cooker on one bench, a security camera on another, a smoke detector on a third. Millions of devices that incorporate mini-computers are being connected to the internet. But as well as convenience, the “internet of things” offers cyber-criminals many new vulnerabilities to exploit. “If I were an attacker, I would never hide in your PC,” says Oleg Brodt, director of research and development at Cyber@BGU, the cyber-security research centre run by Ben Gurion University in Beersheva. “I would try to hide in your smoke detector or door alarm, because nobody bothers to protect them.”

The centre has shown how wearable devices can be used to eavesdrop on corporate networks. It has also demonstrated the multitude of ways in which even supposedly ultra-secure computer systems not connected to the internet can be hacked. These include exploiting FM radio waves emitted by video cards, the blinking of LED lights or even the pattern of heat signatures.

The Israeli government wants to turn Beersheva, a comparatively poor southern city, into one of the world’s prime cyber-security centres, attracting multinationals to work with startups in an incubator (established by JVP, an Israeli venture-capital fund) and with the university’s computer-science department. More important, the army’s signals-intelligence Unit 8200 and other tech-savvy branches are due to relocate to Beersheva in the coming years, providing a flow of young and capable veterans to boost the industry. Alumni of Unit 8200 have already seeded much of Israel’s high-tech industry.

Israel attracts about 15% of the world’s venture-capital investment in cyber-security. It is part of Israel’s booming “startup-nation” economy, the most dynamic innovation ecosystem outside America. Direct flights now connect San Francisco to Tel Aviv. Other high-tech areas look promising, too, among them agricultural and water technology (building on Israel’s expertise in desert farming), digital health services and financial technology.

The biggest buzz is over driverless cars. Boosters think that Israel can help produce their brains—computer vision, lidar (laser scanning), artificial intelligence and cyber-security—leaving the engines and the metal-bashing to others. Intel, a giant maker of computer chips, has recently bought Mobileye, which makes driver-assistance systems, for $15.3bn.

All this marks a remarkable change from the 1980s, when Israel was on the brink of financial collapse. Its near-defeat in the Yom Kippur war had caused it to push defence spending to an extraordinary 30% of GDP in 1975. By 1984 public debt had reached nearly 300% of GDP and hyperinflation peaked at 450% a year.

In the past decade the economy has grown at about 4% a year. The unemployment rate is 4.3%, a record low. The labour-force participation rate has risen. A country with few natural resources plans to export gas to Europe from its offshore fields, and is selling water to Jordan as water desalination gathers pace. Public debt has come down to 62% of GDP, the current account is in surplus and foreign-currency reserves are high. All significant transactions were once reckoned in dollars; the worry now is the strength of the shekel, which has appreciated by 13% against a basket of currencies in two years. The central bank periodically intervenes in foreign-exchange markets to hammer it down.

Israel has not had a recession (defined as two consecutive quarters of falling output) since the height of the second intifada. The Israeli economy “is inoculated to a large extent” from wars in Gaza and Lebanon, says Eugene Kandel, a former economic adviser to the government and director of Startup Nation Central, a non-profit group that links global firms with local startups.

It is easy to be dazzled by Israel’s high-tech firms. In fact, the country has two separate economies. The dynamic, globalised startup nation accounts for only about a tenth of employment, whereas nine in ten Israelis work in something more akin to a left-behind nation that is inefficient and protected from competition. Poverty rates in Israel are among the highest in the rich world, for two main reasons: the ultra-Orthodox often live on public subsidies to pursue a life of Talmudic studies; and Arab citizens struggle to achieve equality.

Float like a Zeppelin

Mr Kandel talks of the high-tech industry as a Zeppelin floating above the rest of the economy and only loosely connected to it. This raises two fears. One is that the Zeppelin will drift away if the regulatory, political or security environment deteriorates. The other is that it will fail to lift the rest of the economy. The answer, Mr Kandel thinks, is for startups to grow into big firms in their own right, instead of selling up to companies like Google. Even if the buyers leave their R&D centres in Israel, only so many people can become high-end developers. Larger companies would hire more lawyers, accountants and the like.

For a country with many highly educated people, Israel scores poorly in the Programme for International Student Assessment (PISA), a test of the science, maths and reading skills of 15-year-olds from across the world run by the OECD, a rich-world think-tank. Even after stripping out the dire results of Israeli Arabs, the results of Hebrew-speakers were still mediocre—and would look even worse except that ultra-Orthodox Jews do not take the test. “PISA does not matter to the startup economy,” explains Mr Kandel. “It matters to the rest of the economy. We need solid PISA results to be able to adopt innovation, not necessarily to create innovation.”

Naftali Bennett, the education minister, is trying to nudge students into taking more demanding maths courses. He also wants to improve the standard of teacher-training colleges, although strong unions make it hard to align pay with performance, let alone sack bad teachers. He argues that the real secret of Israel’s startup economy is not the educational system but rather the culture of entrepreneurialism, rooted in self-reliance inculcated in young Israelis in the army and youth groups.

Dan Ben-David, of Tel Aviv University and the Shoresh Institute, a think-tank, sees things differently: “The IDF is an army, not a school.” He reckons that Israel’s real existential threat is poor productivity, not terrorism or external dangers: “We can’t stay like this for another 30 or 40 years. Sooner or later there will be a crisis.”

He divides Israel’s economic development into two distinct periods. One was the era of catch-up growth leading to the Yom Kippur war in 1973, when Israel’s productivity converged with that of the G7 countries; thereafter it diverged again. Israel’s strong growth of recent years, he says, is due mainly to a rise in the number of workers, not in productivity. Israel’s population is growing fast, and cuts to welfare benefits have pushed more people, particularly ultra-Orthodox women, into work.

According to Mr Ben-David, Israel has chronically underinvested in education and infrastructure because resources have been spent on subsidies for ultra-Orthodox yeshivas and Jewish settlements. And the split-economy problem is likely to worsen. Ultra-Orthodox Jews (about 7% of the Israeli population) and Arabs (approximately 21%) have higher fertility rates than other groups; together they are projected to make up half of the Israeli population within about 40 years, Without big changes, average participation rates and productivity will drop.

By throttling back public spending, Binyamin Netanyahu may have left Israel with too little fiscal leeway to invest in public goods and alleviate poverty. As the country has shed its socialist heritage, government spending has fallen from a hefty 80% of GDP in 1980 to below 40%, low by rich-world standards.

Israel also scores poorly on the OECD’s measures of restrictiveness in product markets and services. Oligopolies and monopolies abound, and over the past decade the country’s position in the World Bank’s ease-of-doing-business index has slid from 26th to 52nd. This has meant low wages and high prices. The cost of living is about 20% higher than in Spain and 30% higher than in South Korea. Kosher certification makes food more expensive, and the panoply of quotas, tariffs, regulatory barriers and guaranteed agricultural prices has piled on extra costs. Strikingly, a country that has produced globally popular taxi and navigation apps does not allow Uber to offer its cheap car-for-hire services because of resistance from the taxi lobby. Bottlenecks in construction and land allocation have driven up the price of housing, especially in Tel Aviv.

Occupation economics

Try to use a mobile-phone app in the West Bank or Gaza and it soon becomes apparent that the Palestinian territories, with 5m people, are in economic oblivion. Palestinian operators have not yet been able to set up 3G services, despite repeated promises; Palestinians with Israeli phones have to get close to settlements to use their services. Navigation apps like Google Maps and Waze offer skimpy information: they cannot find a route between big Palestinian cities—say, Ramallah and Nablus—but offer directions between small Jewish settlements near both.

The economic disparities are striking. With GDP per person at $35,700 a year in 2015, Israel’s standard of living is much the same as France’s. For the West Bank the figure stands at $3,700, akin to Egypt’s; for Gaza it is about $1,700, similar to Congo-Brazzaville’s. In real terms, Gazans are about 25% poorer today than they were at the time of the Oslo accords.

Israel’s security barrier is, to a large extent, also a one-way protectionist barrier. The Palestinian market is fully exposed to Israeli goods, but Palestinian products struggle to get out. Strawberry farmers in Gaza, working less than a kilometre from the border fence, say they cannot export to Israel and only rarely to the West Bank. In the main, Palestinians are treated as a source of cheap, and disposable, labour.

“We have no economic policy. Everything is tied to the political situation,” says Mohammad Shtayyeh, president of the Palestinian Economic Council for Development & Reconstruction, which co-ordinates aid from donors. The Palestinian economy depends on the earnings of workers in Israel and the settlements, customs remittances from Israel and donations from the West and the Arab world. All these are subject to sharp fluctuations over which Palestinians have little control. Palestinian areas, Mr Shtayyeh notes, operate with three foreign currencies: the Israeli shekel, the Jordanian dinar and the American dollar.

There is no lack of entrepreneurship among Palestinians. The new city of Rawabi, rising on a hill north of Ramallah, is as ambitious as any government-built Jewish settlement, yet is a private project part-funded with investments from Qatar. It will count 6,000 units, ranging from homes for middle-class Palestinians to holiday flats for Israeli Arabs; and have amenities from classy global clothing chains to an amphitheatre and the Middle East’s longest zipwire. The project has encountered countless impediments, but families have started to move in.

Rawabi will include space for Palestinian startups seeking to work with Israeli and global firms. “We don’t have to do a lot to attract them. They are already next door to us,” says Bashar al-Masri, the businessman who conceived the city. Gazing west from Rawabi, the Tel Aviv skyline appears starkly against the gleaming Mediterranean. Few Palestinians can hope to visit it. But there are no checkpoints on fibre-optic cables; against the odds, a startup industry may yet appear in the failing startup state that is Palestine.