When Intel introduced its new SkyLake microprocessor architecture in September, it received only a fraction of the attention its Silicon Valley neighbor Apple did while unveiling the Apple Watch, an electronic wallet and the latest iPhone.

But when it hits the market next year, SkyLake promises to bring just as profound a change for consumers. Besides improving performance and battery life, SkyLake will enable computers to be powered up and linked to printers and other peripherals without the mass of wires and cable that users have had to put up with.

SkyLake was developed mostly in Israel at Intel’s Haifa research & development (R&D) center, the latest example of an unusually long and close relationship with one of the world’s biggest makers of computer chips. Indeed, in Start-Up Nation — the moniker Israel has adopted for a cluster of high-tech companies that is among the largest in the world — the most important player isn’t an Israeli company. It’s not even a start-up. It’s the American semiconductor giant Intel.

With some 9,900 people on its payroll in locations up and down the country, Intel is Israel’s biggest private sector employer. It conducts R&D from four locations and manufactures chips from sites in Kiryat Gat and Jerusalem. Between the intellectual property and chips it sends abroad, Intel is also Israel’s single biggest exporter. In its record year of 2012, it shipped some $4.6 billion worth of chips equal to an astonishing 10% of Israel’s non-diamond exports and a fifth of its high tech exports. Even last year, when for accounting reasons exports declined, they still amounted to $3.84 billion.

The impact of the company reverberates through Israel’s economy and tech sector far beyond the walls of its fabrication plants and R&D offices. The firm spends about $1 billion a year sourcing products and services locally. Intel worldwide has made about $5.8 billion in reciprocal procurement purchases over the past seven years, $847 million in 2013 alone. Thanks to their connection to Intel, the company’s local suppliers had some $500 million in exports of their own, according the firm. Over the past decade, Intel has invested $10.8 billion in the country.

Supporting Start-ups

Through its venture capital fund, Intel is also a major investor in local start-ups. Since it began working in Israel in 1996, Intel Capital has invested in 70 local companies, and right now it has 15 in its portfolio out of about 300 worldwide, says Uri Arazy, one of two Intel Capital Israel directors. “In Israel, we look for tech companies whereas in other parts of the world they could be companies that have a strategic tie to Intel related to other areas, growing markets which Intel is involved in, developing ecosystems. In Israel the market is very small, but it is strong in technology,” he says. In addition, Intel Israel alumni themselves have been a major source of start-up entrepreneurship: According to the company’s research, since 2006, former employees have formed 30 new companies every year, creating 250 new jobs annually.

“In Israel the market is very small, but it is strong in technology.” –Uri Arazy

The company even sponsors academic research in Israel. Two years ago, it established the $15 million Intel Collaborative Research Institute for Computational Intelligence to explore technologies that mimic the human brain. It brings together researchers from the Technion in Haifa and the Hebrew University of Jerusalem with Intel employees.

At the elementary and high school level, Intel has been running educational programs aimed at luring young Israelis into science and technology. The programs have, over the past four decades, reached some 500,000 people. Dubbed “We are Tomorrow — the National Initiative for Scientific Excellence,” the program has a 20 million-shekel ($5.5 million) budget. This school year, it has been leading a coalition of overseas tech companies active in Israel to launch the “Math First” program with the education ministry and the Israel defense forces. The first ever joint corporate-government undertaking in education, it aims to upgrade the math skills of high school students.

With such a big presence in Israel, Intel has a stake in Israel’s ability to generate the next generation of skilled engineers and technicians, explains Shmuel (Mooly) Eden, president of Intel Israel. “If you look at the number of graduates in STEM (science, technology, engineering and mathematics), it’s 6.5%. That’s very low. Collectively, we need to work together to increase the pipeline of capable students and increase the size of faculties to support them. We’re not on the verge of disaster, but eventually we will find ourselves in a bad situation, when demand starts surpassing supply, salaries grow and you start being less competitive.”

An Old Relationship

Israel and Intel go a long way back, long before Israel established itself as a high-tech cluster and only six years after the company itself was formed. Intel had no operations abroad of any kind, and Israel was reeling from the trauma of the 1973 Yom Kippur War. Yet the next year, Dov Frohman, an Israeli working at Intel in Santa Clara, convinced Intel to set up an R&D unit in Israel. Just as remarkably, 11 years later, Frohman convinced his bosses to build a fabrication plant in Jerusalem, the company’s first manufacturing operation outside the U.S. Frohman’s grit manifested itself in another way during the 1991 Gulf War, when he defied Israeli government policy and kept the plant operating even as Iraqi missiles were raining down on Israel’s cities. In 1995, Frohman led Intel’s efforts to establish a second fab in Israel at Kiryat Gat.

Today, only one other domestic company — Teva Pharmaceutical industries, the world’s biggest maker of generic drugs — rivals Intel for the size of its operations in Israel. And among multinationals in Israel, no company has established such an enormous and multifaceted presence as Intel.

Israel has attracted a lot of foreign companies as a place for R&D. There are some 200 multinational R&D centers in the country accounting for most of the R&D spending conducted in Israel. But few have complemented that with large-scale manufacturing as Intel has done.

The fact is that Israeli labor productivity is much lower than that in other advanced economies — 23% lower compared to Organization for Economic Cooperation & Development countries, says Shlomo Maital, senior research fellow, Samuel Neaman Institute for National Policy Research, a unit of the Technion Israel Institute of Technology. But by Intel’s reckoning, productivity in its Kiryat Gat plant is $285 per hour, nine times the Israeli average. “The Intel plant at Kiryat Gat is a huge exception, and is said by Intel to be one of its most efficient fabrication plants out of some 30 worldwide,” Maital says. “Why? Intel uses ‘copy exact’. It applies, precisely, the technology and operational methods used elsewhere in its most efficient plants and implements them everywhere, including Israel. So the Kiryat Gat plant could well be on the moon, and it would still be super-efficient.”

If Israel is unusually reliant on Intel, it can at least say it has given much back to the company. Over the years, Israel has become the place where many of the company’s leading products have been conceived, designed or developed — and sometimes all three.

Going back three decades, Intel’s Israeli R&D center created the 8088, a cheaper version of Intel’s flagship 8086 processor that was adopted by IBM to power its first personal computer. Later, it was Israeli engineers who coaxed headquarters back in Santa Clara to abandon a planned shift into RISC technology and instead improve the best-selling 486 into a line of microprocessors that came to be known as the Pentiums (although the chip itself was designed in the U.S.).

Preferring Size to Speed

In the early 2000s, Intel’s Israeli engineers by most accounts saved the company by stubbornly insisting on a new approach to semiconductor design. The company’s philosophy had been that faster clock speed — the rate at which a chip executes instructions — was the only way to measure how well a computer performs. But, looking at the emerging laptop market, the Israelis argued that speed was less important than size. Higher speeds, they contended, generated more heat and required cooling systems that would be too big to squeeze into a thin laptop.

Intel Israel’s engineers bulldozed their idea through a wall of opposition in Santa Clara. “We did it the Israeli way; we argued our case to death,” Eden recalled in an interview with Bloomberg News. “You know what an exchange of opinions is in Israel? You come to the meeting with your opinion, and you leave with mine.”

“You know what an exchange of opinions is in Israel? You come to the meeting with your opinion, and you leave with mine.” –Shmuel (Mooly) Eden

The result was a chip called Banias (better known as the Pentium M), whose 2003 launch helped ignite the laptop explosion and anchored three years of 13% annual sales growth for the company. Next was Merom, the Core-2 notebook processor, launched three years later for mobile and desktop devices as well as servers. In recent years, Intel Israel has been behind the Sandy Bridge and Ivy Bridge family of processors, the latter at its peak responsible for 40% of Intel’s global sales. Intel’s Haifa R&D lent a hand in developing the fourth-generation Haswell chip for the mobile segment and is playing a key role in the next-generation SkyLake core processor.

Shlomo Gradman, a high-tech executive who has worked at IBM, the Israeli company Orbotech, and has shepherded four start-ups to successful exits, says Israelis have demonstrated unusual ability in chip design, a fact attested to by the presence of some 150 semiconductor design centers around the country employing 20,000 people. That may make Israel the second-biggest center for semiconductor design after Silicon Valley, he says.

Gradman, who edits a local industry publication called TapeOut, believes that the secret of Israelis’ success is their ability to solve unexpected problems during the design process. “When you have to develop a product within a timeframe, it is the time for innovation — not improvisation, but to come up with creative solutions. These days, we have added experience to that ability, which is also important,” he says. “When Apple decided to develop their own chips, they went all over the world. At the end of the day, they decided to open their chip design center in Israel. They realized this is the best place to find the best engineers and get the best results in quality and speed.”

Courting Controversy

Back in Santa Clara, California, Intel’s headquarters, Israelis have played key roles in top management going back to the company’s earliest days. One reason Frohman was able to win approval to set up an R&D office in Israel was that he had become a corporate hero for inventing the EPROM, the first semiconductor memory that was both erasable and easily reprogrammable. EPROM helped drive Intel’s sales by more than seven-fold in two years to $66 million in 1973.

In more recent years, Dadi (David) Perlmutter was Intel Architecture Group chief, with all the chipmaker’s main product groups — PC client, mobile communications and data center — reporting to him. Responsible for the successful Centrino line of notebook microprocessors, Perlmutter quit early in 2014 after he was passed over to succeed Paul Otellini as chief executive officer. Still, Israelis hold top positions in the global company. Eden is in charge of the company’s global perceptual computing project as well as president of Intel Israel. Ron Friedman is a corporate vice president and general manager of IP Blocks and Technologies. Perhaps the most senior Israeli at the company is Amir Faintuch, who was recruited in August from Qualcomm, to be a senior vice president and co-general manager of the Platform Engineering Group, responsible for mobile and Internet-connected devices.

“When Apple decided to develop their own chips, they went all over the world. At the end of the day, they decided to open their chip design center in Israel.” –Shlomo Gradman

But for all the benefits the American company has bestowed on Israel, it has also drawn considerable controversy because of the $1.3 billion in government subsidies it has received over the years to build and expand its fabrication plants.

Intel’s first Israel plant, Fab 8, constructed in Jerusalem in 1985, received as subsidy $188 million of the $700 million it needed. Fab 8 continued to operate until 2007, but Intel’s plans to expand and upgrade it were frustrated by local politics. Ultra-Orthodox Jews, who make up a large part of the city’s population, opposed the expansion, ostensibly on religious grounds: it would operate on the Jewish Sabbath.

Instead, in 1996, Intel opted for a wholly new site in Kiryat Gat, a town about 35 miles south of Tel Aviv. The Israeli government provided close to $600 million in aid to build the $2.4 billion facility, known as Fab 18, to produce 65-nanometer chips. The company turned to the government again in 2005 to build another new plant in Kiryat Gat, dubbed Fab 28, using 45-nanometer technology. This time it won $485 million for the $3.3 billion project. Six years later, Israel awarded Intel another $200 million to help finance a $2.7 billion expansion of Fab 28.

In September, the government agreed to provide $300 million in aid for Intel’s $6 billion expansion and upgrade of its Kiryat Gat facility, the single biggest investment project ever undertaken in Israel. The company agreed to some tougher conditions than in the past. For instance, Intel has undertaken to source half the 1,000 new employees it takes on from the economically depressed south of the country. It will buy $550 million worth of Israeli products for its worldwide operations, $100 million more than the investment law normally would require, and for the first time ever commit to buying another 180 million shekels of goods and services locally.

Although the government’s relative contribution has been declining, Intel has received far more money than any other company, Israeli or foreign, has ever got from the state. Intel responds that in exchange for the subsidies it has invested more than $10.8 billion of its own capital in the plants and in R&D, not to mention the jobs it has created and the foreign exchange earned from exports. Indeed, one of the reasons so much data about Intel’s contribution to the economy is available is because the company has had to justify the cost of the subsidies. Moreover, Israel has to compete with other countries every few years to be the site of the next new and upgraded plant. In 2012, Ireland won the race to host Intel’s next generation 14-nanometer chip plant because the company deemed Israel’s offer of 1 billion shekels in aid as insufficient.

In addition, Intel has been accused of paying very low rates of tax. Under the Law for Encouraging Capital Investments, which is aimed at coaxing companies to build manufacturing plants in out-of-the-way locations like Kiryat Gat, Intel is entitled to grants and tax breaks that mean it pays just a 5% rate. A heavily-criticized amendment to the law allowed companies to pay no tax at all if they reinvested the profits, or at least didn’t distribute them as dividends. Many companies opted for the latter creating a pool of some 130 billion shekels in so-called trapped profits. Intel didn’t do that. It reinvested $1.1 billion in profits in 2012 on a new production line and repatriating $300 million after paying full taxes on it. Nevertheless, Intel was routinely cited as one of the companies with trapped profits when the government offered an even bigger tax reduction for companies that agreed to release their profits.

Maital of the Neaman Institute sees both benefits and costs to the aid. “Yes [it’s] highly worthwhile, considering the 25,000 jobs (8,000 direct, 17,000 indirect) created by Kiryat Gat. No, because the subsidy will swallow a very large chunk of Israel’s investment-subsidy budget, leaving too little for other worthy projects,” he says. In the ideal world, Israel should be expanding its investment spending overall, but he concedes that is rather unlikely for the foreseeable future. The Israeli government is embarking on budget cuts for 2015 after running up a multibillion-dollar bill fighting in Gaza in the summer of 2014.