How did Israel become a hotbed for medical devices?

Minnesota may churn out more implantable devices than anyplace else, and you likely can't skip a rock up the Charles River without hitting a Boston diagnostics startup, but, over the past few years, the med tech world's eyes, ears and checkbooks have been focused farther east.

Israel is home to nearly 700 medical device outfits, with companies in all of the industry's in-demand markets. Renal denervation? Tel Aviv's Cardiosonic has hauled in $6.1 million of a $16.1 million Series B for its ultrasound-powered therapy. Neurostimulation? Jerusalem's Brainsway ($BRIN) has racked up worldwide regulatory approvals for its Deep TMS system, treating depression, Alzheimer's disease and autism.

The nation leads the world in medical device patents per capita and, unlike the U.S., its venture capital investments are on the rise in both dollars and deals. So how did a country about the size of New Jersey with roughly the population of Virginia become a go-to medical technology breeding ground?

Like many things in Israeli history, it begins with defense, said Yuval Yanai, senior vice president at Israeli devicemaker Given Imaging ($GIVN). Security has been a concern for the country since its independence, and the Israeli Defense Forces are among the best-funded military outfits in the world, spending billions on weapons R&D and training each year. Couple that budget with Israel's mandatory service for 18-year-olds, and the IDF is churning out tens of thousands of engineers each year, Yanai said.

"When they leave defense, they have the ability to come up with ideas and, more important, they have the courage at a young age to risk years of salary by sitting in the garage or the back office somewhere, trying to come up with something new," he said.

And that's the story behind Given, a titan in the local industry that hauled in $180.5 million in revenue last year. Gabi Iddan, the company's founder, was an IDF-trained engineer working in a government-owned defense R&D outfit when he embarked upon an effort to miniaturize missile-guiding technology and craft a medical imaging device. Thus came the PillCam, a swallowable capsule with two tiny video cameras on each end, allowing physicians to visualize patients' intestines without the need for endoscopy. Fifteen years after its foundation, Given is posting record quarterly revenues and eyeing even more success now that its latest PillCam incarnation has won the FDA's blessing.

It's a similar tale for InSightec, Marketing Director Lynn Golumbic said. The company was founded by defense industry alumni who, after years of developing technologies to direct missiles, decided to refocus their MRI expertise on the medical field. From that came ExAblate, an MRI-guided system that uses high-intensity ultrasound to heat and destroy malintentioned tissues. In 2004, InSightec became the first company to win FDA approval to treat uterine fibroids with the technology, giving women a noninvasive alternative to hysterectomy, then the standard of care for removing the growths.

But the military influence accounts only for the intellectual aspect of Israel's med tech surge. It also took a great deal of governmental encouragement, financial support and political patience to get the Israeli medical device world to where it is now, Golumbic said.

Back in the early 1990s, Israel saw a massive influx of immigrants, she said, many of whom were highly educated. The government, recognizing an opportunity, spent big on business incubators, giving its newfound technorati the cash, lab space and tax incentives it needed to breed a high-tech economy for a country now tasked with supporting a burgeoning population, Golumbic said.

"That created a development environment," she said. "Israelis in general are a very thinking-out-of-the-box kind of people. They don't accept things at face value necessarily, and this affects the R&D approach. It's why you see so many startups."

And Given wouldn't be where it is now without the resulting business-friendly regulation, Yanai said. For its first 7 or 8 years, the company operated in a virtually tax-free environment, he said, as the Israeli government was hardly shy about subsidizing the R&D process for promising high-tech companies. Israel doesn't have the natural resources of its neighbors, so, to build a successful economy, the country's leaders had to bankroll its intellectual capital, Yanai said.

"In a country where we consider ourselves as having the talent to compete with anyone, the government was clever enough to encourage that through financial aid," he said.

Over the past decade or so, the rest of the med tech world has taken notice of what Israel has going, and the industry has expressed its admiration the best way it knows how: with its wallet.

Johnson & Johnson ($JNJ) was among the first out the gate, buying electrophysiology outfit Biosense for $400 million back in 1997, and, in the ensuing 15 years, its competitors have spent billions on Israeli medical device innovators. Medtronic ($MDT), for example, upped its stake in the heart valve business by trading $325 million for Ventnor Technologies in 2009, and Covidien ($COV) owes much of its interventional pulmonology heft to a duo of 2012 Israeli buyouts totaling nearly $650 million.

And for those not looking to make an off-the-bat acquisition, there's plenty of investment opportunity to go around. GE Healthcare ($GE) has long been active in the country, pouring money into imaging startup Check-Cap, bankrolling InSightec and setting up its own R&D shop in Jerusalem. Rainbow Medical, an Israeli incubator that operates a bit like the United States' Third Rock Ventures, pulled in a $10 million investment from Sony ($SNE) in May, following a $50 million round led by the likes of Medtronic and Abbott Laboratories ($ABT).

But while all that dealmaking has established Israel as a breeding ground for life-saving technologies, the government is now focused on building a vibrant R&D climate that will create not just the next Vessix Vascular but perhaps the next Boston Scientific ($BSX).

So far, it hasn't been easy. Unless companies come to and stay in Israel, the country will function as just an IP supermarket for Western med tech magnates, shipping what they purchase to more research-friendly climes. As Medtronic Vice President Steve Oesterle told Globes last year, "While Israel has more innovation per bed, India or China has many more beds."

Take that Ventnor deal, for example: The company's heart valve technology is alive and well within Medtronic, but the Minnesota device giant long since shuttered its original Israeli headquarters and shuttled development to its satellites around the world. A $325 million payday is great for investors and encouraging for entrepreneurs, but it does little to inculcate a life sciences R&D explosion.

Enter Israel's Office of the Chief Scientist, an arm of the Ministry of Economy devoted to fostering R&D growth in the country. OCS has increased its budget to support the life sciences industry by 30%, according to Reuters, encouraging multinational device and drug companies to test Israel's R&D waters.

What the government has so far encountered is a sort of chicken-or-egg game with respect to research spending: There are currently no R&D high rollers in the country, and that keeps would-be local giants from seriously considering Israel, OCS life sciences leader Ora Dar told the news agency.

For example, the nation's largest drugmaker, Teva Pharmaceutical Industries ($TEVA), is a titan in the generics world, but that means its R&D spend is far smaller than that of the likes of Roche ($RHHBY) and GlaxoSmithKline ($GSK), companies that dump billions a year into proprietary molecules.

That's where the medical device industry comes in. What Israel lacks in deep-seeded pharma culture it more than makes up for in med tech, and, as trade group Israel Advanced Technology Industries has said, local devicemakers have created a replicable model for life science success within the country's borders.

But, much like J&J's early bet that set ablaze Western interest in Israel's device industry, it's going to take an Aquinian first mover to get the ball rolling on local drug development, AstraZeneca's ($AZN) Israeli chief David Goren told Reuters. "A mind-set shift needs to happen for Big Pharma, a herd mentality," Goren said.

Until then, Israel's med tech luminaries will keep pulling down profits, InSightec's Golumbic said, lighting the way for life sciences in a country that has to make its money without the cash crops that have turned its neighbors into global powerhouses.