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2017 Annual Assessment

How have the trends toward a richer and more integrated global economy affected Israel and its prospects? How would a general move away from globalization influence its prospects?

Founded in 1948, Israel was created precisely at the dawn of the international system that was framed to nurture and sustain such a global economy. Its elements include the Bretton Woods arrangements for currency and financial transactions between states; international organizations such as the International Monetary Fund, Bank for International Settlements and World Bank; and the early measures that would become established in the form of the World Trade Organization.

Despite this, at the time of Israel’s founding, there were few historical examples of deliberate economic development policy to draw upon. The two most obvious candidates, the military-focused transformations of Meiji-era Japan and the extreme collectivization and centralization of the Stalinist security state in the Soviet Union, were the most successful examples but hardly the most practicable or desirable for the young state to emulate. Instead, what came to be the conventional wisdom among the newly independent states of the post-colonial order was the need for import substitution: native industries should be protected and provided with both centrally funded resources and state management to reduce and eventually remove dependence on former colonial rulers to build the economic sinews of a modern, independent state. This was the course charted by such leaders of the non-aligned movement as India and followed in large measure by the socialist founders of the state of Israel. While not so rooted in autarkic principles as those that emerged victorious in the Soviet Union from its industrialization debates of the 1920s, there was a distinct family resemblance. This period saw the foundation of the economic institutions of an Israel determined to stand on its own feet with everything from its own arms industry to a complete value chain for automobile manufacturing.

In none of the countries that employed these principles was rapid economic development realized in any degree commensurate with expectations. This was as true in Israel as elsewhere. Economic growth was large during the decade following independence, but it started from a comparatively minimal base of economic activity and was largely driven by extensive means –greater amounts of inputs, particularly of labor during the early waves of immigration – rather than intensive means of enhancing productivity and innovation. By the 1960s, the engine was sputtering. At the same time, what became the new dominant model for economic development emerged from the examples of the so-called Asian Tigers (South Korea, Taiwan, Singapore and Hong Kong.) In contrast to the strategy of import substitution (building new indigenous industries from scratch in mild defiance of the economic doctrine of comparative advantage,) the new model emphasized export promotion. Rather than reduce the flows of imports and therefore engagement in international trade, this policy encouraged precisely the opposite: build on inherent advantages to increase exports and vastly outweigh imports while, at the same time, moving up the value chain as more competence was gained in manufacturing and greater presence was gained in the international marketplace.

Following the 1977 political revolution of Likud’s rise to power, this more modern view of appropriate policy for economic development became more preponderant in Israel. (But as we shall see, the vestiges of the former orientation were never completely eradicated.) Today, Israel would be characterized as an open economy, one in which trade – both exports and imports – account for a substantial share of national income. While the actual scale of trade as a component of Israel’s economy is below the average of the countries evaluated for openness by the International Chamber of Commerce, Israel nonetheless ranked near the top third (27th out of 75 economies) in ICC’s Open Markets Index for 2017.2 This constitutes a movement from 38th place in the initial index in 2011. The result was owed largely to reforms that had ostensibly transformed the country’s actual trade policies as well as its openness to foreign direct investment (FDI). This latter fact points out that openness and global connection involves flow of capital (and people) as much as flows of goods. Indeed, the extraordinary growth of Israel’s high technology sector has been very much driven by FDI contributed by multi-national firms and foreign institutional investors.

There are other, less formal ways to consider the degree of Israel’s globalization, albeit more difficult to reduce to numbers. The most significant in affecting Israel’s material well-being is participation in the global knowledge economy. This term may be applied more widely to less formal avenues for knowledge transfer than just to sales of patents and licenses. An important aspect of these more informal pathways is that they result in the phenomenon of “knowledge spillovers,” value that spreads beyond exclusive control by targeted recipients. Knowledge is embodied in the minds of individuals and in the collective interaction among individuals who may each bring their own expertise to achieve a collective cross-product not attributable to any single constituent of the group. This knowledge is notoriously difficult to formally codify, especially in its early stages, yet this represents among the most important flows in the commerce of ideas leading to innovations and their wide diffusion. Israel has been extraordinarily globalized in this sense. Not only do others bring their skills to work in Israel, but Israel has been a large exporter of technical expertise in the form of its expatriates working abroad. These are not losses to Israel in some mercantilist accounting of “brain drain” but rather each represents a potential human bridge of knowledge that flows strongly in both directions.3 An Israeli working as a professor in a U.S. university is in contact with colleagues in Israel and may bring promising graduate students to work with him or her. These contacts are notoriously difficult to quantify. In a world that becomes more nationally focused with more restricted work opportunities for foreigners, this important flow may become attenuated to the net harm of Israel’s research and innovation enterprise.

While global commerce and openness to participation in international efforts brings its benefits, economic openness can clearly also foment local discomfort. It is largely the unwillingness or inability to recognize the potential for individual harms on the part of governments interested in promoting globalized economies that have led to the recent anti-globalization backlash coursing through the developed West. The losers demand redress or retrenchment of the policies of openness. This is especially true in the case of a relatively small economy such as Israel’s and while there have been few if any popular demonstrations, in several subtle ways Israel’s openness has been offset by policies and practices that move in the opposite direction albeit with little public notice. As policy decisions have moved Israel in the direction of a more liberalizing strategy, politics at the local level have adhered more closely to local interests. It is these which have led to retention of a good deal of the structural relationships built during the earlier period of more inward-looking development.

For one thing, the orientation toward exports has been limited to a few sectors. Figure 1 shows how little diversification there is in Israel’s bundle of exports. Israel’s exports are highly concentrated in pharmaceuticals, chemicals, diamonds, and electronics (representing in total more than two-thirds of all exports) and in each case only a few firms tend to account for the greatest flows.4 Israeli exports are considerably less diverse than in other countries at similar income levels.

Figure 1: Diversification in Exports, OECD Countries (1990-2010 averages)

This points to an underlying paradox between policy direction of openness and the realities of Israel’s economy which tends toward concentration, cartelization and resistance to the competition that would come from greater import access into many consumer markets. The banking industry illustrates this. Five banking groups (themselves often associated with large family-owned business conglomerates) account for 95 percent of all assets with two accounting for over 60 percent. There have been almost no banking market entrants in nearly 50 years.5 With market power comes a certain degree of political influence. Owners of firms within industries exhibiting high degrees of concentration and cartelization can become natural allies of workers who, in common with those in the U.S. and elsewhere, fear seeing their jobs eliminated by either foreign goods displacing local products or manufacturing moving elsewhere. So, despite a certain embrace of globalization and even a formal government stance pointing in that direction, there are still forces that while originating in local concerns and interests nevertheless push in the same direction as anti-globalization activists. The aggregate result of the inevitable political pressures on many small specific decisions is (as we have seen) relatively low trade openness, a regulatory structure that often functions as a non-tariff barrier to entry and, as has been seen in the past year in several high-profile legal prosecutions, a susceptibility to anti-competitive insider dealings that keep prices high, efficiencies low, and productivity below the levels of peers at a comparable level of development.

This suggests that even in a country that has benefited considerably from globalization and is well-poised to continue to do so, its relative small size serves to magnify interests that militate against movement in that direction. The small scale of Israel’s home market has always bedeviled those seeking to enhance competition. When the Bazan oil refinery, previously a state-owned enterprise, was privatized in 2006, the regulatory authorities insisted that its two locations (Haifa and Ashdod) be sold to different groups to enhance domestic competition. But instead of having two weaker players compete in a small, protected market, a different approach might have been to keep the company whole so that it could operate more widely in the competitive Mediterranean regional market for refined petroleum products, while opening the local market to greater access from elsewhere.

Such decisions are typical of those faced by a small-market country forced to play a global game. Israel has relatively few global business champions of major size. A significant exception is its dominant player in pharmaceuticals, Teva, which generates $22 billion in net revenues from 57,000 employees worldwide. Of these, fewer than one in eight works in Israel.6 There is little else in Israel to compare with Teva for size and degree of globalization as represented by dispersion of its workforce. Two other major exporters, Israel Chemicals and Israel Aerospace, present quite different profiles (Table 1).

Table 1. Comparisons of Leading Israeli Manufacturing Exporters
Israeli Exporter Income ($millions) Total Employees Israel Share of Workforce
Teva Pharmaceuticals 21,903a 56,960 12%
Israel Chemicals, Ltd. 5,363b 13,414 35%
Israel Aerospace Industries 3,700c 15,734 >60%d

NOTES: a) 2016 Net revenue; b) 2016 Sales; c) 2015 Sales; d) Conjectural
SOURCES: U.S. Security Exchange Commission 20-F filings for Teva and ICL; IAI: https://www.duns100.co.il/en/rating/DUNS_Premium/Israels_100_Leading_Enterprises; https://www.duns100.co.il/en/Israel_Aerospace_Industries_Ltd

The dichotomy between the sectors of Israel’s economy that are active in the global economy and those that are less engaged owing to various policy and regulatory factors maps directly into the “Two Israels” debates discussed in previous JPPI Annual Assessments. It is true that 48.5 percent of Israel’s $43.5 billion exports in 2016 fell into the “high technology” category.7 But these figures exclude the biggest single export, diamonds (nearly $15 billion in 2016)8 and so the effective share is less than usually reported. And of the total in the high-tech category, approximately one-third would include pharmaceuticals, that is largely exports by Teva. Especially if aircraft exports are also deducted, this means that the electronics, communications, and computational exports, what comes most often to mind when thinking about Israel’s high-tech export sector, actually represents a smaller share of exports than might have been thought. To be certain, this sector is highly integrated with the global economy. It might almost be viewed as a relatively isolated economy within the larger economy with relatively few hybridizations with other potential partner sectors such as health, agriculture, education, and so forth. But this also means that a considerable share of Israel’s industry and economy are less outward looking than might otherwise seem to be the case. This less globalized Israel stands behind various walls of protection and is characterized by slower growth and less productivity than is the case for the more globalized sectors.

Were the net result of the upheavals of 2016 to become embodied in a wide international inclination to turn away from the globalization course of the past half century and instead focus on national interests, this may reduce the opportunities that so far have existed for Israeli businesses. But the true casualty might be that the balance of forces in Israel between more and less competitive practices and structures could well shift away from the former and the growth of the latter. This may well then lead to a paradox: the case of Israel suggests that a less global stance in the name of greater national interests could well have precisely the opposite effect on domestic economic outcomes than was intended.

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