- Potential investors sometimes withdraw from their planned investments when confronted with bureaucratic barriers during their preliminary investigation.
- Numerous investors never consider investing in Israel after hearing about the difficulties here, deciding to invest in other countries instead.
- Because of the absence of an expanding industrial sector, the "brain drain" phenomenon prevails and the fruits of research are not developed for commercial use.
- Existing enterprises avoid expanding their investments, production and export activities because the expansion would reduce their efficiency.
- Investing effort and resources in catering to government bureaucracies distorts the normal business calculations of profit and loss which are the basis of economic efficiency, thereby raising expenses and damaging external competitiveness.
- The industrial sector must worry constantly about finding itself on the wrong side of the oppressive and constantly changing network of laws and regulations. The authorities suspect that laws are being broken even when they are not; laws and regulations are often broken unintentionally and laws and regulations are also broken intentionally to circumvent long procedures, thereby saving time and resources.
The Current Stagnation of the Israeli Economy
1. The Slowdown and Halt of Economic Growth
Investment and population growth fueled economic growth and rising productivity in the 1950s and 1960s. Investment was financed by external capital and unilateral foreign transfers which were channelled and allocated by the government. In the 1970s immigration decreased, emigration began to materialize, and industrial advancement slowed. A switch to an export-oriented economy financed by the attraction of DFI was required to sustain growth, but the government failed to recognize the need for such a transition. The result was stagnation in the 1970s and 1980s, despite Israel's high-quality labor force and scientific infrastructure.
The "stabilization policy" announced after the establishment of the national unity government in July 1985 was designed to halt hyperinflation in the 400 percent range, reduce budget deficits, restrain wages, fix the exchange rate and reverse the economic stagnation which had set in after 1973. A "package deal" or "pact" was negotiated between the government, the Histadrut (General Federation of Labor) and the Manufacturers' Association to reduce real wages. Despite this deal, the economy continued to decline.1 Total fixed investment fell by 0.5 percent in 1988 and 5.5 percent in 1989.2 The industrial export sector, the only possible vehicle of sustained economic growth, registered poor investment and production performance during 1988 and 1989, 3 despite reductions in labor costs, interest rates and taxes, along with an improvement in world economic activity. 4
2. Failure to Restart Economic Growth
Conventional economic policies are not likely to generate growth. These include deficit financing, reduction of welfare benefits, unemployment, devaluations, wage restraint, subsidization and protection of industry, sales of government enterprises, deregulation of labor and capital markets and even proposals to introduce free trade nationwide. The reason is political: such proposals are incompatible with the welfare state and conflict with established traditions of national planning, a centralized voluntary trade union, a monopolistic structure of industry and services and planned population dispersion.
Ranking officials in the Bank of Israel and elsewhere have recently proclaimed that signs of growth are in sight. This same "news" has been officially announced time and again since the 1970s. A temporary economic resurgence may indeed result from the recent wave of immigration, as a result of increased consumption needs. Historical experience during the decades 1920-1940 and 1950-1970 demonstrates a correlation between immigration and economic growth. The present economic situation, however, is different. Immigration may temporarily boost demand, but sustained economic growth depends on the expansion of the export-oriented business sector. The funds for this expansion should come neither through government deficit financing nor by increasing the external debt and channelling the funds to industry as in the 1950s and 1960s. Rather, DFI should supply the funds for investments, which requires the enactment of specific legislative measures.
Many conflicting interpretations of Israel's economy have been tendered and many plans of action have been proposed to get the economy growing again. But the stark reality is that attempts by the country's economic decision makers to enact reforms have been blocked by vested interests at every juncture.
Israel's policy makers are hampered by such issues as security, social problems, regional development, a strong trade union, monopolistic structure of industry and services and a large public sector. To break free from these constraints, a whole new approach is required - stimulation of economic growth through the development of an export industry by attracting DFI into special zones in which contravening domestic policies do not apply.
3. The Turnabout of Growth - Deindustrialization and Failure to Attract Foreign Investment
The Israeli economy of the 1960s differs from that of the 1970s. The 1960s were characterized by growth similar to that of the newly industrialized countries in the Far East. The 1970s were distinguished by a sharp decline in GDP growth (6.3 percentage decline) and total factor productivity (3.6 percentage decline) as seen in Table 1.
Annual Average Growth Rates in the Israeli Economy,
1961-1972 and 1973-1981
(in percentages)
| Growth components | 1961-1972 | 1973-1981 | Changes between 1961-1972 and 1973-1981 |
|---|---|---|---|
| Total GDP | 9.7 | 3.4 | -6.3 |
| Contribution of labor and capital | 5.5 | 2.8 | -2.7 |
| Total factor productivity | 4.2 | 0.6 | -3.6 |
Jacob Metzer dramatizes the reasons for the drop in growth and productivity in the last two decades. 5 The chief villains are deindustrialization and the failure to develop a competitive, export-oriented industry. 6
A few explanations have been offered for the economic decline, such as the outbreak of ethnic unrest, which forced the government to increase social expenditure in the 1970s, the opening of the territories as a source of cheap labor which slowed the moderni- zation of industry, and international price shocks and stagflation of the 1970s. These reasons do not hold for the 1980s, as ethnic strife eased and the international business climate improved. The decline was alternatively explained as a "transition" to the slow-growth, advanced European welfare-state countries (EFTA). Table 2 contradicts this explanation by showing that economic growth in the 1960s rivalled South Korea and exceeded the EFTA countries. In the 1970s and 1980s, growth per capita fell substantially below the EFTA countries.
| Area | Total | Per Capita | ||||
|---|---|---|---|---|---|---|
| 1960-1970 | 1970-1980 | 1980-1988 | 1960-1970 | 1970-1980 | 1980-1988 | |
| EFTA | 4.3 | 2.3 | 2.4 | 3.5 | 2.1 | 2.3 |
| Israel | 8.2 | 4.2 | 2.7 | 4.5 | 1.5 | 0.9 |
| S. Korea | 8.9 | 9.1 | 8.9 | 6.3 | 7.2 | 7.2 |
The source of the newly industrialized countries' growth is an export-led industrialization financed by the attraction of DFI along with local capital. This is a profitable, efficient, self-generating system of finance, investment and production, which could have been applied to Israel.
4. Hong Kong and the Republic of South Korea - A Comparison
Two aspects of the East Asian model are noteworthy. One is that policy typically works by influencing, rather than replacing, decisions of the business sector; this reduces the conflict between public policy and competitive market solutions for economic problems. Another is the heavy emphasis on economic growth and the public's expectation that the government will adopt policies that encourage work, saving and investment. 7
Hong Kong, with a population slightly larger than Israel, and South Korea are good examples of outstanding economic performance. These economies achieved high rates of economic growth by emphasizing export oriented industry, attracting DFI and practicing open economic policies, although South Korea opened its economy gradually. In contrast with these economies, the Israeli economy is distinguished by stagnation resulting from massive government intervention, a monopolistic structure of industry and services and a paucity of direct foreign investment.
Economic Growth Indicators: GDP
and Foreign Trade in Israel, Hong Kong and South Korea
(in percentages unless stated otherwise)
| Average real GDP | International trade | |||||
|---|---|---|---|---|---|---|
| Total growth Years | Per capita | Exports | Trade | |||
| Growth | Value in $* | $ Millions | Manufactures in percent | balance as percent of imports | ||
| (1) | (2) | (3) | (4) | (5) | (6) | (7) |
| ISRAEL | 1960 | - | - | - | - | - | -58.5 |
| 1970 | 8.2 | 4.5 | 1,830 | 775 | 70 | -48.1 |
| 1975 | 6.9 | 3.8 | 3,890 | 1,941 | 75 | -52.5 |
| 1980 | 2.8 | 0.5 | 5,320 | 5,540 | 82 | -35.4 |
| 1985 | 2.7 | 0.9 | 6,210 | 6,256 | 83 | - |
| 1987 | 4.6 | 2.9 | 7,410 | 8,475 | 85 | - |
| 1988 | 1.8 | 0.1 | 8,650 | 9,445 | - | -26.9 |
| 1989 | - | - | - | 10,318 | - | -19.8 |
| HONG KONG | ||||||
| 1960 | - | - | - | - | - | -33.6 |
| 1970 | 13.7 | 11.0 | 900 | 2,037 | 96 | -13.5 |
| 1975 | 7.2 | 4.9 | 2,160 | 4,612 | 97 | -58.5 |
| 1980 | 11.9 | 8.9 | 5,210 | 13,672 | 96 | -11.9 |
| 1985 | 7.2 | 5.2 | 6,230 | 16,600 | 95 | - |
| 1987 | 13.6 | 11.7 | 8,180 | 25,036 | 96 | - |
| 1988 | 7.5 | 5.7 | 9,230 | 27,882 | 95 | -1.1 |
| 1989 | - | - | - | - | - | 1.4 |
| SOUTH KOREA | ||||||
| 1960 | - | - | - | - | - | -90.2 |
| 1970 | 8.9 | 6.3 | 260 | 830 | 76 | -59.3 |
| 1975 | 9.1 | 6.9 | 580 | 5,070 | 81 | -24.4 |
| 1980 | 8.3 | 6.7 | 1,620 | 17,446 | 90 | -21.7 |
| 1985 | 8.9 | 7.2 | 2,160 | 30,283 | 91 | - |
| 1987 | 11.1 | 9.2 | 2,900 | 47,172 | 92 | - |
| 1988 | 11.3 | 9.5 | 3,530 | 60,696 | - | 17.1 |
| 1989 | - | - | - | 62,375 | - | 1.5 |
Hong Kong is a British Crown Colony composed of refugees who fled from China in the 1950s, most of them poor villagers. A constant free-trade policy transformed the small colony into a world industrial and financial center in just three decades without national debt, foreign aid or inflation. In the 1950s, South Korea was a poor country based on agriculture. Initial policies of import-substitute industrialization yielded to trade liberalization in the 1960s and 1970s, during which time Free Export Zones were established to attract foreign capital and technology.
In Hong Kong growth was a natural outcome of laissez-faire policies in a small, low-income and resourceless country. Exports expanded rapidly with no previous import substitution phase. Unskilled refugee farmers became industrial and later professional workers. 8 Only competitive industries, resting on private investment, could survive. In South Korea, the government switched to an export-oriented industrialization, based on incentives, to favor exports over production for the home market. Foreign loans and DFI associated with the transfer of technology were estimated to total $11 billion by 1980. During the 1960s and 1970s the manufacturing sector grew by 18 percent a year in real terms, exports expanded by 27 percent, unemployment rates declined from 8 to 4 percent and real wages rose by 7 percent. 9
If we measure economic independence in terms of the balance of trade, Israel reduced its trade deficit from -60 percent of the value of imports to -20 percent during 1960-1989. Hong Kong and Korea, doing better, recorded positive trade balances by the end of the 1980s, indicating the success of their policies.
| MVA | Share of MVA | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| Total | Per capita | In GDP | In world | |||||||
| Value in $* | activity | |||||||||
| Country | ||||||||||
| 1963 1973 | 1973 1981 | 1963 1973 |
1973 1981 | 1963 1973 |
1973 1981 | 1963 1973 | 1973 1981 | 1963 1973 | 1973 1981 |
|
| Israel Hong Kong S.Korea |
9.7 12.3 20.4 |
3.1 12.3 20.4 |
6.4 10.3 17.8 |
0.4 9.2 11.4 |
704 541 123 |
740 966 276 |
19.2 29.1 23.8 |
18.5 30.8 33.8 |
0.14 0.14 0.25 |
0.14 0.24 0.25 |
Source: U.N.I.D.O., Handbook of Industrial Statistics 1984 (New York: United Nations, 1985), pp. 23, 34.
* at constant 1975 prices.
The deindustrialization of the Israeli economy, which was a chief cause of its economic downturn, contrasts with the performance of the Far Eastern countries. 10 In Israel the average growth in manufacturing value added (MVA) per capita dropped from 6.4 percent during 1963-1973 to 0.4 percent during 1973-1981, while in the two Asian countries this value averaged around 10 percent during those years despite the worldwide recession of the 1970s.
If we consider the share of MVA in world activity, Israel's portion reached 0.14 percent in 1963-1973 and failed to rise during 1973-1981. The shares of Hong Kong and the Republic of Korea, which amounted to 0.14 and 0.25 percent respectively during 1963-1973, nearly doubled during 1973-1981. This stagnation in the scope of the export manufacturing sector during the 1970s relative to Far Eastern countries should have sounded an alarm over the declining competitiveness of Israeli manufacturing. Deindustrialization and the discouragement of local and foreign investment continued during the 1980s. 11 The manufacturing production index rose from a 1980 base of 100 to 130 in 1987, while in South Korea it rose to 244. Israel's manufacturing index actually shrank from 130 to 123 in 1989.
| Years | Israel | South Korea | |||||
|---|---|---|---|---|---|---|---|
| Direct foreign investment | Manufacturing production Index |
Direct foreign investment | Manufacturing production Index | ||||
| Long-term Capital | Capital Earnings | 1980=100 | Long-term Capital | Capital Earnings | 1980=100 | ||
| (1) | (2) | (3) | (4) | (5) | (6) | (7) | |
| 1970 | 49 | 41 | 59 | 66 | 5 | 16 | |
| 1975 | 45 | 57 | 82 | 57 | 25 | 35 | |
| 1980 | 51 | 72 | 100 | 8 | 64 | 100 | |
| 1985 | 97 | 138 | 120 | 230 | 118 | 167 | |
| 1987 | 231 | 163 | 130 | 597 | 134 | 244 | |
| 1988 | 220 | 148 | 126 | 872 | 180 | 277 | |
| 1989 | - | - | 123 | - | - | 284 | 1982*-1988 | 883 | 1128 | - | 2377 | 852 | - |
Source: Columns (2), (3), (5), and (6): United Nations Conference on Trade and Development, Handbook of International Trade and Development Statistics 1989 (New York: United Nations, 1990), p. 248; Columns (4) and (7), United Nations, Industrial Statistics Yearbook 1987, vol. 1 (New York: United Nations, 1990), p. 136; United Nations, Monthly Bulletin of Statistics 44, no. 7 (July 1990), p. 22.
* Aggregate
Direct foreign investment in South Korea during 1982-1988 was triple that of Israel, despite the fact that the repatriated earnings of such investment are higher in Israel than in South Korea. The high rate of repatriated earnings of DFI in Israel during 1982-1988 should have attracted higher rates of DFI. Why, then, is foreign capital participation so low in projects approved by the Israeli Investment Center? 12 One answer is that few foreign investors are willing to struggle with Israel's time-consuming and costly bureaucracy, frequent changes in regulations, discrimination between investors and the failure to distinguish between DFI and financial investment.
5. Obstacles Imposed on Industrial Investment
Improving the profitability and competitiveness of industry requires eliminating bureaucracy and red tape. Despite the "Investment Encouragement Law" and other incentives, Israel's technological and scientific infrastructure and Free Trade agreements with the European Common Market and the U.S., negligible amounts of direct foreign investment have been attracted. 13 It appears that these benefits do not compensate the investor for the drawbacks he faces in overcoming the Israeli business environment.
The following sections describe the tangible and intangible price paid under the existing system, which could be rectified through the introduction of Free Export Processing Zones.
| 1985 | 1986 | 1987 | 1988 | 1989 | ||
|---|---|---|---|---|---|---|
| (a) | Total requests by year's end | 658 | 794 | 567 | 699 | 891 |
| (b) | Applications approved during the year | 676 | 719 | 708 | 649 | 733 |
| (c) | Those in (b) with foreign capital participation | 45 | 40 | 20 | 45 | 148* |
| Investment projects implemented | 443 | 546 | 477 | 453 | 433 | |
| (d) | Time elapsed between an application's approval and its implementation | (in percentages:) | ||||
| One Year | 14.8 | 10.0 | 10.9 | 12.1 | 12.9 | |
| Two years | 16.2 | 25.8 | 30.6 | 16.3 | 25.8 | |
| Three years or more | 68.8 | 16.5 | 18.8 | 33.7 | 22.8 | |
| Four years or more | 47.6 | 12.8 | 14.1 | 18.9 | - | |
| Five years or more | - | - | 26.8 | 23.2 | 19.3 | |
| (e) | (b) x 100 Applications approved = (a) + (b) of total processed |
50.7 | 47.5 | 55.5 | 48.0 | 45.1 |
| (f) | = (c) x 100 Foreign capital in total (b) applications approved | 6.6 | 5.6 | 2.8 | 6.9 | 19.2* |
| (g) | = (d) x 100 Projects implemented of (b) total applications approved | 65.5 | 75.9 | 67.3 | 69.8 | 56.0 |
* includes a large project of around $100 million that has been postponed.
During 1985-1989, only 50 percent of the applications processed by the Investment Center of the Ministry of Industry and Commerce were approved. On the average, an application requires about six months to process. Investment projects that were executed may have been in the pipeline three years or more. In the years 1987-1989, around 20 percent of projects implemented were in the pipeline five years or more. 14 This is time-consuming and costly. It is estimated that an entrepreneur must pay for approximately 500 working days of time of foreign and local consultants, experts, accountants and lawyers, which cost between $250 and $1,000 a day for the different levels of expertise. 15
| Processing in man-days (estimated)* | ||||
|---|---|---|---|---|
| Type of processing & approvals | Processing duration in days | Investor Management & Consultants | Government & Lawyers & accountants | Local authorities |
| (1) | (2) | (3) | (4) | (5) |
| Land leasing | 120-200 | 60 | 30 | 200 |
| Building permits & licensing | 500-1,000 | 120 | 120 | 500 |
| Applications for "Approved Enter-prise" status | 80-120 | 20 | 30 | 200 |
| Import & disbursement procedures | 200-500 | 60 | 60 | 200 |
| Total in man-days | 260 | 240 | 1,100 | |
| Price of man-day in $** | 1,000 | 250 | 250 | |
| Total expenses in $ | 260,000 | 60,000 | 275,000 | |
* Columns (3), (4) and (5) are estimates on the basis of interviews with manufacturers and government officials.
** includes travel, office services, levy payments, stamps, and service taxes.
The cost to the investor of initiating a single project is estimated at $320,000. In addition, the taxpayer (government and local authorities) must foot a bill of $275,000.
Annual expenses for an enterprise include the cost of annual foreign currency permits, customs and Value Added Tax refunds (drawbacks) on imported and locally purchased raw materials and services as against exports, other refunds and various applications accompanied by mortgages, trusts, collateral and the owner's personal guarantees signed by a certified public accountant. 16 These operations are estimated to cost $150,000 annually for an average enterprise, requiring two to four employees to handle these functions. For small firms, contacts with customs and tax authorities are relatively large expenses.
Investors become discouraged and may postpone or abandon the project due to these long and costly procedures. In these circumstances, investors with political influence may receive preferential treatment over others, who are understandably disgruntled. Political favoritism may reduce the number of bona fide direct foreign investors, resulting in a negative selection process which culminates in low quality, high-risk projects.
|
|
