The News Behind The News
November 18, 1999
Israel the Economic Powerhouse? Not Quite.The Jerusalem Post, the NY Times, and many other media outlets from Israel to the world proclaim that Israel is an economic powerhouse and soon to be the hi- tech capital of the world. Most often, these pundits, or rather house organs of the Official State Line, tie all of this economic prosperity to the Peace Process and other similar non sequiturs. The fact of the matter is that the Jerusalem Post's recent opinion piece trumpeting these absurdities (Israel, the economic engine of the new Middle East, 8/22/99, by John Benaquen) is no less the work of the State than the propaganda sent directly by the ministries of Finance and of Industry and Trade. The facts, as documented by Professor Alvin Rabushka in the following article, reprinted from the Spring 98 edition of the IASPS Quarterly Report (Volume 7, No. 3) show that Israel's economy is stagnated in socialist red tape and that "growth" is a product of unilateral transfers (i.e., US aid, war reparations, bonds etc.)
The New York Times Wins: Facts Don't Matter
By Dr. Alvin RabushkaMuch hoopla has surrounded Israel's 50th birthday party. The New York Times has been in the vanguard, singing the praises of Israel's economic achievements. The paper's chief correspondent in Jerusalem, Serge Schmemann, wrote on April 18, 1998, that "By any yardstick, Israel is prosperous- more than it has ever been....Exports have catapulted to about $32 billion, most of them industrial and scientific. High tech now accounts for a third of all Israeli exports....The wealth is tangible....Israel has made tremendous strides in reforming its economy and...now stands at the cusp of developed country status."
This is not exactly the same Israel we see from our vantage point at 4 Chopin Street in Jerusalem. Since 1988, the Division for Economic Policy Research at the Institute for Advanced Strategic and Political Studies has focused its research on the Israeli economy. It has published more than 60 detailed studies that reveal widespread denial of individual freedom and massive economic inefficiency- the consequence of still thriving socialist institutions and policies. These studies have documented case after case of waste, fraud, and abuse at a cost to Israelis of billions of dollars. The authors of these studies, increasingly the top graduates of Israel's economics departments, rely heavily on the official publications of Israel's Central Bureau of Statistics and other authoritative sources.
Against the body of this research, The New York Times and other establishment media trumpet a different theme, that of unparalleled free market reform and prosperity.
One is tempted to dismiss journalistic accounts as superficial, written by correspondents who lack training in research, but especially in economics. But that would be the easy way out. Research carries with it the commitment to persuade. We in the public policy business must try to correct, as often as necessary, the gross simplifications and misrepresentations of Israel's economy that appear in The New York Times and other media outlets, however difficult or futile the efforts sometime appear to be.
The New York Times is Americans' premier English language source about Israel. On that fact, let's examine Serge Schmemann's article, "Israel Redefines its Dreams, Finding Wealth in High Tech."
Redefining High Tech
To begin with, what is "high tech" in the Israeli scheme of things? In the official data published by Israel's Central Bureau of Statistics, industrial exports (excluding ships, aircraft, and diamonds) are divided into two industries, those considered as "high tech," and less advanced industries. The division into "high tech" and "traditional" industries is made by the Bank of Israel, based on three criteria: the level of human capital, physical capital, and investment in R & D.
"High tech," in turn, is itself divided into two categories: (1) the metals, machinery, and electronics industries, and (2) the chemicals, rubber, and plastic industries. "Traditional" industries are everything else. The inclusion of chemicals, rubber, and plastic, hardly considered high tech anywhere else nowadays, suggests that the Bank of Israel may be a bit behind the times in continuing to call these industries "high tech." Still, Schmemann used the Bank of Israel's definition of high tech.
Here are some facts on the trend growth rate of "high tech" in Israel. Between 1985 and 1995, the dollar value of all industrial exports (excluding services, agriculture, diamonds) increased at an average annual rate of 8.3 percent. The higher of the Bank of Israel's two "high tech" categories, that of metals, machinery, and electronics, increased at an average annual rate of 9.3 percent, just 1 percentage point faster than the overall rate of all industrial exports. This is not exactly the stuff of a high tech revolution. The lower of the Bank's "high tech" categories, chemicals, rubber, and plastics, grew at a faster 10.5 percent annual rate. To repeat, older industries outgrew the newer, real high tech industries.
By way of comparison with traditional Israeli economic pursuits, the value of diamond exports in 1995 exceeded by more than $1 billion the combined dollar value of the higher "high tech" exports of electric motors, electric distribution apparatus, electrical components, electronic communication equipment, and industrial equipment for control and supervision, medical and scientific. The same was true in 1996. (Data for 1997 have not yet been posted on the web site of Israel's Central Bureau of Statistics.) These facts do not suggest that high tech is sweeping aside traditional industries.
$45 Billion of IOUs
It may be tedious to read and keep track of lots of numbers, but the facts are an important part of any story about Israel's "high tech" revolution. Exports of all goods (high tech, industrial, and non industrial goods, diamonds, agricultural produce, etc.) rose from $17.1 billion in 1994 to $21.6 billion in 1997. Exports of services (e.g., tourism) rose from $7.8 billion to $10.3 billion during 1994?1997. Adding goods and services together, total exports grew from $24.9 billion to just under $32 billion during 1994?1997. By itself, this would be good news.
This apparent good news is more than offset by the hard fact that Israelis do not earn their keep in the world of international business. During 1994?1997, imports increased from $34.4 billion to $43.6 billion, which means that Israelis ran up $45 billion of IOUs in their international trade. (More on how Israelis pay these IOUs later, which is rarely, if ever, part of the establishment media story.)
Stuck in the Stone Age
The $10 billion in high tech exports in 1997, cited in The New York Times (although The San Jose Mercury News, to its credit, uses the more appropriate $6 billion figure for genuine high tech exports) is about 30 percent of total exports of goods and services, or about 11 percent of Israel's $90 billion GDP (plus or minus a few billion dollars depending on the exchange rate). In 1997, the share of high tech exports in GDP, as broadly defined by the Bank of Israel, was not much higher than it was more than a decade ago, when high tech industry was in its infancy. If high tech exports had not increased at all as a share of GDP, it would mean that Israel's economy was stuck in the stone age. The absolute growth, and any modest proportional growth in high tech exports in recent years is largely due to the several hundred thousand well educated Russian immigrants that arrived since 1989.
Let's turn to another statistic in Schmemann's story about Israel's booming economy, namely, that some 120 Israeli companies are traded on New York's several stock exchanges. I tried to replicate this number. Here is what I discovered. As of May 1, 1998, the New York Stock Exchange listed 6 Israeli companies http://www.nyse. com/public/intview/4?1/4?1?6/416fm.htm).
The Nasdaq Stock Exchange listed 81 entries for Israel, but many of these are the same firms that trade A shares, B shares, units, and warrants. Netting out the multiple listings of individual firms leaves 66 separate firms listed on Nasdaq http://www.nasdaq.com/dynamic/ NNonUSoutput_10.stm).
To fill out the details, I phoned the research department of the American Stock Exchange. A staff member advised me that four Israeli firms, all old line enterprises, are listed on the ASE. Altogether, I counted 76 Israeli firms listed on U.S. stock exchanges, not 120 companies. This difference is large.
How much are these U.S. listed Israeli firms worth? The estimated value of Israeli listings on Nasdaq amounts to a market capitalization of $13.7 billion. The six firms listed on the NYSE have a market capitalization in the neighborhood of $6?7 billion, and the four firms on the ASE are worth perhaps $1 billion. This figure includes some double counting, as I explain shortly, and is thus too high. Nonetheless, Schmemann writes that Israel's 6 million people have developed what has come to be known as "The Second Silicon Valley." Known by whom? It would not qualify on the basis of being in place in terms of market capitalization. His description is a bit of a stretch.
Let's compare "The Second Silicon Valley" with "The First," the 3.2 million people living in a 50 miles long strip of land from San Francisco to San Jose. According to the World Competitiveness Yearbook www.imd.ch/wcy/approach/fondamentals.html), the market capitalization of companies in the Valley in 1997 exceeded $450 billion (closer to $500 billion in 1998, which exceeds the value of all firms on French exchanges). Silicon Valley creates 62 new millionaires every day. Eleven new companies are founded every week. One company goes public every five days. Seven thousand information technology companies operate there. Israel's putative "Second Silicon Valley" is a rounding error in "The First."
In Israel's ``Valley'' Business Pays No Taxes
But there is a much bigger difference between the two Valleys. No company in "The First" gets a massive government subsidy, unless it establishes a subsidiary in Israel, such as Intel, IBM, and Motorola, or other country that gives out subsidies. All the large companies in Israel's "Second" receive huge subsidies from the government of Israel, either as support for R & D, to partially reimburse firms for capital outlays, or preferential tax concessions for locating in specified development zones, and so forth. I calculated that the entire Israeli corporate sector, including subsidiaries of foreign firms, paid no net taxes in 1993 because the value of government benefits exactly offset explicit corporate taxes. Imagine how much richer "The First Valley" would be if its firms paid no U.S. or California corporate income taxes.
Let's put Israel's high tech sector into yet another framework, that of Israel's own, still tax exempt Tel Aviv Stock Exchange (TASE). The market value of shares and convertibles listed on the TASE rose from a low of $1.9 billion in 1983 to $9.2 billion in 1990, $14.3 billion in 1991, $29.6 billion in 1992, and $50.8 billion in 1993. The number of listed firms rose sharply, from 271 in 1990 to 558 in 1993 (http://www.tase.co.il). Many of the new listings were high tech firms.
Israel's socialist Labor Party led government couldn't tolerate the sudden burst of individual economic freedom and access to capital on the part of potential entrepreneurs that was outside the bounds of government control. Minister of Finance Avraham Shohat therefore proposed, in the name of social justice, a 25 percent tax on stock market gains. The TASE went into free fall and has never fully recovered. The market capitalization of TASE securities fell to $32.7 billion in 1994, remained roughly stagnant at $36.5 billion in 1995, $35.9 billion in 1996, and finally gained ground to $46.4 billion in 1997. (The value of U.S. securities more than doubled during 1994?1997, so high tech Israel was left behind.) Another 80 firms in registration during 1993 listed in 1994, bringing the total to 638, but that figure has completely stagnated. In 1997, the number of listed companies stood at 659.
To show the extent of the decline of the TASE, only 4 initial public offerings (IPOs) raised $11 million in 1996 and only 12 IPOs raised $170 million in 1997. The Labor Party killed the Tel Aviv Stock Exchange, dead.
Kill it Again, Mr. Levy
As if this weren't enough, the current income tax commissioner seems dedicated to the final burial of the TASE. Doron Levy stated on April 12, 1998 that the subject of taxation of individuals' overseas activities is not properly regulated, and so it might be a good idea to impose a general reporting obligation- including the imposition of a stock exchange tax in Israel itself. As a reminder of the possible consequences of such a tax, Merav Arlozorov, in the April 13, 1998, issue of Globes (Israel's financial daily), wrote that "[Israelis] might hark back to the bitter experience of the 1994 failure, when the announcement of the proposed tax produced a ruinous effect on the stock market." (Profits on sales of foreign securities by Israelis are subject tto a capital gains tax. But even this advantage can't bring life to the TASE.)
What's an aspiring Israeli entrepreneur to do?
Abandon Tel Aviv
The obvious answer was to abandon trying to raise capital and list in Tel Aviv, and turn to the Nasdaq market in the U.S. Let's have one more look at the TASE, and what it says about Israel's supposed "high tech" economy.
The web site of the Tel Aviv Stock Exchange cited above, readily available to Serge Schmemann and every other reporter, is rich in information. Table 13, the Tel Aviv 25 index of leading securities, had a market capitalization of $25.9 billion at the end of 1997. These 25 firms constituted 55.8 percent of total market capitalization. Only two of these, Tadiran and Clal Electronics, both old line companies, qualify as high tech. Most of the 25 are stalwarts of the old socialist economy, including the banks, the bank holding companies, and the concentrated conglomerates. The other 624 companies listed on the TASE constitute the remaining 44.2 percent of market capitalization, and include almost all Israeli high tech securities not separately listed abroad.
To determine the total value of all Israeli equities, it is necessary to add the market value of Israeli securities that trade in the U.S. to those which trade in Tel Aviv. This is not a straightforward addition, because 17 companies are jointly listed in the U.S. and Tel Aviv. Among these 17 companies are Teva, which has a market capitalization of about $3 billion, and Koor, with a value of $1.7 billion, Tadiran, and Supersol.
Missing the Market
As a result of these joint listings, it is necessary to reduce the $20 billion of Israeli securities that trade on U.S. exchanges by the fraction of shares that trade in Tel Aviv, or vice versa. This information is not readily available as U.S. exchanges do not keep track of what proportion of each firm's equities trade on which exchange. Therefore, the $66 billion gross value of all Israeli securities must be reduced somewhat. It is likely that total global market capitalization of Israeli firms, especially when adjusted for inflation, is not much higher than it was in 1993 solely based TASE listings. The conclusion? Israeli high tech has missed the bull market of the past five years.
If the Bank of Israel's first "real" category of high tech exports only amounts to $6 billion, it stands to reason that the remaining $85 billion of national economic output is not high tech, but rather the output, and reality, of Israel's old line socialist economy.
These are the facts of Israel's high tech economy. We at the Institute hope that high tech as a share of national economic activity grows much more rapidly in the future. High tech is global. High tech is outside the bounds of domestic government protection and control, since Israeli firms have to sell the output of their high tech goods and services to foreigners in a fiercely competitive international marketplace. There is no room for monopolies in high tech, as exist in the domestic Israeli cement, insurance, banking, paint, chemicals, agriculture, and other economic sectors. However, it would advance the cause of economic freedom if Israeli taxpayers were not forced to subsidize foreign high tech firms with their taxes, which offsets a good portion of the value added that foreign high tech firms bring to Israel.
Perhaps the Institute's biggest quarrel with Schmemann and other correspondents is their failure to address the most important problem of Israel's economy. This is the fact that imports of goods and services exceeded exports by about $45 billion between 1994 and 1997. How did Israelis pay their bills? As we've repeatedly written, "free money" has financed Israel's deficit in international trade and services. During the past four years, the Israeli government and people have received between $7?8 billion every year in unilateral transfers and grants (U.S. aid, German reparations, charity) along with $2 billion in annual U.S. loan guarantees. Much of the prosperity that Serge Schmemann describes in the Times - cellular phones, cars, m, restaurants, overseas travel - was paid for, up to $40 billion worth, by U.S. taxpayers and generous Jews. $40 billion buys a lot of phones, cars, and vacations for a small population of Israelis.
It would be right to praise Israel for its economic achievements. However, it does not help public understanding of Israel's true economic condition when journalistic enthusiasm is not matched or supported by the facts. The world wide web gives journalists instant access to all the data they require to write about the Israeli economy. We at the Institute hope they will avail themselves of the high tech facilities about which they so enthusiastically write.
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