IASPS Op-Eds
Comments on the Decline of a Nation-State
March 19, 2000
Why Israel's "Second Silicon Valley" Emigrates To The Real Silicon Valley
by Alvin Rabushka, Director of the Division for Economic Policy Research
Frank G. Zarb, chairman of the Nasdaq stock market, visited Israel for two days in mid-February 2000. He reminded his hosts that there are 91 companies from Israel that trade on Nasdaq, more than any other country outside North America, and that Nasdaq lists more Israeli companies than all foreign stock exchanges combined. Most Israeli companies that trade on Nasdaq are not traded on the Tel Aviv Stock Exchange (TASE). Of the 91 companies, 78 trade solely on Nasdaq. The other 13 are listed jointly, but these consist largely of older companies such as Teva Pharmaceutical Industries.
Nasdaq’s Israeli companies had a market capitalization of $67 billion at the beginning of February. In comparison, the market capitalization of the 669 companies listed on the TASE came to $75 billion. Today, most high-tech Israeli firms have their initial public offerings in the U.S. and list solely on Nasdaq. Some Israeli high-tech firms are also incorporating overseas. Some successful Israeli high-tech entrepreneurs sell out to U.S. firms, thus shifting the benefits of future growth to overseas shareholders, rather than growing their businesses inside Israel.
Why would Israel’s dynamic, high-tech firms list their shares in the U.S. but not in Israel? This is a poignant question, especially since the entire world has been repeatedly told that Israel’s “Silicon Wadi” is the second “Silicon Valley.” Why wouldn’t the managers and brokers of the TASE, along with the Israeli government, move heaven and earth to get these high-tech shares listed in Israel?
The chairman of the TASE, Yair Ogler, claims that market executives have tried to persuade Israel’s securities regulators, thus far without success, that any Israeli-owned public company satisfying the United States Securities and Exchange Commission’s reporting requirements should automatically qualify to be listed on the TASE. Israel’s regulators say that the S.E.C.’s more lenient rules for foreign companies, which file 20F financial statements instead of the more thorough 10K forms demanded of companies incorporated in the U.S., are not sufficiently stringent to meet Israel’s tough standards. For Israeli firms listed on Nasdaq to be simultaneously listed in Israel would require the completion of additional forms and subject themselves to Israeli regulators. Does anyone really believe that Israeli bureaucrats are more concerned about the welfare of Israeli investors than the S.E.C. is about U.S. investors?
Israel’s high-flying Nasdaq companies see little benefit in preparing two sets of financial and legal documents for the dubious privilege of jointly listing their shares on the TASE. Less than a hundred Israeli firms listed on Nasdaq will soon likely exceed in value the 669 Israeli firms listed on the TASE. Why would any aspiring Israeli entrepreneur want to deal with Israeli regulators?
According to New York Times reporter William A. Orme, Jr., Prime Minister Ehud Barak came out in support of dual listings immediately after Zarb’s visit. Finance Minister Beiga Shohat asked industry executives and regulators to prepare a new proposal for dual listings, with rules that would make Nasdaq listings of Israeli securities automatic on the TASE. (It should be noted that Barak and Shohat repeatedly pay lip service to privatization of state-owned enterprises and other free-market reforms, but rarely take any real steps.)
If the benefits from dual listings are suddenly so obvious to the prime minister and finance minister, why have Israeli politicians and bureaucrats resisted this measure for the past decade? What could possibly make them take action now?
The Tel Aviv Stock Exchange—Some Recent History
What makes the TASE relevant in the struggle to free up the Israeli economy is that it is one of the few economic institutions which has the potential to thrive inside the stultifying climate of Israeli socialism. The TASE could become a leading edge of private property and entrepreneurial opportunity, which would stand in marked contrast, and even undermine, the central economic institutions of Israel: monopolies, cartels, state-owned enterprises, insolvent kibbutzim, and other bureaucratic restrictions on entrepreneurial freedom.
A well-functioning TASE could be a source of capital to aspiring entrepreneurs without having to subject themselves to the country’s banking system, the whims of the Chief Scientist or to begging for grants from the government. These sources of funding generally serve politically favored, established enterprises, not start-ups.
Capital gains on the TASE are still tax free. The TASE is about the only place in Israel where money can be made without being heavily taxed. This certainly serves the established interests, but could also induce ordinary Israelis to put their savings to work in potentially rewarding high-tech investments.
The recent history of the TASE is worth recounting. Between 1981 and 1992, the market value of securities traded on the TASE increased from $11 billion to $65 billion. The number of equity listings grew dramatically. 1993 was a banner year. All this came to a halt when the government set out to impose a capital gains tax in early 1994, which it subsequently withdrew, but well after the damage was done. It took the remainder of the 1990s for the TASE to regain its lost ground.
Israeli entrepreneurs learned their lesson and headed for Nasdaq. Even though shares traded in the U.S. are subject to capital gains taxation, young enterprising Israelis would rather not deal with Israeli regulators.
Israel’s Capital Markets
Israel has capital markets. But these are Israeli-style capital markets, not the normal kind of capital markets found in the U.S., Britain, or other capitalist countries. Israeli-style capital markets mean that the banks control financial brokerage. The Histadrut—the country’s national trade federation—opposes any changes in the pension markets, in which the government guarantees a fixed return on Histadrut’s holdings of government debt. Tax distortions riddle the capital markets.
There is nothing wrong with concentration of wealth and ownership if it is the result of market forces. This explains the high valuations placed on Microsoft, Intel, Cisco Systems, General Electric, and so on. But political, not market, forces determine the concentration of wealth and ownership in Israeli corporations.
As of June 30, 1999, the market capitalization of the TA 25 companies, the 25 largest firms on the TASE, amounted to just under $31 billion. These 25 firms represented about 60 percent of the total market capitalization of all TASE equities. The top 10 firms represented two-thirds of value of the TA 25, or about two-fifths of the value of all listed TASE firms. Only one of the 10, Teva Pharmaceuticals, can be considered high-tech. The other 9 are the tried-and-true villains of Israeli-style state capitalism: Bank Hapoalim, Bezek, Bank Leumi, Koor, Discount Investment, I.D.B. Development, Israel Chemicals, I.D.B. Holdings, and Bank Discount. The remaining 15 firms in the TA 25 are equally unexciting. There are no Israeli high-tech leaders in the TA 25.
Israeli socialism is a mixture of direct state ownership, state sanctioning of cartels and monopolies, state-subsidized enterprises, and state deals with specific families (the Recanatis, the Fishmans, the Eisenbergs, etc.) that own large stakes in the big TASE firms. In turn, the politicians receive financial and other support from the enterprises which they subsidize and protect. This arrangement may be a virtuous circle for its beneficiaries, but is a vicious circle for the Israeli people as a whole.
The Tech Revolution: Can It Transform Israel into a Free Economy?
The technological revolution threatens to overturn the cozy relationship between politicians, bureaucrats, and Israel’s corporate system. Young high-tech entrepreneurs don’t need the state or its money. In their eyes, the government is the problem, not the solution.
Money inevitably leads to political power. As 25-year olds become wealthier than the established political-corporate interests, they will demand greater political say in Israeli political matters. They will want to dismantle state socialism and recast the country in their free-wheeling, high-tech image.
Even though Israeli high-tech firms are listed on Nasdaq, ordinary Israelis are reluctant to invest aggressively in the U.S. stock market. The reason is that overseas capital gains are subject to a 35 percent tax in Israel, whereas domestic capital gains are tax free. If Israeli Nasdaq firms were automatically listed on the TASE and remained free of capital gains tax, investors would rush out of the TA 25 into the new high-tech firms. State-owned enterprises, along with state-sanctioned monopolies and cartels, would find it increasingly difficult to raise money to fund their activities. Histadrut would find it increasingly difficult to retain the support of its members. Politicians would be forced to look to 25-year old Israeli capitalists for financial and political support. For now, the ruling classes may find it more attractive to keep the new class and its wealth offshore, where it cannot challenge Israeli socialism.
What does the future hold for the TASE? It is highly unlikely that automatic dual listing will be approved anytime soon. Barak and Shohat may talk reform but they will stall dual listing, using whatever excuses come to mind. They and their political colleagues are not willing to risk control of Israel’s socialist economy.
But this resistance is short sighted. Britain’s prime minister, Tony Blair, has embraced high-tech as the wave of his country’s future and looks set to enjoy a long career as head of the government. Al Gore claims that he played a major role in the development of the Internet and actively seeks support from Silicon Valley. Germany’s Gerhard Shroeder is proposing major tax cuts to stimulate investment in the Internet and biotechnology.
Perhaps Barak will awaken one morning and recognize that his political future may come to depend more on Israel’s young entrepreneurs than the old socialist guard. If not Barak, then perhaps his successor. Sooner or later, an aspiring Israeli politician will seek power by joining forces with the new free economy and thereby lead Israel out of its socialist past. This is your chance, Mr. Barak. Just approve dual listing and reap the benefits before they go to your opponents.