WHAT WORKS IN ISRAEL: THE TEL AVIV STOCK EXCHANGE

The four previous editions of the Scorecard on the Israeli Economy (1989-1992) have consistently accorded the highest marks to the broadly-defined policy area of "Money and Capital Markets." Within that area, one institution deserves special commendation: the Tel Aviv Stock Exchange (TASE).

The TASE is a special focus of the 1993 Scorecard. What makes the TASE so special is that it is one of the few economic institutions that thrives inside the stultifying climate of Israeli socialism.
The TASE is the leading edge of private property and entrepreneurial opportunity that stands in marked contrast, and could ultimately undermine, the central economic institutions of Israel: monopolies, cartels, state-owned enterprises and banks, insolvent kibbutzim, protectionist barriers to trade, the Histadrut, along with a raft of other bureaucratic restrictions on the free flow of goods, services and capital. The TASE is important because it affords would-be Israeli entrepreneurs access to capital without having to subject themselves to the country's state-owned commercial banking system, which is not designed to serve start-up, high-risk companies, or to the whims of the Chief Scientist, who controls several hundred million shekels of grants. Israel suffers from one of the world's most highly concentrated banking sectors, second only after Ireland among the Western industrial democracies.

The cartelized banks prefer to loan most of their available credit to well-established, politically-favored enterprises. In April 1993, the Bank of Israel reported that Israel's three largest banks -- Bank Hapoalim, Bank Leumi and Israel Discount Bank -- controlled 86 percent of the country's total banking assets of NIS 226 billion. ($1.00 = NIS 2.97 in December 1993.) Despite the sale of about 25 percent of the shares of Bank Hapoalim and 20 percent of Bank Leumi in 1993, for which the government received NIS 2.6 billion, the State of Israel remains the majority shareholder of the country's four largest banks. The history of Israel is full of examples of discriminatory or preferential treatment to politically-favored borrowers.

The TASE has changed all that. Israelis are flush with money, which means that new as well as established business enterprises can turn to the stock market to raise capital, rather than to the state-owned banks. Foreign investors can also put their money at risk on Israeli entrepreneurs via the TASE. Moreover, equity finance is much preferred to debt finance in that it builds capital stock, not debt, thereby protecting firms from unexpected costs due to increases in interest rates.

The History and Growth of the Tel Aviv Stock Exchange

Securities' trading began in Tel Aviv in the 1930s. During 1976-1982, the number of equity listings and the volume of trade rose impressively; the index of industrial share prices in dollar terms rose fourfold between 1976 and 1982.

The bank shares crisis stalled the growth of the TASE in 1983. In order to prevent great losses to members of the public, who had purchased shares in the country's main banks at vastly inflated prices in 1982, the government agreed to purchase the bank shares over a period of years based on the value of the shares on the eve of the collapse, with linkage to the U.S. dollar plus interest (and an option for linkage to the consumer price index). As a result, the government became the sole owner of the banks, but it did not take over the management of the banks, which it left in the hands of the previous owners, who were responsible for the crisis.

Table 1 displays the market value of securities traded on the TASE since 1981. Note several important trends in the table. First, the value of all stocks and bonds fell by more than half in 1983 due to the collapse in bank shares. Second, total market capitalization did not recover to 1981 levels until 1986, and did not achieve inflated 1982 levels until 1989. The recession and high inflation of 1983 and 1984, followed by another recession that ran from mid-1987 through the end of 1988, held down equity values. Third, bonds replaced stocks as the primary source of market value from 1983 through 1990.

TABLE 1. Market Value of Securities Traded on the TASE, 1981-1992 (US $ millions)

Note the extraordinary boom that occurred in 1992. The market value of equities increased 238 percent. Furthermore, equities constituted half the market value of all securities listed for trading in 1992 for the first time in modern history. To stress the point, the growth rate in equity finance surged past the growth in Government bonds. In 1992, 92 new companies registered their stocks on the TASE, bringing the total number of publicly-traded firms from 286 at the end of 1991 to 378 at the end of 1992. For the first time in the history of the State, Israel had a real equity market, based on the clear Western notion of the primacy of private property rights.

Market capitalization continued to rise in 1993, and equities continued to outpace Government bonds. By June, the value of Government bonds had declined by $1 billion, while equities had increased by $5 billion and the number of listed companies had risen to 471. The number of listed firms reached 516 in October, the total value of shares $46.9 billion, and shares now constituted 60 percent of total market capitalization.

November was an even more extraordinary month. A multitude of new issues, 39 firms, went public, raising $275 million. The majority of issues were heavily oversubscribed. Established firms, rights issues, and other sales totalled another $380 million. At the end of November, a record 555 companies traded on the TASE. In two short, but extremely productive years, the number of firms listed on the TASE doubled.

For 1993 as a whole, 187 new companies were listed for trading. According to a year-end statement by Haim Stoessel, chairman of the TASE, another 106 new prospectuses are in the pipeline for share offerings in early 1994. Only one new state-owned company, Shekem, was launched on the TASE in 1993, although partial holdings in 7 state firms, most prominently in Banks Hapoalim and Leumi, were sold to the public. This means that the TASE is doing precisely the job of any stock exchange, to funnel the savings of individuals and institutions into the hands of private entrepreneurs.
The signing of the peace accord between the State of Israel and the Palestine Liberation Organization gave another boost to the TASE. Between August 23 and September 5, the index of share prices rose about 15 percent and turnover exceeded $100 million a day. Between late August and early November, the total value of shares on the TASE increased by more than $10 billion. In all, the three main indices of share prices in 1993 rose from an average of just under 200 to more than 270.

In mid-1990, the market value of shares represented a modest 18 percent of the gross domestic product (GDP). Two years later, in mid-1992, it surpassed half of GDP, a level that is more appropriate to a modern economy. At the end of 1993, it stood at about 80 percent of GDP. If this trend continues for a few more years, capitalism may finally and irreversibly, after a 45 year lapse from the end of the Mandate era, take hold in Israel.

Table 2 displays the dollar value of new issues raised by listed corporations and the government during 1981-1992, which represents the annual addition to total market capitalization.

Table 2. Capital Issues of Listed Corporations and the Government, 1981-1990 (US $ million)

Equities were in the doldrums from 1984 through 1988, but recovered in 1989. The dollar value of new equity issues, from $350 million in 1989, doubled to $771 million in 1991 and almost tripled from that level in 1992. As previously mentioned, the value of new equity issues in 1993 set still new records.

Previous Scorecards have pointed out the harmful effects of subsidies to business and the harsh tax treatment of domestic firms and individuals. But the harsh treatment of domestic firms does not apply to Israel's modern, high-tech export sector. The reason, as explained below, is that the modern export sector receives a variety of subsidies and tax benefits that offsets Israel's high statutory rates of tax and other regulations. The modern, high-tech export sector works because it is virtually free of direct taxation. But the reader should not conclude that subsidies and tax breaks for export firms are a substitute for good economic policies.

Rather, the point to be made is that these policies compensate for the harmful effects of regulation and the adverse effects of high taxes on business growth. The Government has given Israel's modern, high-tech sector the opportunity to flourish by granting subsidies and tax breaks in order to neutralize the depressing effects of overall policies toward business. It would be far better if the Government simply put in place a set of policies that resulted in a favorable business climate, such as those found in Hong Kong or Singapore.

Corporate Israel: The Modern, High-Tech Export Sector is Virtually Tax-Free

Israelis point with pride to their modern, high-tech export sector, which competes successfully against global rivals. One reason for the success of this sector is that it is virtually free of direct taxation. A careful analysis of the annual statements and accounts of the most important export-oriented firms reveals that they pay little or no taxes on their profits.
Indeed, some of them, which trade on U.S. stock exchanges, are subsidized by taxpayers.

The findings that follow are based upon an analysis of the major Israeli firms whose shares trade on U.S. stock exchanges; these firms are required to file annual reports and F20 forms with the U.S. Securities and Exchange Commission, which imposes severe disclosure requirements. The analysis computes a real effective tax rate by adjusting the reported apparent tax rate, taking into account the tax consequences of two subsidies supplied by the Government of Israel to these export-oriented firms (e.g., exchange-rate insurance, which was finally eliminated in 1993, and research and development grants). The analysis excludes such other subsidies as payroll grants and the implicit subsidy value of guaranteed loans, because these data are not presented in either the corporate reports prepared by Israeli accounting firms or in the F20 forms. It should be noted that any firm which receives these subsidies pays an even lower effective corporate tax rate on profits.

In addition to F20 forms and Annual Reports, the analysis also utilizes information presented in Dun & Bradstreet International's 1992 edition of Israel's Leading Enterprises, which sets forth information on Israel's 150 leading industrial enterprises ranked according to 1991 sales. The survey classifies firms according to sector, share of sales exported, and other standard business variables. The Dun & Bradstreet guide also presents information on the top 100 non-industrial firms. Only two non-industrial firms export more than half of their output, which means that these enterprises do not fall under the rubric of the high-tech, export sector.

The list of firms that was selected for analysis includes: Scitex, Elbit, Elscint, Teva Pharmaceuticals, ECI Telecom, Optrotech, Intelligent Information Systems, Laser Industries, Electrochemical Industries, Oshap Technologies, Laser Industries, Lannet Data Communications, and Aryt Optronics Industries.
These firms are scattered throughout Israel's top 150 industrial firms, occupying in 1991 spaces 7, 8, 17, 35, 37, 60, 100, 117, and 139. Some are newer firms that have not yet made it onto the top 150 list. The analysis does not include Israeli firms that trade solely on the Tel Aviv Stock Exchange, or firms which are privately held, but it seems reasonable to suppose that the sample of firms listed on U.S. stock markets reflects the general state of the tax circumstances that apply to export-oriented firms.

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