Analysis

Debunking the 'Startup Nation' Myth: How Israel's Economy Cut Itself Off From the World

Despite its flashy image, Israel is a superpower of mediocrity and inefficiency, with a resulting 23-percent plunge in international trade during the last decade

File photo: Yellow Vest protest in Tel Aviv, December 14, 2018.
Moti Milrod

Israel is a high-tech power, a startup nation the whole world looks up to. It has an open and vibrant economy, it's innovative and is conquering the globe with its inventions, right? Well, no. Apparently that picture is pretty inaccurate.

Data from Prof. Avihai Lifschitz of the Institute for Economic Policy at the Interdisciplinary Center, Herzliya, compares Israel’s openness to the world in comparison to other economies. This phenomenon is measured by calculating the extent of a country's international trade (exports and imports combined) in relation to its GDP.

Israel was indeed an open economy until 2004, but since then something terrible happened: It shut itself off from the rest of the world. Whereas in other developed countries international trade has been growing, other than during the 2008 crisis – Israel’s continues to diminish. The decline has accelerated over the last decade, with the current level of trade relative to GDP standing at half that of other OECD countries. In fact, there has been a dramatic 23% drop in Israeli trade during this period.

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By comparison, Ireland, which three decades ago was similar to Israel in terms of GDP, has increased its international trade by 70% over the last 10 years, becoming one of the OECD’s most prosperous countries. Israel's image as a flourishing high-tech power is thus a deceptive one.

What went wrong? No economist has an answer to that question. Part of the explanation lies in the discovery of natural gas, which reduced the necessity of importing energy. But that can only account for some of the large drop in imports, overall. And this is good place to dispel a common misconception: Imports and exports go hand in hand, and a decline in the former is always associated with a decline in the latter; imports and exports cannot exist without each other.

So, what's happened since 2004? Economy Minister Eli Cohen recently appointed a committee charged with finding explanations for the worrisome decline in Israel’s openness to the world.

File photo: Israel's Economy Minister Eli Cohen speaks during a conference in Tel Aviv, April 4, 2018.
Meged Gozani

The concern is particularly great because Israel is a small, isolated country that must open up in order to continue developing. This isolation apparently also explains many of our serious problems – the high cost of living; the high rate of poverty; the sluggish rise in wages; deficiencies in the realm of construction; the shortage of housing; the overly concentrated economy and lack of competition; the oppressive bureaucracy; the amateurishness of skilled workers; and the poor level of services. All of these are characteristics of the same problem: inefficiency in the trade and services branches in Israel – areas in which the country has hermetically sealed itself off from the world.

We’re all familiar with it: a computer lab technician who can’t deal with a problem; a renovator who does sloppy work and runs off before finishing the job; a super-expensive garage mechanic; a bank that doesn’t even try to get our business; overpriced milk (even though Israel is ostensibly an agricultural powerhouse); and huge disparities in fees paid to middlemen in the food industry. The thousands of people with trades and professions doing mediocre jobs for high prices make life in Israel expensive and substandard.

It’s hard to admit, but Israel is a superpower of mediocrity, and that includes almost all of us (probably with the exception of a few people in high-tech and the sciences).

In contrast to a commonly held perception, inefficiency characterizes not only manual work in the country. A comparison between the situation here and abroad shows that except in three areas – R&D, computers and advertising – productivity in Israel is lower than in other developed countries, in all other services and trades. Productivity is particularly deficient among bankers, architects, lawyers, accountants and engineers (and maybe journalists?). We pay the price for this on a daily basis, with poor services, a high cost of living and particularly in low wages, which are closely linked to productivity.

Why are we doing so badly?

One possible explanation is poor education. An international survey for assessing adult competency, called PIAAC, shows that language, math and computer skills are particularly low in Israel. Another explanation is government bureaucracy, which kills free enterprise. And then there is the problem of unprofessional management and a lack of interest among controlling shareholders to invest in their businesses.

This has all come about because of the concentrated, limited and isolated nature of the economy, which has essentially closed Israel off to foreign markets. Badly run businesses, relying on unskilled labor, continue operating while demanding high prices for their services.

Imagine what would happen to our own big players if companies such as Walmart, Tesco, Citibank or Amazon chose to set up shop here. Could companies such as Supersol or Bank Hapoalim survive the competition?

So far, the world is not rushing in. But not for long – exposure to the world is growing. Look, for example, at the online shopping revolution. If service industries in Israel aren’t exposed to international competition and don't improve their standards, the blow they will absorb should they suddenly be exposed to such competition in the future may be lethal.

The bulk of Israel's economy is managed using primitive methods such as those in developing countries, with some branches showing 40% less productivity than in the rest of the developed world. Any shock, such as exposure to the world, competition or a crisis, could render the economy vulnerable, with no ability to compete against more successful markets.

Despite this, Michal Fink, director general of the Economy Ministry, says, “the fourth industrial revolution holds the potential for a leap forward in many areas, using intercontinental online commerce, robotic logistical centers and so on. Ground-breaking technologies such as blockchain, big-data and artificial intelligence, are integrated in state and organizational planning. These global developments subvert conventions and borders, challenging existing regulatory structures and redefining the business world.”

So far, that technology revolution is bypassing our isolated and non-competitive island. The good news is that after years of basking in the success of local high-tech, Israel has heeded the alarm and is trying to improve productivity in various traditional industries. But there is still are no government policies promoting productivity. Minister Cohen's new committee is addressing these issues and problems. The bad news? It has no idea of how to resolve them. The reasons that services are so poor are still unclear, even in high-end professions and trades. Who knows what will be done about it.