Analysis

In Israel, Industry Is a Thing of the Past

Services are the economy's engine, and they don’t need a weak shekel

File photo: Women at work at a textile factory in Kiryat Ata
Zoltan Kluger/GPO

Images of Donald Trump, Angela Merkel and Emmanuel Macron have been adorning billboards in Israel these days, which you might think is somehow connected to the Knesset elections in September.

But those stuck in traffic on Tel Aviv’s Ayalon Freeway and have the time to study them will learn that the billboards aren’t touting the leadership capabilities of Benjamin Netanyahu or Benny Gantz or any other party leader. They were paid for by the Israel Manufacturers Association, the trade group that represents Israel’s biggest industrial companies.

And what do these three world leaders have in common that the association thinks is worth advertising? They have all called for protecting their country’s industry. The takeaway is pretty simple: If these three global powers are supporting their domestic industries, the political leadership in little Israel should do the same.

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I doubt this message is reaching the right people, who are too busy right now gearing up for next month’s election. But no matter, the message is also directed at the Bank of Israel and its governor, Prof. Amir Yaron. The manufacturers want him to intervene in the foreign currency market and reverse the growing strength of the shekel.

The shekel is the foremost problem on the industrialists’ minds these days as the dollar has lost about 7% of its value against the Israeli currency this year. The euro and the pound sterling have depreciated even more.

Mixed denomination Shekel currency banknotes and coins sit on display in this arranged photograph at Israel's central bank in Jerusalem, Israel, on Monday, Aug. 19, 2013.
Ariel Jerozolimski, Bloomberg

Over the last decade, the industrialists were ardent supporters of market intervention and they’ve become addicted. Once intervention was a tool used by the central bank in extreme situations, but in recent years it has been added to the policy tool kit. The industrialists have come to look at it as a kind of insurance policy on the exchange rate.

The industrialists aren’t just mounting a campaign over the exchange rate but also one against their declining image. For a long time they were one of the most powerful forces in the economy, in the days when manufacturing accounted for a much bigger chunk of it.

That share has fallen, as it has elsewhere in the developed world as the service sector grows. In 2019, for the first time, exports of services from Israel exceeded exports of goods. Services includes things like software, research and development, communications services, planning of engineering projects and advertising. Incoming tourism is also regarded as a service export, except that the customers come to you. Upgrading and maintaining aircraft is another service. Not surprisingly, technology is a big part of Israel’s service exports.

There are important differences between the two kinds of exports. Service exports don’t need ports or airports. They are more lightly regulated. They don’t require huge factory buildings or local transportation infrastructure or massive amounts of energy. Services and manufacturing are two different worlds.

Thus you don’t hear from Check Point Software Technologies, the maker of cybersecurity software, about delays at Israel’s ports. Food and plastics makers, on the other hand, are reliant on imported raw material and every delay in their leaving the port costs them.

There’s also a big difference in the level of labor productivity and, therefore, price competitiveness between the two sectors. And because Israel’s service sector is more productive, you don’t hear its leaders complaining about the strong shekel as the industrialists do. Both are affected by the strong shekel, but the service sector far less so.

In manufacturing there’s also a big division – between the strong tier of companies in pharmaceuticals, computers, electronics and chemicals and the weak tier of firms in food, wood products, leather and the like. The added value of the strong tier is twice that of the weak tier. The cries of distress we’re now hearing about the exchange rate are coming from the weak tier, which has come to rely on the Bank of Israel’s forex intervention to stay alive.

Companies like Check Point benefit from the intervention, too, but they don’t really need the Bank of Israel’s help. And that’s an important factor when we ask whether the central bank should start buying dollars again: If the core of Israeli exports is advanced services and the exports are generating strong profits, why should the Bank of Israel be subsidizing them?

Thus when we talk about “exporters” or “industrialists,” we’re talking only about part of Israeli business, not about everyone. We’re not talking about the biggest of them, which account for the lion’s share of exports, or the ones with the most added value and which are employing people with the highest wages.

Israeli industry employs about 350,000 people and its share of the country’s GDP was 13.4% in 2015, slightly under the 16.1% average for the European Union. In Germany it’s 23.1%, so when Merkel talks about industry being the generator of Germany’s wealth, she is right. The same doesn’t apply to Israel.

Our wealth comes from high-tech and finance, less from industry. Manufacturing peaked nearly 20 years ago at 18% of GDP and it’s been on its way down since. The industrialists are loathe to lose their status and dream of a return to an era of import quotas and regulated exchange rates.

Of course, that era came to a bitter end in the middle 1980s because the system was unsustainable. There’s no going back to it.