Should Israel Welcome the Flood of Foreign Investment?

Over the last decade Israel has won a place on the global investment map, but the billions flowing into Israel don’t always benefit the economy.

Tomer Appelbaum

Last week a delegation of executives from the German automaker BMW came by private jet to Israel. They stayed just 26 hours, most of that time spent inside the offices of the Israel Export Institute, where they held meetings lasting 25 minutes each with 19 Israeli entrepreneurs.

BMW is on a hunt for advanced technology computerization and new media, fields that have become an increasingly important part of the global automobile industry. Not surprisingly, one of their meetings was with Amnon Shashua, the founder of Mobileye, the giant collision-prevention technology company that went public in the United States this summer.

Motti Ish Shalom, Israel’s economic attaché for South Germany and Australia, said the visit took a year to organize. He set up meetings for BMW’s CEO with Israel’s ambassador to Germany and prepared a list of 150 Israeli companies that might interest them. When Operation Protective Edge broke out in July, all communication stopped.

“We were smart enough not to pursue the connection. [But] when the cease-fire went into effect on a Tuesday, we planned to wait two days before resuming the connection to give them time to digest the news. But by the next morning they were already in touch. We got an email: ‘We apologize, the executives here were on summer vacation in Bavaria and we weren’t able to get back to you on the matter of the visit.’”

Twenty days later, the BMW executives were heading to Israel. And they weren’t the only delegation of foreign investors making their way to Israel after the fighting. Others came from the United States, Europe and China, in visits organized by the local office of the U.S. investment bank Citibank.

“They didn’t come to invest in another day or two, but to look at Israel as a long-term investment option,” says Neil Corney, CEO of Citi Israel. “I asked them if their families were worried when they heard they were coming here. They said they asked a few questions but nothing special.”

The records of the last decade show that Israel is no longer a country where overseas investors dare not go. Warren Buffett bought Iscar; Nestle owns half of Osem; China National Chemical Corporation (ChemChina) controls the agro-chemicals maker Adama; and another Chinese company, Bright Food, is about to close a deal to buy Tnuva from another foreign investor, the British buyout fund Apax Partners.

The biggest symbol

Intel, the U.S. semiconductor company, is perhaps the biggest symbol of foreign investment. In the last 40 years, it has invested more than $10 billion and employs some 10,000 people in Israel. This week, it won government approval for a giant $6 billion expansion and upgrade of its plant in Kiryat Gat. Then there are the hundreds of startups snapped up by foreign companies, most famous among them the social-navigation platform Waze, bought by Google.

In 2013, some $12 billion in foreign investment flowed into Israel, up from $9.5 billion the year before. The record year was 2006, when foreigners pumped $14 billion into the Israeli economy. Relative to its gross domestic product, Israel is placed ninth among countries belonging to the Organization for Economic Co-operation and Development, and 17th in absolute terms.

But Ish Shalom sees a downside, too. “Foreign investment over a decade and a half has been about buying local businesses, but this hasn’t contributed to expanding output. Yes, a lot of money has come, but it doesn’t bring with it technology or new markets,” he says, pointing to Intel as one of the few exceptions.

Foreign investment in real estate presents its own special problems, as anyone who has visited David’s Village, just outside the walls of Jerusalem’s Old City. On a Friday afternoon – a time when most of the city’s neighborhoods are bustling with pre-Sabbath activity – in David’s Village the window shades are down and the streets are empty. Most of the year, the homes are not occupied by the Diaspora Jews who own them.

The last decade has seen a surge of real estate purchases by foreigners, not only in exclusive enclaves of the very rich like David’s Village, but also in central Tel Aviv, Netanya and Ashdod. Foreigners long ago discovered Tel Aviv’s White City Bauhaus district.

In Jerusalem, foreigners have crowded out locals in some neighborhoods, prompting the city to experiment with imposing a higher municipal tax on so-called “ghost” homes. It didn’t work.

“In a certain way it’s easy to understand what is happening,” says Emily Silverman, of the Hebrew University's geography department. “Municipal leaders love the high taxes on luxury homes and builders love the easy money they get from foreign buyers. From the point of view of the municipalities, life is easier if the residents don’t live there. They can provide fewer schools and spend less on parks, because no one is using them.”

Nevertheless, the foreign buyers have accounted for an increasingly smaller portion of the overall real estate market. At their peak in 2005-06, they comprised more than 6% of all real estate transaction. By 2012, their share was down to 4.1%, although in Jerusalem they account for 11% and in Tel Aviv 8.2%.

Not everyone is troubled by the downturn. “Investing in real estate isn’t really an investment in Israel,” says attorney Gadiel Blusztein, who specializes in commercial law. “When a Jew comes and launders his money by buying an apartment on the beach, he’s not contributing a thing to Israel. On the contrary, he causes home prices to go up and that hurts the economy.”

The black years

Avichai Snir, from the Netanya Academic College, has studied the problem. He found that 2008-2010 were the peak years for black capital entering the country because the tax authorities in the United States and Switzerland were cracking down.

Low interest rates were another factor, he says, but less important than the tax shelter advantage since interest rates were low all around the world. “Real estate is simply an excellent option for many who are laundering black capital,” he says.

Alon Shine, an attorney who works with overseas real estate investors, begs to differ. Even if the tax authorities crack down on tax evaders, Diaspora Jews will still buy property in Israel. “Their heart is here whether we want them to come or not. If they don’t invest, then their children or grandchildren will make aliyah and one way or the other their capital will land here,” he says.

Shine also cites Israel’s strong economy and rising anti-Semitism in Europe. “Sure, this summer showed that living here has a risk, too, but there’s a difference between a round of fighting every few years and the fear of leaving your own home or affixing a mezuzah to your door,” he explains.

Foreign investment in Israel’s high-tech sector is very different: The money that flows into the Israeli economy goes to create jobs and increase output. The foreign investors who started arriving in the early 1990s and grew in number as the peace process got underway are the ones that built the foundations of Israeli high-tech.

Today, Israel is the world’s No. 2 destination for multinationals investing in new high-tech products. The investment capital has been flowing in despite the strength of the shekel, the unstable security environment and Israel’s geographical distance from the United States, which is the source of most high-tech capital.

“For years the majority of capital invested in Israeli high-tech has been foreign – 90% of it is foreign investments,” says Eddy Shalev, managing partner of the Genesis Partner venture capital fund. “At the start of the 1990s, Americans began investing here on a large scale, and nothing has changed since. The impact of foreigners on Israel high-tech is unchallenged.”

Investment money for startups comes through two channels – directly through U.S. investment funds; indirectly through Israeli venture funds that raise their capital in the United States. Another source, added Erel Margalit – founder of the Jerusalem Venture Partners fund and now a Labor Party Knesset member – is multinational companies.

“Until foreign companies came, we had research and development here but no one was doing serious business. The Americans brought to the industry a real business and management culture,” says Margalit, whose JVP is among the oldest VCs in Israel.

But there is a downside, too. Israel has had to offer sizable investment aid to lure foreign companies here – most notably Intel, which has been helped to the tune of close to $2 billion on top of tax breaks worth billions of shekels more. Another problem: Tempted by the readiness of multinationals to invest in Israel, many Israeli startups – perhaps too many – sell themselves after developing a single successful product, rather than developing their business and creating more jobs and exports over the long run.

“When a company like Microsoft buys an Israeli company, it’s paying $200 million for its team of developers, but it will make billions from the product,” says Blusztein. “The fact that in Israel companies are sold at their early stages of development and no one tries to increase production or marketing to make more money – that’s simply stupid. The whole world is laughing at Israel because we have such a short-term outlook.”

Part of the problem, asserts Margalit, is that the government and financial establishment don’t encourage small companies to aspire to grow larger.

“To develop something large and independent, entrepreneurs need to be ambitious, investors must be patient and there must be a system that encourages them at the governmental level,” he says.

“In Israel the system isn’t built to support companies like these. The banking system, for instance, doesn’t know how to lend them money or provide them with services needed by this sort of business.”

By comparison with high-tech, financial investment – that is, investment in the stock and bond market – is much more modest. In 2013, foreigners invested $1.5 billion in the Tel Aviv Stock Exchange. Adding in shares of Israeli companies traded overseas, the figure rises to $2.4 billion.

Such a low number reflects the weakness of the Israeli capital market. Even though the TASE’s benchmark shares index, the TA-25, is at an all-time high of about 1,450 points, turnover on the exchange is low, which discourages foreigners who want to be able to get into and out of stocks easily.

The fact that TASE shares didn’t take a tumble in the first days of Operation Protective Edge was less a testament to the resilience of the market than to the absence of foreign investors. In the past, they would have fled in the first days of the fighting, bringing share prices down.

One source in the markets, who asked not to be named, says thin trading is the key reason why overseas investors don’t trade on TASE. “When you buy, you can’t get out because there is no volume. If you check the data, you’ll see that a single stock on Wall Street – let’s say one of the big banks there – has more turnover than the entire Israeli bourse combined,” he says. “If a big investor wants to buy, he’ll also want to sell, and it’s very difficult.”

Alex Zabezhinsky, chief economist at Meitav Dash investment house, notes that foreigners have little presence in the bond market as well. He estimates they account for just 3-4% of trading in government bonds, whereas in many countries the figure is more in the range of 30% to 40%.

“The Israeli capital market doesn’t interest them much: Yields are low, geopolitical risk is high and the market isn’t liquid,” he says.

Margalit has another explanation: The presence of 26 holding groups that control much of what happens in the capital market. “All the pyramids, which I hope are now being broken up, are an abnormal phenomenon. The Israeli capital market is structured in a way that gives an edge to those in the inner circle,” he explains. “That’s not a comfortable situation for foreign investors, and certainly not for high-tech companies.”

During his years at JVP, Margalit helped shepherd 11 companies to initial public offerings on Nasdaq, but none on TASE. “On Nasdaq I felt they knew us, that we’re part of the neighborhood,” Margalit says. “For innovations to come to TASE, the capital market needs to change. Not to act like a junta but to be open and transparent, like the stock markets in Britain and the United States. If we do that, it will increase foreign investment, too.”