Due Dilligence / Thinking Our Way Out of the Export Slump

At a time when merchandise exports are in a slump, service exports have been growing.

These are trying times for Israel’s exporters. World trade has growing at its slowest pace in three decades (not counting the peak year of the global recession in 2009) and isn’t likely to pick up much this year. The shekel has appreciated 5% in the past year, making it harder for Israeli companies to compete in global markets. Europe, which is Israel’s biggest export destination, is in a seemingly endless slump.

The World Trade Organization doesn’t offer much in the way of hope for 2014: It has cut its forecast for world trade growth this year to 4.5%, better than in 2013 but less than the 5.6% it was predicting earlier. The economy of Turkey, which despite its angry politics vis a vis Israel was one of our fastest-growing export destinations last year, looks like it is about to crash. Many economists fear that China, the Great White Hope of the Israeli economy, is losing its economic momentum.

Last year, world trade grew a paltry 2.5%, estimates the WTO, but Israeli exports showed no growth at all. For a country so reliant on cross-border trade, this is an intolerable situation. The economy can’t grow sufficiently to create jobs and raise standards of living if a segment that accounts for about 40% of its gross domestic product is stagnant.

In fact, there are two Israeli export stories – one that is a serious problem for Israel and another that is a success story whose potential has yet to be exploited.

Merchandise 
and services

The first story is merchandise exports, which declined last year by 1%, and by 2% if you don’t count exports of polished diamonds. Merchandise exports are tangible goods, whether it is red peppers or semiconductors, grown on farms or made in factories and making their way to overseas markets by ship or plane. They are the kind of things people ordinarily think about when they think about foreign trade and fret about the exchange rate. These are the kind of exports that gives Alon Hassan — the infamous boss of the Ashdod Port union — a stranglehold over the economy.

Merchandise exports are concentrated in a few companies led by Intel, Teva Pharmaceuticals and Israel Chemicals. Each of these companies has their own story for how they succeeded as major manufacturers in Israel, but they are the exceptions to the rule that Israel has not been a successful producer of manufactured goods. Perhaps when enough natural gas goes on line, Israel will be able to develop some energy-based industries based on low-cost fuel but that is nothing immediately on the horizon.

Exports of services are another story. In 2012, they grew 11% and last year increased another 8%, according to the Israel Export Institute. These kind of exports are often ignored because they either are not thought of as exports at all (such as tourism or the sale of startup companies through mergers and acquisitions deals), or inhabit a virtual world where nothing is coming off a production line and loaded on a truck (such as software, banking services on royalties on the sale of a book).

But in money terms service exports are critical to Israel: They reached $33.5 billion last year, equal to more than half the value of merchandise exports. Moreover, exports of services are growing as a percentage of Israel’s total exports – from 29% just three years ago to an estimated 35% in 2013, according to the Export Institute. It seems that service exports are immune to exchange rate pressures.

Startup Nation is the biggest contributor to service exports. Sales of software and information technology services grew 26% last year to $8.6 billion while the value of research and development conducted in Israel by multinational companies climbed 6% to $3.8 billion. Then there were the proceeds from M&A deals, most famously Google’s near-$1 billion purchase of the navigation apps maker Waze. The value of those deals reached $6.5 billion last year, although note that the value accruing to the Israeli economy in terms of service export receipts was just $2.1 billion. M&A earnings have been one of the fastest growing service exports, the Export Institute says, but the fact is that most of the capital invested in startups comes from overseas and when the companies are sold the profits go back there as well.

And there we have Israel’s technology sector in a nutshell. All three categories added up to some $14.5 billion last year, which is more than the $11.6 billion of high-tech goods it exported. Israel’s high-tech sector is lots of thinking and little making. Israel doesn’t have the cost structure, the location, the economies of scale or, it seems, the workplace discipline required to make a go of big industry, even in our supposed forte of high-tech.

That being the case, there must be other ways Israel can export its brainpower, in particular the brainpower of people who are not engineers and scientists. Among the other knowledge-heavy categories of service exports, only professional services such as engineering, legal, accounting and the like carries much weight, accounting for about $3.3 billion last year. Banking and financial services showed a 5% decline to just $660 million and industrial services dropped 12% to $1.5 billion.

Exporting education

One area where Israel is only beginning to exploit its knowledge base is education. The Interdisciplinary Center of Herzliya has pioneered this segment by offering a high-quality, low-cost degrees taught in English. The Technion-Israel Institute of Technology is taking another tack by establishing campuses in New York with Cornell University and in China’s Guangdong Province with Shantou University. Imagine all the academics now teaching at universities in the United States and Europe being lured back to Israel as new tenure-track positions are created by demand from overseas students.

Another area is the arts. This is not as fluffy as it may seem. As it is, export earnings from films, television and music jumped 80% in the three years to 2012, albeit to just $289 million. Israelis have demonstrated an ability to create original television programming, such as “Homeland” and “Rising Star,” and produce films that lure international audiences and compete for Oscars. Israel can’t build an arts and entertainment industry on the scale of Hollywood, but digital media has flattened, globalized and democratized entertainment to the extent that it’s not inconceivable that a Holonywood should not be employing tens of thousands and exporting billions of dollars of video, online games and programming concepts.

Not everything that is knowledge-intensive is exportable. We’re already facing a shortage of doctors, so medical tourism is a non-starter. But online commerce could exploit using Israel’s talent with big data and Internet analytics. Israel’s budding economic ties with China will without a doubt involve less traditional trade in goods, and be much more of a marriage of Israel’s knowledge assets with China’s manufacturing prowess.

And Alon Hassan will have less power to blackmail the economy.

AP