High Tech, Natural Gas or Small Businesses: What Will Get Israel's Economy Going?

Whether it be high tech, natural gas or mom-and-pop stores — taxes, tycoons and red tape will surely hinder progress.

Energy Minister Silvan Shalom, right, and Yitzhak Tshuva, the controlling shareholder of Delek Group, on a drilling rig, March 27, 2013.
Moshe Binyamin

Regardless of the results of the election in March, regardless of who forms the coalition and who joins, the government will have to do something at which all of its predecessors failed, and that is to create economic growth engines. Israel’s growth may be faster than many other developed nations, but it is far from fulfilling its potential, and if the seeds of growth are not planted now then the harvest in the years to come will be meager.

The most obvious “suspect” as an engine of growth for Israel’s economy is high-tech. The sector has been a growth engine here for two decades and it accounts for 37% of exports, but technology is not a great creator of jobs. Production in the sector has been rising gradually, but the number of jobs it provides has actually declined. In 2013, information technology accounted for 191,000 jobs in Israel, down from 192,000 in 2011.

One reason is that Israeli innovation focuses on creating startups that are eventually swallowed up by multinational corporations. They never become large-scale manufacturers employing thousands of people in Israel. In addition, it’s too easy to move tech operations out of Israel: Welcome to globalization, for good and for bad.

Israel’s tech sector definitely needs a shot of encouragement to make sure it continues to be a key factor in the economy, but it would be a mistake to base the economy on high tech alone. The entry barriers are too high for the average worker — not everyone has the level of education needed to write code or to develop lasers for weapons systems.

So we need to find other growth engines. The natural-gas industry could and should be just such an engine, but it would seem the country is ill-equipped to handle this resource in a way that could make it one. The government made sure, through the recommendations of the Sheshinski committee, which examined fiscal policy on Israel’s gas and oil reserves, to increase its shares of the profit from exploiting the gas, as well as making sure a large part of the gas (60%) will remain available for the Israeli economy and will not be exported — but the government has not yet decided how to make this relatively clean energy source cheap and accessible for local industry or transportation.

The dramatic reversal of Antitrust Commissioner David Gilo this week on the natural-gas monopoly of the Delek Group and Noble Energy was a step in the right direction, but it was only a single step. We must address the enormous power given to this monopoly to stifle competition and raise prices for consumers, as well as the huge power of big business to influence decision making.

The outgoing government has failed in this area. It has not made cheap energy accessible to industries in the geographical periphery, not has it delivered savings to consumers from the introduction of cheaper energy. The next government must do this. The natural-gas discoveries were the most important economic development in Israel in the past decade; if they end up only fattening the wallets of a few big businessmen and their heirs and cronies, it will be a tragedy.

A third growth engine that always comes up in this context is small- and medium-sized businesses. There are studies showing that small businesses are the biggest creators of jobs in developed nations. According to one such study, conducted in 2010 by Davida Lahman Messer and Anat Arbel for the Milken Institute in Israel, small businesses account for 57% of jobs and over half of gross domestic product. It says small businesses created 60% to 80% of all new jobs in the United States since the mid-1990s. Even if these figures are exaggerated, there is no doubt that the potential for small businesses to create new jobs is substantial.

There are some 400,000 small businesses in Israel. If only one-quarter of them were to add a single position, that would increased the workforce by 100,000. That is nice in theory, of course, but in fact many small businesses in Israel fail within two years. The fail rate is high by international standards. According to Lahman Messer and Arbel, only 58% of small businesses in Israel survive more than two years, compared to 74% of all businesses. After five years, only 30% of small businesses in Israel are still on their feet, versus 47% for all businesses in the country.

The reasons small businesses close are varied, but two that stand out are financial difficulties and poor management of credit and customer risks. It is no secret that Israel’s banking system in highly concentrated and does not favor small businesses. The banks will always prefer lending large amounts to a few big customers over issuing many small loans to many small ones. And when banks do lend to small businesses, they charge higher interest rates and heftier fees, as well as demanding collateral and guarantees put heavy pressure on the businesses.

A small business can be a one-person show, performed by someone who is maker, manager, seller and chief financial officer all on their own. Operating a small business is an obstacle race through the swamps of the Israeli bureaucracy and financial system. In order to make this sector an engine for economic growth, much must be done in the way of creating financing solutions and government and municipal incentives. For that to happen, the government must make it a priority. It can start with its own role as tax collector.

Last week the Taub Center for Social Policy Studies in Israel, headed by Prof. Dan Ben David, published its annual report on the state of the nation, in which it discussed — among many other things — the high levels of taxes levied on small businesses. According to the report, the effective tax rate for small businesses in Israel (income tax and value added tax) is 57.8% of revenues, compared to only 51.6% on average for OECD countries.

Then there is the Israeli bureaucracy. According to the World Bank, in 2012 a company in Israel needed 235 hours of work on average to complete the process needed for paying taxes, compared to 163 hours on average in the European Union, 175 hours in the United States and less than 100 hours in certain European states, such as Ireland, Switzerland and Finland.

With such high tax rates, it is clear that it can be very worthwhile to cheat on taxes — and that of course is one of the reasons for the flourishing of Israel’s “black market” illegal economy. It’s a case of chicken-and-egg: The government hinders small businesses with high taxes and bureaucracy, the banks rob them with high fees and interest rates, and as a result they rebel and cheat on their taxes — or the other way around.

P.S.

Some estimate the size of Israel’s “black” at 200 billion shekels a year. Even if the estimate is high, it still means enormous amounts of money are circulating without being taxed. That represents lost revenues for the state, that could go toward improving government services as well as building trust and solidarity within Israeli society.

If the government genuinely sees small businesses as a growth engine, it must create a plan that includes carrots — such as a drastic reduction in red tape, new financing solutions within the banking system and beyond and the introduction of incentives — as well as sticks: real enforcement and tax collection. Such an integrated approach could benefit everyone.