Why Can’t Israel Grow More Big Companies Like Check Point?

Global experience teaches that the best corporate fertilizer is a combination of tax breaks and government grants.

There are 135,000 companies operating in Israel, but fewer than 40% of them are profitable, according to an analysis conducted by the State Revenue Authority.

In fact, nearly all the profit is concentrated in a very small number of firms. The 500 companies in the top 1% earned 62% of the revenues earned by all Israeli companies. And the trend is only becoming more extreme: The top 1% of companies increased their profits from 2004 to 2009 by 128%. Just five companies – Israel’s biggest manufacturers, and mainly the top four: Teva Pharmaceutical Industries, Intel Israel, Israel Chemicals and Check Point Software Technologies – were responsible for a large chunk of that. In the same period, the other 99% of Israeli companies suffered a steep drop in profits.

There is no doubt Israel has too much business concentration; there are too few big, successful companies. “The fact that some 50%-60% of corporate tax revenues are from no more than 500 out of a total of 130,000 companies makes the collection of corporate taxes in Israel more volatile,” warns the 2012 State Revenue Authority report.

While we can take some comfort in the fact that we are not alone in this – in Britain, for example, the top 1% of companies pay 78% of all corporate taxes that are collected – but considering the size difference between the Israeli and U.K., economies, this is cold comfort indeed. In Britain even the topmost corporate crust is adequately large and diverse, in contrast to Israel.

In Israel the top 1% of companies is quite restricted, mainly because of the outsize proportions of the four biggest exporters. Even a small nick in the growth of Intel, Teva or Israel Chemicals is enough to plunge the entire economy into trouble.

“Why was Check Point the last big company to grow here?” asks Nahum Itzkovich, the director of the Economy Ministry’s Investment Center, the agency that issues grants to encourage investment in Israeli industry. He notes that Check Point was founded back in the mid-1990s.

Itzkovich has now put this question to a committee headed by Finance Ministry Director General Yael Andorn and tasked with examining the efficacy of the benefits codified in the Law for Encouragement of Capital Investment. Itzkovich’s own answer, in part, is that the law is ineffective in attracting investment to Israel because it relies on only one tool, tax breaks.

Help the small businesses

Check Point seems to prove this point. It’s a tech company that grew in the relatively well organized support system of the Israeli tech sector. Venture capital funds and the Chief Scientist’s Office assist young technology firms with both financing and administrative support, such as dealing with global markets. But what about a small Israeli factory in a different sector? What aid does it get, and what chance does it have of reaching markets abroad?

The main benefit from the state to such a company is a tax break: As soon as the business exports more than 25% of its production it qualifies for a significant tax break under the Capital Investment Law, reducing its corporate tax liability from 26.5% to just 9%-16%. But to be eligible, this small company must first be profitable, and capable of exporting a quarter of its production. How is it supposed to reach this stage?

To bridge the gap, the Investment Center is launching a pilot program in which it will guide small manufacturers to help them to become exporters. Experts from the agency will help the companies to draft business plans, Itkovich explains. They will provide managerial support and also grants, to fund the investment needed to reach foreign markets.

The lack of such a program is preventing small companies from growing, Itzkovich says. “The Chief Scientist supports startups and helps them to develop patents, but what happens when the development succeeds and you want to build a factory for production? There is no one support the establishment of a factory since Israel is basing [its support] on tax benefits, without enough grants,” says Itzkovich.

Over the past decade the budget for grants of the Investment Center has been cut sharply. It has fallen from 930 million shekels ($266.2 million) in 2002 to a low of 200 million shekels in 2013 (of which 300 million shekels was a grant to Intel). In the same period, the value of the tax breaks provided in the Law for the Encouragement of Capital Investment rocketed to a record high of between 7 billion shekels and 8 billion shekels. The sharp cutbacks in grants stemmed from the Finance Ministry’s desire to cut costs as well as its lack of faith in the ability of its own Investment Center to invest wisely.

Low productivity and low wages

Over the years, the Investment Center has earned a reputation for being bureaucratic and for mostly funding the establishment of low-tech factories, with large numbers of employees but with low productivity and low wages – exactly the kinds of workplaces that have given Israel’s geographic and socioeconomic periphery its bad name. This, in addition to the suspicions of corruption that have accompanied the activities of the agency, which has distributed government funds as it sees fit.

Former Prime Minister Ehud Olmert was convicted of breach of trust in a scandal that occurred when he was minister of industry, trade and labor, for showing favor to associates in disbursing grants.

The treasury thus had excellent reasons not to trust the Investment Center, and to suspect the grant funds were used inefficiently at best and illegally in the worst case. The question is whether to stop giving out these grants, as has happened in practice in recent years, or to rehabilitate the agency.

And that’s where Itzkovich comes in. He says the grants were in fact much more effective than they appeared. Above all, he argues that the Investment Center has learned its lessons. He notes that productivity and innovation now account for 30% of the score by which applicants are evaluated. In addition, there is now a clear preference for small and new companies, with the goal of turning the grants into a tool for encouraging the establishment of innovative, high-quality factories.

According to Itzkovich, Israel has no choice but to revive the Investment Center’s activities if it wants to find and grow the next Check Point. Research from around the world shows that most of the growth in employment comes from building new enterprises, not from expanding existing ones; tax breaks do not encourage new enterprises, he says. New factories needs help to reduce risks, and only government grants can do that, Itzkovich says. All over the world investors receive packages that include tax breaks and grants; even Intel chose a combined track in Israel rather than settling for tax breaks alone, he notes.

Total investment is shrinking

Another sign of the decline of investment in Israeli industry is the drop in the proportion of Israel’s gross domestic product that is invested in the sector, from nearly 4% in the mid-1990s to an average of about 2.5% over the past decade. Only Intel’s investments helped to raise the average slightly. True, most of the investment in industry is from the private sector, but according to a strategic analysis by the Investment Center, there is a direct link between the decrease in state involvement in industrial investment, due to the cuts in grant money, and the decline of private investment. The inability of entrepreneurs to share the risk with the government, especially in the case of large investments in traditional industries, has reduced their appetite for investment in general.

Failure to attract big multinationals

An additional failure of the Capital Investment Law is in drawing large multinational firms to Israel. Only two such firms, Intel and TowerJazz, built significant manufacturing plants in the last decade.

Israel thus lags well behind other countries such as Ireland, which has attracted much more multinational investment than Israel. Even after discounting for the greater geopolitical risk in Israel as well as Ireland’s membership in the European Union, it’s still hard not to be disappointed by the failure of Israel’s enormous tax breaks in attracting more multinational investment.

Search committee for foreign firms

In addition to emphasizing the importance of bundling grants and tax breaks together, Itzkovich proposes that Israel follow Ireland’s lead and establish a kind of executive search committee that would actively approach big multinational companies and try to attract them to the country, rather than passively waiting for firms to show interest.

“We need to build a true strategic track here, composed both of tax breaks and large grants, and which speaks to a range of multinational companies in various sectors and of different sizes to try to vary Israel’s production and employment basket,” Itzkovich says.

International experience shows that countries that have acted in this manner have attracted multinational investments, increased employment and productivity and accelerated economic growth. These are exactly the goals the Andorn Committee needs to try to achieve.

Eyal Toueg
David Bachar