Foreign Investors Flee Israel Amid Regulatory Wave, War Talk

Article Summary
Foreign investors are gradually moving away from Israel — not yet in droves, but it's enough to set the alarm bells ringing for the Treasury. Yedioth Ahronot correspondent Boaz Arad spoke with Finance Minister Yuval Steinitz about his analysis. Sever Plocker reports.

The Treasury is worried. Foreign investors are abandoning Israel. This is not yet a mass exit, and not a crowded push to the door, but the signs herald bad news. First the foreigners sold most of their government-bond holdings, but because they held relatively few of them, those sales did not create a drop in the bonds’ rates. Later, they sold their stocks in a string of leading Israeli companies and minimized their exposure in the Israeli stock market. The sales adversely affected stock rates in general, specifically those of big companies, which foreigners liked to hold. They don’t like to anymore. Now, the Treasury fears, the next stage will be underway: foreign companies will suspend their investment plans in the Israeli market and will look for local buyers for real investments in Israel. They won’t expand; they will reduce wherever they can.

The growth in investments — more than 60% in two years — characterized and led the recovery of the market from the crisis. Finance Minister Yuval Steinitz was proud of that, and rightfully so. More investment means more jobs, more growth, more exports and more competition. Expanding investment attests to the trust that entrepreneurs have in the future of the economy and of the state.

Withdrawal of investment attests, of course, to the opposite. Already in the third quarter of 2011, foreign financial investment in Israel— investments in stocks and market bonds — shrank by $1.7 million, after an almost continuous increase in the two years prior. Real investment also dropped by a few hundred million dollars. In the last quarter, the withdrawal of foreign investors from Israel’s capital market was accelerated, to the point of a mini-crash. The figures on real investment have still not been published, but the Treasury seems to know what to expect, and it’s not good.

What are the reasons for the decline in foreign investment? In conversations with his associates, Minister Steinitz doesn’t hesitate to point out two factors responsible for this. The first, according to the order established by the minister himself, is the “burden of regulation.” The second, he said, is “government talk of an attack on Iran.” Steinitz, as always, is measured and cautious in his speech, and nonetheless he exhibits clear discomfort with the regulatory tsunami currently passing over Israel. In a special interview with our correspondent in China, Boaz Arad, Steinitz  criticized, for the first time, the recent protest against the cost of candy bars. “I don’t recommend turning the protest into a habit,” he said, “where every Monday and Thursday a different company is attacked…an attack on the business community is likely to determine whether people invest here or abroad.” It is not the protests that are hurting the business community, but the over-activity of the government and the Knesset (the Israeli house of representatives). Steinitz supports the state’s involvement in preventing market failures and regulating competition in non-competitive sectors. But he is against the encroachment of the state into the micro-management of business, as is happening now in Israel in dimensions unseen in the west. This encroachment causes foreign investors, especially foreign corporations who have no emotional connection to Israel, to “reconsider their presence in Israel.” Here and there, the Finance Minister and senior officials from his office are pelted with questions about different commissions and their recommendations, with the critical tone rising from meeting to meeting. Israel seems like a state seized by a demon of hyper-government regulation in a most uncomfortable time; who would invest in it?

In extreme cases, the Israeli legislature has tried to offer foreigners exemption from the burden of regulation. They have not been comforted by this. They see Israel as a country working rapidly to ruin its economic achievements, without solving any of its social problems. Additionally, security officials, with the Defense Minister at their helm, speak publicly about a large impending war. This campaign, Steinitz charges in the interview, “was intended basically to result in the transfer to the defense budget another billion or two, but it caused the market strategic damage. In my estimation, we lost because of it foreign investments amounting to tens of billions of shekels.” I tried to clarify to which specific investments he was referring, but the Treasury refused to elaborate, so as not to compromise business secrecy nor “continuing efforts of persuasion.”

Only in the technology field are Israeli companies still managing to sell to foreign ones, but the sales do not exceed the inventory of consumer capital available to the Israeli market. The existing inventory is only changing hands. When Intel announces the establishment of a new factory in Israel, or the expansion of its research-and-development center in Israel, it expands the production capacity of the Israeli economy. But when investment reports go the stockholders of Intel around the world, its real fruits stay here; that is why it is so important for Intel to continue investing here.

Not so with the purchase of an Israeli high-tech startup by a foreign technology corporation. Often, the foreign corporation buys the Israeli startup in order to develop the invention that the startup was based on, and to modify it to meet its own needs. After a few years, the Israeli startup gets swallowed into the belly of the foreign whale. There’s no shortage of such examples. “Israel,” says Avi Hasson, the chief scientist in the Industry, Trade and Labor Ministry, “was the only country in the world whose leading export branch was startup companies. Each year, Israel produces these companies in large quantities and sells them to the highest bidder. The startups are our assembly line.”

The office of the chief scientist in the Trade Ministry is in charge of government policy to encourage industry research and development. The scientist assists, (partially) funds, takes risks and encourages initiatives and innovation. He has at his disposal a research-and-development fund, which is the state’s main source of support for that area. In recent years, his actual budget has been eroded, down from NIS 1.7 billion in 2009 to NIS 1.4 billion in 2011. On the other hand, says Hasson, in the last few months there has been a “dramatic rise” in requests for assistance, and their monetary scope reaches NIS 7 billion. The pressure is heavy and choices are difficult, but Hasson gives preference to assisting companies that are just starting out.

Arad had additional questions for Steinitz:

Arad:  In the past, Israel was a leader in the share of local production dedicated to research and development. What about now?
Steinitz:  Israel is still at the lead, but other countries, especially in Asia, are quickly closing the gap with us. They are increasing their investment in research and development, and we aren’t. Within a few years, they will pass us.

Arad:  The office of the chief scientist is criticized for the assistance you still give to large and strong technological companies. It’s unnecessary, no?

Steinitz:  Not unnecessary. The large companies produce more, directly and indirectly, from every shekel of my assistance. Their national yield is especially high; their activities have industry-wide and market-wide influence. Especially welcome are multi-national companies’ local research-and-development activity. They are responsible for half the business research and development in Israel. However, only 16% of my budget goes to large companies. This year, I’m placing an emphasis on encouraging research and development in the periphery, in the spirit of the new law to encourage capital investments.

Arad:  I heard someone say he would be “happy” if the state didn’t need to encourage business research and development. Would you also be happy?

Steinitz:  No. I’d be sad. The state interferes because there is a structural market failure in industrial and technological research and development: The expected profit to the private investor is considerably lower than the expected profit to the market as a whole. The risk he faces is lower than the risk for the government. Therefore, without government involvement, the level of research and development will be lower — and we’ll all suffer.

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