Home inFocus Israel’s External Economic and Trade Policy

Israel’s External Economic and Trade Policy

Dan Catarivas

Israel’s external economic ties are fundamental to the health of the State. The Israeli economy is largely dependent on international trade, and import and export of goods and services represent 77 percent of Gross Domestic Product (GDP). The reason is not hard to discern: Israel has a very limited and small internal market, and a lack of natural resources. Therefore the Israeli economy is characterized by importing raw materials, adding knowledge and exporting finished goods with Israeli added value in it.

Geo-political conditions have forced Israel to reach and develop foreign markets and to behave like an “island economy.” With its immediate neighbors long having been hostile states with closed markets (rather than oceans), Israel had to leapfrog across them for both exports and imports. This disadvantage of the first 35 years of Israel’s existence forced decision makers and private sector players to develop an economy able to compete in the developed markets of Europe and North America. “Globalization,” therefore, was practiced by Israel companies and the Israeli government many years before it became a buzz word of the economic world.

For many companies in Israel, foreign markets (i.e. exports) were the major destination from the very beginning—export being synonymous with expansion of sales and growth. Operating on the international scene was therefore very natural. Parallel to the understanding of the companies themselves about where the best markets were, economic decision makers in government developed a formal international trade policy to enhance and support the activities of Israel’s private sector.

Israel and Europe

A multitude of trade agreements were negotiated and signed over many years in order to create the best environment for Israeli exports to flourish. The first major trade partner for Israeli exports was the European continent. Israel understood from the very beginning that Europe would be its best partner for the import of machinery and raw materials and for the export of its finished products.

The first decades of Israeli development were based on export of fresh agricultural products to Europe as well as the export of polished diamonds. Slowly, with the development of industry in Israel, the composition of products shifted to products with more Israeli added value and industrial products, including chemical products and fertilizers. Special trade agreements were signed between Israel and the European Common Market as early 1964, but the real breakthrough in the relationship occurred with the signing of a free trade agreement in 1975. This agreement stipulated a gradual dismantling of all tariff and customs between Israel and the European Common Market over a period of several years, and enabled the expansion and development of trade between Israel and the European Common market. It ensured that Europe and Israel would be major trading partner for many years to come. An expansion of the 1975 agreement was signed later culminating in an association agreement in 1995 that covered many other areas of economic cooperation beyond pure trade, including technological and scientific cooperation.

Despite periodic political disagreements between Europe and Israel, the magnitude, diversity, and depth of the economic and scientific ties between the two sides remains extremely deep.

Linkage between economic decisions and politics in the Israel-EU relationship seems to have been gaining ground in the last few years, complicating relations between the two sides. Nevertheless, the importance of the partnership with Europe cannot be ignored and is definitely to be a constant in the economic external relations of Israel.

Israel and the United States

Aside from Europe, North America—and the U.S. in particular—gained growing importance for the external economic capabilities of Israel especially after the 1967 war. The shift from strong military and political ties with Europe—France in particular—to strong military and political ties with the U.S. had a major influence in developing the economic relationship with the U.S.

The military and political importance of the U.S. in the Middle East region contributed a lot to the development of economic ties between Israel and the U.S. The spill-off and spill-over of military and political ties to economic relations was very significant. The development of the defense industries following the French embargo on arms sales to the State of Israel and the extensive ties with the U.S. military establishment created a climate of intimacy between Israel and the U.S. that contributed greatly to the development of strong economic ties between both governments and private companies.

Since the 1980s, the U.S. been a tremendous partner for the nascent Israel high tech industry. A major step was taken in 1985 when the two countries signed a free trade agreement: the U.S.–Israel Free Trade Agreement was the first of its kind to be signed between U.S. and any country and was an expression of the deepening and strengthening of the relationship.

The Larger World

Considering overall Israeli external relations over the last 30 years, one can see that the U.S. and Europe represent the two major partners and contributors to the development of the Israeli economy. The rest of the world—South America, Africa and Asia—have only started up to pick up as significant trade and economic partners in the last twenty years. Most noticeably are the relations with China, India and Korea in the eastern hemisphere and with Brazil, Colombia, Argentina and Chile in the western hemisphere. In the last twenty years, Israel has tried to institutionalize preferential trade agreements with its new trading partners, and a free trade agreement was signed between Israel and the MERCOSUR (Brazil, Uruguay, Paraguay and Argentina) and Columbia, and between Israel and Turkey. Negotiations are still underway with India, and Israel plans eventually to reach agreements with China and perhaps Korea. There are plans to negotiate agreements with Russia and the Euro-Asia economic community that also includes Kazakhstan and Belarus; negotiations may start soon with Vietnam and Ukraine.

The African continent has also recaptured the attention of both the Israeli private sector and Israeli officials in recent years. In the early 1960s, Israel had extensive relations with many newly established states in Africa that saw in the State of Israel a role model. Unfortunately, after the 1967 War and more so after the 1973 Yom Kippur War, Arab pressure on many African countries seeking an end to their diplomatic ties with Israel was successful, and it put an end to Israel’s relations with many countries in the continent. Only in the mid-1990s were political relations in most cases resumed, but economic ties have developed very slowly. The coming years might bring some expansion of those ties as parts of Africa have shown some considerable economic growth.

The Role of Free Trade Agreements

The overall Israeli international trade strategy is to sign as many free trade agreements as possible in order to facilitate Israeli exports worldwide, and develop and enhance a competitive economy at home.

Israel is a founding member of the WTO and free trade is one of the pillars of its economic policy. The Israeli private sector had therefore to adjust itself and to become extremely competitive both internally and on external markets.

Aside from the aspect of pure trade relations, one must also look at the other aspects of Israeli international economic activities mainly inward and outward investments. The last decades were characterized by growing foreign investment in Israel, primarily the establishment of R&D centers of major foreign companies. As of today, over 300 R&D centers of foreign companies have been established in Israel employing thousands of talented Israeli engineers and workers. Some well-known companies operating R&D centers in Israel include Microsoft, Texas Instrument, Google, ebay, GE, and Yahoo; India’s Tata and Sun Pharmaceuticals; Nestle of Switzerland; SAP and Siemens of Germany; France’s Dassault; and Barclay’s UK.

Taking advantage of the innovative eco-system of the “Startup Nation” parallel, many Israel companies have also set up facilities abroad contributing to the expansion of exports and presence in foreign markets. One major characteristic of Israeli companies abroad has been the listing of Israeli high-tech companies on the American stock markets with some shift also to European markets, particularly London and Frankfurt.

Israel and the Arab World

Another dimension of the Israeli trade scene is its relations with the Arab world surrounding it. Since the signing of peace agreements with Egypt and Jordan, attempts have been made both at the private sector level as well as at governmental level to develop economic ties with our immediate neighbors. So far relations have been relatively limited mainly due to the lack of complementarity between the Israeli market and the surrounding markets of Jordan and Egypt.

Politics and the absence of a comprehensive peace agreement in the region also have a negative effect on the possibility of stronger ties with neighboring countries. However, one must point to one particularly successful agreement between Israel and Egypt: the Qualified Industrial Zones (QIZ) that have just celebrated their 10 year anniversary. The QIZ agreement stipulates cooperation between Egypt, Israel, and the U.S. Egyptian products produced in a U.S.-designated QIZ benefit from custom-free entry in the U.S. market as long as they contain as much as 10.5 percent Israeli added value. Almost half of Egypt’s exports to the U.S. (about $1 billion annually) is produced in these qualified industrial zones, generating over $100 million in Israeli exports to Egypt. This agreement illustrates how economic ties can play a very positive role in developing good relation between Israel and its neighbors.

A similar agreement exists between Israel, Jordan and the U.S., but the signing of the free trade agreement between Jordan and the U.S. made the QIZ agreement redundant. Economic ties between Israel and the rest of the Arab world do exist even in the absence of peace agreements and formal diplomatic relations but their magnitude and importance in overall Israeli foreign trade is almost negligible.

Israel’s economic ties with the Palestinians are the most significant and developed ties Israel has with an Arab partner. Ties are conducted under what is known as the Paris Protocol signed in 1994, governing the economic ties between the two sides. This agreement stipulates a kind of common market with a common custom envelope between the Israel and the Palestinian Authority, including coordination in a vast array of economic fields such taxes, duties, fiscal coordination, standards, and more. Unlike relations emanating from most other agreements, these relations are very much connected to the political and security reality on the ground.

The Challenges Ahead

The overview above gives only a broad picture of the diverse economic ties Israel maintains with the world at large. There is no doubt that both the Israeli government and private sector should pay major attention to maintaining and developing extensive and diversified economic relations around the world—especially when attempts are made to hurt and restrict Israeli activity abroad, as the BDS campaign attempts to do. Such attempts are mostly part of a campaign to delegitimize the very right of Israel to exist and their damage has been minimal. In fact, in many cases factories operating beyond the 1967 lines employ Palestinians as well as Israeli workers. Actions taken against those factories might even have negative effects on the employment of Palestinian workers. The best way to surmount those negative trends is to expand, develop, and diversify Israel international economic activities even more. The more activity we will have abroad the less vulnerable these ties will be.

Our challenge is to continue to expand Israeli activity both via government channels (trade agreements and G-to-G activities), and private sector expansion, whether through investment, joint venture, or trade. Trying to maintain Israeli economic activity abroad separate from political involvement is a major challenge. Europe and the U.S. will probably remain major destinations both for Israeli export and import, but one should not diminish the importance of new emerging markets. Special attention should be given to developing the right tools and environment to make the expansion of Israeli activities a major priority, both of government and private sector alike.

Dan Catarivas is the Director of the Division of Foreign Trade & International Relations for the Manufacturers Association of Israel (MAI).