Issues and challenges facing Israel`s foreign trade policy makers:

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Marcia Harpaz
20.8.07
Unfinished Draft
Please do not quote without permission of author
Israeli Trade Relations with the European Union: The Case for
Diversification
1. Introduction
With the introduction of the European Neighborhood Policy (ENP) in March 2003,
Israel appears to be facing a real policy choice regarding further economic and
political integration into the European Union (EU). But what exactly is the EU
offering? And at what cost to Israel? Is this a good policy option for Israel? What are
the alternatives? This paper focuses on some of the trade-offs of enhanced integration
with the EU.
As a relatively small and geopolitically-isolated economy, Israel has historically
pursued a foreign trade policy of linking itself to one or both of the two Western
trading blocs as an integral element of its economic growth policy. Close to 70 % of
Israel’s trade is currently conducted with Europe and North America as a result of
trade liberalization through preferential trade agreements with the European
Communities in 1975 (updated to a Euro-Mediterranean Association Agreement in
1995, hereon after referred to as Association Agreement), the US in 1985, EFTA in
1993, Canada in 1996 and Mexico in 2000. (MOITAL, 2006, 55)
The European Union alone accounts for 34% of Israel’s foreign trade, making it
Israel’s largest trading partner. In 2005, Israeli industrial exports to the EU amounted
to 28.7% ($12.25B) of total Israeli industrial exports while Israeli industrial imports
from the EU amounted to 38.6% ($17.35B) of total Israeli industrial imports.
(MOITAL, 2006, 55) Although Israel has already made significant headway in
linking its trade to the EU, the EU’s untapped market potential is still considered
enormous. The 27 EU Member State trading bloc now represents a population of 490
million, almost 2/3 greater than that of the US’s 300 million, and 7.6% of the world’s
population. The EU’s GDP of $13.5 trillion is about 8% greater than that of the US.
(CIA World Factbook, 2007)
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On a global level, against the backdrop of an explosive rise in preferential trade
agreements, Israel is experiencing rapid erosion in the preferences it was granted by
its Free Trade Area (FTA) trading partners as they grant the same preferences to
additional countries, expand preferences to new sectors which are not covered in
Israel’s FTAs such as services, and join large trading blocs that exclude Israel. Israeli
trade may also be affected adversely as its non-FTA partners sign preferential trade
agreements that give preferences to imports from their new partner countries making
them more competitive than imports from Israel on which MFN tariff rates and/or
other non-tariff barriers are still imposed. The World Trade Organization (WTO)
Doha Round talks, regarded as an important means to a more level playing field, are
currently in a stalemate, and even if negotiations are eventually concluded, there is
little hope that they will lead to significant liberalization.
In the face of these global trade challenges and the obvious attraction of the EU
market, some circles in Israel believe that Israel has little choice but to seek deeper
economic integration with a large trading bloc, with the EU as the best choice.
(Harpaz, 2006, ? , Tovias, ? ) This essay takes a contrary view, raising a number of
concerns about the implications of further anchoring Israel’s economy to that of the
European Union.1
The paper is organized as follows. Section 2 briefly discusses one of the inducements
that could potentially generate the highest payoff for Israel, the services sector, and
questions whether the EU offer through the ENP, in fact, constitutes a real incentive.
Next, Section 3 looks at some of the possible costs to Israel. First, the cost of further
integration into the EU is analyzed in terms of risk, based on the argument that Israel
starts with a high level of risk to begin with due to its already high degree of trade
exposure, making it particularly vulnerable to exogenous factors beyond its control.
This risk may then be compounded because, despite the size of the EU economy,
Israel would be deepening its integration with an economy that is considered to be
stagnant in terms of economic growth and competitiveness. But beyond the risk of
further dependence on the EU, Israel is likely to incur additional costs. Two possible
costs are the potential loss of policy space that would result from the ‘intrusiveness’
1
It is beyond the scope of the paper to tackle the possible security motivation for linking Israel to the
EU.
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of the EU regional system, and the linkage with non-trade issues2 that the EU is
extracting as side payment, linkage that at the very least may lead to uncertainty for
exporters and investors.
Section 4 proposes an alternative trade policy option for Israel – a diversification
strategy of securing access to foreign markets through preferential trade pacts with as
many partners as possible, a strategy that has been dubbed ‘promiscuous bilateralism’
with respect to Chile and Mexico. (Baldwin, 2006, 1485). But in fact, Israel, the first
country to have FTAs with both the EU and the US, is probably the pioneer in
pursuing ‘promiscuous bilateralism’ with its long list of FTAs by 2001.3 Now, instead
of confining its pursuit of bilateral free trade agreements to countries linked to the EU
and the US as it has in the past, the paper proposes that Israel should start looking
eastward for new trade alliances.
The following assumptions, admittedly challengeable, underlie the arguments made in
the paper:
1) Preferential trade agreements (PTAs) are now a given fact of global life –
something that Israel, like other nations, must contend with, even though in
theory, PTAs don’t constitute the first best option for the global system or for
a particular country;
2) Government has a role to play in preparing the infrastructure for promoting
foreign trade, including among other things, establishing preferential trade
agreements;
3) Israel is at a significantly different level of development and domestic reform
than its Mediterranean neighbors;
2
Here, non-trade issues does not refer to labor and environment, but rather to foreign policy objectives.
By 2001, Israel’s FTAs included the EU(1975), the US(1985), EFTA (1992), Canada (1996), Turkey
(1997), Mexico (2000),Czech Republic(1997), Slovak Republic (1997), Hungary (1997), Poland
(1997), Slovenia (1997), Romania (2001), Bulgaria (2001), although the latter seven were dissolved
when the respective countries joined the EU. Israel signed FTAs with Eastern Europe countries and
Turkey in order to maintain its competitiveness there vis-à-vis the EU once they signed preferential
trade agreements with the EU.
3
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4) The current policy choice facing Israel constitutes a somewhat unusual case in
integration research because it is questionable whether the commonlyaccepted economic drivers for entering a preferential trade agreement apply:
a) Securing expanded market access is usually an important driving
force in seeking preferential trading agreements, but Israel already has
had close to three decades of access to the EU market for industrial
goods and about ten years access to the new Eastern European
members’ markets.4 Restrictive rules of origin and technical
regulations may have impeded Israel’s access to the EU industrial
goods market to some extent, but probably only marginally. Although
Israel has already been admitted into the Pan-Euro-Mediterranean rules
of origin system,5 it still is too early to tell whether they will benefit
Israeli exports, particularly since they only permit diagonal rather than
full cumulation.6 This makes increased market access in services, not
presently covered under the Association Agreement, all the more
important as an Israeli objective in an enhanced relationship with the
EU.
b) Foreign Direct Investment (FDI) Effect: Preferential trade
agreements are considered to be an important means of stimulating
FDI in a less developed partner, first, because a country that is willing
to sign preferential trade agreement with a developed partner such as
the EU or the US is signaling that its commitment to reform is credible.
Secondly, a new less-developed partner to an agreement or trade bloc
may attract investment from other partners and non-partners as a lower
cost production source and from non-partners to gain access to the
market of the developed partner (i.e., investment in Mexico to gain
access to US market, investment in Poland for access to the EU) The
FDI effect regarding commitment to reform may not be necessary for
Though I haven’t seen studies on this, Israel may even have lost trade in the short run in the East
European markets following the May 2004 enlargement since Israel’s products are competing with
Western European products there.
5
Israel and the EU revised Protocol 4 of the Association Agreement in 2005…(check source)
6
For an excellent description of impediments caused by rules of origin and cumulation see Appendix B
of Mueller-Jentsch 2005.
4
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Israel to attract FDI, since it is already considered to be a highly
attractive economy for FDI. Israel was recently ranked 15 terms of its
2006 Global Competitiveness Ranking and 19 on the Business
Competitiveness Index (World Economic Forum, 2006-7, Executive
Summary), both rankings higher than many of the EU members.
Moreover, Israel has demonstrated that its economy is even strong
enough to withstand shocks such as war. 2006, the year of the war in
northern Israel, saw GDP growth of 4.8% and is expected to grow 6%
in 2007.
c) Lock-in mechanism: Governments often use international obligations
to demonstrate their commitment to irreversible domestic economic
reform. Over the past two-three decades, Israel has already proven that
it is committed and able to implement an autonomous policy of
economic reform that has led among other things, to a relatively liberal
foreign trade regime through the establishment of preferential trade
agreements, unilateral liberalization7 and GATT/WTO commitments;
d) Efficiency effect: Governments use preferential agreements, as well as
multilateral and unilateral trade liberalization to expose domestic
industries to foreign competition forcing them to lower prices, achieve
economies of scale, and become more efficient. Much of the Israeli
manufacturing industry has already been forced to adjust to
international competition from imports due to low or duty free MFN
rates and its numerous FTAs over a period of years.
e) Domestic resistance effect: Governments may use preferential
liberalization, as opposed to unilateral liberalization, as a first stage in
overcoming resistance by domestic industry lobbies. Preferential
liberalization may be easier to sell to vested interests because it limits
exposure to foreign competition and offers access to a foreign market.
Traditional pro-protectionist forces have been subdued to a large extent
7
In 1991, Israel undertook a unilateral Liberalization Plan, abolishing non -tariff barriers and gradually
reducing MFN tariff rates between 1991 and 2000 to a maximum of 8% and 12%.
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as a result of Israel’s three-track trade liberalization policy over the
past thirty years, making the emergence of substantial domestic
resistance to liberalization through new trade agreements unlikely.
Moreover, the Israeli public has internalized the necessity for
autonomous pro-competitive reform in many spheres.
f) Technology transfer (knowledge spillover): Governments are often
attracted to preferential liberalization in order to gain access to
technology not otherwise available both for their own product
innovation and to lower prices of products that incorporate technology
in their products. (Figures on technology in Israel, vs EU)
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2. The EU Offer: European Neighborhood Policy and Israel
What is the ENP really offering Israel? The following section provides a short
background on Israel-EU relations, and then looks at what the ENP is offering by
analyzing the EU/Israel Action Plan regarding the services sector, as it could
potentially generate the highest payoffs for Israel. The section concludes that the
potential gains are questionable in view of ambivalence of the ENP offer, and the
present state of the EU services sectors, which are still undergoing considerable
restructuring as a result of their inefficiency and lack of competitiveness.
Israel and the EU have enjoyed a long history of economic ties. Unable to trade with
its closest neighbors, when Israel started to open its markets to foreign imports and
look for markets for its exports, it turned first to the EC, due to its geographical
proximity, its large market and the complementarity of their respective products. As
early as 1964 and then in 1970, Israel concluded trade agreements with the EC. In
May 1975, Israel signed a free trade area agreement with the EC, covering all
industrial goods and some agricultural products, but under which Israel was permitted
a longer transition period for phasing out its customs duties on industrial imports from
the EC (by January 1, 1989) than the EC (by July 1, 1977).
The Euro-Mediterranean Agreement Establishing an Association between the
European Communities and their Member States, of the one Part and the State of
Israel, of the other part (Association Agreement), is currently the principle legal
instrument governing relations between the EU and Israel. The Association
Agreement that was signed on November 30, 1995 and entered into force on June 1,
2000 replaced the EC-Israel Cooperation Agreement from 1975. The trade provisions
of the Association Agreement were in effect between 1995 and 2000 until all 15 EU
Members had ratified it.
The Association Agreement is more comprehensive than a simple trade agreement
and encourages ties in numerous fields. It not only provides reciprocal duty-free
movement of industrial goods and preferential access for some agricultural products,
but also contains provisions, among other things, on protection of intellectual property
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rights beyond WTO obligations8 (albeit, not to the extent that the US is now including
in its FTAs) and customs cooperation. In addition, the Association Agreement covers
completely non-trade related spheres such as a dialogue and cooperation on political,
cultural and social issues. In some areas such as anti-dumping, the Association makes
reference to WTO rules, thereby reinforcing the Parties’ legal obligations under the
WTO.
Various provisions of the Association Agreement have led to signing additional
agreements that extend the ties between the EU and Israel. For example, the provision
on scientific and technological cooperation (Article 40 of Association Agreement) led
to the signing of a bilateral agreement whereby Israel became an associate member of
the Fourth R&D Framework Program. Israel has subsequently been an associate
member of the Fifth, Sixth and recently, the Seventh R&D Framework Program for
2007-2013. Other such provisions that have led to additional agreements are two
agreements concluded in 1996 further to the provision (Article 35) regarding
government procurement and telecommunications.
The Barcelona Process provides the overall regional context for the Israeli-EU
relationship. In November 1995, with the Barcelona Declaration, the EU launched a
new Euro-Mediterranean policy aimed at promoting the development of the
Mediterranean region: the Euro-Mediterranean Partnership (EMP) or Barcelona
Process. The Barcelona Declaration sets forth three main objectives: I – Political and
Security Partnership; II – Economic and Financial Partnership and III – Cultural,
Social and Human Partnership. The second objective is the one relevant to the present
analysis. Among other things, it calls for the creation of a Mediterranean Free Trade
Area by 2010 through the establishment of individual association agreements between
the EU and each of its 12 Mediterranean partners including Israel.
To date, association agreements have been concluded with Algeria, Egypt, Israel,
Jordan, Lebanon, Morocco, the Palestinian Authority, Tunisia, and Syria. Turkey has
8
In Article 39 of the Association Agreement, the Parties commit themselves to protection according to
the “highest international standards, ” compared to the WTO standards, which are considered
‘minimum standards.’ In addition, Annex VII of the Association Agreement, requires Israeli accession
to a number international conventions, beyond WTO requirements. (find something on this.) Moreover,
recently the EU has made TRIPS-plus requirements a new priority in its FTAs… …
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established a customs union with the EU, and Malta and Cyprus have acceded to the
EU. In addition, as part of the Barcelona Process, the Pan-Euro-Mediterranean
Protocol on Cumulation of Rules of Origin has been adopted by its Mediterranean
partners, enabling diagonal cumulation among the Euro-Med partners. Overall, the
Barcelona Process is not considered to have been an economic success, that is, it
hasn’t led to a significant impact on trade. (Hoekman: 2005, Emerson and Noutcheva:
2005).
The enlargement of the EU from 15 to 25 Members necessitated new thinking
regarding the EU’s newest neighbors, Belarus, Moldova and Ukraine as well as its
Mediterranean neighbors. This culminated in the European Neighborhood Policy
(ENP). The ENP is aimed at countries that are not on the road to membership. For the
Mediterranean partners, it adds a new layer that builds on the Barcelona Process, a
layer that may be considered a potentially deeper level of integration that permits each
country to expand its relations with the EU at its own pace and on an differentiated
basis, so that the progress of one country is not linked to the progress made on the
regional level, as was the case in the Barcelona Process. (EC, 2003)
Within the framework of the ENP, the EU and each of its Euro-Med partner countries
drew up an individualized 3-year action plan to expand on their existing bilateral
Euro-Mediterranean Association Agreement. The EU/Israel Action Plan along with 6
other Action Plans was launched in December 2004.9 Although the EU/Israel Action
Plan aims at strengthening political, security, economic, scientific and cultural
relations, this paper focuses on the economic aspects of the Plan, and in particular,
trade.
While the EU/Israel Action plan calls for going beyond cooperation to economic
integration, it is not entirely clear how far it goes beyond the Association Agreement,
that is, what new incentives are actually being offered to Israel. For one, many of the
provisions of the EU/Israel Action Plan merely reinforce the provisions previously
agreed upon in the Association Agreements.
9
See http://ec.europa.eu/world/enp/pdf/action_plans/Israel_enp_ap_final_en.pdf.
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Let’s take services as an example, since the services sector represents a key sector of
the Israeli economy, and an important component of Israeli exports. In 2004, services
comprised 77% of Israel’s NDP and 76% of employment (WTO, 2006), exports of
services in 2005 amounted to $20B or 36% of Israel’s total exports (MOIT, 2006).
The EU for its part, is the world’s leading exporter and importer of commercial
services. (WTO, 2007, 109)
Because services are not presently covered by the Association Agreement, services
commitments under the WTO for both Israel and the EU are limited, and the WTO
negotiations on further services liberalization are presently stalled, access to the EU
services market could be the principal economic benefit of the ENP for Israel.
However, despite the fact that access to the EU services market could be one of the
main gains of the ENP for Israel, it only rates a few paragraphs in the EU/Israel
Action Plan. Moreover, the EU/Israel Action Plan’s call for the promotion of the
opening of negotiations on the liberalization of trade in services (Paragraph 2.3.2 of
EU/Israel Action Plan) appears to be only one small step forward from the declaration
of intent in Article 29 of the EU/Israel Association Agreement, which calls for
widening the scope of the Agreement to cover right of establishment and the
liberalization of the services sectors. The use of the term ‘promotion’ of the opening
of negotiations demonstrates the lack of concrete commitment to actually hold
negotiations, in addition to the fact that no definite time limit was set for completing
the negotiations (although the Action Plan is a 3-year plan).
Nevertheless, service negotiations on rules are taking place among the Euro-Med
partners in line with a framework protocol for negotiations on services that was
established in 2005 in the context of the Barcelona Process. (Istanbul - ? ) Hence,
although progress of one country is not supposed to be linked to the progress of the
others, the talks that are currently taking place are being held jointly with all EuroMed partners. This suggests two things: first, that negotiating text on rules for trade in
services that is being formulated will be identical for all Med partners even though
they are at different levels of development with different needs and different levels of
existing internal reform; and second, until the rules negotiations are completed among
the Euro-Med partners, no one Med partner will be able to conclude a services
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agreement with the EU, which otherwise might have been possible since market
access is being negotiated on an individualized basis.
Under the above-mentioned framework, market access will be based on a positive list,
similar to the GATS model, (unlike the negative list approach of NAFTA) and apply
to all Euro-Med partners on an MFN basis.10
Moreover, mention is made of ‘progressive alignment’ with the Acquis on services,
though it is not entirely clear what is meant by ‘progressive alignment’, i.e., what
degree of harmonization is called for?
The EU/Israel Action Plan specifically mentions the financial services sector. The
financial services sector is considered to be one of the critical sectors to infrastructure
or the ‘backbone’ of any economy; other such services include telecommunications
and transport. Because reform in these services is essential to the overall development
of the economy, Israel has already undertaken significant autonomous domestic
reform. In addition, Israel adopted both the Fourth Protocol (on telecommunications
services) and the Fifth Protocol (on financial services) to the GATS, in which it has
locked in reform by taking on specific commitments.
There seems to be slightly more progress from the Association Agreement to the
EU/Israel Action plan in the financial services in comparison to the overall services
sector. The EU/Israel Action Plan calls for carrying out an “assessment of the scope
for legislation approximation with a view to inclusion of this sector in a FTA and
ultimately Israel’s participation in the European Single Market for financial services”
while the Association Agreement had only called for cooperation on the adoption of
rules and standards. (Article 48). But even here, it appears that Israel still has
numerous hurdles to overcome before it will achieve ‘participation in the European
Single Market for financial services.’ Here again, what is intended by the term
“legislation approximation”? Is it necessary for Israel to completely transpose EU law
into its national legal system? It seems that use of the word ‘approximation’ would
10
See Hoekman, 2005, 24-5 for a discussion of the pros and cons of a positive list approach. Though it
permits flexibility, a positive list approach provides transparency only in the sectors that are covered by
the commitments and thus a negative approach might be preferable for transparency purposes.
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imply less than complete transposition. In any case, it can be claimed that such a high
degree of harmonization is unrealistic and even undesirable. What appears to be most
important is domestic reform and multilateral commitments, rather than regional
initiatives. (Muller-Jentsch, 2005).
Finally, a general note on the services sector in the EU: the EU is itself undergoing
significant reform towards creating a single internal market because its market is still
characterized by high barriers to trade, including lack of cross border competition,
monopolies, inefficiency and different regulation across Member States. (WTO,
2007,109-110, OECD, 2005, Shelburne, 2005, 27). Under the Directive on Services in
the Internal Market that passed the European Parliament in November 2006 (Financial
Times, 2006), the deadline for removing regulatory and administrative obstacles to
trade is only 2010. (WTO, 2007, 109). As for financial services, progress towards a
unified financial market has also been moving slowly, leading to the formulation of a
new five-year financial services strategy in December 2005. (WTO, 2007, 112)
The state of flux of its Internal Market in the services sectors may explain the lack of
clarity regarding services in the EU/Israel Action Plan. For the same reason, it is
unlikely that the EU will be able to grant meaningful market access, beyond what it is
willing to offer in the multilateral framework. This reinforces the uncertainty
regarding the expected benefits of the EU offer under the ENP, at least in the shortrun. Finally, the EU can slow down the talks quite easily by prolonging the
negotiation process of defining ‘progressive alignment’ or ‘legislation
approximation’ in Israel’s financial services legislation.
To summarize, the following three main concerns arise: 1) The language in the Action
Plan in the services sector, an area of significant interest to Israel, is ambiguous as to
what is expected of Israel; 2) Israel, at a different level of structural reform, is still
linked to the timetable and rules of the other Med Partners; 3) The EU itself is not
considered competitive and is still evolving so it is not clear when and what Israel is
being offered in the framework of the EU/Israel Action Plan.
Interestingly, where the EU has found it expedient, such as in Research and
Development (R&D), it has not needed the ENP to promote EU-Israel relations, nor
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was Israel required to harmonize its laws as the EU is mandating in other fields. Israel
was invited to be associated with the R&D Framework Programs as early as 1996.
Though it is an honor, Israel pays a lot for the privilege; to join the Seventh
Framework Program (2007-2013), Israel has agreed to contribute 63M Euros
annually. According to the European Commission, “the EU is Israel’s second biggest
source of research funding.”(EC, 2007b) But despite having full access to the program
and making a large annual contribution, Israel is still not permitted to be involved in
the decision-making process. Two questions arise: What does this portend for Israel’s
participation in the other Community programs and bodies being offered in the ENP
framework? And should the Israeli Government be devoting such a big portion of its
R&D budget to themes and projects defined and decided by the EU, rather than
directly on Israeli R&D?
.
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3. Increased Dependence on Trade with EU: A Risky Proposition
For Israel, increased dependence on trade with one trading bloc and particularly with
the EU is a risky proposition. Let’s start by examining the characteristics of the Israeli
economy. Israel’s small size in terms of population (though its classification as a
small economy is debatable) and land area, its geo-political isolation and its limited
natural resources have propelled it to turn to distant markets for production inputs,
consumer products and advanced technologies as well as for selling its own goods.
From a policy of import substitution and protectionism that characterized its early
years, by the 1970s Israel had embarked on a path of trade liberalization as an integral
part of its national development policy. Its foreign trade policy has taken three
complementary tracks with special emphasis on the bilateral track:

multilateral – Israel joined the GATT in 196211 and became an original
member of the WTO in 1995 (WTO, 2006);

bilateral – Israel signed its first trade agreement with the EC in 1964, then a
preferential agreement in 1970, an FTA in 1975, then one with the US in
1985, followed by a long list of FTAs;

unilateral – In 1991, Israel implemented a liberalization plan that abolished
quantitative restrictions and gradually reduced tariffs between 1991 and 2000
towards industrial goods from third countries (goods eligible for MFN rates).
This plan particularly affected trade with Asia; imports from Asia increased
from about $1B in 1990 (7% of total imports) before the implementation of
the plan to $5B in 2000 (14.5% of total imports) at the end of the liberalization
plan, and since then, to $8B in 2005 (18% of total imports). (MOIT, 2001, 52,
MOIT, 2006, 55)
11
It must be noted that trade was not the only impetus for joining GATT. Since its establishment in
1948, one of Israel’s main foreign policy goals has been international acceptance; accession to
international institutions has always been considered an important means for achieving this.
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This three-pronged trade liberalization policy has been directed, among other things,
at creating cheaper prices, better selection and higher quality for consumers and
increased competitiveness of Israeli products on domestic and foreign markets from
lower costs of production through cheaper inputs, specialization, gains from
economies of scale, competition, and more efficient domestic production. As a result
of its trade liberalization policies and the resulting economic benefits, foreign trade
has become a major driver to Israel’s economic growth.
Indeed. Israel has become one of the most open economies in the world, as indicated
by its high trade to GDP ratio. According to WTO statistics, Israel’s trade to GDP
ratio was 86.8% between 2003-5. This can be contrasted to that of the US (24.4%),
India (36.7%), China (64.5%), UK (54.5%) and Germany (71/3%) and Switzerland
(91.7%). (WTO Statistics Data Base)
Paradoxically the very same openness that has proven to be so beneficial to Israel’s
growth, leaves the Israel economy especially vulnerable to exogenous factors that can
potentially have an adverse effect on its exports, imports and FDI. A slowdown in the
economy of one of its trading partners is a key example of a global economic
disturbance that could have a direct negative impact on the Israeli economy. Due to
Israel’s high degree of trade exposure to trade with just two partners, the EU and the
US,12 a slowdown in either one can be expected to lower the demand for Israeli
exports, and in turn, lower the growth rate of the Israeli economy. Immediately
following (during) the correction in the US housing market in the summer of 2007,
that led to revised downward estimates of US GDP growth to 1.9% in 2007 from
2.9% in 2006, Morgan Stanley revised its growth estimates downwards for the Israel
economy from 6% to 5.6% in 2007 and from 5.5% to 4.4% in 2008. (Morgan Stanley,
2007)
Unlike the US, the European economy is not facing a temporary downturn, rather it is
characterized by a more chronic problem of stagnant economic growth. Much has
been written about the EU’s poor economic performance over the past two decades.
Some 29% of Israel’s exports go to the EU and 38% to N. America (MOIT, 2006, 10). If we take the
entire European trading bloc(25+EFTA), about 35% of Israel’s exports went to Europe in 2005.
12
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Indeed, it has even been dubbed the ‘sclerotic continent’.13 While the US has been
growing, the EU has been losing competitiveness steadily, in both high tech (to US
and Japan) and lower-end manufactured goods (to emerging Asian economies). This
has been partially attributed to the low European investment in R&D (less than 2% of
GDP compared to 2.68% in US (OECD, 2007, 15)) as well as in higher education (a
huge gap exists between the US – 2.6% of GDP and the EU – 1.2% of GDP) and its
lack of researchers (Tilford, 2007)
Rigid labor markets, the EU’s poor institutional design, demographics (slow
population growth) and low productivity all add up to economic stagnation according
to Robert Shelburne of the UN Economic Commission for Europe. In his view, the
prognosis for improved overall economic performance is not good in the short or
medium term and is even worse in the long run. (Shelburne 2005, 29) To counter this
economic stagnation, in March 2000, the EU had launched the Lisbon Agenda aimed
at making it “the most competitive and dynamic knowledge-based economy in the
world” by 2010”14 but economic growth continued to decline. Following a mid-term
review in 2005, the EU simplified and narrowed the Lisbon goals focusing more on
boosting employment and economic growth rather than on environment and social
protection.(Groom, 2005) But although EU GDP grew by 2.9% in 2006, the Lisbon
Agenda is not considered by economists to be the main driver of its recent increased
growth rate; the improvement has been attributed to a cyclical upswing and an
improvement in Germany’s competitiveness both of which may only be short-term.
(Economist, 2007) The uncertainty related to the long-term growth prospects of the
EU economy adds to the trade exposure risk for Israel. Becoming more dependent on
Europe as deeper integration would suggest, simply does not make sense.
Just as investors are advised to balance their portfolio with investments of various risk
levels in order to lower the overall risk of their portfolio (rather than hold similar lowrisk investments), an individual country should consider the trade exposure risk it
13
For a good though brief overview of the problems faced by the EU economy see Economist, 2007.
This article does point out that not all countries in the EU have shown slow growth: Denmark, Finland
and Sweden have performed extremely well, while France, Germany and Italy, which account for 2/3
of the EU’s GDP have brought down the growth average of the region.
14
For European Commission summary of Lisbon Strategy, see
http://europa.eu/scadplus/glossary/lisbon_strategy_en.htm.
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sustains in limiting its trade and investment base to too few partners, or partners with
similar economic growth rates15 and/or partners with correlated growth.16
Israel, presently highly vulnerable to what happens in the EU and the US
economies, can mitigate its trade exposure risk through a strategy of diversification,
that is, spread its risk by forging trade links with different foreign markets.
Integrating more deeply into the European market will only increase its trade
exposure risk.
[add here something about ‘promiscuous bilateralism’ as alternate strategy]
Some other concerns
a) Policy Space
In considering whether or not to link itself more closely with the EU economy, two
additional concerns may arise: the loss of policy space and linkage of foreign policy
issues with trade issues.
Let’s start with the loss of policy space. As mentioned above, the exact extent of
harmonization of its regulatory regimes that is going to be expected of Israel is not
entirely clear from the language of the ENP and the EU/Israel Strategic Plan. The
terms ‘approximation’ of laws and ‘progressive alignment’ are ambiguous and openended.
There are a number of options for harmonization. In discussing deeper integration of
the Mediterranean Partners with the EU, Mueller-Jeutsch suggests that harmonization
options might include the full adoption of the EU’s rules, mutual recognition of rules,
defining minimum standards for both sides, or adopting the rules of a third party
(international best practices such as in accounting), and concludes that the option
15
The 30 OECD countries are predicted to grow by 2.7% in 2007 and 2008. (OECD, 2007, 1)
In an economically integrated world, this may be a difficult goal to achieve, however, it still may be
possible to identify countries whose economies that are less driven by exports (driven by domestic
consumption-China is attempting to move from an export driven economy to one driven by domestic
consumption) or whose economies are less correlated to the US and EU economies.
16
17
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chosen should be determined selectively according to policy area and priority sector,
in view of the complexity of full harmonization, and high negotiation, transition and
compliance costs. In some cases, domestic reform may even be sufficient. (MuellerJeutsch, xiv) He stresses that the optimal degree of harmonization is not necessarily
full transposition of the acquis communautaire, as was required of the acceding
countries in the EU enlargement. (Mueller-Jeutsch, 24)
From a comparison of the full transposition undertaken by the Eastern Europe
countries with the NAFTA model, and taking into account GATS obligations,
Mueller-Jeutsch determines that sectors such as transport benefit from domestic
reform and regional integration, whereas in the financial services and
telecommunications sectors where the GATS is very developed, domestic reform with
multilateral commitments is preferable.(Mueller-Jeutsch, xvii) In line with this
analysis, since the reform process in the telecommunications sector is fairly advanced
in Israel, and Israel has undertaken strong multilateral commitments, it would not
benefit from harmonization or even regulatory coordination with the EU but rather
continuation of its present policy promoting competition in the sector.17`
What is behind the high costs of negotiating, moving to, and complying with EU
regulation? According to Francesco Duina, in contrast to preferential agreements
such as NAFTA that is ‘minimalist’, the EU itself is highly intrusive, covering 80,000
pages of law, since it is composed of states from a ‘civil’ rather than a ‘common law
tradition.’ “The former is more idealistic and rigid, the latter more pragmatic and
flexible.” (Duina, 2005, 4) Its intrusiveness extends to every facet of life in the EU,
including the definition of nighttime. (Duina, 2006, 78) Will the religious community
in Israel ever be willing to permit the EU to dictate the definition of nighttime?
Deepening its integration in the EU would also limit Israel’s policy space for
development. Although the WTO limits the industrial policy instruments its Members
can utilize in contrast to the GATT, regional agreements constrain them even more. In
a study of NAFTA and the US’s more recent FTA agreements in comparison to the
WTO, Kenneth Shadlen argues that WTO-plus provisions freeze existing comparative
17
For description of telecommunications and postal services sector in Israel, see WTO, 2006, xix, 8487 159-60.
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advantages rather than promoting new productive capacities and altering comparative
advantages. In this way, they prevent countries from climbing higher on the
development ladder. (Shadlen, 2005, 752) 18 In his view, one area where regional
agreements have become most constraining is in intellectual property protection.
True, the WTO intellectual property regime reduces development policy options, but
the US’s recent insistence that its regional/FTA partners exceed the WTO level of
patent protection, affects not only public health but technology learning and industrial
development. (Shadlen, 2005, 760-762)
The intellectual property provisions of the EU/Israel Association Agreement already
exceed WTO standards. Article 39 of the Association Agreement calls for intellectual
property protection in “accordance with the highest international standards” while
WTO standards are considered minimum standards. Moreover, Annex VII of the
Association Agreement commits Israel to acceding to a number of multilateral
conventions that go beyond WTO standards. Although intellectual property is
mentioned only briefly in the Action Plan as a key area, it could be a source of
contention between the EU and Israel in future negotiations towards deeper
integration,19 in the same areas that are bones of contention between the US and Israel
such as data protection.
In view of the limited coverage of the WTO TRIMS Agreement under which many
pro-development tools are still permitted such as the possibility of requiring
technology transfer of foreign firms, joint ventures or local partner, and regulation of
hiring, preferential trade agreements may significantly restrict a country’s autonomy
in promoting development through investment. (Shadlen, 2005, 759) This may also
prove true with Israel because both the Association Agreement as well as the
EU/Israel Action Plan relate to investment. Article 29 of the Association Agreement
calls for widening the scope of the Agreement to cover the ‘right of establishment’ as
18
Some of the examples he uses are note relevant to Israel and the EU. For example, he notes that it is
still possible to use drawbacks under the WTO, which are not defined as subsidies under the WTO but
are in fact payments to producers. (Shadlen, 2005, 758). Israel in its Association Agreement with the
EU relinquished the right to give drawbacks. See Article 16 of Protocol 4 Concerning the Definition of
the Concept of “Originating Products” and Methods of Administrative Cooperation.
19
The Action Plan calls for enhancing “dialogue on the promotion of IP issues, including for example,
data protection, enhancement of enforcement through a dialogue with prosecutors and other relevant
entities, etc.”
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does Paragraph 2.3.2 of the EU/Israel Action Plan. The services negotiations under
the Euro-Med initiative and the ENP will also have an impact on investment policy
space.
While Israel has an open investment regime, and even provides more favorable
incentives for foreign investors than it does for local investors, it does apply
restrictions on foreign ownership such as in the telecommunications sectors, as well
as on land ownership. (WTO, 2006, 12) These kinds of restrictions and other types of
development tools may not be possible following further integration with the EU.
Israel is not likely to relinquish its right to deny foreign investment based on security
considerations, and indeed inserted this as a reservation to its position under the
OECD Declaration of International Investment and Multinational Enterprises,
adherence to which is voluntary. (OECD, 2002, Annex 2) Limitations on Israel’s
subsidies may also affect its ability to attract FDI…
b) Linkage of Non-Trade Issues to Trade
Now for a few words on the risk of the EU linkage of its political agenda to trade. The
EU/Israel Action Plan clearly links political co-operation and economic integration; in
the very first paragraph of the Introduction to the EU/Israel Action Plan, the
reinforcement of “political and economic interdependence” is called for, as well as a
“significant measure of economic integration and a deepening of political cooperation.” (Action Plan,) In a speech in Jerusalem, in February 2007, Commissioner
Ferrero-Waldner also linked economic integration and political dialogue leading to
the future possibility for Israel “to align with the EU CFSP declarations, the coordination of positions on international issues, and co-operation in crisis management
operations.” ( European Commission, 2007a)
Despite the long-standing EU-Israel trade relationship, the EU’s ongoing criticism of
Israeli policy towards the Palestinians has led to the Israeli perception that EU foreign
policy is clouded by an unbalanced political agenda, and that this agenda has spilled
over to the trade front. In 1997, the EU concluded a separate trade agreement with the
PLO over Israeli objections, and in contrast to the approach taken by the US that
avoided a formal agreement with the Palestinians by taking a unilateral declaration
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extending free trade to the Palestinians under the Israel-US Free Trade Agreement.
Then, to bring additional pressure on Israel regarding the Palestinian issue, the EU
cancelled the preferential status of Israeli products exported from the settlements
under the rules of origin stipulated in Protocol 4 of the Association Agreement.
Professor Moshe Hirsch has concluded that, in contrast to a similar case involving
imports from Taiwan, in which the EU managed to avoid questions of sovereignty, in
the case with Israel, the EU permitted its political agenda to color the legal
interpretation it gave to the provisions of the Association Agreement. (Hirsch, 2003)
(also threat of EU not to let Israel join pan-european rules of origin)
Such measures can be considered to be a kind of economic sanction, aimed at
compelling Israel to change a non-economic national policy, namely its policy
regarding the Palestinians. Is this an effective way for the EU to achieve its goal?
Researchers have not reached a consensus on the likelihood of economic sanctions
succeeding (Hufbauer, Schott and Elliott –new version?) Moreover, we have to ask
how can such a simplistic approach even be expected to solve such a complex
problem, one that has existed for decades, involves more than one party and is
considered to affect the core of the very existence of the State of Israel? In fact, we
can’t even be sure what the EU’s objective is in using economic sanctions as leverage
over Israel. If it wants to raise its profile in the Middle East by strengthening its
influence over Israel, its approach is counter-productive since it merely reinforces
Israel’s conviction that the EU’s agenda is unbalanced. In any case, the result is an
uncertain and unpredictable business climate for both exporters and foreign investors,
an approach that disrupts trade rather than promoting trade.
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4. Diversification and the Israeli Trade Agenda
That brings us to the question, if not Europe, where? What markets should Israel be
looking at? While the EU has stagnated, new players such as Brazil, Russia, India and
China (the ‘BRIC’ countries) are rising rapidly in the global market. China and
India’s growth rates are more than triple those of the EU and the US.20 By 2030,
China will account for over 18% of global purchasing power, and India is projected to
be half that size. In terms of demographics, the share of the West as percentage of the
world population is expected to decline from 30% to 16% by 2030, and Asia is
expected reach 58% of world population. (Check source) With one of most liberal
trade regimes in the WTO, China is already the third largest global importer of
merchandise, in 2005 its imports grew 18% while India is the eleventh largest global
importer of merchandise, in 2005 its imports grew by 39%. (WTO, 2006, Int Trade
Statistics, Table 1.6)
At the same time (2005) less than 3% to Israel’s total industrial exports went to India,
while only 2% of Israel’s total exports went to China. Exports to both these countries
decreased slightly in dollar terms between 2004 and 2005. (MOITAL, 2006, 55) The
potential is there, the question is what should the Israeli government to promote trade
and investment with Asia?
Their new power is also reflected in WTO. It used to be the ‘quad’ that ran the
multilateral trade negotiations – US, EU, Japan and Canada. Now they have been
replaced by 5 interested parties – US,EU, Australia, Brazil and India who were able to
mediate restart of Doha round talks in July 2004.
Israel is now ready to turn eastward from a domestic standpoint. In the past, domestic
industry lobbies would have objected strongly to preferential trade agreements with
Asia. Now, as in Mexico and Chile, Israeli trade policymakers should meet with little
resistance by domestic industries when seeking access to additional export markets
through new preferential agreements. After over a decade of exposure to imports from
20
Both the US and European growth rates have been lagging significantly behind those of India and
China, which grew at estimated rates of 9.2% and 10.7% respectively in 2006. (World Factbook, 2006)
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the Far East through low MFN rates, as well as duty-free imports from FTA partners
in Eastern Europe, Turkey and Mexico, the Israeli economy has adjusted. Industries
that are not competitive on a global level, have simply been eliminated. For example,
the textile industry has seen its number of employees fall from 43,000 in 1995 to
24,000 in 2004. (WTO, 2006, 73)
On the other side of equation, the export side, there is still a lot of potential for growth
in exports to Asia. As noted above, only 5% of Israel’s exports went to China and
India, though even without signing preferential trade agreements, exports to Asia have
grown significantly more in the last 15 years than they have to the rest of the world.
Between 1990 and 2005 exports to Asia have grown 294% compared to the rest of the
world where exports have only grown 262%. (MOIT, 2001, MOIT, 2007)
Israel’s competitiveness, particularly in high tech and water technology make it an
attractive trade and investment partner for China and India. Israel discovered some
years back that developing countries look to establish free trade agreements with
Israel because FTAs are associated with FDI – they think that if they sign agreement
with Israel, they will get FDI from Israel.
Israel has the advantage of being more flexible in negotiating trade agreements than
the bigger players such as the EU and the US. For one, Israel won’t make as many
demands as the big players make – in rules or in market access. For example, Israel
has an enormous advantage over the EU and the US regarding rules on intellectual
property rights. Israel is not in a position and probably has no interest in imposing
TRIPS-plus provisions on potential trade partners. Though Israel does have problems
with countries like China regarding IPR, actual compliance with TRIPS would be
enough, and the US and the EU have a lot more leverage than Israel. The same should
be true of trade defense instruments, particularly in light of the WTO-minus
commitments China took on when joining the WTO, which permit other WTO
members to impose safeguard measures selectively to its exports in contravention to
the MFN rule applicable to other WTO Members, as well as making it easier to apply
anti-dumping and countervailing duties. (Harpaz, M. 2007)
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Where should Israel start? Between India and China, China looks to me to be a better
choice. China is growing faster with more potential for growth. India has real
problems in infrastructure – roads, bridges, airports, no reliable power or clean water,
as well as problems with ports. India is where China was 10 years ago in
infrastructure development. China invested in infrastructure and moved ahead and
will stay ahead – it is putting 9% of GDP into public works, India is only putting 4%.
(Business Week, 2007) Many negative things can be said about China’s authoritarian
government, but one thing is true – it gets results. China also attracts more FDI than
India - $63B compared to India’s $8B. China is the third largest global importer of
merchandise while India is only 17. China’s economy is 3 times as big as India’s in
terms of GDP.
What about Israel’s relationship with the United States? How would deeper
integration with the EU affect Israel’s relationship with the US? If Israel established
preferential trade agreements with China or India, would they affect Israel’s
relationship with the US? Does the US represent a better partner for Israel than the
EU, in view of some of the arguments in the paper concerning economic growth?
These are all questions for another paper.
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5. Concluding Remarks
When balancing the payoffs against the costs of deeper economic integration into the
EU through the ENP and the EU/Israel Strategy Plan, this paper concludes that the
potential costs are greater than the potential gains. Access to the EU’s services sector
could provide one of the potentially highest economic payoffs for Israel, but the
potential gains are questionable in view of the ambivalence of the ENP offer, and the
present state of the EU services sectors, which are still undergoing considerable
restructuring as a result of their inefficiency and lack of competitiveness. On the cost
side, the paper demonstrated that further dependence on the EU is a risky proposition
from a number of vantage points: its trade exposure risk would increase, it would lose
policy space necessary for development, and the linkage between trade and its
political agenda that the EU has demonstrated in the past would most likely continue
in the future leading to a less certain business climate in Israel, and in turn, trade
disruption rather than trade creation. As a diversification strategy, the paper proposes
a continuation of Israel’s international trade policy of ‘promiscuous bilateralism’ but
now with an Asia emphasis.
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