Introduction:
The team was divided into five secondary teams according to the following topics: the importance of multi-national companies (Prof. Manuel Trachtenberg, Eli Horowitz, Dr. Orna Barry and Yossi Hollander); the restrictions that globalization imposes on monetary and fiscal policy ( Prof. Assaf Razin, Dr. Adi Brander and Dr. Liora Meridor); the restrictions that globalization imposes on taxation systems (Prof. Ephraim Zedaka and Yoni Kaplan); the implications of the exposure of the local economy (Yoram Gabai and Zippi Gal); implications for the labor market (Dr. Eran Yashiv).
1. Multi-national companies
There are very few multi-national companies in Israel and it appears that Israeli companies in the high-tech field are not capable of exceeding the hundred million dollar mark in market value, thus forfeiting the possibility of obtaining a hold in international markets. The main reasons, and hence the recommendations presented below as well, are related to the business management of the firms:
Companies in Israel need to adopt strategic modes of thinking and approaches: the goal of strategy is to anticipate the next market well enough in advance (before the competitors), the next product (leaving as much time as is needed for its invention, development, manufacture and marketing, before the competitors) and new technology (which will replace existing technology before that of the competitor). The importance of the strategic approach is particularly apparent in the international context.
A global strategy must also answer the question of whether the company’s optimal growth trend is organic or takes place via acquisition of and merger with foreign companies.
In the global world a firm must adopt a functional strategic approach, viz., it must adapt a strategy for each country according to the economic, business, social and cultural needs of that country. This strategy is not necessarily the same in each country, and this is reflected in the company’s positioning in different markets. A synergistic integration of strategy is what generates the added value of multi-national as compared to national companies.
Encouraging the establishment of multi-national countries in Israel would require a change in the macroeconomic conditions, in government policy and in the business environment. The establishment of multi-national companies whose head offices, research and development laboratories and other management institutions are located in Israel should certainly be encouraged. The “Encouragement of Capital Investment” Law should be adapted to these companies and the tax regulations amended accordingly.
2. Does globalization restrict monetary and fiscal policy?
2.1 Monetary policy
The main task of the Bank of Israel is to work toward stability of prices and its preservation over time, in accordance with the declared inflation targets. These targets serve as a coordinating tool for stabilizing public expectations. Non-graduated changes in interest are a cause of instability in the capital market and hence also influence fluctuations in the product. Therefore, the Bank must employ an interest policy that will lead to interest smoothing over time.
The Bank must support other goals of economic policy, including providing assistance in the moderation of cyclical fluctuations in growth and employment, provided this does not compromise the stability of prices in the long-term. These fluctuations become more serious during times of globalization.
2.2 Fiscal policy
One of the main problems in adopting anti-cyclical policy in the global environment and implementing automatic stabilizers in periods of economic slowdown, is preserving the credibility of policymakers so that an increase in deficit during the period of slowdown will not be interpreted as a permanent change, but rather as a temporary exigency.
The ability to convince international capital markets that these are indeed only temporary changes depends to a large extent on the measure of credibility that the government has accumulated in the past. This credibility rises the more the government is careful to employ a consistent policy of decreasing the deficit and reducing the debt-product ratio over time. Frequent deviations from the policy of decreasing the deficit target have damaged this credibility over the last decade.
The emphasis in coming years should therefore be on implementing policies which will lead to a cumulative girding of credibility that can serve the Israeli economy in facing future challenges. Consequently the policy targets in the coming years should be transparent and simple in order to make it possible to easily judge to what degree they are met. The targets must also be sufficiently ambitious in order to converge with received norms in the developed countries with which Israel is competing in global markets.
For this purpose it is proposed that the fiscal policy for coming years be defined in the following way:
- A “strategic” goal for fiscal policy should be defined. For example, convergence with the debt-product ratio ceiling determined by the countries of the European Union (60%) within 12 years – slightly after the target date in Greece, Belgium and Italy, which are the members of the Union with the highest debt-product ratio (similar to Israel’s).
- Lower deficit ceilings that are consistent with the “strategic” goal will be determined. In particular, it is proposed that by 2005 the deficit be reduced to one percent of the product according to the present definition. The government would thus declare its commitment to the original goal that was abandoned following the increase in the deficit in 2001-2202 and show that the cyclical increase in the deficit is not becoming permanent. The entire reduction in deficit-product ratio, after 2005 as well, will be effected by means of reducing the weight of public expenditure in determining the product.
- In 2005-2008 the deficit will be reduced so that the government budget will be balanced in 2008. Deficit ceilings from 2005 on will be determined according to the accepted definitions in developed countries.
- The deficit ceilings after 2002, providing that the targets are attained by then, will be determined in accordance with the business cycle. The budget, which is adapted to the business cycle, will be determined according to the following principles:
1. A multi-annual product growth forecast will be determined. The government should take care to establish an objective and politically independent mechanism that will be responsible for assessing the potential product growth rate. Should the establishment of such a mechanism (similar to that established in Germany, for example) not be possible, a forecast by a team of economists from the public sector and outside it should at least be issued.
2. According to this forecast the team will determine a forecast for revenue from taxes and a multi-annual budget for the National Insurance Institute, based on present tax rates and policies.
3. The expenditure budget, tax reductions and changes in revenue that do not derive from tax, will be determined according to the forecast average revenue for the coming years and the deficit targets. The budget will be adapted from year to year in response to cyclical changes in activities and revenue. This is especially important with regard to investments in infrastructure that must be based on long-term planning and not compromised by cyclical adjustments.
4. One-time income will be used to reduce the debt or finance one-time expenses in the parallel period. In addition to their being recorded in the budget, as is customary, a separate and balanced account for such income and expenditure will be maintained.
5. A significant reserve will be set aside in the budget (about one percent of the product) for “expenditure contingent on level of revenue” for cases in which it becomes clear that the estimated potential product, or revenue, was too high. This reserve can also help to determine the order of priorities in the budget because the expenses transferreto it will be those that the government sees as the lowest priorities.
- Because of the need to rehabilitate credibility that has been damaged in recent years, and in light of the “strategic” target in item 1 above, references to deviations from the annual deficit ceiling will not be symmetrical in the first years (for example until 2006). In years in which the deficit declines faster than planned, it will be determined that the deficit in the next year will not exceed the actual deficit in the current year in any case.
- In order to ensure the most rapid progress possible in reducing the weight of the public expenditure in the product, it will be determined that every year in which the growth forecast and the deficit ceiling facilitate an increase of more than one percent in the actual public expenditure per capita, the remainder of sources will be used to reduce the tax burden or effect more rapid decrease of the deficit – and not for increases in public expenditure.
2.3 Principles of taxation
Economic theory teaches that economic efficiency requires the comparison of gross yields from capital (before tax) between the state and other countries. If the capital yield abroad is higher that in Israel, it is economically feasible to transfer funds from Israel to abroad. This kind of movement would increase the GNP (as opposed to the GDP). Conversely, when the yield abroad is lower than that in Israel, capital invested abroad should be returned to Israel. This kind of movement will increase the GNP.
Therefore, the choice of a taxation system must be considered in the light of the question as to which system would lead to comparison of gross yields in Israel with those abroad. An Israeli resident will invest abroad until the net yield he receives for his investment abroad is equal to the net yield in Israel. If revenue from these two sources of income is equally taxed, then equalization of the net yields will lead to equalization of the gross needs, that is, economic efficiency. Therefore, the personal taxation system (the residence system) is the preferred system of taxation.
The transition to the personal taxation system also requires attention to a situation in which investments are not made directly, but by companies that are registered and located outside the country of residence and controlled by taxpayers whose residence is different from the country of residence. In such cases a curtain lifting (CFC) must be performed and tax imposed on those with control, in excess of the determined control rate and on the basis of residence.
In order to preserve the yield’s neutrality in terms of tax considerations, it should of course be ensured that the taxation rates on revenue from capital in the country of residence be equal for all types of income (interest, dividends and other capital profits). It should also be ascertained that the tax conventions that determine the rules of taxation and primary right to taxation have the same rules.
3. Continued exposure of the economy to the international market
Exposure of the economy to international merchandise and services markets began in 1970, but only in the past 15 years have we witnessed a significant decline in the protection, both financial and non-financial, of local markets. As a result of this exposure cheaper sources of raw materials (mainly from third world countries) have become available to local manufacturers and inefficient manufacturers have needed to streamline in order to compete with foreign manufacturers. The process of exposure lead to a deviation of foreign trade by increasing the portion of the market occupied by third-world countries. This exposure simultaneously contributed to a reduction in the price of imported products. The average reduction in the relative price index of exposed products is estimated at one percent per year.
The question nevertheless arises from time to time whether the exposure has not damaged employment, particularly employment in traditional manufacturing areas. There is no evidence of a decrease in employment in the first half of the 1990s, but there was a significant decline in the second half of that decade, mainly in textiles, wood and furniture. In view of this there is once again a demand for a partial and gradual retreat from the policy of exposure employed thus far.
The team examined these claims and stressed that if there is indeed call for retreating from this policy, then it applies only to the measure of openness that the economy demonstrates toward imports from third world countries. With regard to protecting against imports from developed countries (the USA and the European Common Market) the State is bound by a series of agreements that do not facilitate deviating from present policy.
The implications of a number of possible steps that can be taken toward retreating from the policy of openness to third world countries can be examined. Such measures would differ from each other in the degree of damage they would cause the Israeli economy in the long-term. The steps are as follows (in descending order):
Imposition of a protective customs duty on imports from third world countries – This step will lead to an increase in the cost of final products, interim products and raw materials that involved local manufacture. The influence of this measure on employment is mixed: on the one hand the protective customs duty will increase employment at least in the short term; on the other, the rise in the cost of interim products and raw materials will damage the local manufacturer’s ability to compete with imports from the countries included in the agreement (European Market and USA) and export will make competing abroad difficult. (The European Market countries and the USA purchase most of their raw materials and interim materials from third world countries.) The negative influences of the step in question are well known: trade shifts, lower standard of living, waste of foreign currency and decreased efficiency. In this case it is clear that the loss exceeds the profit.
Protective customs duty on import of final products – This step suffers from the above-mentioned drawbacks. Its advantage is that it avoids increases in the prices of raw materials and interim materials and therefore its influence purely in the areas of employment appears positive (with the exception of the negative influence of decreased public buying power and the response of foreign countries).
Safety and standardization surcharges – The utilization of these surcharges and renewed use of standardization as a means of protecting local manufacture, means differential protection that is usually (with regard to safety surcharges) effective within a short time. The advantages and disadvantages of this measure stem from the same factor: the partial nature of the move and its focus on areas selected by government. Another advantage of temporary measures is that companies will avoid new investment in inefficient areas because after time the surcharges and artificial protections will be removed. Nevertheless, familiarity with the political system in Israel raises a well-founded concern that these steps will be exploited to defend the power of the strong elements in the economy, who are mainly monopolies (cement, plywood, iron and steel), This tool will thus be abused in order to increase the strength of the monopolies at the expense of local consumers, with no proven impact on employment.
Reciprocal purchasing and government tenders – The implementation of steps in this area is possible and can encourage local manufacture. Even if it is at the expense of efficiency and prices, this step could still lead to a response from the other countries and thus damage Israeli exports in international tenders. Also, the resulting rise in prices is equivalent to an increase in the tax burden on the public and damage to the public’s buying power.
4. Possible policy measures for reducing the number of foreign workers
A prominent economic phenomenon throughout the world, especially in Western Europe and the United States, is the immigration of workers from poor countries torich countries and their integration in the workforce in areas of unskilled labor. This phenomengives rise to several problems, including: preclusion of technological improvements and the growth of productivity in the relevant fields; reduction in wages in those fields and edging of less educated Israelis out of those fields. Inequality and unemployment are thus expanded; there is use of physical and cultural infrastructure with almost no payment of taxes; an “infrastructure” of various future problems in the socio-political sphere is created, when the temporary workers become a community of immigrants; moral problems resulting from employment of workers in circumstances that infringe on their various human rights (long hours, less than minimum wage, etc.), and their accommodation in disgraceful conditions of poverty and crowding with insufficient public services. The following are a number of possible policy measures:
- Taxation of employers. If the wages of foreign workers are made equivalent to the wages of Israelis, the incentive for bringing the former in will be reduced or removed. It should be noted that (see Ministry of Finance’s survey above) the employer only sets aside one or two percent for National Insurance and health insurance for foreign workers, in comparison with 15% for local workers.
- Reduction or abolishment of permits for importing workers.
- Enforcement of minimum wage and labor laws.
- Granting of visas to the worker and not the employer. The existing policy created a connection between the foreign worker and the local employer in a manner that increases the employer’s returns (see papers by Shmuel Amir on the subject).
Failure to put these measures into practice appears to be the result of a political economics problem: the employers are organized in pressure groups with a great deal of influence over policy-makers and legislators. This explains decisions such as the one taken recently to bring in more foreign workers for agriculture.
Two significant issues pertaining to the implementation of the above policy measures should be noted:
- Palestinian workers are an alternative to foreign workers. This exchange, however, is not perfect and its value not static. On the one hand political-security problems reduce or negate that value. On the other, the cost of these workers is lower: there is less burden on the infrastructure and fewer immigration problems. These considerations raise the value of the exchange for Palestinians. Policy must take these aspects into account, even though they change substantially over time. It is also clear that political considerations are important here.
- It is reasonable to consider a gradual line of taxation, given the uncertainty of every aspect of a substitute supply of workers. Stopping the influx of workers would be harmful in the sense that production would be damaged and therefore employment of Israelis could also be damaged. Gradual policies would facilitate examination of the compatibility of the market with the small supply of foreign workers if and when taxation is imposed.