The Surging Israeli Economy

Counting Israeli Shekels. Photo: Ariel Jerozolimski

We all know the old joke: “How do you become a millionaire in Israel? You come with two million!” While that one-liner used to be true, nowadays Israel’s economy is flourishing, and economic and employment opportunities abound. Israeli ingenuity and creativity are leading the way, and the country has become one of the leading investment destinations in the world.

Silicon Wadi
Take a look at the products you use on a daily basis, from voicemail to instant messaging to the firewall that sits on your computer, and you will be surprised to find that many originated with Israeli technology. The technological revolution of the past decades is, and continues to be, powered by Israeli technology. Small wonder that global corporate giants like General Electric, Microsoft, IBM, Intel, and Johnson & Johnson have made large investments in Israel both by buying local companies and setting up R&D (research and development) facilities in Israel. In fact, Warren Buffett, perhaps the world’s most famous and successful investor, made his largest investment outside of the United States when he purchased Iscar, an Israeli company that makes high-tech cutting tools for cars and planes, for $4.4 billion. Buffett later referred to the purchase as a “dream investment.”

One of the engines behind Israel’s $26 billion high-tech industry is the military, according to Dan Senor and Saul Singer, authors of Start-Up Nation: The Story of Israel’s Economic Miracle (New York, 2009). The high-tech industry draws upon military technologies and repurposes them for civilian use. The book features numerous anecdotes, including that of Gavriel Iddan, a rocket scientist who adapted the miniaturization technology in missiles to develop the PillCam in 2001.

Created by Given Imaging where Iddan serves as chief technology officer, the PillCam is a tiny swallowable camera that beams images from inside a person’s intestines out onto a monitor. Given Imaging was the first company to go public after September 11, 2001.

From $6 Million to $80 Billion
Gone are the days of Jaffa oranges being the top Israeli export. Israel’s exports have grown an astonishing 13,400 times since 1948, according to the Israel Export and International Cooperation Institute (IEICI). Exports rose from $6 million when the State was first founded to $80 billion in 2010. While Israel used to be known primarily for its agricultural exports, Jaffa oranges are no longer grown only in Israel. Israel’s Citrus Marketing Board has started leasing the brand name “Jaffa” to Spanish farmers. In a recent article on Ynetnews.com, the Citrus Marketing Board Director Tal Amit stated that for the past few years, Jaffa has been branding fruits that aren’t even grown in Israel with “the condition that they are of high standard quality” in return for royalties. “The idea,” she says, “is that the [Jaffa] brand gets exposure for all twelve months of the year, even during a season we don’t have fruit.” While some may cry heresy, it is this change in perspective, from being a provincial, insular economy to profiting from globalization that has significantly contributed to Israel’s economic surge.

Rush hour traffic on the Ayalon Highway. Photo: James Margolis

It’s the Economy
Amazingly, just ten years ago Israel was teetering on the verge of bankruptcy. The Internet bubble had burst, the threat of being drawn into the Second Gulf War was very real, and Israel was faced with high unemployment and interest rates. The Israeli shekel was a favorite of currency speculators and it weakened substantially against the US dollar. Like him or not, current prime minister—and former finance minister at the time of the crisis—Benjamin Netanyahu implemented a policy of both fiscal discipline and lower taxes, successfully bringing the economy back from the brink. With these policies firmly in place, Israel has successfully made it through the latest global economic crisis without so much as a scratch. The US economy is still plagued by large levels of unemployment, a slumping real estate market, and a general feeling that its days as the number-one economic power are numbered. The situation is even worse in Europe, with some European countries on the verge of bankruptcy. Not so in Israel. Unemployment is hovering at about 6 percent—a lot better than in the US.

Back in May 2010, Israel was reclassified as a developed country by the MSCI. This was viewed as a feather in the cap of Israeli economic policy. For investors, this means that one gets the stability of a developed country with the strong growth prospects of an emerging economy. To top it off, while Israel is lacking in natural resources, huge natural gas reserves have been found off the Haifa coast. This will turn Israel into a net exporter of natural gas!

Not all of the credit goes to Netanyahu, however. Experts cite many reasons for Israel’s robust economy: a “can-do” culture, the IDF, and various political and economic factors unique to Israel.

With the world’s highest percentage of engineers and scientists, Israel’s skilled workforce is exceptionally resourceful and known for its entrepreneurial spirit. In fact, Israel’s greatest natural resource is its workforce.

Israel has gone from being just a tourist destination to one of the leading investment destinations in the world.

As Senor and Singer state in their book, the army, which young Israelis experience before attending university, teaches leadership skills and helps breed an innovative “can-do” attitude. Furthermore, since Israel is surrounded by hostile countries, global thinking is imperative for the economy to flourish. Shuky Sheffler, Retalix CEO, was quoted in a recent article on Ynetnews.com, stating, “The Israeli market is not sufficient to be successful. So in Israel, if you are not successful globally you’re not going to be a success”(“Taglit Tours Israel’s Silicon Valley,” June 23, 2011).

Can this economic growth continue? Elan Zivotofsky, managing partner of the Prelude Israel Fund, an affiliate of Fortissimo Capital, thinks it can. His firm is generally upbeat about both the Israeli economy and stock market. As Israelis get richer, they are spending more money on themselves and on real estate, helping to fuel economic growth. Additionally, Israel’s goods and know-how are in increasing demand. “During 2010, the Israeli economy grew 4.7 percent, one of the fastest rates of expansion of any OECD country. For 2011, growth will likely be close to 5 percent, much greater than the US or Europe,” says Zivotofsky.

Will the rise of China’s and India’s economies mean the end of Israel’s days as an innovation hub? Michael Eisenberg, general partner at Benchmark Capital, one of the largest and most respected venture capital firms in the world, believes that Israel’s leading role in global innovation is actually growing. “Well-traveled Israelis are particularly adept at developing innovation for global markets, such as the Far East and Eastern Europe, in addition to traditional markets such as the USA and Western Europe,” he says. Eisenberg cites Israeli technological leadership in the mobile and agricultural sectors. “As the world braces to sustainably feed and provide water to 9 billion people,” he says, “more and more third-world countries will turn to Israel’s agricultural technologies for help.”

As Israelis spend more money, they are also becoming more sophisticated shoppers. Many are fed up with paying such high prices for basic goods, as is evident by what has become known as “the cottage protest.” This past June, a boycott spurred by the rising price of cottage cheese in Israel started on Facebook and quickly gained national traction. The campaign was sparked by an article in Globes, the Israeli financial daily, which ran a story comparing food prices in Israel to basic food products in Germany. According to the article, Israeli prices were often twice as high. As a result of the boycott, cottage cheese prices dropped by more than 35 percent. These protests have spread to other consumer products. Ultimately, this will likely lead to significantly lower prices, and help keep inflation in check. The downside is that the government will have to find other sources of revenue to make up for the revenue shortfall that the lower prices produce.

As the world braces to feed and provide water to 9 billion people, more and more third-world countries will turn to Israel’s agricultural technologies for help.

Aliyah by Choice
Has this economic strength translated in more frum Jews making aliyah? “While those who make aliyah do so because they want to live in Israel,” says Rachel Berger, director of employment at Nefesh B’Nefesh, “Israel’s strong economy certainly helps in the decision-making process.” Berger notes a slight upswing in what is known as “Tuition aliyah,” US Jews moving to Israel because they are unable to keep up with the spiraling cost of Jewish education in the States. “But generally it’s people who want to live here who come, and one of the benefits is the low cost of Jewish education in Israel.”

The Real Story Behind Real Estate
While home prices in the US are still searching for a bottom, the real estate market in Israel has been booming. Prices have been surging for more than six years, fueled by historically low interest rates, a lack of new construction, and demand far outweighing the supply. This continuous rise in home prices has brought talk of a real estate bubble to the forefront. Many young couples seeking to live in Jerusalem, for example, have been priced out of buying an apartment. Recently the government and the Bank of Israel have started to take drastic steps to try and cool the market. New regulations increasing the amount needed for a down payment and raising interest rates are just some of the new measures taken. While this may be a start, the consensus among policy makers is that this is a supply-and-demand issue. The government has therefore pledged to add 100,000 new units over the next year and a half.

Microsoft Israel R&D Center in Herzliya
Photo: Hanan Isachar

Similar to the situation in the US, real estate in Israel is very much localized. Unfortunately, while the government plan to add 100,000 new units may increase supply in peripheral communities, it won’t make housing more affordable in upscale neighborhoods in the center of the country. Consequently, the government has also put forth plans to convert unused office space into housing and eliminate the equivalent of capital gains tax for those selling investment properties. These attempts to cool the market have yet to meet their stated purpose, as prices are still climbing. (I have personally been looking to buy an apartment in the Katamon/Rechaviah neighborhood of Jerusalem for quite a while, and prices have shown no sign of stabilizing.)

Throughout Jerusalem, balancing growth needs with the need for preserving historical buildings and green spaces remains an ongoing struggle. Until this is resolved, new construction will remain at a standstill.

The Downsides to a Strong Currency
With all the good news, there are still some headwinds facing the Israeli economy. It goes without saying that geopolitical risk is always a cloud hanging over the Israeli economy. However, the more immediate threat for sustained economic growth is the shekel. The shekel has turned into one of the world’s strongest currencies. Recognizing that an overly strong currency is harming exporters, the Bank of Israel has continuously intervened in the currency market to try and quell the shekel rise, but to no avail.

As a result, Israeli goods have become more expensive abroad, and Israeli exporters are having a very difficult time. Manufacturing companies have closed up shop locally and have moved to cheaper, foreign destinations. With an economy that is so dependent on exports, continued strength of the shekel could have a negative impact on economic growth.

Olive Grove in the Sharon area. Photo: Ariel Jerozolimski

The strong currency has also impacted Israeli tourists, especially frum families. When tourists convert their dollars to shekels, they get fewer shekels than they once did, which means that they have to pay more for the same goods and services than they had in the past. Additionally, those seeking to buy apartments in Israel so they can visit a few times a year and see their children living there or studying in yeshivah or seminary not only face rising real estate prices, but since real estate is now quoted in shekels, the shekel strength means that that same apartment is now 15 percent more expensive in dollar terms.

While there are some downsides to a strong currency, it can be taken as a sign of approval from the market that the economy is doing well. After all, despite the problem exporters are having, Israel is still posting near 5 percent growth. And as former President Ronald Reagan once said, “A strong currency is a sign of a great nation.”

Aaron Katsman is a financial professional, licensed in both the United States and Israel. He helps Americans invest in Israel and works with olim on their US investment accounts. He can be reached at (02) 624-0995 or aaron@lighthousecapital.co.il.