Breaking Israel’s monopolies

The Wall Street Journal
8 Oct ’10

Economic concentration hurts the country’s viability and the chances for peace.

Filed under:

financial markets • reform • peace process

While the world focuses on yet another putative “peace process,” Israel’s internal struggle to break up its concentrated economy receives scant attention. The Bank of Israel’s annual report on the economy published in April included a study showing that “some twenty business groups, nearly all of family nature and structured in a pronounced pyramid form, continue to control a large proportion of public firms (some 25% of firms listed for trading) and about half of market share.” These business groups, the bank warned, show “higher levels of financial leverage#8212;and therefore also of risk,” than stand-alone companies.

Reforming this unproductive economic structure, inherited from the socialists that ruled the country for decades, will have a great impact on Israel’s capacity to initiate peace through economic development. As events in Europe and elsewhere have shown, prosperity can mitigate conflicts and facilitate their resolution. Before the first intifada in 1987, an informal economic peace process had done wonders to reconcile Jews and Arabs.

Given the Israeli economy’s remarkable resilience, some may question the urgency for unraveling these conglomerates. Since a 2005 financial reform liberated Israel from some of its statist rigidities, it has grown by almost 5% annually, despite the world financial crisis. The country boasts more than 3,000 start-ups, more than in all of Europe and almost as many as in the U.S.

But this growth may not be sustainable as long as Israel’s economy remains dominated by about 20 politically connected families that own so much of the country’s traded assets, which they acquired from the government and labor unions in a privatization process with credit provided by the nationalized banks. These cross-sectoral, multi-layered conglomerates have evolved into monopolies that inhibit competition, efficiency, and growth, and choke Israel’s hapless consumers. Israeli citizens#8212;overtaxed and underpaid, and shouldering three years of service in the regular army and a month to 45 days yearly in reserve duty#8212;must also pay monopoly rents of between 20% and 30% on everything they consume, as researchers at Israel’s ministry of finance calculated. All that makes Israelis poorer.

These vertically integrated groups have cross-holdings in both industrial and service companies, and in financial firms. The result is a misallocation of credit to companies owned by these tycoons. Consider that until the 2005 financial market reform, 70% of credit was granted to just 1% of lenders. Meanwhile, Israel’s small and medium-sized businesses#8212;the chief engines of Israel’s economic growth#8212;have been squeezed. Particularly in Israel’s “periphery,” the Negev and the Galilee, smaller firms suffer from a permanent credit crunch.

The largest of these pyramid-style conglomerates is also one of the most powerful and complex. Through his IDB Holdings, Nochi Dankner controls 60 companies through several layers of ownership. Among these companies are Israel’s cement and paper monopolies (Nesher and Hadera Paper), one of Israel’s two largest insurance companies (Clal Insurance), its largest grocery retail chain (Shufersal), its largest cellular-phone operator (Cellcom), one of its largest real-estate groups (PBC), a leading internet company (013 Netvision)#8212;you get the idea. Mr. Dankner controls all these companies, with consolidated assets of $35 billion, through an equity position of around $300 million, or less than 1% of those assets.

Faced with similar pyramidal groups, economists in the Roosevelt Administration in the 1930s convinced the U.S. Congress that this sort of economic concentration causes moral hazard, problems of corporate governance, tax avoidance, and excessive political influence. The U.S. government’s response#8212;effective or not#8212;was to tax intercorporate dividends, exempt the liquidations of controlled subsidiaries from capital gains taxes, and to restrict the ability of business groups to file consolidated returns. Later, in 1957, Congress passed the Bank Holding Company Act to prevent investment companies from controlling banks.

Too big to fail but big enough to dominate, Israel’s large, multi-layered conglomerates have acquired huge political clout, enabling them to obtain monopoly privileges and other benefits worth billions of shekels from the government. And that’s even before considering the fact that as the country’s biggest employer and buyer in the Israeli economy, the government naturally tends to favor big business.

This clout also enables the conglomerates to erect a thicket of entry barriers and keep their would-be competitors out. This lack of rivalry, combined with so-called “progressive” labor laws, have contributed to low per-capita productivity (about half that of the U.S.) and in the dismally low wages of Israeli workers.

Despite his understandable focus on foreign challenges, Prime Minister Benjamin Netanyahu, together with his Finance Minister Yuval Steinitz, has publicly expressed his determination to address this complex problem. Mr. Netanyahu did not flinch from fierce media attacks demanding that he should focus instead on issues like poverty; as if it were not clear that poverty is in large part a result of consumer exploitation by the monopolies.

Reason demands that Israel’s reformers will proceed with their reforms without delay. But reason does not always influence political developments, not even in Israel. Let us hope for the sake of Israel’s future viability, and for the sake of peace, that this time it does.

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