Desert boom - Israel's free-export processing zone

Reason, Oct, 1994 by Robert Pollock

"TILL NOW THE WALLET COMES out--and the government takes half," declared Knesset member Raphael Eitan. He was explaining why despite a highly skilled labor force, excellent ports, and a prime location at the crossroads of Europe, Africa, and Asia, Israel's economy stagnates. Burdensome tax and regulatory policies have long made it a terrible place to do business. That is, until now. "Now" was June 20, the day the Knesset approved the creation of Israel's first free-export processing zone (FEPZ).

More than 100 companies have already expressed interest in locating in the zone, including clothing manufacturers Liz Claiborne, Phillip van Heusen, and London Fog, as well as chemical, trade, telecommunications, and pharmaceutical firms. That's because they will benefit from exemptions from tariffs, personal and corporate income taxes, and a whole host of regulations. And Israel is the only country in the world to have signed free-trade agreements with both the United States and the European Union, giving companies in the zone a competitive advantage abroad, too. In return for the hands-off treatment, Israel expects the zone to generate as many as 50,000 jobs within four years.

The FEPZ will likely cover about 500 acres located near Beersheba in the Negev desert. It will operate as a privately run, semi-autonomous laissez-faire state. In the coming months, Israel will award the rights to serve as concessionaire in the zone. The winning investors will purchase the land and be responsible for providing all infrastructure and services. In return, they will get to lease the land for a profit. This means roads, water, sewers, electricity, and telecommunications, as well as police and fire protection, will be privately provided--another bonus for potential tenants. Backers expect the zone to be able to offer the lowest telecommunications rates in the world. In an information economy that can mean huge savings.

The FEPZ is not unique as a concept. The first free zone started in Taiwan in the '60s. And depending on how you define them, there are now between 120 and 150 special free-market zones in 70 countries. But Israel's FEPZ is important because it may herald a coming wave of privately created, financed, and run free-market zones. It was not proposed by any politician nor planned by any government. It began as an offer from a group of Jewish-American venture capitalists that Israel quite literally couldn't afford to refuse.

ALTHOUGH IT MAY SEEM ODD THAT A LAbor government would accept such an offer, the economic situation forced a move away from government intervention, says Jerry Stoch, an Israeli consul for economic affairs. High inflation and unemployment in the '80s were followed immediately by a tidal wave of immigrants from Russia, Ethiopia, Bosnia, and elsewhere. They needed jobs. Meanwhile, thousands of Israel's own entrepreneurially inclined citizens were emigrating to the United States. And without general economic growth, the new Palestinian-administered regions promised to provide fertile ground for militant activity.

But with Israel's tax and regulatory climate, no relief was in sight. Getting government approval for a new business venture might take two years. And at the $40,000 income level, it cost an employer $3.60 to give an employee an extra dollar of after-tax income. Even at the lowest pay levels, that ratio was 2-to-1.

Reliance on foreign aid long allowed Israel to forego much-needed economic reforms. Last year, the unilateral transfers--in other words, free money--that Israel received from overseas totaled about $6.7 billion. That's more than 10 percent of its Gross Domestic Product. About $3 billion came from the U.S. government, about $3 billion more from private donors. Prominent New York real estate broker Larry Silverstein, for example, alone has raised more than $250 million annually for Israel.

But when it came to investment, even the donors said no way. Upon passage of the FEPZ bill, Member of Knesset Amir Peretz (Labor) recalled how he once said to a donor, "Stop building us buildings, we have enough; stop building clubs and recreation centers. Build us a factory. But the donor replied: 'Your bureaucracy ruins everything. Forget attracting investment and entrepreneurship.'"

Enter David Yerushalmi, a former California real estate developer and lawyer who had recently emigrated to Israel. As it happened, he was also a former student of Robert Loewenberg, president of the Institute for Advanced Strategic and Political Studies, the Jerusalem-based think tank where the idea for the Israeli FEPZ originated. The possibility of an FEPZ gave Yerushalmi a chance to put his business talents to work for his homeland and make a profit in return. He convinced 26 Jewish-American businessmen who had been prominent donors to Israel that they could do the same. In 1992, Yerushalmi's Israel Export Development Corporation (IEDC) offered Israeli Finance Minister Avraham Shohat a guarantee of at least $750 million in investment in return for creation of the FEPZ.