All Commentary
Friday, September 1, 1989

Israel: The Road from Socialism

Mr. Dean, a veteran journalist, has lived in Israel since 194Z

In the last decade, Israel has undergone a great change in its thinking about state-owned companies. Most Israelis, including a large percentage of the socialists who formerly backed state-owned companies, now regard these firms as a drain on the nation’s resources.

What brought about this change? To find an answer, we need to understand why the Israelis established state- owned businesses in the first place. And to do this, we must review the factors that preceded the founding of the State of Israel in 1948.

Years before the 1917 Balfour Declaration granted the Jews a homeland, Jews had been settling in Israel, then called Palestine. Many of them belonged to one or another of the various workers’ movements which were in vogue around the turn of the century. In that era, socialism was believed to herald not only better times, but some sort of economic millennium.

An integral part of socialist dogma was the belief that capital was ruthlessly exploiting labor. This, it was believed, could be eliminated only when the means of production were owned and controlled by the socialist state.

This philosophy was rejected by the forerunner of Likud, today Israel’s largest political party by a tiny margin, which is considered to be moderately “right” in the political spectrum. But at that time—and to a smaller extent even today—these dissenters were castigated as “fascists” by the socialists. And the word “fascist,” in the days of Hitler’s Germany and Mussolini’s Italy, was a snarl word of immense propaganda value. It could be used against anyone who wasn’t a socialist of one type or another.

The leftist workers founded the Histadrut (the General Federation of Labour) early this century to unionize and thus protect the workers from “exploitation.” The main problem, however, was not exploitation, but creating jobs, since the few Jewish capitalists, mainly landowners, preferred Arab labor to Jewish.

So the Histadrut went much further than merely unionizing the workers. It set out to gain control of existing means of production, to create new places of work for immigrants (a forerunner of the state-owned companies), and to situate these work places, if possible, in areas that would be critical in the event of war. (Today’s settlements in the West Bank and Gaza Strip follow the same pattern as outposts which constitute a line of defense.)

In all fairness to the Histadrut, then, and to the State of Israel today, no profit-seeking businessman would have established enterprises in these militarily vulnerable areas. After years of subsidies, some still face difficult struggles for survival. Others barely make ends meet.

Thus, the Histadrut developed a dual personality: it was, and is, both a labor union and an employer. This conflict of interests has caused many of the problems that have beset Histadrut enterprises for decades.

The problems came to a head more than a year ago when the Histadrut’s huge industrial sector, Koor, ran into grave financial difficulties. Typical is what happened to Alliance, its tire plant. Alliance was facing bankruptcy. The Histadrut knew this, yet it approved wage hikes—not wage cuts. The outcome: the plant was closed down, and the workers were thrown out of work. What is interesting here is that the government itself followed the same policy: giving wage hikes to faltering enterprises such as E1 A1, the national airline.

The long-range significance of the Histadrut, which considered itself (and was) an integral part of a state in the making, is that it embarked on building its own economic em-pire-in a way quasi-state-owned compa-nies- before the State of Israel was founded.

The Histadrut gradually became involved in nearly every field of endeavor—agricultural settlements, agricultural marketing, housing, construction, quarrying, cooperative groceries, industry, transportation, insurance, banking, exports and imports, social welfare, health services (still the largest system in the country, encompassing two-thirds of all Israelis), and even education—although this once large network has shrunk over the years. Today, the Histadrut directly controls about 25 percent of the Israeli economy (according to its own claim) and has a huge influence on another considerable percentage.

This background is very important, for when the State of Israel was founded in 1948, the leaders of these socialist organizations (most of which today are banded together in a political body called the Alignment) became the major policy makers in the various socialist-dominat: ed coalitions from 1948 until 1977. Thus we see that the setting up of state-owned companies was a continuation of a policy started decades earlier by the Histadrut.

A Mixed Economy

But, if socialistic thinking prevailed in Israel in 1948, why did Israel’s leaders adopt a mixed economy,-one featuring cooperatives, kibbutzes, government companies, and private firms? Why didn’t they try to establish pure socialism? The answer is simple: Israel at that time (as today) depended heavily on financial help from abroad, mainly from the U.S. government and American Jews. The U.S. government favored a free economy; and although many American Jews leaned toward socialism, they generally contributed only small amounts; the really big contributions came from the capitalistic sector.

Two of today’s largest state-owned companies-Israel Chemicals (formerly the Dead Sea Works) and the Electric Corporation—were founded by private investors. The government took them over when both ran into financial hardships and faced dissolution. The Dead Sea Works’ original installations were destroyed by the Jordanians in the 1948 war. Because investors were hesitant to put their money into the strife-torn Middle East, the company couldn’t raise the immense sums needed to rebuild in a different location. Similarly, as Israel’s population soared after 1948, the founders of the Electric Corporation couldn’t raise enough capital to meet the Israelis’ burgeoning demand for electric power.

Today, Israel has 159 state-owned companies. The total revenues of these firms in 1987 stood at 12.1 billion New Israeli Shekels (NIS) (At that time the exchange rate was NIS 1.60 to $1; since then the shekel has been devalued to NIS 2.00.) These companies employ 65,000 persons, about five percent of the labor force. If we add the employees of the state-owned firms to those employed in the various civil services (state, local, and public institutions, and so on), we find that one-third of all gainfully employed Israelis work directly for various branches of government. And this does not include the armed forces.

The state-owned companies include some of the largest firms in Israel. In addition to the two already mentioned, Israel Chemicals and the Electric Corporation, they are: Bezek (communications), Israel Refineries (petroleum), El Al, Israel Shipyards, Israel Aircraft Industries, and Mekorot (which controls the nation’s water supply).

Some of these companies made money in 1987, some lost. The money-makers included the Electric Corporation, NIS 73.2 million; Bezek, NIS 36 million; El Al, NIS 37.3 million; Israel Chemicals, NIS 36.7 million; Israel Refineries, N-IS 22 million. The big losers were Israel Aircraft Industries, NIS 151 million; Beit Shemesh Motors, NIS 41 million; and Israel Shipyards, NIS 21 million.

The purchase value of these companies is a matter for negotiations, but the government has quoted a figure of $1 billion for Israel Chemicals and the same amount for Bezek. This is a fairly large sum even in most Western countries.

To sell these firms, the Israeli government will have to overcome the difficulty faced by the Dead Sea Works and the Electric Corporation: most businessmen still have doubts about investing in the strife-torn Middle East.

True, Egypt has signed a peace treaty with Israel, but most major Arab nations maintain a state of suspended hostilities. The Iraq-Iran war has just indeed wound down, but the Iranians still preach a type of Moslem fundamentalism that could spread to other Moslem countries, and is already wreaking havoc in Lebanon. Moreover, for years Lebanon has been torn by an internal civil war, and it was further battered when Israel launched a campaign in 1982 to force out 20,000 soldiers of the Palestine Liberation Organization. In the meantime, Qaddafi of Libya continues to threaten Egypt, and there have been serious troubles in Yemen, the Sudan, and Ethiopia. The latest round of difficulties has been the Palestinian uprising in the West Bank and Gaza Strip territories occupied by Israel as a result of the 1967 Six-Day War. All in all, not a very promising region to set up a business.

Despite these difficulties, dozens of mainly American but not necessarily Jewish-run companies, some of them fairly large, have invested in Israel during the past few decades. They feel that Israel has advantages which overshadow the disadvantages: a strong and stable democracy, trained labor, plenty of highly skilled university graduates in the sciences, and easier access to the Common Market than they can gain from the United States.

Some of these companies have done quite well; others have not. Several have repatriated their investments, as they have from other countries, when they began to retrench their international activities. The picture which emerges is that these investors generally have done no better or worse than they would have in any other foreign country, despite the ongoing turbulence in the Middle East that shows no signs of subsiding.

What caused the great change in Israelis’ thinking about state-owned companies? Several things.

Perhaps the outstanding reason was economic: Israel gradually realized that to compete in international markets it had to produce quality goods at competitive prices. This change in thought became essential following its agreement with the Common Market (not as a full member but as one enjoying most of the rights) which forced it gradually to scale down its customs duties. More recently, Israel and the United States signed a Free Trade Area agreement which stipulated a gradual reduction of duties.

Improving Efficiency

Israel government officials, therefore, had to run the nation’s factories at peak efficiency if they wanted the nation to export; they also had to insure that better-made and lower-priced foreign goods didn’t replace Israeli products within Israel itself.

All this meant overhauling Israel’s industry, and the state-owned companies were hit particularly hard because their management had rarely attracted top men. They preferred the private sector where the salaries were much higher, and were paid in accordance with performance. Moreover, many of the Israeli directors of state-owned companies were hand-picked for their political views, not for their administrative ability and business acumen.

As Oudi Recanati, a leading Israeli banker, said in 1987 about the inability of state-owned companies to pay top managers competitive salaries:

One of the biggest drawbacks in state-owned companies is that there rarely is a direct relationship between performance and compensation for this performance. The compensation structure in state- owned companies is rigid. Any attempt to try to compensate an outstanding manager for his performance creates a web of complication in a system where nearly all salaries and wages are linked.

If the top man is given a pay hike—which he honestly deserves—it would start a chain reaction through the entire company. His deputies would also demand a hike, even if they did not deserve it, and so on throughout the entire managerial and manpower structure. Giving the top man a deserved pay raise leads to giving everybody a pay raise. And then other state-owned companies fight for the same benefits. In the end, everybody gets a pay raise, which in effect means that the man who “performs” is robbed of his salary differential.

Privatization would allow establishing a system of compensation for performance whose effects would be enormously beneficial to the company. It would also lead to the complete separation of politics and management.

In a similar vein, consider the following 1986 statement by Natan Arad, spokesman for Moshe Shahal, Minister of Energy and Infrastructure. Shahal has been a life-long and dedicated member of the socialist Alignment:

The Minister firmly believes that private initiative is superior in efficiency, in lowering prices through competition, and so on than government regulation. The Minister believes that no matter how dedicated, hardworking and intelligent government-employed or government-regulated management is—and many of our men certainly fit this category—private management will turn in better results. This philosophy has proved itself abroad in other countries which once believed in direct government intervention in every phase of business life.

It is interesting that Arad made this statement only after the 1977 national elections had brought the moderate rightist Likud to power for the first time since the State of Israel was founded in 1948.

Although the Likud has always favored selling state-owned companies, it sold only a few in the past decade. Why?

The answer is patronage. Government companies provide a valuable outlet for patronage, especially for placing party adherents, civil servants approaching retirement age, and so on.

Undoubtedly, one of the reasons that the socialist Alignment came out for the sale of state-owned companies in the past few years—and did nothing during the 29 years it was in power—is that the Likud is now appointing its own men, ousting Alignment men if possible. The Alignment began yelling “politicalization,” conveniently forgetting that it had initiated and for many years had benefited from the patronage provided by state-owned companies. All of these state-owned companies are connected in one way or another with a Ministry. The Minister appoints the Director-General and the Board of Directors, and fills lesser positions.

Since the state-owned company’s Director-General wants to expand his power, he takes two major steps: he brings in the people he can best work with—not necessarily the best people available—and he sets up subsidiary firms that he can control from top to bottom. One government company, Paz, which owns 45 percent of the gasoline stations in Israel, was recently sold for $95 million to Australian businessman Jack Liberman. As a state-owned company, it had set up 28 subsidiaries that were sold with it.

Gradually the Alignment’s demand for privatization gained the support of many members of the Likud (whose ideals about selling the state-owned companies never wavered). Pressure to sell the companies began to mount. Serious efforts were initiated.

Efforts to Privatize Move Slowly

During the past four years, the government has sold only three of its companies and has sold shares in another three, out of 30 companies marked for sale. This still leaves 129 state-owned companies that haven’t been put up for sale. Some undoubtedly will be put up for sale, but some cannot be sold since they perform government services, and no one expects that they will ever make a profit; others are subsidiaries of major companies; and some will never be put up for sale for strategic masons. It is hard to conceive, for example, that the government will sell any of its industries closely connected with the defense effort, such as Israel Aircraft Industries.

There are reasons why more of the 30 haven’t been sold despite the government’s serious intentions. One frequently mentioned is that the government doesn’t know how to engage in a “hard sell.” As the saying goes in Israel (and probably throughout the world): those who know how to make money go into private business; those who do not become civil servants regulating the country’s economy.

To this must be added the resistance of members of the Knesset who ask: “Why sell a company making a nice profit? How can we know that the new owners will be able to maintain the same level of productivity and sales?” One always hopes that a better buyer will come along, outbidding an investor who makes a good offer, but who may lack the marketing outlets and promotional ability to foster the company’s growth. Preferable is a businessman who will Offer less, but who possesses the marketing facilities and the promotional ability to see that the company flourishes in the future.

The government must carefully check out each potential investor. What if one of them, through a front company, is run by an Arab citizen living in a country that is openly hostile to Israel? On a more practical scale, what if the potential buyer has a reputation of buying a company, then stripping it of its assets, leaving it an empty shell?

Other reasons fall into several categories. Incumbent senior officials often fear they will be thrown out of their jobs, since new owners usually put their own people in key positions. Elderly people of top managerial status find it difficult to obtain work on the same level. And since they were put in their posts by political friends, they can often still mobilize these friends for help.

These senior officials will fight tooth and nail to delay the sale, and to muddy affairs, hoping that the interested buyer will back out. One method of delaying a sale is to play around with the books. The State Comptroller in 1986 accused Paz of indulging in “sophisticated” and “creative” bookkeeping soon after it was mentioned for sale. This change would certainly prevent any potential buyer from getting a clear picture of the company’s worth.

Perhaps the following example will illustrate how difficult it is to figure out the worth of a state-owned company.

Early in the 1980s, El A! was plagued with a series of strikes; it was also flying deeper and deeper in the red. In 1982, after a four-month strike that culminated in a lock-out, El A1 was placed in “temporary” receivership (which is still its status).

Although the staff was cut 40 percent, the national carrier managed to fly almost the identical amount of hours, and almost the same passenger load. The company moved from the red to the black.

Interestingly, in 1987 when there was considerable talk of selling El Al, the government suggested a figure of $800 million. The best offer received was for $300 million. This discrepancy shows the huge difference—much more than the usual “bargaining” gap—which exists in all negotiations between the government’s idea of a company’s worth and the potential buyers’ assessments.

The problem of selling state-owned companies seems so formidable that an outside agency, First Boston, has been called in to work out a marketing strategy.

Buying shares in a state-owned company has its own pitfalls: both wages and the prices of the company’s goods may be fixed by the government in an effort to keep the cost-of-living index down; most importantly, the Treasury sometimes has the power to overrule the board on dividend policy, and the government can decide that, for the sake of national interest, some state-owned companies will not be run according to accepted business practices. In this case the government, not the market, decides the size of the profits, if there will be any profits at all. Hence, an investor is buying a company over which he has no control.

No businessman in his right mind would invest in a state-owned company under these ‘conditions. Indeed, when the government was interested in selling shams in Israel Chemical’s Bromine group, it had to waive these provisions. Yet assuming that these provisions are abolished all together, can the government allow a monopolistic company—such as electricity, or water—to set prices? Both could lead to demonstrations and near- riots by a wide swathe of citizens who felt they were being taken for a ride.

Another reason why it has been difficult to sell state-owned companies is that rank and file Israeli workers, at one time even supported by the Histadrut, had a policy of demanding something akin to a “transfer of ownership” payment. (This policy has largely disappeared in recent years.) Although they weren’t losing their jobs, they demanded severance pay (often double and triple ordinary severance pay), since somehow they believed they were technically losing their jobs because of the transfer of ownership, although they continued to work, i.e., they were hired immediately and never missed a paycheck.

There are certain unusual “benefits” that workers in state-owned companies receive. For example, the 7,000 workers of the Electric Corporation receive free power. In itself, this is no big deal, although they do use about three times the national average; 30 use eight times and one person uses eleven times the national average.

This waste is irritating to the consumers, and is especially annoying to every Minister whose province includes the Electric Corporation. They have all solemnly promised to end this practice. No one has succeeded, for within a few days after the Minister makes his public announcement, stories begin to appear in the press that the workers are considering “turning off the country’s lights.” This expression does not mean throwing a switch to put the country into darkness, but rather that there will be a series of unexplainable breakdowns which will reduce power output.

What does the future hold? In all probability the government will continue to sell its companies, if possible to foreign investors for hard currency. At least it claims that it will abstain from setting up new state-owned companies except as a “last resort.”

One such “last resort” occurred in 1983 when the four leading banking networks were tottering on the brink of collapse. The government moved to guarantee the price of the shares of these banks on the stock market, picking up several billion dollars of such shares in the process. So, today, although these four banks are not in the legal sense “state-owned” companies, they are close to it since the government holds about 70 percent of their shares, and can find few buyers.

Clearly, the road from socialism will offer many challenges in the coming years.