Red tape strangles the ‘Start-Up Nation'

Excessive state bureaucracy is shackling Israeli firms and depressing market competition, leading to low levels of productivity.

By ALEX BENEDYK
Ramat Gan's business district. (photo credit: REUTERS)
Ramat Gan's business district.
(photo credit: REUTERS)
Excessive state bureaucracy is shackling Israeli firms and depressing market competition, leading to low levels of productivity. Productivity measures how much value workers produce for each hour worked, and since records began in 2000, Israeli productivity has been consistently below the OECD average – a group of 34 economically developed countries. In 2013, the latest data set, Israeli workers produced an average of $33 per hour worked, almost 20 percent less than the OECD average of $41, and less than the aging workforces of Slovenia, Italy and Japan. Norwegians, in stark contrast, produced an average of almost $63 per hour worked. This is particularly surprising since Israel outperforms much of the OECD in many important macroeconomic objectives such as GDP growth, attracting foreign investment and international trade.
The Israeli government must take significant responsibility for this. Government red tape is “hampering private sector activity” according to a 2015 OECD report on Israel. Red tape lowers productivity of firms directly by making it more cumbersome to do business, and indirectly by allowing them to “rest on their laurels” since market competition is reduced as potential new firms find the prospect of excessive bureaucracy an overwhelming obstacle to starting up.
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Red tape is a problem experienced by all firms, in all countries, but Israeli firms are particularly hard-hit.
While governments world over have made paying corporation tax easier, Israel lags far behind. Medium-sized Israeli businesses spend an astonishing 235 hours a year filing tax returns according to The World Bank’s “Doing Business” report published in 2015. While governments elsewhere boosted firms’ productivity by consolidating tax filing to reduce the number of forms needing to be filled out each year, medium-sized Israeli firms will complete on average 33 tax payments a year, almost triple the OECD average.
The administrative burden of complying with tax regulation gives Israel the unenviable rank of 97 out of 189 countries, almost twice as bad as the average for high-income OECD countries (53). These hours are all taken away from producing output, thus squeezing business productivity.
A further illustration of excessive red tape lies in the difficulty of enforcing contracts. These protect the rights of buyers and sellers and, on the business side, encourage firms to seek new clients with the peace of mind that they are protected should customers fail to pay. Israel’s judicial system is ranked among the least efficient in the world at resolving commercial disputes. On average, working through the courts to ensure contracts are honored takes a staggering 890 days, over 200 days more than the Middle East and North Africa average (658), and almost twice the Europe and Central Asia average (448).
This dire figure impacts productivity in at least two ways. Firstly, it creates a reluctance to form risky but potentially high-value new business relationships for fear of not being able to collect payment, and secondly business employees are spending time working on legal cases rather than producing output. According to The World Bank, when it comes to “ease of contract enforcement,” Israel is situated in 111th place out of 189 countries, a position worse than countries with notoriously suspect judicial systems such as Sierra Leone, Haiti and South Sudan.
As if the aforementioned issues were not enough to scare off potential new firms, when it comes to building factories, things get even worse. New Israeli firms face particularly severe difficulty when dealing with construction permits needed to acquire a warehouse. It takes on average almost seven months to get a permit (209 days), about three months more than the average time in the Middle East and North Africa region (132 days). Israel is considered the 121st worst country out of 189 when it comes to getting a construction permit, thus fairing worse than countries with little record on property rights such as the Democratic Republic of Congo, Zambia and Kuwait.
Whilst existing firms also suffer from this, they might be able to tolerate it by improving current facilities. New firms however face a long and frustrating time on the sidelines, unable to get started. Potential new entrants are thus discouraged from entering the industry, reducing the urgency for existing companies to enhance their productivity.
Early last year, a committee was set up and tasked with identifying the regulatory obstacles to doing business.
Judging by the above, this should not be too difficult, or take very long. However, actually overturning the culture of rigid government bureaucracy presents a far greater challenge, and will take much courage and determination in order to free Israel from the shackles of red tape so it can truly fulfill its potential as a world-class economy.
The new Israeli government must take a close look at methods used by other governments to slash red tape, and enable Israeli employees to spend their time on producing output rather than satisfying archaic bureaucratic demands.
The author is a Research Fellow at the Jerusalem Institute for Market Studies.