Capital drain

How far will the economic sector’s opposition to the government’s judicial reform go?

Among the multitudes who have expressed their opposition to the Netanyahu government’s judicial reform, is an increasingly vocal segment of hi-tech entrepreneurs and economic leaders warning about the financial implications of such an overhaul.

Amid the high-rises of Tel Aviv, in the streets of the Holy City, outside of the prime minister’s Caesarea home and at traffic lights throughout the country, concerned Israelis are gathering en masse and protesting, all in order to get a single point across: “We don’t want judicial reform.”

Over half of Israel’s GDP is the result of its hi-tech sector’s industry and service exports. In 2021 alone, hi-tech exports accounted for 54% of Israel’s GDP, totaling around $67 billion. A majority of Israel’s investment capital flows into the hi-tech sector from foreign investors seeking the Start-Up Nation’s world-renowned innovation.

Therein lies the concern of the judicial reform’s economically minded critics: a lack of legal checks and balances will result in less direct foreign investment from wary investors. The fear is that if investors are unsure about Israel’s protection of the rule of law – including property rights and the ability to get to the court in the event of a dispute – they’ll be much more reluctant to invest.

“Businesses need checks and balances, and they need consistent rule of law. When a government has all the power, as an independent business you’re no longer protected or have that predictability you need,” said Ben Rabinowitz, managing partner and founder of Amiti Ventures, a leading early-stage venture capital firm in Israel.

In an interview with The Jerusalem Post, Rabinowitz explained the threat posed by the judicial reform to foreign investment. According to him, not only will the practical effects of the reform affect the willingness to invest in Israel, but there’s also serious concern about how the reform – and the controversial views of the government that puts it into place – will harm Israel’s optics among investors.

“Companies and investors really do care about whether a country supports diversity and inclusion. There are some major investors around the world that have made very clear that this is part of their evaluation for investing. And so if we go against that trend, it will hurt us,” Rabinowitz said.

“Even if you have a government with views that are racist and anti-gay and against the Israeli-Arab community – if you have an independent Supreme Court, it’s shown again and again that it can protect minorities and protect against a government that tries to overreach,” he said.

A LOWER NATIONAL CREDIT SCORE

“The other problem,” said Rabinowitz, “is that we’re already seeing from the S&P and other rating agencies that this will affect the credit rating of the country, because if you’re not a liberal democracy with checks and balances, you can’t expect to have the same type of credit ratings.”

Indeed, this has already proven to be a salient point. Following the initial outcry about the reform’s economic consequences, a representative of S&P stated: “A consistent tendency to weaken key and essential institutions or the system of checks and balances is liable to increase the risk of a reduction of Israel’s credit rating.”

Prof. Karnit Flug, vice president of the Israel Democracy Institute and former governor of the Bank of Israel further elaborated on this idea during an interview with the Post.

“Based on the experience of some other countries that went in the same direction, if the government goes ahead with the judicial reform as it intends, we definitely have a heightened risk of reducing our sovereign credit rating,” said Flug.

“If this controversial and very extreme reform goes through, I’m afraid the risks are high that it will have consequences in terms of Israel’s rating, which will impact both the government and the general public .... It means less resources will flow to the economy, so certainly less capital will flow to the hi-tech sector. And that means that the economy as a whole and individuals in Israel are going to suffer from a much weaker economy and incomes, and that will have a detrimental effect on the standard of living,” Flug said.

IS IT JUST HYSTERIA?

Some have suggested that everybody’s just exaggerating the risk of economic calamity. It could be that they all just wanted a fun excuse to stand around and yell in the cold every Saturday

night for four consecutive weeks. Who among us hasn’t wished for the same?

Start-up marketing adviser Hillel Fuld suggested that the entire story surrounding the judicial reform’s risk is overblown.

“We are still building the best tech in the world. Israeli tech isn’t going anywhere. If people pull money, then it’s their loss, not ours,” he said.

During a press conference, Prime Minister Benjamin Netanyahu and Finance Minister Bezalel Smotrich dismissed concerns that the proposals would harm the economy.

“Nobody will harm intellectual property rights and the honoring of agreements, values which are sacred to us and which are the critical test,” Netanyahu said. “Not only will our moves do no harm, but they will strengthen [the economy] and return Israel to a stronger legal status.”

The prime minister followed up these statements with the ironclad argument that “over the years, many [critics] were wrong all along.”

Smotrich aptly added: “A lie that is repeated a lot apparently becomes the truth. A billion lies will not become the truth.

“Israel’s macro data are fantastic due to consistent and good government policies,” he continued, neglecting to mention whether any of those prior “good government policies” included a first-of-its-kind judicial system overhaul.

EITHER WAY, HI-TECH IS UPSET

Despite the government’s remarkably reassuring remarks, much of the Israeli hi-tech sector has begun to cry out in protest against the proposed reform. In mid-January, over 270 business and economy experts signed an open letter to Netanyahu warning of the “danger to Israel’s economy” posed by the judicial reform.

As well, hi-tech strikes featuring participation from over 100 companies have taken place across the country over the past two weeks, with employees and executives rallying together in order to prevent the damage that they fear will be done by the government’s plan.

“No wealth holder will put money in a state where democracy is crumbling,” said Eynat Guez of Papaya Global, during a rally in Tel Aviv last week. “The Start-Up Nation without democracy can’t exist.”

Papaya Global’s 700 customers include Microsoft, Toyota and General Dynamics, according to Forbes. The company was valued at $3.7b. in 2021.

Later that week, Guez

announced the decision to pull Papaya Global’s money out of Israel.

“Following Prime Minister Netanyahu’s statements that he is determined to pass reforms that will harm democracy and the economy, we made a business decision at Papaya Global to withdraw all of the company’s funds from Israel,” Guez tweeted. “In the emerging reform, there is no certainty that we can conduct international economic activity from Israel. This is a painful but necessary business step.”

“Everybody knows Israel is never on safe ground, because of the complicated diplomatic issues,” Guez later told Reuters. “But now we’re adding this reform, which is ultimately emerging as harming democracy. That’s a fatal blow.”

The same day, Disruptive Technologies Venture Capital, a Herzliya-based firm with $250 million under management, also announced its decision to withdraw its funds from Israel.

“Assuming the reform, which is a legal coup, happens, economic instability will be created in the State of Israel, when in practice there will be one authority that will do what it wants, including corrections and changes in taxation and the way companies work,” Disruptive’s founder, Tal Barnoach, told Calcalist. “Economies are built on stability. I am now in London. I met my investors, and they are very worried. They say that if the reform passes, it is not clear to them if they will continue to invest in Israel,

and they may have to make a change because they do not want to be at the mercy of one authority.

“The message here is that the banking activity in Israel will also be affected, and this is what they do not understand: that the next in line to be affected will be the citizens of Israel and less money for people who need it,” Barnoach said.

On Tuesday, Tom Livne, CEO and founder of the Israeli unicorn start-up Verbit, announced that he will be leaving the country and ceasing to pay taxes as an act of protest against the judicial reform. As well, he said that he has already begun withholding investments in the Israeli economy.

Livne, whose company is valued at $2b., stated that such hard stances must be taken

by the tech industry, which he called “the engine of the economy,” in order to show the government that it means business. “Then they’ll come to the table and talk to us as equals,” he said.

“I hope [others] will see me doing this and follow my lead... to stop residing in Israel and to stop paying taxes. This is the solution and one that will hurt [the government] the most,” Livne said.

IS NOW THE TIME FOR BATED BREATH?

Despite the suspense surrounding the judicial reform saga, hundreds of thousands of Israelis have thus far refused to hold their breath and see what happens. Already, more organized protests are being planned, though it remains unclear whether the government will actually decide to hear the concerns of critics, rather than try to wave away the issue with the political jargon equivalent of “It’ll be fine, just trust me.”

As more investors and companies pull out of Israel’s economy, the country’s leaders may soon have no choice but to consider alternatives to the reform.

Of course, that’s assuming that the experts, economists and leading tech executives who are warning against the reform’s potential harm actually know what they’re talking about. But all they’ve got is a vast collection of expertise, academic degrees and multibillion-dollar success stories, so what do they know?