Israel's Trade Relations with the European Union: The Case for Diversification

Abstract

Since the introduction of the European Neighbourhood Policy (ENP) in March 2003, Israel, like the other Mediterranean partners, appears to be facing a real policy choice regarding further economic and political integration into the European Union. The purpose of this article is to provide a qualitative policy perspective regarding some of the trade-offs of enhanced economic relations with the EU. It argues that for Israel the potential benefits are questionable, while the potential costs are high, including an increase in Israel's already high level of what is referred to in the article as ‘trade exposure risk’. As an alternative to deepening its trade relationship with the EU, the article proposes that Israel manage its trade exposure risk through diversification, that is, expand its geographical trade and investment base to faster growing economies such the ‘BRIC’ countries (Brazil, Russia, India, China). It then outlines possible criteria for assessing the BRIC countries as potential FTA partners.

Acknowledgements

An earlier version of this paper was published in L. Cabada and M. Mravinac (Eds) (2008) Integrating with the European Union: Accession, Association and Neighbourhood Policy (Pizen: Aleš Čeněk). I would like to thank Prof. Arie Reich and three anonymous reviewers for their valuable comments. The opinions expressed, however, and any mistakes made, are my responsibility alone.

Notes

¹ It is beyond the scope of the paper to tackle the possible security motivation for linking Israel to the EU.

² By 2000, Israel's FTAs included the EU (1975), the US (1985), EFTA (1992), Canada (1996), Turkey (1997), Mexico (2000), Czech Republic (1997), Slovak Republic (1997), Hungary (1997), Poland (1997), Slovenia (1997), Romania (in effect from 2001), Bulgaria (in effect from 2002), although the FTAs with latter seven were dissolved when they joined the EU. Israel signed FTAs with eastern and central European countries and Turkey in order to maintain its export competitiveness with EU goods after they signed preferential trade agreements with the EU. Israel also has had a preferential agreement with Jordan since 1995. It was replaced in December 2004 (WTO, 1999: Table II.2; 2006a: Table II.4).

³ Israel adopted the Pan-Euro-Mediterranean Rules of Origin in January 2006 by amending Protocol 4 of the EU–Israel Association Agreement by Decision of the EU–Israel Association Council on 22 December 2005. See OJ L 20 dated 24 January 2006.

⁴ In a full cumulation arrangement, inputs or processing activities from any of the countries in the trade bloc may be combined to confer ‘originating’ status, whereas in a diagonal cumulation arrangement, an input or processing activity would have to confer originating status prior to leaving the individual country to another country in the trade bloc. Hence, under diagonal cumulation, a country with few raw materials or the ability to produce intermediate inputs (such as assembly) would have more difficulty in exporting originating products to the other countries in the trade bloc. Since Israel is a small country with few natural resources and lacks any economic advantage in performing a sufficient number of processing steps for its inputs to qualify as originating, it would be better off as part of a full cumulation of origin arrangement where all inputs/processing can be pooled. For a description of the three different types of cumulation (bilateral, diagonal and full cumulation), see Muller-Jentsch (2005: 86).

⁵ Gross national income (GNI) per capita of $11,116 or more in 2006. Other Mediterranean partners are classified as follows: lower middle income (GNI per capital of $906–$3,595) include Algeria, Egypt, Jordan, Morocco, Syria, Tunisia and the Palestinian Authority (West Bank and Gaza in World Bank classification), and upper middle income (GNI per capita of $3,596–$11,115) include Lebanon and Turkey.

⁶ In 1991, Israel undertook a unilateral liberalization plan for industrial products, abolishing quotas and gradually reducing MFN tariff rates between 1991 and 2000 to a maximum of 8 per cent and 12 per cent. Today, the average applied MFN tariff rate on industrial products is 5.1 per cent (WTO, 2006a: xviii).

⁷ Euro-Mediterranean Agreement Establishing an Association between the European Communities and their member states, on the one part, and the state of Israel, of the other part, Official Journal (OJ) L 147, 21 June 2000, pp.0003–0171.

⁸ For a survey of the trade barriers existing between Israel and the EU in the context of the Barcelona Process, see Sadeh (2004).

⁹ See http://ec.europa.eu/world/enp/pdf/action_plans/Israel_enp_ap_final_en.pdf (accessed 10 September 2008).

¹⁰ Since the EU/Israel Action Plan is a jointly owned document, the argument can be made that if Israel viewed the services sector as a key priority, it should have ensured that more ambitious commitments regarding the progress of the service negotiations be included. In response, it can be claimed that the EU was the stronger party in the negotiations with more power to determine the outcome. Moreover, according to Israeli officials, the EU negotiators often claim that it was not ‘in their mandate’ to go any further.

¹¹ Tovias (2003: 3–4) has therefore suggested that it would be appropriate for Israel to first join EFTA and then the European Economic Area (EEA), in order to achieve economic integration with the EU.

¹² See Hoekman (2005: 24–5) for a discussion of the positive list approach. Though it permits flexibility, a positive list approach provides transparency only in sectors covered by commitments and thus a negative approach might be preferable for transparency purposes.

¹³ The 30 OECD countries are projected to grow by 2.3 per cent in 2007 and 2.4 per cent in 2008 (OECD, 2007b).

¹⁴ In an economically integrated world, this may be a difficult goal to achieve; however, it still may be possible to identify countries whose economies are driven by domestic consumption rather than exports or whose economies are less correlated with the US and EU economies.

¹⁵ Trade was not Israel's only impetus for joining GATT. Since its establishment in 1948, one of Israel's main foreign policy goals has been international acceptance; accession to international institutions was considered an important means to this goal.

¹⁶ For the history of Israel and the GATT/WTO see Reich (2006).

¹⁷ See note 2 above for a list of FTAs.

¹⁸ The trade-to-GDP ratio is the sum of imports and exports divided by GDP. This ratio is commonly used as an indication of trade openness. However, the low ratios of the large OECD economies such as the US and Japan may not indicate that they are not open, but rather that due to their size they can be more self-sufficient.

¹⁹ For an overview of the problems faced by the EU economy see Economist (2007). This article does point out that not all countries in the EU have shown slow growth: Denmark, Finland and Sweden have performed extremely well, while France, Germany and Italy, which account for two-thirds of the EU's GDP, have brought down the growth average of the region.

²⁰ For European Commission summary of Lisbon Strategy, see http://europa.eu/scadplus/glossary/lisbon_strategy_en.htm.

²¹ For description of telecommunications and postal services sector in Israel, see WTO (2006a: xix, 84–7 159–60).

²² Some of the examples he uses are not relevant to Israel and the EU. For example, he notes that it is still possible to use drawbacks under the WTO, which are not defined as subsidies under the WTO but are in fact payments to producers (Shadlen, 2005: 758). Israel in its Association Agreement with the EU relinquished the right to give drawbacks. See Article 16 of Protocol 4 Concerning the Definition of the Concept of ‘Originating Products’ and Methods of Administrative Cooperation.

²³ Fink and Reichenmiller (2005: 8–9) of the World Bank, in their comparison of TRIPS-plus provisions in US trade agreements, make a similar point, noting that stronger intellectual property rights are not necessarily welfare-enhancing, and should not be subject to mercantilist bargaining.

²⁴ The Action Plan calls for enhancing ‘dialogue on the promotion of IP issues, including for example, data protection, enhancement of enforcement through a dialogue with prosecutors and other relevant entities, etc.’.

²⁵ Euro-Mediterranean Interim Association Agreement on trade and cooperation between the European Community and the PLO for the benefit of the Palestinian Authority of the West Bank and the Gaza Strip, 16 July 1997 OJ L187 (1997).

²⁶ Proclamation No. 6955 to provide duty-free treatment to products of the West Bank and the Gaza Strip and Qualifying Industrial Zones, 61 Fed. Reg. 223 (13 November 1996), pp.58759–65.

²⁷ For a detailed description of the legal and political aspects of this dispute see Harpaz (2004).

²⁸ Notice to Importers: Imports from Israel into the Community, 23 November 2001, OJ C328/04 (2001).

²⁹ This linkage appears in May 1998, in Commission Communication to the Council and Parliament on the implementation of the interim agreement on trade and trade-related matters between the European Community and Israel, in which the Commission stressed that full compliance with existing agreements was a ‘precondition’ of extending diagonal cumulation to Israel, noting problems in application of Protocol on Rules of Origin and suspected violations in products originating in Israeli settlements in East Jerusalem, the Golan Heights, the West Bank and the Gaza Strip. See Commission Communications from Bulletin EU 5-1998, points 1.3.26 and 1.3.85.

³⁰ Notice to Importers, Imports from Israel into the EU (2005/C20/02) Official Journal of the European Union, 25 January 2005.

³¹ Needless to say, the goal of this particular sanction was relatively modest in comparison to sanctions that are intended to force a regime change or promote democracy. Nevertheless, the EU action of restricting certain imports with the possible result of impeding all imports from Israel seems to meet the Elliott et al. (2007: 3, 44–5) definition of economic sanction as a ‘deliberate government-inspired withdrawal, or threat of withdrawal of customary or financial relations. “Customary” does not mean “contractual”, it simply means levels of trade and financial activity that would probably have occurred in the absence of sanctions’.

³² Although the affected exports to the EU were estimated to constitute only a small proportion of total Israeli exports to the EU, a strong spillover effect was anticipated on all Israeli exports to the EU (Harpaz, G., 2004: 1052–3).

³³ These criteria do not consider relative distance between Israel and the BRIC countries. Because all four are a considerable distance from Israel, the respective differences in distance are assumed to be marginal. Nor is language or culture considered.

³⁴ The GDP growth rates (at constant prices) of India and China were 9.1 and 11.4 per cent respectively in 2007 while the US and the EU (27) only grew 2.2 and 3 per cent respectively in 2007. The Commonwealth of Independent States (CIS), including Russia, also saw high GDP growth of 8.4 per cent in 2007. South and Central America including the Caribbean grew 6.3 per cent in 2007 (WTO, 2008: Table 1). In 2006, Russia's GDP growth rate was 7 per cent, and Brazil's 4 per cent (WTO Statistics Data Base: Trade Profiles).

³⁵ The Russian Federation started the accession process in 1993. For information see WTO website under accessions. Available at http://www.wto.org.

³⁶ The rates of the US and the EU have been added for the sake of comparison; however, in fact, the comparison with the US and the EU is not relevant since Israel's industrial exports have entered their markets duty-free for many years as a result of FTA agreements.

³⁷ In contrast, countries with high MFN customs tariffs on agricultural products would be attractive FTA partners for countries specializing in agricultural exports such as Brazil, New Zealand, and Australia.

³⁸ According to the WTO Secretariat, the average GATS sectoral coverage for developing countries is 23 and 93 for developed countries (WTO, 2006a: 74).

³⁹ According to WTO statistics, in 2006 Israel ranked as the 45th largest merchandise exporter and the 42nd largest importer, and in commercial services it ranked as the 31st largest exporter and the 36th largest importer, counting each EU country separately (WTO Statistics Data Base: Country Profile).

⁴⁰ Israel's outward foreign direct investment has been rising steadily since the 1990s. According to the OECD Investment Policy Review of Israel in 2002, Israeli companies made substantial investment in EU candidate countries in the 1990s, often using western European-based companies to channel their investments (OECD, 2002: 21).

⁴¹ To impose safeguard measures selectively on China, however, Israel would have to have the appropriate domestic legislation in place.

⁴² Common Market of the South (Mercosur) consists of Argentina, Brazil, Paraguay and Uruguay.

⁴³ The agreement with Mercosur can be considered a shallow or light FTA, dealing only with trade in goods. It would have been in Israel's interest to cover cross-border services trade, but this has been put off to the future according to Article 9 of the FTA. Among other things, the agreement covers bilateral safeguards, global safeguards, reaffirms WTO rules on technical regulations and standards, sanitary and phytosanitary measures, and has an elaborate dispute settlement mechanism. There is no provision for intellectual property rights or government procurement. The full agreement in English can be found on the site of Israeli Ministry of Industry, Trade and Labor: http://www.tamas.gov.il.