Connected Economics — Part 2 — Wasteful Spending, Corporate Taxes and Obama’s Threat

Three economic events threaten to rattle the Israeli Economy in the coming 3–24 months and they can either be very negative or a catalyst for positive change.

1. Israel’s budget deficit and the required reduction in government spending

2. A pending increase in the corporate tax rate

3. President Barak Obama’s support for the Start Up Visa

Well publicized budget cuts are on the way. And they should be. However, we should not let this next round of cuts pass in the same pathetic way that the last round of budget cuts was executed. Last time, by cutting equally across all ministries except for Education and Defense, Prime Minister Netanyahu and Finance Minister Steinitz avoided a showdown with his ministers, but, at the same time, did not make any decisions as to what is important to us as a country. This is deciding not to decide and it should be unacceptable to us citizens. Moreover, when money is tight the most important thing to do is to focus on what is important to us. In the world of budget deficits and connected economics, we cannot afford NOT to decide what is important to us. We need to demand this focus and decision making from our leaders. Spending must be cut in a focused way.

This is a risk and an opportunity. You see, the Hebrew word Bizbuz (בזבוז) means both spending and waste. That is, in fact, very true. The first thing this government needs to do is differentiate between spending and investment because Every Shekel we “spend” will go to waste in the connected economy. Actually, what we need to do is to drastically cut spending and significantly increase investment.

In part 1, I summarized why the connected economy was deflationary in nature and, when combined with global labor forces and capital, it was a net negative for local employment. These forces are driving what Harvard Professor and leading thinker on innovation Clayton Christensen calls efficiency innovations. There is a lot of pressure on the government to spend on job preservation and keeping factories open either through subsidies or preventing layoffs. “Spending” has the effect of actually enshrining labor inefficiencies and sets both corporations and populations up to be disrupted by transformational innovation. Worse, it actually condemns those workers to a life of rotating unemployment because they have not enriched any advanced skill which makes them more employable in the connected economy.

Let me give you an example of spending vs. investment on human capital. Today in Israel, when someone goes to the unemployment bureau, the local bureaucrat is tasked with finding that job-seeker a job. So the government bureaucrat collects available jobs and then sends the job seeker out to fill one that they are currently suitable for.

Let’s understand the dynamic at a more granular level. Based on my theory of Connected Economics, it is likely that the new job seeker was laid off from his job because his company became more efficient through technology or because his job was shipped overseas like I wrote in my last blog post. Alternatively, the industry he worked in was deemed inappropriate for this geography or the changing connected economy. In Israel, Cellcom employees were laid offbecause of efficiencies and employees of Pri Galil were sent home because it no longer made economic sense to can those vegetables in Israel. These jobs are not coming back to Israel and there will be more similar layoffs at other carriers, banks, insurance companies and every other service business in Israel that is being made more efficient by the digital economy. In fact, these efficiencies have a tendency to accelerate and with them layoffs are accelerated. Any government intervention in propping these businesses up, as suggested by Shelly Yehimovich, is simply “spending” that is a waste of money.

These newly laid off employees, whose jobs and industries are going through efficiencies, are now sent to the unemployment bureau and then recycled into jobs that their experience prepares them for. In reality, these are no more than temporary jobs to keep them from coming back to the unemployment bureau tomorrow because nothing in these people’s skill set has changed. We have simply kicked our human capital can down the road and are just waiting for the same people to turn up at the unemployment office in 30 days or 6 months when either their ruthless new employer or the ruthless connected economy renders them unnecessary. So we have spent money on the unemployment bureau, on its bureaucrats and on recirculating the people but have done nothing to create an economic gain or better human capital. This is wasteful spending. Worse, this is why people cannot break out of poverty and it is also why we are losing our competitive edge as a nation.

I am trying to keep this post shorter than the last one so I will not list other examples but suffice it to say that useless spending like this persists in every government ministry in this country because we measure spending, or inputs, and we do not measure outputs. I once heard Israel Makov point this out at the Caesarea Economic Conference and it really resonated. Now Bill Gates has highlighted this in his annual letter.

The same efficiencies of connected economics that already contribute to accelerating unemployment are the reason that the government must not raise corporate taxes. As I wrote in part 1, larger companies are quickly disaggregating and employing more and more people remotely and over the internet and on variable contracts and expenses. These same companies are watching their profitability very carefully because the stock market is and their competitors are getting more efficient. They also need cash flow to continue investing in efficiencies.

Raising the corporate tax rate in Israel will further encourage these companies to shed employees quickly to maintain their profitability and will leave them less money to compete on innovating efficiencies that are necessary for thriving in the connected economy. They will take advantage of the connected economy to fund lower cost employees elsewhere and to send their intelectual property overseas . And, since capital is global, they will establish new activities in lower tax districts. Apple recently showed the lengths corporations will go to legitimately avoid domestic local taxes and Israeli companies are no different. This is inevitable and no screaming about Zionism or corporate responsibility will change this because companies like Teva, Intel, eBay and even startups are competing globally and they need the extra cash flow to keep growing and to stay competitive. This has been proven empirically as HBR Editor Justin Fox has written:

“low taxes on capital and corporate income, that’s partly neoclassical theory (by encouraging investment, you get more growth) but also just realism about enforcement (global corporations and investors can easily get around such taxes).”

Our goal, therefore, as an economy is to stay competitive as a place where companies big and small want to do business. We are at an inherent disadvantage because Israel is a small market. Our internet connectivity hovers between the speeds in the Second and Third World. We have real challenges around a shortage of talent in high tech and other areas here. We have created other challenges by making it so difficult to set up and license a small business in Israel and we might be about to make it more difficult to be competitive by raising corporate taxes. Remember that connected Global Economy? So we must not raise corporate taxes. They will not close the budget deficit since the capital IP and jobs will escape to lower tax districts like switzerland and the islands and they will cause more Israeli unemployment. We actually need to lower corporate tax rates and make it more friendly for entrepreneurs of all kinds and nationalities to set up shop in Israel.

President Obama has finally figured this out and he is yet another risk to Israel’s entrepreneurial economy. Obama’s support for visa’s for foreign tech entrepreneurs is earth shattering. If it passes, it will attract many Israeli entrepreneurs alongside Chinese and Indian entrepreneurs to move to the US, the biggest tech market on the planet. What President Obama has figured out is that in the connected economy, the winner is the one that attracts the most entrepreneurs and the most members of thecreative class. (For now Obama is only focused on tech but ultimately it will get to all entrepreneurs). The job of political leaders who want to have a flourishing economy is to attract the most creative and talented people and entrepreneurs and make it easy for them to come, set up shop, connect, collaborate, profit and adapt to the new world. It is true in technology and it is true in real estate, agriculture, manufacturing and commerce as well.

This ought to be a wake up call for Israel’s leaders. Global-minded entrepreneurs who can get a US start up visa, our insufficient communications infrastructure, rising taxes and inefficient spending are enemies of the connected economy. Worse, inefficient spending does not advance our human, physical and digital infrastructure that we desperately need to compete in this fast evolving economy. In part 3, I plan to highlight potential investments that we ought to make while we dramatically cut spending in a brave, bold and focused approach.

[Originally published on 6th February 2013 by MIchael Eisenberg]