Israel Ponders a ‘Free Export’ Zone : Mideast: Tax-exempt, loosely regulated business havens might be a way to lure foreign investment. But the nation’s socialist roots die hard.

Of all the statistics describing Israel’s economy, none is more telling for Israel Export Corp. President David Yerushalmi than the fact that Israelis invest more money abroad--60% more last year--than foreigners invest here.

“First, there is a real question of confidence in Israel’s future, and then there is the question of the growth potential for long-term investments here,” Yerushalmi said. “But there is also the very practical question of why it is so darned difficult for anyone to invest here and make money.”

His answer to that question differs little from the diagnoses of many other businessmen and economists who cite Israel’s high taxes, heavy labor costs, extensive government regulation and small domestic market.

But Yerushalmi disagrees with the usual proposals for incremental reform. He favors a demonstration project to prove that Israel could be weaned more rapidly from decades of socialism.

His vehicle for change would be a “free export processing zone”--an Israeli version of the American “enterprise zone,” where foreign and Israeli investors would pursue a wide range of export-oriented manufacturing, marketing, services and research activities free of most government regulations.

Paying only a limited, 15% tax on profits returned to their home countries, investors would be able to utilize the country’s highly educated work force--particularly new immigrants from Russia--without most of its highly restrictive labor laws and practices.

In return for reduced taxation and government regulation, the companies operating in the zone would give up the extensive subsidies that export-oriented enterprises here enjoy--subsidies that often exceed both the taxes the firms pay and the foreign investment they attract.

“In Israel, people still don’t believe that capitalism works better than socialism, and for that reason we will never get an across-the-board transformation of the Israeli economy,” Yerushalmi said. “I think we can prove it, though, and in the process get real growth that brings in investment, creates jobs and promotes exports.”

The proposal has run into stiff opposition in a country long accustomed to state intervention in its economy.

Meir Tamari, the former chief economist of the Bank of Israel, compares the proposal to 19th-Century European colonialism. “It is freedom from Israeli law, public supervision and government regulation that is being sought,” Tamari wrote. He predicted “dangerous labor conditions, shoddy building, . . . inadequate town planning” and environmental damage resulting from a drive for quick profit.

“We would be left with the result of this freedom for many years after the. . .investors had disappeared, just as people in underdeveloped countries are left with the faulty infrastructures left by their foreign investors,” Tamari declared.

Yerushalmi, however, said he believes the initial, proposed 500-acre zone would begin replicating itself across Israel within a couple of years.

“This is the experience of most other places, starting with Taiwan and South Korea 25 years ago--until the whole country is pulled out of its socialist lethargy and into the competition of the global market with the profitability that would bring,” he said.

His arguments are supported by Alvin Rabushka, a leading American economist who strongly advocates freeing markets from over-regulation. Rabushka, a senior fellow at Stanford University’s Hoover Institution, cites the high success rate of the more than 160 such zones in 65 countries and territories around the world.

“It is the right idea for Israel and will have a powerful effect, not just in the jobs it creates and exports it generates, but the way it drives the whole economy forward,” said Rabushka, who has followed free-enterprise zones around the world for 25 years. “Israel has this window of economic freedom before it--a chance to escape from socialist failure and to assert its economic independence.”

Yerushalmi, an intense, 36-year-old former lawyer and real estate developer who came here from Los Angeles a year and a half ago, said he already has commitments for more than $700 million in initial investments that would create 19,270 jobs. He also has $125 million from his own stockholders--25 leading Jewish businessmen in the United States--to pay for the zone’s infrastructure.

The first Israeli zones would be either in the Galilee region or the Negev Desert.

They would be designed to attract companies in activities ranging from auto assembly to stock brokering and offshore banking, from technology research and product development to satellite communications and data processing.

Draft legislation authorizing such area is near completion; Finance Minister Avraham Shohat, an early supporter against the views of his advisers, is expected to put it before the Cabinet. The hope is that the Knesset will pass it by the end of summer.

The strong opposition that the proposal has encountered over the last year has made Yerushalmi cautious, however. Some critics have said that workers, driven to the zone by the shortage of jobs elsewhere, would be exploited as cheap labor, that Israeli companies would shift their new investment there to avoid taxation and that little additional foreign investment would be attracted. Still others--particularly in the Finance Ministry--have said pressing ahead with the special zones would delay the overall reform of the Israeli economy.