The U.S.-Israel Free Trade Agreement: Aid Instead of Trade?

By Colin MacKinnon

Much ballyhooed when it was under negotiation in the early 1980s, the U.S.-Israel Free Trade Area Agreement is showing its defects after eight years of operation. How the agreement is working—or not working—raises real questions about whether an economy like Israel's, which is small, troubled and has a persistent state component, can be linked up in a genuine free trade area with the largest economy on earth.

A friendly Reagan administration negotiated the agreement, supposedly as a way of weaning Israel away from reliance on U.S. financial support. That notion was backed up with wishful studies from conservative think tanks such as the consistently pro-Israel Heritage Foundation, which made "trade instead of aid" the slogan of the campaign.

Some slogan. The agreement, which went into effect on Sept. 1, 1985, has had no discernable effect on the level of American aid to Israel. In fact, by eliminating U.S. tariffs while permitting a whole range of Israeli non-tariff barriers, the treaty is turning out to be just another form of U.S. aid to Israel.

And not a very honest one. Its effects are hard to see and, because they occur in the private sector, they don't show up on government books. But they're there.

The idea behind free trade agreements is that they increase international commerce by dropping administrative barriers like tariffs between the countries that sign them.* Typically, too, these agreements contain "national origin" requirements. That is, for goods to get the benefits of the treaty, they have to meet complicated tests showing they really and truly are from a signing country, not just transshipped through it.

The U.S.-Israel FTA is reasonably typical. It does, for example, phase out tariffs—they're to be gone by mid-1995—and has reasonable and enforceable rules of origin.

But it allows other restrictive devices, of which Israel makes use, and doesn't address Israel's own domestic practices, which have the effect of favoring Israeli over American producers.

Loophole—or Barn Door—in the Agreement

The main loophole in the agreement is an article covering agricultural products that allows each party to set up a whole range of bans, quotas, licensing restrictions and other barriers to the flow of agricultural trade. Israel takes full advantage of the loophole; the U.S. does not.

Thus, Israel maintains a complete ban on poultry, dairy products, eggs, most fresh and prepared vegetables, most fresh fruit, and prepared products like olive oil, apple juice, and grape juice. Israel also maintains quotas that keep out large quantities of items ranging from lamb, sheep, and fish to raisins and prunes.

To be sure, the U.S. also bans or limits some imports, for example, sugar, dairy products and peanuts. But none of these are important Israeli exports and banning them doesn't disrupt, at least not in a major way, Israeli sales to the U.S.

The agreement establishes a Joint Committee of Israelis and Americans who meet twice a year to thrash out problems. The agriculture loophole is a continual hassle. One involved U.S. official says negotiators "are having a terrible time" with the Israelis over the issue.

The Real Problem: Israeli Domestic Practices

The real problem, though, is not so much loopholes in the agreement as Israeli domestic practices that the agreement doesn't touch on and that favor Israeli producers. Here are some examples and how they work.

TAMA. The Israelis evaluate the cost of an import in order to put a later purchase tax on it. The practice is called TAMA, an acronym for a Hebrew phrase meaning "additional rate of increase."

The price Israeli officials use, however, is not the price at the dock but a wholesale price they simply dream up. They can, and often do, set the assumed wholesale price at double the dock price. Since the purchase tax is typically 100 percent of wholesale, the markup on imported goods can be extraordinary.

An American widget coming into Israel with a dockside price of, say, $100 might be assumed to have a wholesale price of $200. The tax on the widget therefore— not officially a tariff, mind you—would then be $200, raising the wholesale price to at least $300.

The Israelis put a purchase tax on Israeli products, too, but U.S. officials complain that the Israelis use "untransparent" (bureaucratese for "secret") methods for doing so. "It's not at all apparent how they do that," says one, "and we have concerns that local products end up being taxed much more lightly than imported products. "

Harama. To calculate customs duties, Israeli officials take a look at the sticker prices of products coming into the country and automatically increase them by 2 to 10 percent. The assumption is that Israeli importers and foreign vendors collude to undervalue the prices of imports.

Whatever the truth to that is, increasing the declared value of goods (the term is harama, meaning "uplift") has the effect of increasing duties, and thus making the imported goods more expensive.

Because tariffs are being phased out, harama will be less of an issue in the future, but it is a nuisance now and even after tariffs are gone may still be used to set some domestic taxes.

Unfair application of luxury taxes. Israel puts a tax on "luxuries" like washing machines, automobiles and so on, which are tremendously expensive in Israel. The U.S. Trade Representative says it believes there are cases where locally produced appliances are not taxed as luxuries when similar American goods are. The suspicion is that luxury taxes are manipulated to favor the Israeli producer.

Wharfage and port fees. For the use of Israeli ports and stevedores, Israeli Customs charges importers 1.5 percent of the cost of goods coming into the country. The charge, naturally, gets tacked onto the final price in Israel.

Exporters, on the other hand, don't pay port or stevedore charges, so Israeli goods get a free ride out of the country. This means that Israel is using imports to subsidize its exports.

Product and packaging standards. A lot of goods in Israel have to be sold in standard metric sizes. A jar of mustard, say, has to weigh 500 grams, not 16 ounces. Rules like this make it tough for U.S. producers, most of whom still use English measurements. U.S. trade officials believe that some of these standards, like the luxury taxes and TAMA, are applied to favor Israeli over American producers.

Government procurement. Very few Israeli government tenders are open to U.S. bidders on an equal footing with Israeli bidders. And Israeli ministries that don't discriminate overtly against American bids often give so little advance notice when a tender is announced that U.S. firms can't get their bids in before the deadline.

Israeli government procurement practices also illustrate why an economy with a large state component finds it hard to fit into a free trade agreement. One large Israeli government entity is in charge of importing all beef into the country. Since American beef tends to be high quality and high priced, Israel buys virtually none from the U.S. If the market were open and free, however, some private sector importers would go for the American product.

The upshot of all this is that under the so-called free trade agreement with the United States, Israel gets away with hard-to-see, discriminatory trade practices.

For the last few years, trade between the two countries has been in rough balance (it totaled $8 billion last year). You could argue that if Israel's non-tariff barriers were suddenly eliminated, however, Israel would start showing trade deficits with the U.S.

You could also argue that if the U.S. has to make concessions to Israel to keep bilateral trade in balance or otherwise enhance Israel's economy, it would be better to make them explicit and put them up front in the agreement itself, where Congress and the public could evaluate them in light of Israel's already immense share of U.S. foreign aid.

But that won't happen. Devices like TAMA, the high luxury taxes and all the rest have become permanent fixtures of the Israeli economy, ever-present to skew a free-trade agreement in Israel's favor.

The U. S. currently has three of these agreements—one with Canada, one with approved states in the Caribbean region (the Caribbean Basin Initiative), and the one with Israel. All of them are products of the Reagan years. NAFTA, between Mexico, the U.S. and Canada, is a Bush administration creation and has yet to be approved by Congress. For its part, Israel has free trade area agreements with the EC (1975) and EFTA (1992), both of them rather restrictive.

Colin MacKinnon is chief editor of the Washington-based Middle East Executive Reports.