Is It Time to Update the 1985 US-Israel Free Trade Agreement, in View of EU Neighborhood Policy?

By June 29, 2009

BESA Center Perspectives Paper No. 84

EXECUTIVE SUMMARY: As the Israel-US Free Trade Agreement (FTA) approaches its 25th year, the treaty’s terms should be reevaluated. Much has changed since the signing on April 22, 1985, and while it may be time to negotiate an updated, more sophisticated agreement, especially in light of the developments between Israel and its other main trade partner – the EU – the author argues that it may be best for Israel not to do so.

Reasons for Updating

There are several reasons for reevaluation. First, the 1985 FTA is an outdated agreement compared to today’s agreements, particularly for the US. This is manifested in the limited scope of the agreement. The FTA is limited to trade in goods, and does not touch upon important topics such as trade in services, intellectual property, R&D cooperation, foreign investment protection, competition law, protection of the environment, energy, or transportation. Additionally, the FTA’s enforcement mechanism is quite primitive; while it allows one party the right to an arbitration panel to hear its complaint against the other party, it does not make the decision of that panel binding. Israel experienced this problem firsthand when it won the 1991 Sharnoa case against the US, but was unable to enforce the panel’s full decision due to the FTA’s deficiency.

Second, one would expect the US to keep up with the EU’s efforts to upgrade its agreements with Israel. In 1995, the 1975 Israel-EU Free Trade Agreement was substituted by a more comprehensive agreement – the Association Agreement –which came into force in 2000. Along with this agreement there have been several other initiatives to further integrate Israel into the European economy, such as Israel’s admission into the European Framework Program for Research and Technological Development and the Galileo Program. In addition, in 2004 the EU came out with its European Neighborhood Policy and within this framework, Israel and the EU have been working continuously to widen their bilateral trade, economic, social and political relations.

Some of these initiatives may come at the expense of US economic interests, such as the integration of Israel into European standard setting procedures and harmonization of Israeli technical standards with EU standards, and not with US standards. Another example is the EU R&D program: this program has caused a significant increase in EU-Israel scientific cooperation and a corresponding reduction in US-Israel scientific and technological cooperation.

Third, Israel’s political relations with the US are stronger than its relations with the EU. One would expect the parties to keep their economic relations on par with their warm political relations. If the Europeans are doing so, why wouldn’t the Americans?

Against a New FTA

Despite the abovementioned reasons, it is not in Israel’s interest to update its FTA with the US.

One important reason against updating is that the rules of origin of the existing FTA are the most lenient of all of Israel’s FTAs, as well as of all of the US’s FTAs. Moreover, the same rules apply for all types of products, so they do not allow their use for protectionist purposes in certain “sensitive” areas. This means that it is easy for Israeli exporters to meet the rules and receive duty-free treatment when their products are imported into the US. While the same rules apply for US imports to Israel, the rules are more beneficial for Israel because of Israel’s greater dependency on raw materials and components imported from third countries. The US has asked Israel several times to change the rules, but Israel has refused and managed to fend off these requests. If the FTA were to be renegotiated, the rules would most likely be changed and brought in line with the rules of all other US FTAs, which would not be in Israel’s interests.

Another strong reason against a new FTA is the inclusion of an Intellectual Property (IP) chapter in all recent US FTAs. This is aimed at promoting the interests of US IP holders, in particular that of pharmaceutical companies. These chapters impose higher standards of IP protection than what is required under general international law, and in particular under the TRIPs agreement of the World Trade Organization. Such standards are contrary to the interests of Israel’s pharmaceutical industry, especially Teva, one of the world’s largest generic drug companies that provides thousands of jobs in Israel. The US has applied pressure on Israel in this area, to no avail. Opening up the FTA for renegotiation will lead to US demands for “TRIPs-plus” obligations, contrary to Israel’s national interest.

In order to outweigh the likely costs of an FTA renegotiation, there must be significant benefits for Israel. Yet, the benefits do not outweigh the costs. For instance, one possible improvement of the FTA could be a chapter on foreign investment protection, which is a common component of many modern FTAs, including those in the US. The objective of such a chapter would be to attract foreign investment by ensuring protection for US investors in Israel from direct or indirect expropriation or other unfair or discriminatory treatment, and for Israeli investors in the US. However, US investment in Israel has grown immensely over the last decade without any such protection by international law. This shows that US investors have faith in Israel’s economy and in its domestic legal system to protect them in case of undue treatment, without an investment chapter in the current FTA.

Another possible benefit is a further opening of the services market. However, the US, with its strong service industry, is more likely to benefit from such a mutual opening than Israel. There are less artificial barriers to entry into the US service market than in Israel, and large US service providers in fields such as banking, insurance, brokerage and entertainment are more likely to be successful in entering the Israeli market than Israeli providers are likely to enter the US market.

Nonetheless, there is room for improvement for the rules governing US-Israel economic relations. However, tactically it may be better for Israel not to update the FTA, and instead pursue ad hoc solutions for pressing problems.

For instance, there is room for improvement in relation to bilateral scientific cooperation. This will lead to industrial and commercial cooperation and development. Currently, the EU Seventh Framework Program provides Israeli institutions with an annual budget of over 70 million Euro, while the US-Israel Binational Science Foundation (BSF) only provides about $15 million dollars a year to US and Israeli scientists. This explains the diversion of scientific cooperation towards the EU. To increase cooperation with the US, the BSF should be allotted more money and its activities widened.

Finally, the human and intellectual resources of Israel’s Ministry of Trade and Industry are limited. When deciding whether to launch bilateral trade negotiations with another state, alternative projects – where the potential for gain is higher – should be taken into consideration. At this time, there is higher potential for Israel’s economy in developing its trade relations with the emerging Asian economies, such as India, China and Korea. Currently, no free trade exists between Israel and these countries. Asian economies offer different types of comparative advantage, which means the potential for gain from trade is higher. It would therefore seem wiser to invest Israel’s limited resources into negotiating a free trade agreement with these countries rather than renegotiate the FTA with the US. Therefore, regarding the US-Israel FTA: “If it ain’t broke, don’t fix it!”

BESA Center Perspectives Papers are published through the generosity of the Littauer Foundation

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Prof. Arie Reich

Prof. Arie Reich is the Dean of the Faculty of Law at Bar-Ilan University.