In March this year, China and Israel officially launched discussions for a long-rumored free trade agreement (FTA), reflecting the budding rapport between the two nations. As China and Israel become progressively more politically isolated due to their assertive geopolitical policies, the two controversial states are growing their economic and political ties closer together. Israel’s traditional economic and political partners in the U.S. and Western Europe are becoming increasingly critical of their longtime Middle Eastern ally, while China’s aggressions in the South China Sea are unnerving Pacific countries wary of the Middle Kingdom’s rise.
In light of these political realities, China and Israel are finding each other to be convenient collaborators as they seek to diversify their economic dependence and profit from each other’s comparative advantages. Israel, with its small population of about eight and a half million and world class high-tech capabilities, and China, with its immense population, manufacturing prowess, and huge capital waiting to be spent, are naturally complementary economies. Despite presenting rapidly expanding bilateral trade and investment opportunities, however, sometimes divergent political interests and persistent concerns over IP protection prevent the countries from fully embracing their burgeoning friendship.
Snapshot of China-Israel Relations
When Chinese and Israeli politicians make public appearances together, they enjoy stressing the fact that the Jewish and Chinese people comprise two of the world’s most ancient civilizations and have held relations since trading using the Silk Road in the 8th Century. Despite this storied history, the modern state of Israel and the People’s Republic of China did not establish formal relations until 1992, making their present day political and economic connectivity relatively immature.
While Israel sold arms to China with quiet U.S. support beginning in the late 1970s to counter the USSR, the formal economic relationship between the countries had been fairly limited until recently. In 1992, bilateral trade between China and Israel comprised only US$50 million; this number reached US$11 billion in 2015. Although trade between the two countries got off to a late start, Israeli Prime Minister Benjamin Netanyahu remarked in 2014 that “China is Israel’s largest trading partner in Asia and fast becoming perhaps Israel’s largest trading partner, period, as we move into the future.” Such declarations are notable given that China has long been a supporter of Iran – Israel’s regional rival.
The steady rise in trade between China and Israel mirrors the swelling enthusiasm they display for one another and coincides with Israel’s increasingly rocky relationship with the West. Israel joined the China-led Asian Infrastructure Investment Bank (AIIB) as a founding partner in 2015, and Netanyahu established an Israel-China task force for his office the same year. The two countries have also recently created a range of initiatives to promote exchange and investment, such as the China-Israel Technology, Innovation & Investment Summit held this January in Beijing, the upcoming Innovation: China-Israel Investment Summit in September in Tel Aviv, and the US$300 million Tel Aviv University-Tsinghua University joint center for exchange and collaboration. Further, the countries are easing visa requirements and establishing direct flights to promote greater interconnectivity and tourism.
Bilateral Trade and Investment
The political rapprochement between China and Israel allows them to take advantage of their highly complementary economies. China excels in its industrial and manufacturing capacity that supplies the world with affordable goods, while Israel is known for its high-tech sector and innovation. Indeed, China has been investing heavily in startups and high-tech as it seeks to move up the value chain to keep its manufacturing sector competitive as the country faces rising labor costs and a changing demographic makeup. Meanwhile, Israel is highly competitive in innovation, ranking first on Bloomberg’s index of R&D intensity, while its manufacturing sector is fairly negligible.
China’s exports to Israel, which amounted to about US$8 billion in 2015 and 14.1 percent of Israel’s total imports, were led by electronic equipment (US$1.7 billion), machinery (US$1.2 billion), and clothing (US$475.9 million). On the other side of the relationship, Israel’s US$3.3 billion worth of exports to China in 2015, 5.4 percent of its entire exports, were driven by electronic components, primarily from Intel’s semiconductor plants (US$1.7 billion), medical and technical equipment (US$417.7 million), and fertilizers (US$346.4 million).
Agricultural and Water Management Technology
As is seen from Israel’s leading exports to China, the Middle Kingdom has a keen interest in acquiring advanced Israeli technology and expertise. Areas of particular appeal include desertification prevention technology, water desalination and irrigation, advanced agricultural equipment, medical devices, and general high-tech. China’s agricultural and water management sectors are notoriously inefficient, and Israel has strong expertise in technology that can reduce waste and pollution.
Adopting such practices is of increasing importance for Beijing, as seen in the environmental emphasis of the 13thFive Year Plan, as the public grows tired of pollution, contaminated goods, and other environmental issues. Efforts with Israel to this end include a US$300 million deal in 2012 to acquire Israeli water technology, Dowell Technological and Environment Engineering Co.’s Sino-Israeli Water Treatment Innovative Industrial Park established in Dongguan in 2013, and an Israeli “Water City” venture in Shougang to test and develop water management technology.
Semiconductors and Startups
In addition to the aforementioned technology, semiconductors – one of Israel’s leading exports to China – remains a hot commodity and may be set to rise further. Although manufacturing has slowed, China is still the world’s largest producer of electronic products and the biggest consumer of semiconductors as a result. However, China is reliant on Pacific countries such as the U.S., Taiwan, Japan, and South Korea to satisfy this appetite, leading Beijing to invest heavily in its domestic semiconductor industry. Semiconductors are potential dual-use technology that can be used for both civilian and military use, making Pacific countries in China’s vicinity cautious of sharing technology. Several potential Chinese acquisitions of American semiconductor companies, for example, have already been discarded this year due to the expectation of being blocked by the U.S. government for security reasons.
Due to political interventions in the semiconductor industry, China has strong incentives to diversify its supply chain to reduce its reliance on potential regional adversaries. Israel, as a Middle Eastern country, has less immediate concern for Chinese expansion in the Pacific. Israel has angered the U.S. multiple times for selling arms to China behind its back, which the U.S. has described as a repeated pattern of behavior. The U.S. is likely to keep a close eye on Israeli technology transfers to China, as is the case with Israel Aerospace Industries’ (IAI) new factory in China, which it assures will only serve the civilian sector.
With the expectation that Israeli technology will be easier to acquire than that from the U.S. due to less political interference and Israel’s limited domestic market, China is increasing investments in Israeli startups. China’s venture capital investments in Israel amount to approximately US$1.77 billion and are concentrated in the tech sector; in 2015 alone, China invested about US$500 million in Israeli startups. Although China may see Israel as more lenient than the U.S. in sharing technology, Israel may ultimately act similarly cautiously as it does not want its technology to be shared with opponents like Iran.
China and Israel’s relationship is blossoming, with significant economic opportunities presenting themselves with little immediate political conflict. As China seeks to improve its environmental standards and move up the manufacturing value chain, Israel’s robust high tech and innovation make the countries natural partners. However, although Israel is pivoting away from traditional allies towards Asia, China and Israel are unlikely to wholly embrace their relationship.
As is the case with high-tech companies in other countries, there are significant concerns over IP protection and reverse-engineering in China. Further, although China has traditionally been relatively passive in the Middle East, it could eventually become more assertive in the region, as is currently the case in the South China Sea, and more actively support allies such as Iran and Pakistan. As such, despite Israel’s strained relations with the West, its relations with China are likely to be predominantly economic and could be upset if political differences emerge. In the meantime, however, economic opportunities between China and Israel are bound to grow and bear significant fruit.
This article was first published June 2016.
Since its establishment in 1992, Dezan Shira & Associates has been guiding foreign clients through Asia’s complex regulatory environment and assisting them with all aspects of legal, accounting, tax, internal control, HR, payroll and audit matters. As a full-service consultancy with operational offices across China, Hong Kong, India and emerging ASEAN, we are your reliable partner for business expansion in this region and beyond.