Israel, the Judicial Reform Earthquake, and the Misleading Signs of a Shuddering Economy
Finally, How Not to Misread the Tealeaves
Israel is right now weighing a once-in-a-lifetime overhaul of its judiciary. Elements of the proposed bill include limitations on the Israeli Supreme Court’s heretofore unfettered powers and significant changes in how its Justices are selected. The tabled legislation has been the cause of the greatest civil consternation seen in the world’s only Jewish State in at least forty years.
Advocates say that the Israeli Supreme Court long ago arrogated to itself powers that far exceed those of any other comparable judicial body in the developed world. This essay in the New Republic by Richard Posner from 2007 is perhaps the best exemplar of this argument, in that it both greatly pre-dates the current controversy and explains exactly how the former President (Chief Justice) of the Israeli Supreme Court engineered the current landscape.
Opponents of judicial reform contend that, if passed by the Knesset, Israel’s parliament, the sole remaining check on the newly puissant conservative-and-further-right coalition will be removed. They fear that this could open the door to unwelcome policies of many kinds — but usually of a religious-nationalist stripe — that could manifest, among other things, in discrimination against women, Arabs, less faithful Jews, homosexuals, and others.
It is hard to overstate the national reaction to the bill. The people have gone wild. Israelis who have never before voted are taking to the streets. Current and former leaders from all corners of civil society are risking careers and livelihoods to speak up for or against. The roster includes former senior military and intelligence officers (I mean really senior ones, like a former head of Shin Bet, a former Defense Minister, a former head of the Israeli Police, a former head of Mossad, a current Brigadier General), Supreme Court Justices, Attorneys-General, professors, economists, so many.
Generally speaking — you can tell we’re wading into delicious summary when one writes “generally speaking” — the intellectual left is opposed to the current draft legislation. You can also add that the opposition is largely Ashkenazic and represents Israel’s traditional elite, which has been ceding ground politically to the Sephardic and more religiously adherent parts of the Israeli population for some decades. This change has been slow but has come to feel nearly inexorable, and the sense is that the Supreme Court is its last and final citadel which must be protected at all costs. We need not examine this much further right now, but it is certainly an interesting overlay to the scene now unfolding in Israel.
What is more important for our instant purpose is that the kindred spirits to the Israeli intellectual left — the equivalent elite left in the United States and Europe — are picking up on the notes sounded by their friends in Tel Aviv and Jerusalem. Out of nowhere, just a few days ago, Vice President Kamala Harris appeared to condemn the proposed judicial reforms in a public speech. (She was roughly criticized for her remarks — too roughly, as her comments on the matter were really short, oblique, and facially neutral, though the implied meaning at least felt clear, something like “we’re watching the developments closely, and we are not going to be happy if the reform passes as such.”) The European Union has initiated debate on what the Israeli government’s draft changes would mean for international relations with the Jewish State. Just a handful of years ago, the prospect of judicial reform was not really a controversial topic in Israel, at least theoretically. And, at least theoretically, even opponents of judicial reform today still concede that some version of it is necessary or wise. They just don’t like that Bibi Netanyahu’s government — with its broadly rightist coalition — is the one proposing it, as they fear that what would follow would be a despicable policy deluge without a Court empowered or inclined to stop it.
The animus in Israeli society is the most fevered I have ever witnessed. Protesters fill the streets declaiming (or cheering) for the current government’s draft legislation. The Knesset rings out with animated accusations of deceit in the name of constitutional debate. Jewish moms WhatsApp me from Rehovot saying, “Michael, your mother would turn in her grave – by us, the dictatorship is coming!”
This fearsome dispute has bled into everyday conversation about the economy and the startup world, which is of essential importance to Israel. A number of parties to the Startup Nation, from entrepreneurs to investors, have loudly declared themselves to be disinterested in Israel until the current storm passes. I have elsewhere in these pages written on this particular form of diseconomic insipidity.
But the conversation about Israel’s current woes have both broadened beyond startups and directly connected current downward trends in venture investment to the debate about judicial reform. If you listen to the pundits, the political friction is pushing the Israeli economy’s most important sector into imminent freefall. Experts beat their chests. They claim that global fears about Israel’s judicial status are leading directly and concretely to a worldwide turning away from Israel’s venture bankable companies.
This, finally, is bunk.
Don’t give into the fear. Israel is in a superb position – probably the best globally, except for the United States – to ride the current and future waves of venture capital allocation. Israeli startups have never been stronger, more inventive, more dynamic, more sophisticated, or more attractive. The recent downturn in venture capital investment in Israel mirrors the declines across the globe. It has precious little to do with how many opposition MKs get to vote on judicial candidates.
For reasons of their own – understandable concern, political conviction, or just personal inclination toward catastrophic thinking – commentators against judicial reform link a couple of juicy data points together to paint a picture of looming economic doom for the State of Israel. They correctly understand that Israel’s startup ecosystem has been the primary driver of the country’s economic boom. These doomsayers, most or perhaps all of whom are well-meaning, want you to believe that judicial reform is not only existentially bad for Israeli’s political and civic future – a question I will not reach here – but also extremely bad for Israel’s economic life. The motivating argument goes something like this: Even if you don’t comprehend the import of the judicial reform debate, or even if you think it might be a decent idea, you are mistaken, because the world is reacting so negatively to it that this political discussion is about to kill Israel’s golden goose.
Proponents of this view point to a pair of major recent news items as evidence. First, they cite the Spring decision by Moody’s Investors Service, one of the world’s important credit ratings agencies, to downgrade Israel’s outlook from “positive” to “stable.” In explaining their downgrade, Moody’s Senior Vice President Kathrin Muehlbronner explicitly tied the change to the prospect of judicial reform in a country without explicit separation of powers. No matter your initial reaction to the downgrade, you have to hand it to those credit ratings services. Despite their whiffs on WorldCom and Enron and the mortgage backed securities that gave us the 2008 Global Financial Crisis, they certainly do get it right sometimes!
The second major observation doomsayers make is that venture investment in Israel has fallen. They’re right. It has. A lot. One well-credited report has it that VC going into Israeli startups declined in Q1 2023 by 70% as compared to Q1 2022. That headline number does make it seem as if the sky is falling. Until you learn that global venture funding decreased by 53% over the same period. In the United States, venture funding fell by about 40%, according to a report by EY, and almost 40% of the investment that did come in Q1 2023 was in two massive individual deals. European venture investment was down about 75% year over year. A KPMG report shows that Asian VC investment declined about 70% over the same period, too.
Getting the picture? No matter how hard they try, surely the doomsayers can’t blame judicial reform for investment declines in China, Korea, Finland, Germany, or even Indonesia.
Which brings us back to Moody’s downgrade and what to make of its impact on Israel’s startup investment climate. Here’s a conversation that has never happened:
“Sam, I love this startup in Tel Aviv. Amazing founders, huge market, defensible technology, traction. Let’s go!”
“Yeah, but Sarah, don’t you know anything? Moody’s downgraded Israel’s sovereign credit outlook. This startup should be dead to us.”
A recent shift in the alleged creditworthiness of a country has never once, in the history of ever, entered into an investment committee discussion about a particular startup. At the limit, surely the fund-of-fund allocators will be influenced by the prospective stability of a country’s governance. A pension fund or sovereign wealth fund may, during their periodic reviews, determine that they want more exposure to a risk-off market versus a market that is deemed to be trending towards higher risk. There must be some rational actor in the world who will say “let’s pause a little on Israeli venture investment allocation for next year.” But these decisions happen slowly and only once in a while, and unless the country is in a full-fledged war like Russia or Ukraine, they happen only marginally, as well.
The reasons for the global, synchronous, and fairly homogeneous decline in venture capital investment cannot be seriously in dispute. The United States Federal Reserve has raised interest rates from effectively 0% to effectively 5% in the space of about a year. Today, US bonds, the safest, most reliable, most tried-and-true investment vehicles in the world, yield investors about 5%. And they’re liquid, meaning you can buy and sell your US bonds at just about any time for very close to the face value. By contrast, venture capital is an extremely risky asset class, and it is extremely illiquid, meaning your cash can easily be tied up for well over a decade. In response to the global crisis of 2008, the Federal Reserve collapsed interest rates to near zero. The effect was fast, cumulative, and humongous: investors needed to chase riskier investments to make returns, so they plowed funds into risk-on assets like publicly listed stocks, real estate, high tech venture, and well beyond. During this period, Quantitative Easing (remember “Helicopter Money”) poured never-before-seen sums of new dollars into the system. For fifteen years, the financial world has been awash in cash seeking risk-on investments.
Suddenly, that train has come to a halt. Out of the blue, United States bonds once again produce beautiful returns. Central banks from other stable countries are making similar promises with their bonds. It is only natural that investors of all sizes would look to reallocate a lot of their money into safer, liquid assets like US government bonds and away from publicly traded high tech stocks, private equity, and venture capital. Speaking for myself, I have done the same: I now hold more United States bonds than I can remember. It’s not just me. Bank of America’s global fund manager survey recently revealed that investors favor bonds more than they have since the Global Financial Crisis almost fifteen years ago. (No, this isn’t financial advice; do your own research!)
This is what happens when the Fed raises interest rates above 4% for the first time since January 2008, when the Israeli startup boom was just beginning to collect its blistering speed. This is also what happens when the possibility of a material global recession is on the lips of investment allocators. There is a flight to safety. And guess what: venture capital has never been a safe asset, anywhere, not even in your son’s company even though he was 8200 and graduated Hebrew U for Engineering, G-d bless him and he should marry soon he’s so handsome.
Israel is experiencing a venture capital reset along with the rest of the planet. It is a healthy thing, a good thing. You might even conjecture that over the past decade there has been too much venture capital flowing into companies around the world, perhaps into Israeli startups more than those of most other countries. A reset is fine. It is right. It is typical. And it will make Israeli startups only stronger in the medium and long term.
And, more than anything else, no matter how you come out on the politics, the venture capital reset has, finally, just about zippo to do with judicial reform.
Great article, keen insights into what we are seeing. Thank you.
Nicely written. There is a massive amount of conflating going on these days. And much of it by the press (on all sides).