ISRAEL'S ECONOMY

ECONOMIST BEMOANS ISRAEL’S ECONOMIC RESILIENCE
By Judith A. Klinghoffer

The headline reads: Israel’s economy: The government says it’s perky If you expect the following text to spell out the reason the government is wrong, you’d me mistaken. The opposite is true. The text explains the reasons the government is right:

It is the job of a finance minister to talk up his economy. Even so, Mr Steinitz’s optimism seems broadly justified, as he prepares to present a budget for this year and next. Israel’s economy has grown by an average annual rate of 5% in the past five years. Its GDP per head is ahead of Portugal, a shade behind Greece and five times bigger than its neighbour Egypt (see chart).

Why the misleading headline? I suspect pure bile. None of this means that Israel is not suffering from the global downturn. The opposite is true given the nature of it’s exports. It merely means that the government is dealing with it in the manner I wish the US would, by playing close attention to manufacturing of high end products and creating a pro business atmosphere:

Still, Israel is suffering with the rest of the world. Exports, which accounted for 44% of its GDP of $200 billion last year, have shrunk by more than a quarter since September. Foreign investment has dived. High-tech, one of Israel’s biggest successes, is marking time. Tourism and diamonds have lost their glitter. Fewer buildings are going up. Nearly 8% of the workforce is jobless, up from 6% nine months ago.“But the government has not had to step in and save any bank or insurance company or indeed any major company,” says Mr Steinitz. Some economists say it was lucky for Israel that a big share-dealing scam in the 1980s encouraged governments, after bailing out a number of banks, to pursue conservative fiscal policies and tighten regulation. Now, apart from Bank Hapoalim, the country’s largest, which has had to write off more than $1 billion in American mortgage-based securities and other toxic assets, Israeli banks have so far been clean. The central bank’s respected governor, Stanley Fischer, a former top man at the IMF, monitors them closely. They have to hold more capital than banks in many Western countries. Their lending to commercial clients and to homeowners is generally cautious.

The government is spending a lot on building roads and schools to create jobs. It also proposes to drive out illegal foreign workers—300,000 of them, says Mr Steinitz—by heavily fining their employers. “Unlike the EU countries, we’re not short of young people. If the foreign workers go, wages will rise and young Israelis will work in all kinds of jobs they balk at now.”

Surprisingly, Mr Steinitz has raised VAT from 15.5% to 16.5% (but had to drop a proposal to levy it on fruit and vegetables), while embarking on a seven-year plan gradually to reduce company tax and income tax instead. “If I put money in ordinary peoples’ pockets, they’ll spend it on imported goods and foreign holidays,” he says. “Our own economy doesn’t produce consumer goods for them to buy. We make know-how and software, chips for Intel [a giant American maker of processors] and computers for irrigation, chemicals, stents for heart surgery and pilotless drones.”

Mr Steinitz says Israel must make such products more competitive as the world economy recovers. He proposes to double government funding for research and development. No bank bail-outs, he argues, means he can keep the budget deficit down to 6% this year and 5.5% next. His “temporary” rise in VAT is meant to help offset a drop in tax revenue. “Other countries will be raising their direct taxes to cover their deficits just when our taxes will be coming down. In five or six years, Israel’s company tax will be lower than Ireland’s. Intel and others will think hard about that when they decide where to invest.”

But Intel and others may not warm to the package deal that Mr Netanyahu struck three months ago with the trade unions when he was wooing the Labour party to join his coalition: scant hope now of trimming the bloated public sector or reducing its wage bill. “The entire recession has fallen on the private sector,” says a prominent financial commentator. “The public sector continues to be a bottomless sinkhole.”

The budget prescribes a cut of 5% in government ministries’ spending. But no one believes it will happen. The defence minister, Ehud Barak, who leads the Labour party, refuses to hear of cutting the military budget, an Israeli sacred cow. And as a sop to Shas, a religious party that is another needed partner in his coalition, Mr Netanyahu has reversed some of the cuts in child allowances he himself imposed as finance minister four years ago.

Indeed, unmentioned goes the fact that this economic growth has been achieved in the teeth of ongoing expensive security concerns, two wars and the prospect of a nuclear Iran. And, yes, Israel has a very strong safety net. It also had very strong unions which Netanyahu did much to trim. Indeed, past Israeli economic success and its current resilience owes much to the reforms instituted by Benjamim Netanyahu (M.S. degree from the MIT Sloan School of Management) but, then, the Economist reporter would rather eat his hat than give credit to the “right wing” Israel prime minister.

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