Restoring Israel's Economic Miracle
President Bush told Congress and the nation last March that one of the greatest challenges of the post-Gulf War Middle East is "to foster economic freedom and prosperity for all people in the region." Nowhere is the challenge more urgent than in Israel. Enormous Israeli government spending, high taxes, and stifling overregulation have for years frightened away foreign investors, penalized Israeli businessmen, and discouraged would-be entrepreneurs. The result has been economic stagnation. Now mass Soviet and Ethiopian Jewish immigration is overwhelming an Israeli system ill-equipped for such dramatic, indeed cataclysmic, change.
The Israeli government says the cost of absorbing the 300,000 immigrants who have already arrived, and the one million more expected by 1995, is likely to be in the range of $50-$60 billion. Yet, Israel's gross national product in 1990 was only $50 billion. Thus, it will be impossible to raise the needed funds from higher taxes. Nor is it possible to raise the money from Western governments, who find themselves increasingly distracted by the enormous needs of Eastern Europe and the Soviet Union, nor from world-wide Jewry, who are already donating charity to Israel in record amounts.
Overgrown Government
Israel's economy instead needs immediate, comprehensive free-market reform to attract billions of dollars in desperately needed foreign investment and to unleash the creative talents of its own people. Without major structural change, such as large budget cuts, tax cuts and tax reform, privatization of government-owned companies, and significant deregulation of the private sector, Israel's economic crisis will worsen dramatically and exacerbate ethnic and political tensions between Soviet and Ethiopian Jews, native Israelis, and Palestinian Arabs on the West Bank and in the Gaza Strip. With a potentially historic, although still fragile, Arab-Israeli peace process gathering momentum, this is no time to allow Israel to edge toward economic chaos. American loan guarantees may temporarily alleviate Israel's immediate housing crunch, but such guarantees do not solve Israel's larger problem of stagnant economic growth. Only free-market reform can do that; yet Israeli leaders hesitate to move boldly and decisively on such reform.
In its early years, Israel was an economic miracle. The immense political and environmental challenges facing the fledgling state required central direction; government involvement helped channel Israelis' bold, pioneering spirit, not cripple it. Malaria-infested swamps were turned into rich, productive farmland. Creative irrigation strategies made "the desert bloom." And despite war and terrorism, Israelis built industry and infrastructure, homes and hospitals, to welcome hundreds of thousands of Jewish refugees from Arab and Islamic persecution as well as from the butchery of Nazi Germany and Stalinist Russia.
Once the new state had become established, however, government involvement in the economy began to grow dramatically rasher than recede. Between 1965 and 1985, government spending doubled from 36 percent to 74 percent of Israel's gross national product. (Israel's proposed 1992 budget will also be about 75 percent of GNP.) Some argue that Israel's heavy defense burden has been responsible for the surge. The numbers, however, prove otherwise. Israeli defense spending as a percentage of GNP did soar from 9.5 percent in 1965 to 32 percent in 1975. This was due to the Six-Day War of 1967, the ensuing War of Attrition, and the Yom Kippur War of 1973. However, defense spending has since dropped steadily to less than 24 percent of GNP in 1985, and less than 10 percent today. The dramatic rise in Israeli government expenditures has actually come from domestic spending, not spending on defense. Between 1965 and 1985, Israeli public-sector non-defense consumption jumped from 21 percent to almost 35 percent of GNP. During the same time, transfer payments soared from 6 percent to 16.5 percent of GNP, and payment on external debt rose from .5 to over 6 percent of GNP.
As total spending doubled, the government, not surprisingly, also doubled Israelis' tax burden, from 25 percent of GNP in 1960 to over 50 percent in 1985. Top marginal tax rates have been reduced dramatically, but they are still among the highest in the industrial world. In 1965, Israel's top marginal tax rate exceeded 70 percent (in 1975 it was over 85 percent!); today it is 48 percent, although in January 1991 the government added a 5-percent surcharge to pay for increased immigrant absorption costs, raising the rate to 53 percent.
The Israeli government also owns 93.5 percent of the land within its pre-1967 boundaries, which it administers through the Israel Land Authority (ILA) to about 540,000 leaseholders. "The ILA, through its executive council, decides who is to get land, what price they will pay for it and the conditions under which they can use it," says Paul Rivlin, a policy analyst for the Institute for Advanced Strategic and Political Studies in Jerusalem. Such state control drives up the cost of land and thus the cost of housing by as much as 40 percent, according to Shlomo Schattner, former deputy director of the Israeli Finance Ministry's budget department. Such state control also hinders the ability of Israelis to use the land in the most efficient manner possible. The Jerusalem Post noted, for example, that a farmer with orchards near the town of Petach Tikva or cotton fields near the Ben Gurion International Airport may be making little or no profit, but because he leases the land and does not own it, he does not stand to benefit personally from selling it to someone who could use it more productively.
The Israeli government also employs one-third of the labor force, controls the nation's five largest banks, and permits the legal operation of 60 monopolies and cartels. It also owns over 160 companies, including total or substantial portions of the water company, the electric company, the shipping company, the radio and television stations, the telephone company, the airlines and the railroads, as well as dozens of other smaller companies in a variety of fields. Furthermore, as in other government-dominated economies, decisions made by Israel's state-owned companies often have less to do with profits than with political patronage and back-channel deal-making.
Regulatory Nightmare
What the government does not own, it heavily regulates. Agricultural regulations alone fill an 833-page tome. Until very recently, obtaining a building permit in Tel Aviv required 74 separate steps, 20 separate licenses, and could take up to five years to process, according to Ezra Sohar, an Israeli free-market pioneer, in his most recent book, Israel's Dilemma: Why Israel Is Falling Apart and How to Put It Back Together. Obtaining a business license could be just as difficult. Sohar cites a leaflet from the Tel Aviv Municipality sketching the process:
Present an application to the Business Licensing Department, [then] obtain approval of the Planning and Building Department...the Fire Department...the Ecology Department...the Veterinary Service...the Public Health Department...the Police...the Ministry of Labor...the Ministry of Health...other agencies, as warranted... [then] pick up your license.
The leaflet concludes by saying that it "does not purport to list all the requirements in detail; it is meant to help the citizen understand the subject." It is not surprising therefore that many Israeli entrepreneurs have found themselves compelled to hire "go-betweens" who can navigate the labyrinth of government bureaucracy to finally obtain the desired license. Others simply give up.
Socialism's Stifling Hand
Such massive government interference has had a number of effects. First, Israel's economy faced a major crisis between 1983 and 1985. Inflation shot past 400 percent and the government was forced to cut $1 billion from its overall budget and nearly 25 percent of its defense budget. It also requested and received massive emergency assistance from the United States totalling more than $1.5 billion. American officials such as Secretary of State George Shultz helped make Israel's economic stabilization program a great success (bringing inflation down as low as 16 percent), but since then Israel has remained slow to implement other American reform suggestions. As a result, inflation is again creeping up, and now stands at 20 percent.
Second, Israel has suffered severe economic stagnation. From 1950 to 1973, Israeli real per-capita growth of GNP averaged 5.5 percent annually. Since then, it has averaged less than 1 percent a year, and last year Israel actually registered negative per-capita growth. As a result many Israelis have left for the United States, Canada, Australia, and other free-market countries in search of better economic opportunities.
Third, Israeli productivity is among the lowest in the Western world. The average output in the leading industrial countries is $40,000 per worker, and the leader, Switzerland, averages $49,600 per worker. Israel averages $28,200 per worker. Worse still is that Israeli productivity is rising more slowly than other industrialized countries. Israeli productivity in 1989 increased only .2 percent over 1988; by contrast, Italy's productivity (the leader in this area) rose 3.7 percent.
Fourth, since Israeli workers have little incentive to succeed within the system, they circumvent the system. Tax evasion in Israel is estimated at more than $3 billion a year, and Israel's underground economy is estimated at nearly 30 percent of GNP, a figure rivalling even the Soviet Union's famed black market.
Return to the Promised Land
Now enter overwhelming numbers of Soviet and Ethiopian Jews into a stagnant Israeli economy, dominated by a cumbersome, bloated, inefficient public sector. "The Soviet immigration is the greatest thing that could happen to Israel, but in terms of sacrifice, it also has the potential to destroy us and tear society apart," says Michael Kleiner, chairman of the Israeli parliament's committee on absorption. Michael Bruno, former governor of the Bank of Israel, warns that unless the government moves quickly to reform the economy, unemployment, which has already hit 11 percent, could reach as high as 18 percent, with more than 200,000 people leaving Israel in search of better opportunities. Israel's Manufacturers Association predicts the "worst socioeconomic crisis in Israel's history."
By contrast, if the Israeli government takes immediate steps to reform its own economy, these new refugees of socialism, and those who have already arrived, can offer Israel great hope for the future. Twenty-five percent of the newly arrived Soviet immigrants have an advanced degree, compared with less than 2 percent of native Israelis. With sufficient venture capital, Israel has the potential of becoming the Silicon Valley of the Middle East, specializing in high-technology exports and capitalizing on the skills of more than 2,000 top-line Soviet scientists and more than 40,000 architects and engineers who have arrived in Israel since 1989. Nearly 7 percent of the new immigrants are doctors. With additional investment and advanced equipment from the West, Israel could also become the medical center of the Mediterranean. With some entrepreneurial training, small amounts of capital, and the removal of government obstacles to the creation of small businesses, Israel could also enable Soviet and Ethiopian Jews to start newspapers and tutoring services as well as open ethnic restaurants and grocery stores, plumbing and electrical services, beauty salons and craft shops.
International investors see the potential for an enormously lucrative market developing in Israel, but they are discouraged by Israeli government interference in the economy. The Atari Corporation recently cancelled plans to build a $150-million plant and a $75-million investment center in Israel because of excessive government delays in approving their proposals, reported the Jerusalem Post.
In fact, by delaying reform, Israel has cut itself off from much foreign investment, and is left to rely upon foreign aid and charitable contributions. In 1988, total net foreign direct investment in Israel was only $311 million; in 1989 it was less than $100 million, while American and German foreign aid and charitable contributions to Israel topped $5 billion both years.
Recalcitrant Politicians
The obvious question, then, is why do Israeli leaders hesitate to enact sweeping economic reform despite such economic stagnation? There are many reasons. Other urgent issues--was at times, the peace process at others--take precedence; both major parties like to dole out political favors when they are in power and thus profit from the status quo; and Histadrut, the national labor union, fiercely resists economic reform--to the point of virtually shutting the country down with mass strikes when reform legislation appears imminent.
Some Israeli officials believe economic reform is important--but not just yet. Zalman Shoval, Israel's ambassador to the United States, for example, has said publicly that mass immigration is creating such disruptions in the economy that now would not be a good time to press forward with reforms, since they would likely cause further disruptions. On the contrary, now is the best time to move boldly and decisively on comprehensive reform. Foreign investors are waiting for a strong signal that Israel wants to become a haven for private enterprise, and the Israeli public understands the urgency of the hour and would likely be willing to endure the short-term difficulties of reform if it were convinced of the long-term benefits. Israeli leaders are unlikely to find a better international and political climate for reform than they have today.
Perhaps the most important reason behind the government's unwillingness to implement comprehensive structural change is that Israeli leaders have been insulated by American foreign aid from the full detrimental effects of their unique brand of socialism. Currently, Jerusalem receives from Washington $1.8 billion a year in military assistance and another $1.2 billion annually in economic assistance. The economic assistance helps Israel cover the interest payments on its outstanding debt to the United States. The debt, $5.5 billion of which is owed to American commercial banks and $4.5 billion of which is owed directly to the U.S. government, accumulated during the 1970s when American military assistance to Israel was given as loans, not in grants as it is today. Former Jerusalem Post economic reporter Joel Bainerman recently wrote in the Wall Street Journal that, since 1948, Israel has received nearly $48 billion in U.S. foreign aid. Of that, it has received $45 billion since 1973, the same year that Israeli domestic spending really began its significant upward spiral and Israel's economy began to stagnate.
Faithful Ally
From an American perspective, such aid has been a wise investment: Israel has been a faithful friend in a troubled and turbulent region. Throughout the 1980s, Israel was an extremely cost-effective asset in countering Soviet forces in the Middle East. Military planners in Moscow had to account for Israeli Jericho missiles capable of hitting southern Soviet targets and an Israeli air force widely believed to be capable of rendering the Soviets' Mediterranean naval forces ineffective in less than 24 hours. Today, Israel continues to provide the U.S. prepositioning sites for military equipment and supplies, excellent intelligence data on Middle East regimes and terrorist factions, practice bombing ranges for American fighter pilots, and docking rights for U.S. Navy ships. Last Christmas, Israel's navy and medical teams provided critical assistance to the crew of the USS Saratoga when a ferry shuttling sailors back to the aircraft carrier sank off the coast of Haifa. So, while decreasing foreign aid to Israel may someday become an issue of changing U.S. military priorities, it is unfair to say that this has been a giveaway by U.S. taxpayers. Israel has earned every bit of American military aid it has received.
That does not mean that American foreign aid to Israel should not be linked to economic reform. It should. George Bush once said, "Just as a strong Israel is in the national security interests of the United States, so, too, is a healthy Israeli economy." Because economic reform is, after all, in Israel's and therefore America's best interests, we should not hesitate to insist that American aid prompt such reform.
Lukewarm Reform
While Israeli leaders remain hesitant to move forward on bold, sweeping, comprehensive economic reforms they have made some positive changes, partly as a result of American nudging, partly as a result of internal pressure for reform. In the past year, the government has cut many subsidies and price supports (which sent the cost of eggs, for example, soaring by 50 percent) and reduced import taxes on automobiles (previously as high as 250 percent on some models). The latter measure sparked a sharp increase in the number of car imports last quarter and led to a 33.2 percent rise in customs income, no surprise to believers in the importance of supply-side tax cuts to Israel's future. The government has also taken measures to ease restrictions on Israeli capital markets and announced that a new three-member treasury committee will have exclusive control over the sale of government companies. This should eliminate the primary obstacle to privatization--the veto authority of individual ministers over companies under its jurisdiction. The government thus plans to raise more than $500 million by selling 20 percent of its holdings in the Zim Navigation Company, 23 percent of the Bezeq Israel Telecommunications Corporation, 26 percent of Maman Cargo Terminal and Handling Ltd., and all shares in Malam System Ltd., Agridev Ltd., and Dead Sea Periclase Ltd. Some will be sold through the Israeli stock market, while others will go to private buyers.
While these have been positive moves, they are not enough and at times have been offset by the government's numerous regressive economic steps. Last January, for instance, the government raised value-added taxes from 16 to 18 percent, raised fuel and tobacco taxes, and added a 5-percent surcharge to personal income taxes--all to pay for increased government spending on immigrant absorption. Corporate taxes have been lowered by 3 percent, but are still a daunting 42 percent, hardly a rate to encourage significant private sector growth. And many familiar with Israel's numerous, although still largely unimplemented, privatization plans say they remain leery of the government's much-trumpeted new plans. Furthermore, the government plans massive subsidization of new employment projects in 1992, including 880 new jobs at archeological digs, 150 new jobs in the census bureau, and 15,000 new jobs to "expand government services due to the increase in population," reports the Jerusalem Post.
Israelis are increasingly unhappy with the state of affairs. A recent poll in the Hebrew Davar newspaper indicated that 78 percent of Israelis were "not very supportive" or "not supportive at all" of the government's handling of the economy and 61 percent were unhappy with its handling of Soviet Jewish immigrant absorption. Another poll taken by the business daily Mabat in May showed that only 20 percent of the public supports Yitzhak Moda'i in his role as finance minister, and still fewer--less than 9 percent--want to see Labor Party leader Shimon Peres return to that post. Most simply registered their discontent with the economic status quo by indicating "no preference."
In fact, while their own government continues to debate endlessly the pros and cons of comprehensive economic reform, Israelis see many nations in the throes of a free-market revolution. Mexico, for instance, has sold 875 of its 1,155 state-owned enterprises, including the national telephone company and the national airline. And with a free-trade agreement likely between the United States and Mexico, foreign investors are growing eager to tap into Mexico's enormous potential. At the same time, Israelis read about Russia's Boris Yeltsin and Poland's Lech Walesa winning landslide victories on bold free-market reform platforms, leading many to ask: If even Poland and possibly Russia can plunge ahead toward economic reform, why can't Israel?
Out of the Wilderness
As a result, support for economic reform is growing in Israel. "Five years ago the free-market movement was still just a cloud on the horizon, barely the size of someone's hand," says Daniel Doron, a leading Israeli free-market proponent. "Today, that movement occupies center stage in the public debate." Israeli newspapers and magazines increasingly run articles criticizing the government's economic policies and airing the views of reform advocates; the army radio network's most popular economic program is hosted by a believer in the freemarket; a number of books calling for free-market reforms have been published in Hebrew. More important, a growing number of politicians on both sides of the political spectrum agree reform is the way Israel must now go. David Brooks recently wrote in the Wall Street Journal that "you can't throw a stone in the Israeli parliament without hitting four politicians professing their faith in the free market."
The engines behind the economic reform movement in Israel are the free-market think tanks that have sprung up since Israel's last major economic crisis in the early 1980s. Most notable is Daniel Doron's Israel Center for Social and Economic Progress (ICSEP), launched with the help of American conservative Irving Kristol in 1984. Just one indicator of ICSEP's impact on Israeli thinking was its February 1990 conference on Soviet immigration and the urgent need for comprehensive structural reform. The event attracted 2,000 Israelis and nearly all of Israel's top economic policy-makers, including President Chaim Herzog, Prime Minister Yitzhak Shamir's chief economic advisor Amos Rubin, and Labor Party leader Shimon Peres. It also received widespread attention in Israeli newspapers, including a two-page spread in the leading financial daily, Globes. Such impact would be an impressive accomplishment even in Washington, but is particularly indicative of the significant change in attitude among Israeli government leaders and academics toward the free-market over the past 10 years.
While ICSEP stresses free-market education, the Institute for Advanced Strategic and Political Studies (LASPS) stresses critical evaluation of Israeli economic policy. In 1987, IASPS's founder, Robert Loewenberg, published a book by Hoover Institution economist Alvin Rabushka and Johns Hopkins University professor Steve Hanke called Toward Growth: A Blueprint for Economic Rebirth in Israel, explaining what Israel could learn about economic growth from the four "Asian Tigers": Hong Kong, South Korea, Taiwan, and Singapore. IASPS also publishes an annual Scorecard on the Israeli Economy. Rabushka and his colleagues recommend that the Israeli government adopt a 25-percent flat business tax to spark growth and eliminate inherent political pressures to award exemptions and loopholes to special interest groups. They also recommend closing numerous Israeli government agencies to eliminate redundancy and cut wasteful spending. IASPS's bold ideas have attracted considerable press attention both in Israel and the United States and are becoming a significant factor in the growing Israeli economic reform movement.
America's Role
Free-market think tanks are not the only ones championing reform. The Bush administration has been urging Israel to move decisively on free-market reform for years via the U.S.-Israel Joint Economic Development Group (JEDG). Begun in 1984 by President Reagan and Israeli Prime Minister Shimon Peres, the JEDG is composed of American and Israeli economic officials and private consultants who originally met to help stabilize Israeli hyperinflation and have since met twice yearly to help Israel develop and implement a reform strategy. The stabilization program was initially a great success; the long-term reform efforts have had mixed results. American JEDG participants say the Israeli delegation agrees with most of their reform suggestions but cannot get Prime Minister Shamir interested in, or the parliament committed to, reform legislation. Richard McCormack, who until recently served as U.S. undersecretary of state for economic affairs, is encouraged by the vast publicity the March JEDG meeting in Jerusalem received and agrees there is growing public support for economic change. However, he and other American officials are unsure whether current efforts are enough to get Israel's top leadership to take the necessary steps toward reform, especially amidst the ongoing and delicate peace process.
Bush has also spoken out strongly on the need for Israeli free-market reform. In July 1986, then-Vice President Bush told the Israeli Knesset that "the question for Israel's future is no longer how to stop the Israeli economy from deteriorating, but how to restore growth." And he offered four suggestions for sparking such growth: reduce government spending, lower taxes, avoid excessive regulation of the private business sector, and privatize state-owned industries. "Freer markets and lower taxes go hand in hand with more growth," Bush declared. He also stated that economic growth--both in Israel and throughout the region--can contribute to peace. "More jobs and more opportunities on the West Bank and Gaza, for example, could increase the confidence of Palestinians, and make it easier for them to participate directly in shaping a negotiated peace," he said, adding that such economic growth could "draw the energies of more young people into building a world for themselves, rather than destroying someone else's.
Opportunity for Quayle
Now is the time for the Bush administration to dust off these ideas and make Israeli economic reform a top priority on its Middle East agenda. That would first involve raising the profile of the JEDG. With the president and secretary of state already deeply involved in the specifics of the peace process, Vice President Dan Quayle should attend the next JEDG meeting likely to be held in Washington this November. Quayle is well-admired and trusted among Israelis and he played an important role in providing Israel with ballistic missile defenses and promoting strong U.S.-Israeli cooperation during the Gulf War. He is also an energetic free-market advocate.
Second, the Bush administration should encourage public support of economic reform in Israel by raising the profile of Israel's free-market movement. Quayle should make his first trip to the Jewish state by the end of this year to meet with the leaders of Israeli free-market think tanks, supply-side economists and journalists, and the top political leadership of both the Labor and Likud parties. He should also request to speak to the Israeli parliament, as did then-Vice President Bush, to discuss the shared American-Israeli values of strong defense, as well as the importance of free markets and limited government.
Third, the Bush administration should support and promote Senator Connie Mack's Index of Economic Freedom amendment to the 1992 foreign-aid bill as a way of encouraging Israeli free-market reforms. The index will rate the economic policies of countries receiving or requesting American foreign aid in order to give lawmakers accurate information regarding that country's "progress toward policies conducive to sustainable economic growth." If a country is not moving toward a free market, aid might either be denied or linked to a series of specific reforms.
The Index of Economic Freedom would subject Israel's foreign aid requests to such criteria as "the extent to which poor or landless individuals are illegally or otherwise artificially constrained from acquiring land" and the extent of a country's "nationalization of property"; "the difficulty and costliness of securing a business license"; "the extent to which government policies force economic activity into nominally illegal informal sectors" (i.e., the black market); "the highest level of taxation...and the rate of value added tax"; "the value of industries owned by the government, [and the] percentage of GNP produced by state-owned industries"; and the "degree of government ownership of the banking sector."
Involvement of American Jewry
The American Jewish community should be included from the start in this effort to encourage economic reform in Israel. While generally more favorable toward liberal Democrats than conservative Republicans, the American Jewish community nevertheless realizes that Israel is facing the greatest challenge and opportunity in its brief modern history and that only with massive foreign investment, a more efficient economy, and a strong U.S.-Israel relationship can Soviet and Ethiopian Jews be successfully absorbed. Vice President Quayle and Secretary of Housing and Urban Development Jack Kemp should discuss the importance and benefits of Israeli economic reform in both private and public meetings with the American Jewish community, particularly at the annual policy conference of the American Israel Public Affairs Committee coming this spring.
Soviet Jewish immigration and the peace process are making Israel's economy an increasingly important issue for Washington policy-makers. Israel's request in September for $10 billion in American housing loan guarantees was essentially a request for an American vote of confidence in the long-term future of Israel's economy. The Bush administration should not hesitate therefore to make clear that only comprehensive free-market reform will enable Israel's economy to succeed over the long haul. In fact, it should promote reform at the highest levels of U.S.-Israeli contact. And while it may be tempting to set aside talk of reform for a day when Israel has "less important" issues to tackle, when will such a day ever arrive? Israel has not stopped facing monumental challenges since its creation. Indeed, unless Israel moves boldly and decisively on free-market reform, the monumental economic challenges it faces today will be only more urgent and even more difficult to solve tomorrow.
PHOTO (BLACK & WHITE): Ethiopian Jews arriving at Ben Gurion airport. Israel needs immediate, comprehensive free-market reform to accommodate the inflow of hundreds of thousands of Soviet and Ethiopian Jews.
~~~~~~~~
By JOEL C. ROSENBERG
JOEL C. ROSENBERG is assistant to Burton Yale Pines, senior vice president at The Heritage Foundation.
No comments:
Post a Comment