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PDF FormatIn July 1985, Israel faced the most serious economic crisis of its history. Inflation was spinning out of control, and economic growth was grinding to a halt. Over a decade of huge government deficits had created a public debt equaling more than two times the annual Gross Domestic Product (GDP). The country had nearly exhausted its international credit, which was necessary to finance essential imports of machinery and raw materials. To deal with the emergency, the national unity government under the leadership of Prime Minister Shimon Peres implemented a set of broad economic reforms known as the Economic Stabilization Program. While the immediate aim was to bring inflation under control, it was understood that long-term recovery would depend on ending the government’s deep involvement in the economy, and on extensive market-based reforms to restructure the business sector. The highly successful program enjoyed widespread popular support, as well as cooperation from the business community and organized labor, and was maintained for close to a decade by a broad political consensus.
In recent years, however, the project of reform has come under sustained attack by Israel’s emerging “social lobby.” This unofficial coalition of members of Labor and Likud, the newer Shas and Gesher parties, members of the Yisra’el Ba’aliya immigrants’ party, as well as other smaller parties and extraparliamentary groups, is fueling a resurgence of étatist economic sentiment, and with it an intensifying clamor for new, costly social programs, a loosening of fiscal restraint and general abandonment of the commitment to reform.
What unites these disparate forces is the claim that the free market has a disproportionately harsh impact upon those members of society who are least able to fend for themselves, and that as a result it alienates them from society and increases social polarization. Echoing the rhetoric of social-democratic parties in France, Germany, Sweden and elsewhere, they claim that a magnanimous government can create a society more compassionate and unified than is possible in “vicious,” profit-driven economies such as those of the United States and Great Britain; they view the recent electoral victories of social-democratic parties in Europe as a harbinger of their own political triumph in Israel.
But the social lobby’s arguments, both economic and social, are wrong. The European states, their model for emulation, demonstrate spectacularly just how such policies fail, and how they will fail if they are applied in Israel. Their social-democratic economic ideas have long been discarded by economists, and their policy proposals are destined to worsen the very problems they seek to alleviate: Unemployment, poverty, social solidarity. Yet despite this, the social lobby’s political ability to affect economic policy has increased dramatically in recent years, undermining the resolve of those who would complete the project of market reform. Given the keys to the Treasury, they may undo all that has been gained since 1985, and place Israel back on the road to economic instability, or even disaster.
II
To understand the danger involved in undermining the reform effort, one need only consider the state of the economy prior to 1985. For decades, successive Israeli governments had pursued irresponsible fiscal policies, living well beyond their means. Spending began to rise after the Six Day War of 1967, and accelerated further after the Yom Kippur War of 1973. From 1973 to 1984, government spending averaged 76 percent of Israel’s annual Gross Domestic Product. Although Israel’s defense burden grew during this period, only a third of total government expenditure was directed to the military. Most of the rest was in the form of government grants and subsidies to individuals or to businesses. The budget deficit averaged a gigantic 18 percent of GDP during this period, fueling a massive rise in inflation. By mid-1985, annual inflation stood at 460 percent.
Besides running up inflation, the budget deficit also resulted in a large and growing trade deficit, which had to be funded by borrowing heavily in foreign exchange. By 1985 Israel had just about exhausted its foreign credit.1 Had the economic profligacy continued, the international financial community might have cut off credit to Israel, abruptly halting Israel’s ability to pay for imports: Food, fuel, weapons, raw materials for industry. The consequences would have been incalculable—and disastrous.
For most Israelis, the experience of the early 1980s was harrowing enough to convince them to support a program of far-reaching reform. The stabilization program of 1985 was only the first, if most urgent, step in a series of market-oriented measures. The government withdrew its subsidies in a broad range of industries. The annual deficit fell below 5 percent of GDP, and the budget gradually declined from over two-thirds of annual GDP in 1986 to the current 47 percent. This reduced the government’s need to borrow, brought inflation down to single-digit figures, and encouraged private saving and investment, which became an important part of the Israeli economy. Private enterprise created whole new industries in computers and other high-tech areas. As privatization began to pick up speed during the 1990s, foreign trade was liberalized. Since 1995, most of the banking sector, which had been nationalized in 1983, has been sold into private hands. In 1997 the shekel, long subject to exchange controls, was made a fully convertible currency.
The rehabilitation of the economy which began with the 1985 reforms was responsible for the economic successes of the early 1990s, when the performance of the Israeli economy was truly remarkable. Between 1990 and 1996, investment rates rose rapidly, and the economy grew by almost 50 percent. Six hundred thousand new jobs were created, an increase of over 40 percent. In absolute terms, this was more new jobs than either the French or Italian economies, with their vastly larger populations and workforces, created in the same period.2 This made it possible to absorb the huge wave of immigration from the former Soviet Union, which added over a quarter million new workers to Israel’s labor force. Among immigrants who have been in the country for at least five years—and this now includes the majority—unemployment rates today are no higher than for other Israelis. During this period, per-capita income in Israel rose by nearly 30 percent, notwithstanding the addition of hundreds of thousands of Russian immigrants to the country’s population.
For nearly a decade, the economic stabilization program enjoyed considerable prestige, even during hard times. The spirit of fiscal responsibility which had taken hold of the political community was so strong that in 1988, Finance Minister Moshe Nissim rejected the Bank of Israel’s advice to devalue the shekel in the midst of a transitional recession—because he feared the political consequences of being thought soft on inflation.3 Economic reform and privatization were popular enough for both major parties to include them in their election platforms in 1988 and 1992.
Yet beyond adhering to specific economic policies, it is significant that during the years after 1985 the political community in Israel subscribed almost universally to the idea of reform—that the nation’s economic future, even its long-term survival, depended on the economy being transformed from one dominated by government expenditure and regulation to one where market forces and economic freedom reign, the government endeavors to live within its means, and prosperity and welfare are attained through economic growth. It is the erosion of this consensus in recent years that has cast doubt upon the entire project of reform, and upon the country’s economic future.
III
The principal threat to the idea of market reform has come from an emerging political coalition that includes several new populist parties—David Levy’s Gesher party, the Sephardic-religious Shas party and Natan Sharansky’s Yisra’el Ba’aliya—as well as a revitalized social lobby within the Labor and Likud parties. Though differing widely in both theory and rhetoric, these political actors are united by a skepticism regarding market reform and by a political agenda that calls for increased public spending on social programs and greater government intervention in the economy—in essence reversing the commitment to reform that was the crowning achievement of 1985, and seeking a return to the economic étatism of Israel’s past.
Leading the change are two parties which represent the interests of Israel’s putative underclass: Gesher and Shas. Together these parties presently control fifteen seats in the 120-seat Knesset. Each stands for more spending to help the poor and traditionally disadvantaged, particularly in the development towns, and more government control over wages and employment. As a member of the government coalition in 1996-1997, Gesher wielded considerable influence in promoting social legislation, twice forcing the government to surrender important budgetary objectives in exchange for continued support. It also supported a 13-percent hike in the minimum wage in 1997. At the end of the debate over the 1998 budget, Gesher left the coalition, even though the government had in effect sacrificed its deficit target to meet this faction’s demands for increased spending for the poor in development towns.4
