A Change of Heart: Regulation Is Good

Why Angel Gurría feels at home here, and why Ireland's bankers aren't to blame

1 Allow me to introduce you to him: Angel Gurría, the new star in the Israeli economic scene. The third paragraph of his biography on the OECD website states, "Under his leadership, OECD has expanded its membership to include Chile, Estonia, Israel and Slovenia and opened accession talks with Russia." It seems the secretary general of the Organization of Economic Cooperation and Development views expanding the organization as a milestone in his career.

Gurría and the OECD will be making headlines in the Israeli press in the years to come. We love to read about how outsiders view Israel.

The great advantage of OECD analyses is international comparisons. The Israeli mentality of the "chosen people" to whom the usual rules of macroeconomic management don't apply has been chastened in the last decade. We have started to grasp the importance of international comparisons. Joining the OECD is another step in consolidating a more global economic view.

Sometimes the view of Israel from afar, from an international perspective, can have a sharper resolution than the view from inside our local swamp. But make no mistake: It's going to take the OECD's economists a long time to grasp the Israeli economy's true problems the way we know them, if they ever do.

Last Monday, I found Gurría in the lobby of the King David Hotel in Jerusalem, unsettled about the latest headline he'd generated. He was holding the translated English version of TheMarker, describing his criticism the day before of the Bank of Israel's intervention in the currency market.

He wanted to correct a misapprehension: Israel is blessed with one of the cleverest central bankers in the world, he stressed, a man with vast theoretical and practical knowledge of the financial markets. Stanley Fischer surely knows how far he can take intervention in the markets, the secretary general underscored.

Put otherwise, Gurría was saying: We can't advise you on managing your economy, we can only compare your actions with the economic policies of the organization's other members.

Gurría has a BA in economics from the University of Mexico and a Master's in economics from the University of Leeds. He speaks Spanish, French, English, Portuguese, Italian and a little German. From 1998 to 2000 he served as Mexico's finance minister; when discussing Israel's special problems on various topics, he feels right at home, he says.

The Mexican economy is very different from Israel's, but they have one striking thing in common: a handful of families control a vast swathe of the economy. Mexico is known for a business magnate, Carlos Slim, who owns the local telecoms monopoly and is the richest man in the world. Most of his wealth came from owning Mexican monopolies.

There are three topics the OECD decided to study in depth in Israel, Gurría says; one is the concentration of economic power - how certain families and business groups control much of the economy, and the need to separate non-finance and finance holdings. The second is the rapid increase in real estate prices. The third is government tax policy on the gas finds, he says, adding that the real estate and gas markets would be analyzed by the OECD's Israel desk.

But regarding economic concentration, the OECD would set up a task force.

So how did the OECD conclude that economic concentration is so central to the Israeli economy? Representatives of the families claim it isn't clear that it causes any real economic damage.

"There are three reasons: Competition, competition and competition," the secretary general says.

And how does economic concentration reflect on competition?

"Concentration affects competition and competitiveness," Gurría explains. Competition determines innovation and the economy's rate of change. If there is no competition, there is no innovation and no investment in innovation.

Without competition, all the big players hunker down in their market shares and have no incentive to move beyond, to innovate, to invest, Gurría explains. In the end, competition is what decides whether a nation will move ahead.

Mexico was a test case of that theory: Now they realize, based on studies conducted there, that economic concentration and low competition cause a country to lose its relative advantages on the international scene. A country that isn't competitive won't be at the forefront of global progress. An absence of competition is the economic parallel to an absence of democracy, Gurría says.

Israel can indeed claim credit to great achievements in high-tech during the last 20 years. We are perceived as a country with great human resources. But the deteriorating results of Israeli education in international comparisons within the OECD threaten our development.

Does that mean we're now seeing the fruits of our education system as it was 20 and 30 years ago? Of the great aliyah from Russia and other things that don't exist anymore?

Gurría shrugs off the idea; he doesn't see Israel retreating. "You did it. You developed an advanced knowledge economy," he says. It's true that in international comparisons of elementary and middle schools, Israel's grades have been low. But one shouldn't fixate on school results, one should also look at the level of knowledge and education at the universities and in the workforce, he adds.

In the United States, for instance, school children achieve mediocre results, Gurría points out, "but they have the best universities and research institutes in the world." That makes the American economy the most innovative and advanced in the world. "I don't know where Israel stands," he says - that remains to be seen over the years. He proposes to add Israel to case studies of the entire education chain, not only schools.

But his sense is that in the last two decades, Israel took a leap forward and turned into a knowledge economy, and as such it would have a mechanism to stay that way. By now it has the infrastructure, the industry and a great many models of success, Gurría says.

In other countries the model of success is to be a banker; here it's to be a scientist or to work in high-tech. This, in and of itself, attracts new blood to the field.

But there is a dark side too, he notes: Many people have no stake in the economy's progress, especially in the knowledge economy. The Arabs, the ultra-Orthodox, the Bedouin, the Ethiopians and many others lag behind.

I'm not convinced by Gurría's theory that Israel's international standing can't erode. The deterioration of the education system, the dearth of long-term planning, the weakness of the government and the widening economic polarization paint a bleak picture.

What's for sure is that joining the OECD gives us an international mirror in which to see our face clearly. It can help us see the reality and compare ourselves with countries that do things we care about right.

2 Ireland, one of the OECD's founding nations in 1948, was considered quite the economic wonder until two years ago. Gross domestic product per capita soared from $8,000 to $43,000 in the space of 27 years. Yet last week Ireland was reduced to asking the European Union for help that could reach 100 billion euros.

Do its economic travails cancel out all its economic achievements in the last 20 years? That's far from certain. Much of the reforms and changes in the Celtic Tiger remain in force. Once the crisis is over, Ireland will still be in far better condition than 20 years before.

But the story has a lesson to teach: Countries can change direction abruptly. Economic history can be rewritten with no advance warning.

It was the banks who brought Ireland to its knees, and the people responsible for the fall of the banks weren't greedy, uninhibited bankers. They were regulators who sat back admiring the power and greatness of the businesspeople who seized control of the economy. The regulators kowtowed to the bankers instead of supervising them; the result was mass bankruptcy by the biggest banks. The collapsing banks are simply too big for Ireland. Rescuing them is essentially a rescue of the whole country.

Another lesson is to beware of complacency. Despite the signs, Ireland's bankers, regulators and their many international advisers continued to claim that everything was under control. The banks' situation wasn't that bad, they shrugged. Only in recent weeks did the banks' true condition start to leak: it turned out they're dead broke.

3 The lesson Ireland is learning, about the importance of regulation and government involvement in the business sector, is being learned by the rest of the world too, including the institutions that preached the free market and privatization over the last 20 years.

One such animal is the EBRD, the European Bank for Reconstruction and Development. It was founded in 1991 to help build democratic market economies. The EBRD is owned by 61 countries and two international institutions. It lends money for business endeavors. Last week the EBRD published its annual report, in which it dropped a bombshell.

In the past the bank had graded economies based mainly on the freedom of their markets, the pace of privatization and government noninvolvement. It has sharply changed course and has published new grading rules.

From now on, it ascribes great weight to the power of the supervisory institutions and regulation.

Like many others, the EBRD grasped that the "free" market hadn't been free at all. All too often it had been a market of cronies who engineered things for their own good. For the market to be truly free and advance everyone's economic interests, significant regulation is needed after all.

The OECD understands this. Ireland now understands it too, and the European Bank for Reconstruction and Development is changing its position.

You have to wonder when we'll get the point in Israel.