Bottom shekel / Nietzsche can get it wrong, too
Here's a philosophical conundrum for you. Say somebody told you that unless Israel behaves responsibly regarding its budget, it will face the same fate as Spain, Britain and Ireland. Say he goes on to remark that the economic crisis is still raging and therefore Spain, Britain and Ireland are instituting radical budget cuts and even cutting public-sector wages. What would you expect to happen?
A. That he's go on to say, that's why we have to behave responsibly like the rest of the world and therefore, here's a plan for radical budget cuts and a public-sector wage freeze.
B. That he'd say, that's why we're going to do the absolute opposite: expand the budget and negotiate wage increases with the Histadrut, because I know more about economics than Europe's finance ministers.
You know what the answer should be. Yet Finance Minister Yuval Steinitz chose B.
He has analyzed the global reality perfectly well, but he reached the wrong conclusions. The result is that he's about to make a bad economic mistake and we will all pay a heavy price, in the short run and in the long one, too.
In the short run, the price is higher taxes. The moment Steinitz chose to expand the budget by 2.66% instead of sticking to the previous plan of a 1.7% increase (the same as population growth ), tax hikes became inevitable. There are no free lunches: If you increase spending and the deficit, you have to increase revenue.
We've been there before, too. Roni Bar-On was also subjected to terrific pressure by politicians (Ehud Barak and Avishay Braverman ) and erring economists, who demanded he increase the budget by 2% to 3%. The same people who came to Steinitz also showed up at Bar-On's office: Karnit Flug from the Bank of Israel, Manual Trajtenberg from the National Economic Council, claiming to have a new paradigm for increasing budgetary spending. But Bar-On shrugged them off and persuaded Ehud Olmert to stick to a 1.7% increase, no more.
But Steinitz knows more about economics than Bar-On, hence the increase in spending and the tax hike. He knows more so we shall pay more for cigarettes and gasoline. He knows more so the government will break its promise to lower VAT and cancel the jump in social-security provisioning, which means, we will pay higher marginal tax rates, and why welfare allowances including old-age support will be updated only in part.
Tax hikes disincentivize people to work and invest, so it's bad for economic growth and employment. But what happened is even worse: Trust was breached. For Steinitz to break his promise to lower tax is bad for the economy. Domestic and foreign investors thought Israel won't be able to believe any more that Israel will lower taxes in the future, and will divert their investments elsewhere, to places where people keep their promises. The result will be a blow to long-term growth and employment.
Thus, long-term growth and employment will be badly damaged.
There's another dangerous aspect to this new policy: A worrisomely large deficit, equal to 3% of GDP. This deficit is too big, and will keep Israel from being able to reduce its debt-to-GDP ratio, or will let it reduce it only slightly. And we've already learned that the world wrinkles its nose at countries with high debt-to-GDP ratios, and our debt ratio is high indeed: 78% of GDP. Even Spain has a lower debt ratio, of only 53%, and it's facing troubles.
Last week, when Steinitz presented the budget, he stated that we'd gotten through the global financial crisis relatively easily, and even quoted philosopher Friedrich Nietzsche: "That which does not kill us makes us stronger." But even Nietzsche can be wrong. If you absorb blow after blow, you don't get stronger; it actually makes you weaker. That's how it is in politics. Look at the blows we took from Turkey and Europe, which brought us to capitulate regarding the closure of Gaza. That's how it works with the economy, too. A bigger deficit and more adventures are merely not going to make us stronger, but they will also lead to a major crisis, a recession and unemployment.
This raises the question of whether a philosopher is suited to be finance minister. The role of a finance minister is to give simple, conservative answers, based on existing economic theory, while a philosopher shies away from simple answers. The philosopher seeks exactly the opposite - difficult questions - and needs to question and unseat existing consensuses.
Maybe that's the reason why our policy is currently the polar opposite of what every country in Europe is doing. Thus, Steinitz and Prime Minister Benjamin Netanyahu can continue being "good" and increasing expenditures and salaries. But the day will come, and that day isn't far off, when we will be crying over today's adventures in philosophy.