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Our situation has never been better. The prime minister promises that Israel will soon be one of the most advanced nations in the world: "Israel will establish itself as a regional economic superpower and as a global technological superpower, guided by its values and living in security and at peace with its neighbors." So stated Benjamin Netanyahu at a press conference called shortly before Independence Day to commemorate his first year in office.

Europe is mired in recession, while in Israel economic growth has resumed. The financial crisis largely passed over our heads, causing little damage. No Israeli banks collapsed, none needed bailouts. We weren't part of the housing and credit disasters. Most important, our unemployment is low, compared to the West.

Add to that the appreciation of the shekel, which has inflated the per capita gross domestic product, in dollar terms, and the change in our national debt, which suddenly seems reasonable by current global standards rather than horrific. Doesn't it all look wonderful!

Or not. If you haven't succumbed to the thrall of the bubble in Tel Aviv stocks, if you measure the world against something besides the sky-high level of the TA-100 shares index or the self-satisfaction of Israel's wealthiest people, then you might sense intuitively that bad things are happening in our little country.

For a decade now, Prof. Dan Ben-David of Tel Aviv University has been urging Israel's leaders to look at the real road taken by the country's economy. After making headlines several times during the 2001-2002 technology crisis, he disappeared from the news pages.

Now he's back, this time as executive director of Jerusalem's Taub Center for Social Policy Research in Israel, bearing a fat report with the pretentious name "Annual State of the Nation Report 2009: Society and Economy in Israel" as well as, wouldn't you know it, more bad news. in fact it's the worst yet: The Israeli economy is headed for disaster.

All societies can be measured by three main parameters, write the authors of the report, which Dan Ben-David edited: the general standard of living, the poverty rate and the extent of inequality.

When one of the parameters goes bad, the society is in danger of crisis. When all three parameters are out of whack and the problems are ignored - and in fact are growing worse all the time and have been for decades - the society is "following unsustainable trajectories," as he puts it.

Israel's standard of living is not catching up to that of the developed nations of the West, just the opposite, the report states. (The report was written in Hebrew; all translations given here are by TheMarker.)

"Despite its high-tech, medicine and higher education, which are at the forefront of human knowledge, since the 1970s the standard of living in Israel has been retreating relative to the leading Western nations, which will only serve to exacerbate emigration."

The rates of inequality and poverty in Israel are among the highest in the West, the professor goes on to say. "As long as the country doesn't take systemic action to reduce inequality and poverty at source, meaning gross income, it will have to keep expanding its social safety net in order to keep more and more families from falling below the poverty line. The sums involved are growing continually, and the state cannot finance them forever."

The main reason for the poor performance in all three parameters, the report concludes, is that a growing proportion of Israeli society cannot cope in an open, competitive, advanced economy. Worse, this non-coping segment is growing faster than the segment that can cope and that has to finance the safety net.

TheMarker: Prof. Dan Ben-David, the Western nations to which we compare ourselves have been pulling back fast in the past two years, while Israel's figures have been impressive. Why do you insist on delivering bad news, studded with dramatic superlatives? What's wrong with you? Did you discover something new, or is this a ploy for media attention?

"What happened is that several things came together for me," says Ben-David. "In the last year I realized the gravity of our situation. In economics there is the absolute level, and there is the pace of change. I've long been aware of Israel's bad situation regarding important parameters such as the employment rate and the quality of education. What I learned in the last year is the pace of change. I discovered that we are moving down the problematic trajectories much more quickly than I'd realized.

"A superficial glance at the data on economic growth, debt and unemployment indicates that we have cause for pride. In some areas we're in a better state than the West, and in others our situation is worse, but near the average. But focusing on unemployment is misleading. It shows how many people are seeking work and not finding it. The main problem is those who are neither working nor seeking work, and here the figures are frightening."

Isn't it the usual story about the ultra-Orthodox and the Arabs?

"No, as it turns out. Nonemployment among Haredim and Arabs is indeed very high, but it turns out that among non-Haredi Jews as well it is around 25% above the average for developed nations.

"The figures on nonemployment add to astonishing data I discovered about the education system. Here, the surprise is in the direction and the intensity of the changes.

"I found that in the last decade, the number of students in the mainstream state education system dropped by 3%, while enrollment increased by 8% in the national-religious system, by 33% in the Arab education system and by 51% in Haredi schools. These are astounding figures - and that's just in a single decade.

"Now let's see what happens if we extrapolate this pace of change 30 years ahead, to when our children are the age that we are today. If we continue down our present path, in 2040 we will find that 78% of Israel's children will be studying in the Haredi or Arab education systems.

"Now let's get back to the issue of nonemployment. Here too the trends are terrifying. Ostensibly, there's nothing new in the non-participation by Haredim in the workforce. But when I checked the data I found that 30 years ago, when we were a normal country, the rate of nonemployment was about the same as in the West. A far greater proportion of the ultra-Orthodox worked then.

"People say that Haredim don't work, that it's a religious or a cultural thing. But that isn't true. Thirty years ago they did work. Then, the rate of nonemployment among the Haredim was 21%. Now it's 65%. It grew threefold."

OK. The pattern there is clear. But Israel's economic data, GDP per capita and economic growth, look better today.

"That isn't so. Productivity is most important determinant of growth in GDP per capita. What we find is that in the 1970s, productivity in Israel was growing rapidly. Since then it's been growing very slowly relative to the world. We have a tremendous yoke around our necks, and it's growing all the time.

To what degree does this yoke depend on the ultra-Orthodox population?

"Less than you might think. When you analyze the deterioration of education in Israel, you find that Israel's children place lowest in most test criteria. Remember that these figures don't include the Haredim because they don't participate in these tests. The education system is in decline. In the Arab sector, the level of education is Third-World, and in the Jewish sector it's among the lowest in the West."

But our path in the past two years, in terms of GDP, growth and unemployment, looks better than that of other nations.

"We indeed weathered the financial crisis relatively well," Ben-David agrees. "But that's also because our real crisis was at the start of the last decade. When the global economic crisis hit, we had the momentum from exiting our previous crisis. The past year, when we were in relatively good shape, was just a continuation of the correction from the bad years we had in 2001 and 2002. But from the long-term perspective we do not see any change in the trend. We've been on the same slow-growth, low-productivity track for the last 35 years."

But in recent years the poverty rate has dropped, after rising very rapidly in the 1980s and 1990s.

"There have been improvements, and certainly they are encouraging. But there is no reason to think they will continue or that the situation has changed. It seems to be nothing more than a correction after protracted, rapid deterioration. Our levels of poverty and inequality remain very high. Some of the improvement is due to the very good five years we had, and I see no reason for them to continue because none of the economy's fundamental ills has been cured.

"Aside from maintaining budgetary discipline, which is important, we did nothing significant to improve the infrastructure of the economy, human or physical. Ostensibly we have more higher education in Israel, but how good is it?"

Is there no chance that the development of recent years attest to a change in the trend?

"No. We did nothing to initiate change. We reduced welfare payments in order to motivate people to work, but that's just half the story. What we need is a comprehensive, system-wide program, because if you don't give people the tools to work in modern society, what exactly are they supposed to do after you take away their welfare payments? Tell the Haredim to work, but where can they do so? Who would hire them? What tools do they have? And it isn't just the Haredim. The performance overall of Israeli schoolchildren is declining.

"Our education system is in a state of anarchy, which is not unique only to it. There is no enforcement of the law in Israel, neither with regard to minimum wage nor education.

"It is said that the [official] nonemployment rate is inflated, that many people work 'off the books.' That's even worse, in my opinion, because these are people who aren't sharing the national burden but are part of the taxpayer's burden."

There's been a lot of talk about the need to reform the Israeli education system.

"That's just part of the story. We need a comprehensive plan. Incentives are just a small part of the story, reform is just a small part. We need law enforcement. We need budgetary transparency. We need constant debate of all these issues. Who talks about these issues, apart from [Haaretz-TheMarker]? Who even knows how to read the national budget? There is a systemic failure. People get incentives to work, but where exactly are they supposed to work? Where will their children work?

"I am a great believer in market forces. That's the only way to solve things. But I also believe that there are great market failures here, that only the government can solve. The state must step in and fix things."

Can you point to another state, one that has managed to jack up its productivity, that you think we should emulate?

"No. I don't think there's a model for Israel. We are an anomaly in the Western world. On one hand our nonemployment, poverty and inequality rates are among the highest in the world. On the other hand we have some of the most important institutions of human knowledge. This isn't South America or Central Asia. We don't have to import solutions from other places. We aren't a homogenous country. We have to find unique solutions for different populations. We are also a small nation, and therefore we can make big changes. What are we, after all - a country the size of Greater Philadelphia. This isn't America, with a population of 300 million."

What are the barriers to change?

"The political system, of course. There is no political ability here, no governance. The greatest danger is that our demographic changes will only make it more difficult to change things in the future. Today it's difficult but not impossible. In 10 or 20 years it will be impossible."

Is there any good news in your report? "Our health care system is still among the best in the world. Our life expectancy is rising, infant mortality is dropping. But that, too, isn't guaranteed forever. There is a dangerous process of Americanization, of privatizing health care, which gradually makes health care less accessible to all. It's a problem throughout the world and is beginning to develop here, too. Just as in the academic world, the question is how to keep the best doctors here, when they could earn more overseas."

Are you in despair?

"On the contrary. We have terrific potential. Israel is a young country, while the nations of the West are growing old fast. They have a problem of supporting all the old people. Who will be the next generation? Who will work? They need foreign workers.

"We are a young country with excellent, creative people who can think outside the box. Our abilities are astonishing. The sky is the limit, if we come to our senses. But we must come to our senses. There is a demographic point of no return. If we cross it, we reach a point that isn't sustainable, with all that entails."

What does it entail?

"We see examples of nations that stumble into crisis, that fall, rise and stumble into crisis again. That won't be the case with us. We live in a very bad neighborhood, and if we fall we only get an opportunity to rise again once every 2,000 years. Falling is not an option for us. We can't be like Greece or Argentina or Turkey, which fall due to mismanagement then get up again."

History shows that Israeli governments kick into action only in financial crisis. Without crisis, there's no change.

"We are apparently far from a financial crisis. We have a reasonable debt-GDP ratio, compared to the rest of the world. But the paths we are taking in education and in employment are clear. Look at the gap between gross and net income in Israel, which we plug with budget transfers. How long can these gaps be bridged with taxpayer money, if the poor, non-working portion of the population keeps growing? Eventually it will lead to gargantuan budget deficits because the part of the population financing the budget is shrinking. It can't end well."

Not many politicians seem to share your view.

"Yes. We're like the frog dropped into a pot of water that is heated gradually on the stove. If put in a pot of boiling water, he'd jump out to save himself. But when put into a cold pot, he doesn't recognize the implications of his continuously warming environment until it's too late. By the time we realize the pot is boiling, it will be too late."