An Equation With Two Unknowns

These are all revaluations in real terms; in other words, increased spending - exactly the opposite of what exporters need right now. That's why Barkai has good reason to be a concerned citizen who asks tough questions.

Radio personality Razi Barkai sounded surprised. How is it possible that the stock market is going up when the south is being bombarded by Grad rockets? That's what he asked Army Radio's economics reporter earlier this week. Then, on the very same day, Israeli data showed that exports had continued to rise and reached the high level they had enjoyed in 2008, before the world economic crisis.

How is it possible that the dollar is declining against the shekel and exports aren't collapsing? Barkai isn't alone in wondering why. These two enigmas are causing many economists sleepless nights. I encountered the first enigma during the Second Lebanon War in the summer of 2006. The north of the country, including Haifa, was being bombarded, factories were closed, but investors didn't flee. Price stability was maintained and the economy continued to grow as if nothing had happened.

That was when I understood that something very basic had changed in the economy. It had grown and become stronger and more flexible. If one plant closes the second doubles production. The high level of competition and the openness to imports have led to a situation where no factory can exploit a crisis situation and raise prices, for fear of being thrown out of the market. Israel's business center wasn't affected either: Tel Aviv was outside the game. That's why the economy wasn't upset by the Second Lebanon War, or by Operation Cast Lead or the current rocket attacks in the south.

The stock market is a good reflection of that. It continues to rise because the people don't look at the short term, only the long term. They figure that even if Israel enters the Gaza Strip, the outcome will be a blow to Hamas followed by quiet. In other words, in economic terms, there is no fear of a military campaign - even the opposite is the case.

And now to the second enigma, the exchange rate. In mid-2004 it was NIS 4.5 to the dollar. It stayed around there for two years, but in the second half of 2006 the dollar began its journey south and crossed NIS 4 in October 2007. Exporters began to shout loudly that an exchange rate lower than NIS 4 meant an end to exports, growth and the economy. They said they would be forced to fire people and even close production lines. But the exchange rate continued to decline (despite the efforts of the Bank of Israel's governor ); it is now below NIS 3.5 to the dollar. So why haven't exports collapsed?

Because our private sector doesn't wait for Bank of Israel Governor Stanley Fischer or Finance Minister Yuval Steinitz. It is constantly streamlining, inventing products with high added value and penetrating new markets in India and China. This flexibility and prudence enables exporters to continue to export and profit, despite the eroding exchange rate.

And another factor has helped the business sector from 2003 until recently: economic reforms. We have to understand that reforms mean a devaluation in real terms, or to put it more clearly: reduced spending. Because the moment government companies are privatized, or competition is introduced (as in the case of the cell-phone industry ), government spending is reduced, making it possible to lower taxes - which means lower expenses for exporters and therefore an increase in the feasibility of exports.

But in the past two years the engine of reforms has been halted, even though two to three years ago Prime Minister Benjamin Netanyahu promised major reforms - a reform in electricity, which would lower prices, a reform at the Israel Lands Administration, which would reduce the price of land, and a reform at the ports, which would lower the costs of marine transport. But none of these things happened.

To that we should add the generous wage agreements that have recently been signed in the public sector, with some strong trade unions receiving exaggerated wage increases of 20 percent. This means the private sector will also be forced to raise wages so it can compete with the government for manpower. The wage agreements will also force the municipalities to increase property taxes, and the government, which until two years ago lowered taxes, will be forced to raise them to finance all the increases.

These are all revaluations in real terms; in other words, increased spending - exactly the opposite of what exporters need right now. That's why Barkai has good reason to be a concerned citizen who asks tough questions.