An unusual economic phenomenon occurred in Israel last year. For the first time since 2006, the country ended the year with lower prices. The consumer price index eased 0.2% from 2013.
- Israelis learn to live with falling prices
- Israeli consumer prices fell in 2014 for third time since 2003
- Israeli economy still hasn't recovered from Gaza war, central bank says
- Four ways Israel can head off recession
- Israeli prices fell in January, the steepest drop since 2006
- Where is Israel's tax abolitionist party?
Economists call a fall in prices over a certain period “deflation” — experts who want to be more technical call it “negative inflation.” If we leave out housing prices, the drop last year was much deeper — 1.3%.
Deflation means a fall in the price of goods and services, and in 2014 the prices of food, clothing and shoes, health services, transportation, education and communications all declined.
In the previous decade, Israelis saw prices fall twice. In 2003, the country suffered a deep recession amid the terror attacks of the second intifada. The consumer price index fell 1.3%. In 2006, a good year economically, prices eased 0.1%.
The 2014 drop in consumer prices was not unique to Israel. In the euro zone prices fell 0.2%. In individual European countries, the declines were as follows: Cyprus 1.5%; Greece 2.6%; Bulgaria 0.9%; Croatia 0.5%; Belgium and Portugal 0.4%; Ireland, Sweden and Switzerland 0.3%; Spain, Poland and Hungary 0.1%.
Over in Asia, Singapore also experienced a 0.3% fall. In the United States, which ended 2014 with economic growth of 2.4%, prices may not have fallen, but inflation slowed to only 0.8%.
Each country had its own reasons for deflation, but there was one mutual reason: the drop in global oil and food prices. This is why fuel and lubricant prices declined 6.9% in Israel last year, while the price of fresh vegetables tumbled 13.8%. The price of fruits dropped around 10%.
In Israel, these price cuts were further supported by the Communications Ministry’s reforms in the cellphone industry, which sent prices in that sector falling 8.3% for the year.
Housing prices aren’t included in the consumer price index; these prices climbed 7% last year. The CPI only includes rental prices and the cost of home maintenance.
Israelis pushing for politicians to help lower the cost of living consider deflation a good thing; after all, prices in the stores have fallen, not to mention the numbers at the gasoline pump. These observers note that such drops provide consumers with more disposable income, whether for consumption, investment or savings.
The Japanese disease
But the issue is a bit more complicated. Rising prices of up to 2% annually usually buoy economic growth. They reflect a healthy level of demand and an improvement in labor productivity, which leads to a real rise in workers’ wages.
In fact, a continued erosion of prices, which the Japanese have been experiencing for the past two decades, reflects a sick economy with low demand and weaker investment. This is the reason central banks like the Bank of Israel set annual inflation targets between 1% and 3% — a target the Israelis missed in 2014.
But Israeli economists say that unlike Japan, the euro zone or other countries and blocs around the world, Israeli deflation is “positive deflation.” It doesn’t meet the classic definition of deflation and isn’t necessarily a problem.
"The deflation in Israel is an excellent process. In recent years we’ve seen prices fall, with consumption growing at a high rate close to 4%. This means the drop in prices has not been expressed in weakened demand,” says Alex Zabezhinsky, the chief economist at the Meitav Dash investment house.
“In other words, the drop in prices came from the supply side, not from the consumer. In other words, the drop in prices helped consumers increase their purchasing power — and they bought a lot more.”
Rafi Gozlan, the chief economist at the IBI investment house, also believes that Israeli deflation is different from what we’re seeing in the rest of the world, at least for now.
He says Israel is not experiencing classic deflation, which comes at a time of recession or high unemployment. He too cites Israel’s “positive deflation.”
“The price level in Israel is too high compared to the average and median earning power in quite a number of areas. The Israeli economy is undergoing a process of increasing competition accompanied by a change in awareness among consumers,” Gozlan says.
“People check prices today and make sure they’re not paying too much. This is the direct continuation of the social protests, even though more than three years have gone by since they started. This is an in-depth process that will be with us for a long time. We see price increases only in industries where this is possible; for example, in the housing sector.”
A little competition can't hurt
This price drop could be a good thing for certain businesses as well as households. Industrial companies benefit from it in particular; they enjoy the decline in fuel prices, electricity and raw materials. It does less good for companies operating in sectors characterized by low competition, which are now being forced to adapt to a new environment.
“The deflation and competition aren’t beneficial in equal amounts for manufacturers and merchandisers, who in some cases are forced to lower prices,” Zabezhinsky says.
“In the short term this may raise the risk for such companies, but in the long term the competition will be good for them. They’ll be forced to become more efficient and transfer resources from money-losing sectors to areas that can generate growth and profits.”
One of the main industries in which companies have suffered from increased competition and falling prices is cellular telephony. The opening of the market to new competitors spawned a price war, which has only become more fierce in recent months.
After the opening of the cellular market, the share prices of older players Partner and Cellcom have plunged 60% and 53% respectively over the past year. The risk level investors ascribe to these firms’ debts has also risen significantly.
Also hurting today is the supermarket industry; it could continue to show losses for investors because of increasing competition.
The old-line supermarket chains — Super-Sol and Mega (Alon Blue Square) — are suffering the most from competition from aggressive discount chains such as Rami Levi and Victory. There is also the legacy of the 2011 social-justice protests on consumer preferences.
The large food manufacturers may also be stung, though so far they’ve suffered only partially as far as lower prices are concerned. These companies include Osem, Strauss and Neto.
Gozlan says the large banks — Bank Hapoalim, Bank Leumi, Mizrahi-Tefahot Bank, Israel Discount Bank and First International Bank of Israel — may also take a hit. They may be forced to adapt to a more competitive environment.
If that happens, customers will no longer feel captive; it will be easier for them to switch banks and demand discounts and benefits on banking services.
“Most of the banks are trading today at a market value below their equity, maybe out of investors’ fear that they will be forced to operate in a more challenging business environment,” Gozlan says. “It could be investors are pricing in this future increased competition.”
Other companies that realize they may be forced to operate in a more competitive environment are the energy companies; the main firms here are Delek Group (Delek Drilling and Avner Oil Exploration), Ratio Oil Exploration and Isramco.
The stock prices of these companies, partners in the large offshore gas fields Tamar and Leviathan, have fallen sharply in recent months because of the decision by Antitrust Commissioner David Gilo requiring structural changes in the industry. Gilo wants to prevent the creation of a dangerous natural gas monopoly in Israel.