Four Ways Israel Can Head Off Recession

Unprecedented, dramatic steps must be taken by the government to avoid a spiral of deflation, unemployment and a collapse in private consumption.

Ofer Vaknin

Even though it might involve new players, the current contentious drama over adjustments to the 2014 state budget and the passage of next year’s budget are nothing new. There’s a budget crisis every few years and every time the same questions come up: Should taxes be raised? How much should be cut from non-defense spending? Should the deficit be increased? How should the budgetary demands of the military be addressed? As with all the prior rounds, ultimately the prime minister will decide what to do.

Because there's nothing new here, it’s fairly easy to guess that it will all end in a middle-of-the-road compromise. Finance Minister Yair Lapid wants to raise the deficit to 3.5% of the country’s gross domestic product while Bank of Israel Governor Karnit Flug believes that anything over 3% would put both economic stability and Israel’s international credit rating at risk. So they probably will settle for 3.25%.

Lapid is being interviewed in every TV studio possible so that he can proclaim that he will not raise taxes, but the Bank of Israel thinks there’s no alternative. New taxes may not be instituted, but old taxes will be reinstated, tax exemptions will be eliminated, tax brackets will be adjusted and in the end, the public will end up with a little less in its pockets.

Knesset Finance Committee chairman Nissan Slomiansky insists that he will not agree to cuts in civilian spending? In the end, future expenditures will be deferred, including the full implementation of plans in the field of public health and the war on poverty.

And what about the defense budget? Publicly the government will give the Israel Defense Forces just a portion of what it is asking for. Lapid and others will declare victory, but in practice, down the line, we will discover that the army was given the money via other budgetary clauses.

Chances are the drama will continue until the end of December and on into January, meaning that for a short time in 2015, the government will be operating on a budget based on this year’s spending in the absence of a new blueprint. A compromise will come just before the March deadline that demands that the government resign if there is no budget.

Unlike previous years, however, the State of Israel and its citizens won’t be witness to exactly the same scenario as in the past. Even before this summer’s war, the economy began to slip toward recession. In the second quarter, the economy grew by just 1.7%, which on a per-capita basis, taking population growth into account, translates into an economic standstill. And when figures for the third quarter are compiled for a period that included 50 days of military hostilities that brought with them a sharp decline in economic activity – we will get the final diagnosis. It will apparently include further reductions in economic activity, making even the European economy look good by comparison.

The reasons for this recession – which is what it should be called rather than the more mild term “economic slowdown” – are familiar to readers of this newspaper. The economy has lost its growth engines, chiefly the export sector. Exports have been hurt due to the sluggish European and Asian economies, the strength of the shekel, and perhaps also because of growing efforts to boycott Israeli products.

The second growth engine is investment and corporate spending. And in the current climate of uncertainty, it would be a surprise if companies invest in Israel at the same pace as in the past. Israelis themselves are looking to invest only abroad, while foreigners have been frightened by the news from Gaza and Syria, where Al-Qaida already has a foothold on the Israeli border in the Golan Heights.

Lastly, the engine of growth provided by private consumption has also begun to sputter. That’s because households don’t have enough money due to the crazy cost of living and because economic security has been compromised as a result of the war.

If the diagnosis that Israel is slipping into recession is correct, economists have a variety of remedies, from austerity measures to just the opposite: expansionary government spending. Currently, most economists around the world support expansionary policies in the face of a real recession, but the first step in determining economic policy must be based on a dispassionate analysis of the state of the economy. Reality can no longer be viewed through rose-colored glasses and the lessons of the past also no longer apply – because things have changed.

If we’re not headed for recession, then the budget should be dealt with as in the past. If recession is in the cards, however, dramatic steps should be taken that are different from anything we have done before, to head off a spiral of deflation, unemployment and a collapse in private consumption. Here are some possible steps:

1. Why not raise the minimum wage? At first glance, it’s a strange, illogical suggestion that would only deepen the budget deficit and make it harder for corporations to turn a profit. But giving money to the weaker segments of the population is one of the most effective ways to encourage economic activity, because these are precisely the people who will spend the money and help jump-start the economy.

It’s similar to what U.S. President Barack Obama did in 2009, but it wouldn’t be simple. Employers and the wealthy would object. Conservatives would certainly explain that what Obama did may be right for a huge economy like that of the United States but not for a small open economy such as Israel’s, where any increase in the deficit or drop in the national fiscal reputation could drive away investors. But it would deal directly with one of the fundamental problems with the Israeli economy and the cost of living. And that’s low wages.

2. Another option would be launching a national emergency infrastructure construction plan of the type financed primarily by the private sector. Infrastructure will be one of the first places that Finance Ministry officials will target to save on government spending and close the budget deficit. But it's easy to postpone them. Postpone railway improvements and highway projects and you can save billions of shekels in the 2015 budget. But that’s precisely what should not be done, because they are a good way to provide economic incentives. And many of these projects can be financed by the private pension sector, which has racked up more than a trillion shekels (more than $280 billion) in assets. In any event, most institutional investors don’t have anything to do with the money they are sitting on. What would be more natural than freeing up these funds to build rail lines, highways and a natural gas transportation network? All of them could provide higher yields than the lower interest individual investors are earning on government bonds.

3. The government could announce an initiative to build tens of thousands of housing units over the next two years. The fact that such a plan isn’t already on the table is a national failure, of sorts. It’s clear that housing prices are high due to a lack of supply, and the situation is getting worse all the time because young couples continue to get married. And everyone also knows that fast-paced housing construction spurs the entire economy, from contractors to door manufacturers and furniture importers. The government has not managed so far to overcome obstacles to free up state land for housing construction on a large scale. But aren’t we in an economic emergency? That’s precisely when things should be done that have not been done before. This should also include implementing policies that would help the construction industry, like expanding the number of visas for foreign construction workers and cutting customs duties on cement and iron. The obstacles are not insurmountable.

4. Quantitative easing and devaluation of the shekel: The Bank of Israel has purportedly just ended its role in the battle against recession when it lowered the base interest rate from 0.5% to 0.25%, but the central banks of countries facing recession have found other ways to address the situation including so-called quantitative easing, in which they inject money into their economies by buying bonds. Granted, it’s a controversial step that many people think does not work. There are also those such as Yaron Zelicha, the former Finance Ministry accountant general, who says it’s actually low interest rates that hurt the economy. There is no doubt that higher interest rates would stop the rise in real estate prices and enable the public to stash more in pension savings. And at least it would be an attempt to do something rather than standing by helplessly. Plus, this seems to have worked in the United States, even if there are critics who say the recovery there is attributable to other factors.

These are things that should be considered, at least. Moreover, we should also remember that it is precisely during times of crisis that reforms are easier to carry out.