Is Israel Fiscally Ready for a New Intifada?

The government frittered away the fruits of the laudable economic policies it adopted a decade ago and doesn’t have the budget flexibility to deal with a slower economy.

AP

“The 2015-16 Budget and Economic Program” was the title of the presentation the treasury gave the Knesset Finance Committee this week: 89 PowerPoint slides detailing every conceivable bit of economic data about the economy and government spending.

The tone was optimistic. The presentation notes that Israel is one of only three developed economies to have lowered its debt-to-GDP ratio since 2008, to just 67% in Israel’s compared to an average of 110% for Organization for Economic Cooperation and Development member states. It also notes that Israel is one of the few countries to have lowered its unemployment rate over the last decade, and now enjoys one of the highest rates of labor force participation in the world.

But the 89 slides don’t talk about what happens after 2015-16, and whether we will be able to overcome the budget hurdles waiting just around the corner. The 2017 budget is likely to be “unpleasant” because the economy is also going to be “unpleasant.” We know that based on the data that are already available.

Worse, there may be a global economic crisis on the horizon, and worse still a third intifada here.

The dark clouds have been gathering for a few years. Beginning in 2012, Israeli gross domestic product began slowing significantly. In 2014-15 it will probably expand 2.6%, and the forecast for the next few years is for growth of 2.9% to 3% annually.

Excluding a few crisis years, such as the recessions of 1966, 2001-03 and 2008, that would be the slowest rate of growth Israel has ever known. It would even mean a slower pace of growth than the so-called lost years of 1973 to 1985, when the average annual growth rate was 3.7%.

If Israeli growth sinks to a rate of 3% or less, it would constitute a dramatic structural deterioration for the economy.

But instead of grappling with the problem, Israel has chosen to rest on its laurels. Over the last five years Israel enjoyed the fruits of the proper economic management it had pursued after 2003, when the recession prompted by the second intifada forced the government to introduce significant structural changes.

The result was rapid economic growth, a sharp rise in tax collections and in the workforce participation rate, and a decline in debt and the cost of paying interest on the debt. In fact, a key reason why Israel sailed through the 2008 global financial crisis so easily was due to the policies it undertook (as well as the reforms enacted after 1985 and into the 1990s).

Since then, the benefits have been frittered away. Take, for instance, the debt-to-GDP ratio. The rate fell to 67% during the years after 2000, but since 2011 it has been stuck at between 66% and 68%.

The savings in interest payments on debt that Israel has enjoyed due to the reforms amount to 40 billion shekels ($10.4 billion) a year, enough to cover the Health Ministry’s budget or 80% of the Education Ministry’s budget. In fact, much of the rise in the standard of living over the last decade is due to the lower interest payments.

But interest rates have been at historic low and the cost of paying interest on national debt will inevitably rise, perhaps as soon as this year. Even today, interest payments on debt are 39.4 billion shekels a year, the third biggest item in the budget after defense and education.

If Israel is going to contain the rising cost of interest payments at a time of rising interest rates, it needs to bring down its debt. But over the past four years, Israel has done exactly the opposite.

Spending in 2016 breached the ceiling by 6 billion shekels, for no other reason than politicians demanded all kinds of allocations as part of the coalition agreement for Prime Minister Benjamin Netanyahu’s new government. There were no forces there to put a stop to the populist spending spree.

The result is that the budget framework that enforced discipline on the politicians is shattered. Israel has no long-term planning mechanisms in place that would ready it for a crisis. Instead of using the years of economic growth and tax revenues to narrow the fiscal deficit and pay down debt, the government repeatedly violated the budget framework.

Instead of a deficit equal to 2% of GDP, as targeted, the government settled for 2.9%, a level too high to reduce public debt.

In short, if a third intifada does break out — a scenario that seems by no means impossible right now — Israel has no reserves to cope with the economic crisis that might follow.