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Israel Can’t Revert to pre-COVID Economic Truths as if Nothing Has Happened

Sami Peretz
Sami Peretz
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A line at the National Insurance Institute office in Petah Tikva.
A line at the National Insurance Institute office in Petah Tikva.Credit: Tomer Appelbaum
Sami Peretz
Sami Peretz

Two years of political chaos will end after Election Day, March 23, with the formation of a stable government that has a clear vision and priorities. Or not.

The results of the next election and the composition of the next government look increasingly unclear. All options are open.

But the inescapable fact is that whatever government is formed will have to decide on what socioeconomic model Israel is going to have in the post-coronavirus era. Ostensibly, the model was decided back in 1977, when the government of Menachem Begin vowed to create a capitalist economy and free markets. That really began to take shape in 1985 with the Economic Stabilization Program that sharply reduced government intervention in the capital market, opened the domestic market to imports, curbed subsidies and introduced privatization and a host of structural reforms.

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All of that led to economic growth and development and to the unemployment rate ultimately falling to historical lows. It also increased socioeconomic inequality and created a generation of powerful tycoons who amassed empires with debt.

Yet some of the centers of power from the old socialist era remained intact – the powerful trade unions, the bloated civil service and a handful of government-owned companies that avoided privatization. As a result, Israel had two economies: a public sector of protected jobs and a private sector where market forces ruled. The dichotomy was evident during the coronavirus crisis when the unemployment rate shot up in the private sector while public sector jobs were preserved.

Prime Minister Menachem BeginCredit: Dave Pickoff/AP

Some of these distortions have been corrected over the years. For instance, the Business Concentration Law helped whittle down the pyramid-structured holding groups that gave tycoons excessive power at great risk to the economy. Increases in the minimum wage, the introduction of a negative income tax (or tax credit), mandatory pensions and so forth helped narrow socioeconomic gaps.

And then came the coronavirus. A traumatic event for the economy that led to unprecedented measures in terms of public health and government spending, but it cannot serve to forecast the socioeconomic model that Israel will adopt going forward. First, because nearly every country in the world adopted policies similar to Israel’s to address the pandemic’s economic effects. Second, the pandemic hit Israel in the midst of a political crisis. That caused Prime Minister Benjamin Netanyahu to adopt fiscally generous policies in opposition to his worldview, such as an expansion of unemployment benefits.

Over the last two decades, when Netanyahu has been the dominant political figure by far, Israel hasn’t been a believer in big social welfare spending, especially vis-a-vis transfer payments. That is the result both of a right-wing ideology and of a political culture in which public trust in government has been very low.

How can we say this nicely? We have a lot of freeloaders, scammers and loophole artists who make it difficult to create the kind of social solidarity needed to successfully implement more generous welfare policies. To quote Prof. Milton Friedman, a free market works better in Israel than a welfare state because so many segments of society hate each other.

The formation of a new government, not to mention the need to create a new normal with the completion of the vaccination program and the reopening of the economy, will require a reexamination of Israel’s socioeconomic policies. Israel faces new challenges.

Where we once had full employment, we now have double-digit unemployment. Where we once enjoyed steadily falling tax rates, we now must contend with a big budget deficit and a much higher ratio of debt to gross domestic product that will have to be brought down. Where we once were seeing modest improvement in the Gini index of economic equality, it’s safe to assume the pandemic has reversed that.

In short, many of the things we took for granted in years past are no longer. The question now is whether Israel needs a new socioeconomic model. Does the coronavirus have anything to teach us?

One can argue that the pandemic was an exceptional event that required exceptional measures, and that after it ends we can return to our pre-COVID ways. That means the Israeli model shouldn’t be to provide a strong social safety net on a permanent basis, but rather to deploy it only when needed. That’s the system in Israeli banking, where the government does not insure deposits but when banks do collapse it steps in to rescue customers. It doesn’t want the public to lose faith in the banking system much less spark protests. This was also the logic behind the aid the government provided during the coronavirus crisis.

A vacant store for rent last year in the Tel Aviv suburb of Holon.Credit: Tomer Appelbaum

In the case of a pandemic or a failed bank, the government has no choice but to act. It’s harder to say what it should do in a smaller crisis, when only one small segment of society is harmed. The government will face this question in regard to the labor market as the economy returns to normalcy. Hundreds of thousands of jobs have vanished. The state will have to introduce comprehensive programs that include vocational training, extended unemployment benefits and intelligently designed incentives to coax workers back to those jobs that will be waiting to be filled.

What should be the Israeli model? Are there models we can copy, such as Denmark’s? The question also applies to labor market flexibility, mainly in the public sector. Does the current situation, in which there are two labor markets, each with its own level of job security, need to be changed? Should we make it easier to fire government employees while increasing employment protections in the private sector?

These are not easy issues to resolve. Before the coronavirus crisis, they were the source of labor disputes and strikes. But after the crisis, that’s no longer sustainable. Developments whose pace has been accelerated by the pandemic, including office automation, online ordering and home delivery as well as cost-cutting in many workplaces, means fewer jobs and the job-security gap demands a more balanced labor market going forward.

That’s also true for the tax system. In its first year in office, the next government will not be able to raise taxes because the economy will still be struggling to revive growth, but the government will have to find a way of reducing the debt-to-GDP ratio. And, it will have to do this as it tries to strengthen the health care system, education, infrastructure and, of course, defense. Those who weathered the coronavirus crisis the best, and in some cases even prospered, will have to bear most of the burden. That is the case even though the top three income deciles already carry 90% of the tax burden.

Still, the post-COVID era should give us a chance to rethink the tax system – to consider the rates that the biggest companies pay, the tax exemptions that cost the government 70 billion shekels ($21 billion) annually and the lack of any tax on large inheritances and residential rental income.

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