The Free Market Isn’t in Retreat, Israel Just Needs a Fairer Economy

Everywhere you look the state is trying to influence prices: food, housing, health care and the dollar. But don’t worry, we’re not returning to the 1980s.

Gil Cohen magen

True believers in the free market are going through a confusing period. The government is intervening in almost everything.

The Health Ministry is going crazy over how to limit private health care. The Finance Ministry has put the sour cream and cheese made by privately owned company Tnuva under price supervision.

That same treasury is trying to clamp down on executives who draw huge salaries. It’s also taking desperate measures in the housing market with plans to cancel value added tax on small homes for first-time buyers. Meanwhile, the Bank of Israel has been intervening aggressively in the foreign exchange market for four years to prevent the dollar from plummeting against the shekel.

Everywhere you look the state is trying to influence prices: food, housing, health care, executives’ salaries and the dollar. What’s going on here? Has the free market stopped working? Are we returning to the 1980s?

There’s no need to eulogize the free market, but let’s examine if there really is a free market in Israel. Let’s figure out where we want such a free market and where not, and where there’s a very limited free market whose failures are obvious.

Since the late ‘80s, the Israeli economy has rapidly been moving from a socialist economy to a capitalist one. So we still suffer vestiges from the socialist past; for example, the state’s control of land.

And we suffer new and extreme phenomena that aren’t really based on competition; for example, excessive executive pay in the financial sector. Meanwhile, public-service products have deteriorated because of unsavory developments on the private-sector side — such as in public health care.

Housing: Everything in the government’s hands

Let’s start with the easiest example: housing. The housing market has three elements: land, construction costs and financing costs. The last two work freely and even meet the definition of a sophisticated market where there’s a large number of buyers and sellers.

But this market depends entirely on the land market, which isn’t free at all; it’s under the complete control of the state. Ninety-three percent of the land in Israel is owned by the state, which decides on the supply of land. This means the state’s involvement in the housing market is very deep.

The 80% rise in housing prices in recent years is the result of cheap money, provided generously by the Bank of Israel. These cheap funds are meeting low supply, courtesy of the Israeli government and in its various institutions — the Israel Lands Administration, the Interior Ministry, the Finance Ministry, the local authorities and many more agencies.

Even though housing prices have surged, and even though many young couples have been pushed out of the market and are being crushed by soaring rents, the state hasn’t learned to release land at an adequate pace to lower prices — or at least to stop the rise in prices.

In a true free-market economy, the state would sell more and more land and free up this bottleneck. But it has failed, and it has deepened its involvement in the housing market via Finance Minister Yair Lapid’s initiative to grant a VAT exemption for first-time home buyers of small apartments.

This accompanies the initiative backed by Housing and Construction Minister Uri Ariel to set low “target prices” in tenders for thousands of new apartments. We’ll then have a housing market where the government is trying to set prices, appraise apartment values and employ assessors who busy themselves with these issues. We’ll have an attempt to engineer the market. This isn’t good news for the free market, it’s a retreat from it.

Forgoing VAT is an easier step than selling land, but the easy solution isn’t the right one. Milton Friedman used to say that a government solution is usually as bad as the problem itself.

Deteriorating public health care

Health care is more complicated. Over the past two decades we’ve seen a very swift rise of the private health-insurance industry. From a purely public product, the health sector has morphed into health care for the well-to-do.

Private spending on health care climbed more than 70% between 2001 and 2011; the result is long waits in the public system and huge gaps between doctors as well as patients. Many physicians have become millionaires as many of their colleagues wallow in the public health system. Here the state is trying to do something: the committee on reforming the health system headed by Health Minister Yael German.

Health care is a public service by definition, so the German committee seeks a formula that will allow a careful retreat from the accelerated privatization of health services. We needn’t fear such a pullback, we must fear leaving the situation the way it is.

Price controls: A small, feeble step

The battle over the cost of living was meant to open markets and usher in imports, but in the dairy sector we saw a return to the price controls of the 1980s. The price committee of the agriculture and finance ministries decided last summer to add two products from Tnuva to supervision: 5% fat white soft cheese and sweet cream. Here, as in housing, the government seems to have surrendered.

Instead of opening the market to competition and letting in imports of dairy products, the state has taken a small step toward price controls. The bigger step of opening up the market could have created much greater competition, but limited price controls on a very small number of products is something Tnuva and the farmers can live with. It doesn’t rock the basis of their business — unlike all the implications of free markets and imports. The free market is the loser from all this.

Executive wages: Stopping the lunacy

Here the state has actually moved forward with very small and deliberate steps. Five years ago Labor MK Shelly Yacimovich proposed a bill limiting executive wages to 50 times the salary of the lowest paid employee in an organization. The initiative, considered radical at the time, was blocked. But it spawned Amendment 20 to the Companies Law, which did not significantly improve the situation.

Now a move is afoot to increase the tax burden on financial firms that pay executives more than 3.5 million shekels ($1 million) a year by not recognizing the excessive wages for tax purposes. Did we say slow and deliberate? Here there’s logic in the intervention, because it’s gradual and the financial sector must be told it needs to curb its greed. This won’t help? Then we can expect more intervention in the future.

It depends who you talk to

There’s no point in viewing the free market as a pure ideology without compromises. The greatest supporters of free-market capitalism agree that the government has a role in solving market failures. The biggest arguments are usually over what constitutes a market failure, and this is usually derived from ideology.

Executives who make 10 million shekels a year will tell you this isn’t a market failure, it’s a free and competitive market. If you ask the same people about the weakening dollar, they’ll say it’s a market failure and the state must intervene to prop up the exchange rate and protect exporters.

Food makers will tell you the high prices stem from a long list of factors, none of which are their fault. It’s always the government, kashrut supervision, local authorities, taxes, labor laws. They won’t mention that their own factory was built with government help. Jerusalem provided generous investment grants and tax breaks.

Today’s battles aren’t between socialism and capitalism, and they’re definitely not over free-market ideology. They’re about generating a bit more egalitarianism than what has developed in Israel over the past two decades. The awareness and need exist, but the solutions are far off and require government intervention — which can ruin things, too.