Reforms Urged to Cope With Long War and Cooling Growth

Economists tell TheMarker policy makers must look to budget to revive the economy and peace accord to end fighting.

Ilan Assayag

There have been two critical developments for the Israeli economy in the past week, both of which bode ill for future growth. One was the failure of Israel and Hamas to put a decisive end to the war in the Gaza Strip, which threatens to turn into a war of attrition. The other was the Central Bureau of Statistics' first readout of second-quarter economic developments, which pointed to a steep drop in growth.

Three leading economists interviewed by TheMarker on Wednesday say both developments will require the government to rethink its economic policies in the coming weeks, particularly the 2015 budget, in order to restore growth.

As to the prospects of a lengthy, low-level war with Hamas, the economists have fewer quick fixes.

The economists spoke as Hamas rained down some 150 rockets on Israel and Israel made an apparently unsuccessful attempt at killing a key Hamas leader as a 10-day cease-fire unraveled. The fighting is entering its sixth week.

Meanwhile, the government reported last week that Israel’s gross domestic product slowed to a preliminary 1.7% annualized rate in the second quarter, even before Operation Protective Edge got under way. The decline in growth was led by a double-digit decline in merchandise exports and shrinking investment in machinery and equipment as well as construction.

Each work day lost to war costs the Israeli economy about 4.2 billion shekels ($1.2 billion). Operation Protective Edge didn’t force the entire country to shut down, but Eran Yashiv, who teaches at Tel Aviv University estimates it did cost the economy 10% to 20% of output, in other words 420 million shekels to 840 million shekels a day.

“In a war of attrition the daily losses would not be as high but they would accumulate over time,” he said. Tourism, incoming and domestic, would be hurt, more people would be absent from work due to reserve duty and defense costs would grow.

Michel Strawczynski, a Hebrew University professor who heads the Economics and Society Program at the Van Leer Jerusalem Institute, estimated the fighting so far had shaved half a percentage point off the GDP, or about 5 billion shekels. Growth this year will be 2.4% instead of 2.9%.

He said he expected something of a postwar bounce for the economy, as consumers indulge themselves in compensation for their perceived privations during the fighting. Domestic tourism should recover quickly, but incoming foreign tourism will take longer.

He warned that a war of attrition would sap the economy, undermining the tourism industry and giving momentum to the global boycott, divestment and sanctions movement against Israel.

“It will be difficult for Israel, from a public relations perspective, to show that we are right,” Strawczynski said. “In other words, from an economic point of it acts as another incentive for our political leader to act on a diplomatic arrangement.”

“The time has come to enter into negotiations toward a real peace agreement with the Palestinians,” said Avi Ben-Bassat, a professor of economics at the Hebrew University and a former Bank of Israel official and Finance Minister director general.

“A war of attrition, or a resumption of operations such as Protective Edge, will do much damage. Cease-fire agreements aren’t a solution to attrition because they are temporary and no one can be sure when they will end.”

Ben-Bassat said the GDP figures were particularly worrying because the drop in investment signaled that business was pessimistic about the outlook even before the fighting got under way.

Economy in slowdown

“The economy is in a slowdown that threatens entire segments of the Israeli economy. No one sees any positive change ahead for the potential growth engine of exports, which is dependent on recovery in the economies of Europe and the United States,” Ben-Bassat said. He added that the government should be looking to reform the business sector, public service and the tax regime.

More immediately, Strawczynski asserted that a sluggish economy hit by war requires the government to look for a more expansionary fiscal policy. Yashiv agreed, noting that with interest rates at close to zero, the Bank of Israel doesn’t have the monetary tools at hand to breathe life into the economy.

Strawczynski said the treasury should return to its old budget-growth formula, which would allow it to increase spending next year by 3.5%, instead of the 2.6% ceiling now in place. The current budget deficit target of 2.5% of GDP is too ambitious; it should be raised to 2.75%, he said.