The global financial crisis erupted in full force in September of 2008 with the collapse of Lehman Brothers investment bank. Up to that crisis point, the Israeli economy was enjoying unprecedented success. The Olmert government, with Roni Bar-On as finance minister, managed to balance its budget in 2007 and achieve a surplus in 2008. The deck was reshuffled in September of that year, and the surplus for 2008 ended up as a 2.2% shortfall. Still, this was quite a small deficit when compared to the huge ones faced by many other countries.
Such was the legacy inherited by the Netanyahu government upon assuming office in April 2009. Israel, with a small deficit, operated as an economy heading towards a surplus. Now, at the end of its four-year tenure, the Netanyahu government is facing voters with a diametrically opposed scenario: As of late September, Israel is operating with a budgetary deficit of over 4%. This is more than twice as large as the goal figure set by the government for 2012, and constitutes the largest deficit in a decade, excluding the extreme crisis years of 2003 and 2009.
The fact of the matter is that Netanyahu was handed a country operating under strict fiscal discipline, and is returning one with a total lack of budgetary restraint. The so-called "Mr. Economics" has managed to navigate the Israeli economy backwards so that impressive fiscal policies turned into a dismal failure. This is the most serious economic failure of this government, which, after four years at the helm, bears sole responsibility.
There are many reasons that led up to this state of affairs. First of all, the Finance Ministry is at fault for the manner in which budgets were handled. It committed serious professional errors over the last two years, which led directly to the growing deficit.
The first of these was a gross underestimate of tax revenues, which are now estimated to have been NIS 20 billion short of target. Another mistake lay in decisions taken in January 2012: The government approved some parts of the Trachtenberg committee's report, such as a longer school day and subsidized after-school care, and approved wage settlements with doctors and teachers' unions. It also added NIS 3.5 billion to the defense budget. These budgetary supplements were countered with budget cuts across the board, including to all other ministries.
In retrospect, it turned out that the math was wrong, and these decisions amounted in practice to the production of a deficit. Thus, there was a twofold error, in estimates of revenues and of expenses.
Don't worry, spend money
The professional errors in judgment at the Finance Ministry were linked to more basic errors in policy. The Netanyahu government, self-satisfied with its weathering of the global crisis (ignoring the fact that this stemmed mainly from the benefits it inherited from the Olmert years ) and facing pressure from the social protest movements, decided on expansionary fiscal policies. The feeling was that all is well and that the crisis warrants some loosening of restraint.
In addition, it appears no one added up the supplements to the defense sector handed out by Netanyahu in the course of the year, beyond the amounts that were allocated in the budget. Adding billions of shekels to the defense industry has been customary over the years, a practice that the Bank of Israel has warned against continuing. However, due to the sense of economic well-being and the looming security threat, the sums involved were apparently inordinately large. Thus, a slight loosening of budgetary restraint turned into a collapse.
To their credit, the prime minister and the Finance Ministry now acknowledge these mistakes, and realize that corrections are necessary. This has led to the raising of taxes, mainly an increase in the value-added tax, in an attempt to bridge the budgetary gap. Netanyahu should be credited with making such an unpopular move on the eve of elections. However, this falls far short of the required steps. The huge budget cuts expected in the 2013 budget are a major factor in the decision to move up the elections, signaling the anticipated large-scale correction about to be applied.
Make no mistake - the impending correction will be very painful, involving several months of tight budgetary restraint as the government initially switches to operating on the basis of the 2012 budget. The burgeoning 2012 deficit will force the Finance Ministry to start applying fiscal measures as early as November or December of this year. This will mean denial of approval for expenses by other branches of government, in an attempt to reduce the growing deficit.
However, the actions of the Finance Ministry are under legal constraints. Many expenses have to be paid out, including salaries, servicing of debts and the honoring of signed contracts. Thus, any reductions in the coming six months will be limited to areas in which there is some flexibility. These include purchases by the government from the private sector through contracts that have not yet been signed. Contractors or businesses selling goods and services to the government will soon see a sharp fall in their revenues.
This will greatly exacerbate the slowdown that is already upon us. The only saving grace is the Bank of Israel's interest rate, currently at 2.25%. Monetary policy steps may partly ease the oncoming woes.