Prime Minister Benjamin Netanyahu has appeared before the public almost every day over the past several days, and each time he declares increasingly harsh measures aimed at curbing the spread of the new coronavirus. The Israeli economy, however, has so far received considerably less attention.
The absence of real-time economic data makes it very difficult to grapple with the problem. Is it too early to talk about a recession? Prof. Zvi Eckstein, dean of the Herzliya Interdisciplinary Center’s Arison School of Business and Tiomkin School of Economics, says that policymakers should operate on the assumption that Israel is heading in store for.
“You have to plan for the worst-case scenario,” said Eckstein, who was deputy governor of the Bank of Israel during the 2008-09 global financial crisis. “In the previous crisis, anyone who operated on the assumption that everything would be fine got it wrong.” He said the economy will only begin to recover when an effective treatment or vaccine is found for the virus.
“I believe that we face one or two quarters of declining gross domestic product,” Eckstein said. Israel’s jobless rate is today at a very low 3.6 per cent, but he said it is expected to rise rapidly. “Unemployment will increase significantly, maybe even double; it depends how long the crisis lasts.”
Prof. Rafi Melnick, an economist at IDC, is certain the world economy is heading into a recession. The coronavirus crisis has developed differently from most other economic crises because supply has been affected, not only demand. Supply crises, like the oil crisis of the 1970s, are much rarer. “The conventional tools for dealing with an economic slowdown, like cutting interest rates, aren’t effective today,” he said.
Melnick said the most critical short-term problem is the break in the supply chain due to disruptions in manufacturing and in transportation, especially air cargo. Once those issues are solved, policymakers will have to address the hit to the demand side.
“In the atmosphere in Israel and the world right now, there’s nothing to say about business investment – there won’t be any,” he said. “Consumer spending will shrink because people prefer to save and unemployment is rising. Governments will have to deal with that without a lot of tools at their disposal.”
So what should Israeli policymakers do?
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“What’s needed in terms of policy is a very clear message from the government – accompanied by actions, not only explanations – that it will do everything needed to make sure that healthy businesses don’t fail,” said Melnick.
He recalled the remarks of Mario Draghi, then-president of the European Central Bank, in an address to a global investment conference in 2012: “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.” That promise to do “whatever it takes” is now regarded as having saved the euro.
By comparison, his successor at the ECB, Christine Lagarde, last week promised a much more modest “ambitious and coordinated fiscal policy response” by European governments. She said most of the work of dealing with the crisis should be done by European Union member states employing fiscal policy.
For its part, the German government has taken up the challenge and said it would provide unlimited loans to businesses affected by the crisis. “This is the bazooka, and we will use it to do everything we can,” said German Finance Minister Olaf Scholz.
Said Melnick: “We face a real danger of fundamentally healthy businesses going bankrupt. Because of the unusual situation that has been created, governments must make clear commitments to prevent businesses like these from going under. In fact, Israel is in a good situation because our public debt level is low. It was for situations like this that we undertook to reduce debt – so we would be able to increase the budget deficit without having to worry about a deterioration in our macroeconomic condition. We also have large foreign currency reserves.”
The viewpoint isn’t shared by all economists. Some see the coronavirus crisis as an opportunity to let loose some “creative destruction” that rids the economy of weaker businesses. The government, they contend, shouldn’t waste the taxpayers’ money trying to save them.
Melnick said the loan guarantees the Israeli government made available last week are insufficient.
“We need credit lines directly from the government for the business sector via the banks, not guarantees but real cash. It’s up the government to make sure that healthy businesses can survive the crisis,” he said, adding that corporate tax payments should be delayed.
Eckstein said he believed the loan guarantees were an effective tool for helping companies with liquidity problems, so long as they don’t contain terms that deter businesses from taking them.
“In the United States, they have loan guarantees for small- and medium-sized businesses, and they can be taken out without the business owner personally pledging collateral,” he said. He added other conditions for government-backed loans to succeed: They must be short-term – no more than a year – and regulators must ease capital requirements on borrowers.
If the government allows businesses to delay paying value-added tax and social security (National Insurance Institute) payments, that would also help them cope with a coronavirus-induced liquidity crunch. “Any undertaking that spreads the pain over time and helps individuals and businesses to get through this period is for the good.”
Eckstein said the government must use the budget to ensure the economy continues functioning and especially can supply essential goods. It’s especially important to keep air cargo links up and running.
However, the Finance Ministry has hesitated to offer aid to El Al Airlines, the country’s flag carrier, out of concern that even before the pandemic the airline was struggling. Eckstein looks at the problem from a different perspective.
“The issue here isn’t taking taxpayer money and giving it to El Al but to use it to make sure a critical economic function continues to be performed. When governments rescued banks during the global financial crisis, they didn’t do it to rescue shareholders but in order for the banking system to continue to function,” he explained.
He added that the government could in addition use other airlines to provide services and either buy or lease jets from El Al, or subsidize designated flights.
Melnick admits that government aid could be used to prop up failing businesses but stressed that that shouldn’t be an excuse to do nothing.
“You can form a professional team that will make use of bank data to decide who should get loans,” he suggested. “There’s always a risk that you’ll be supporting ailing businesses, but in my view this isn’t the time for a policy of ‘survival of the fittest.’ It’s the time to calm the markets and prevent all sizes of businesses from falling into bankruptcy.”
The kind of measures that both economists talks about would require big increases in government spending at a time when tax revenues are expected to fall. That spells a wider budget deficit. But neither Eckstein nor Melnick expressed much worry.
“I don’t think an increase in the deficit will endanger Israel’s macroeconomic stability,” said Melnick. “Quite to the contrary, it would stop the situation from snowballing.”
If Israel acts responsibly, he said, the financial markets won’t question its commitment to returning to lower spending and deficits once the crisis passes. “We’ve been through worse crises and the government kept to it commitments. Our starting position right now is good,” he said referring to relatively low budget deficit and national debt.
Eckstein noted that when the global economic crisis exploded in 2008, Israel’s budget deficit was a much lower 2.1 per cent of GDP, versus 3.1 per cent in the 12 months through February 2020. But, he pointed out, Israel’s national debt was higher than it is today, about 60 per cent of GDP.
“It’s unfortunate that we have a big deficit right now, but this doesn’t need to be our main consideration, so long as we have a plan for exiting the crisis within a year and afterward to return to a deficit of 3 per cent,” said Eckstein. “Our debt ratio is expected to grow to 62 per cent or 63 per cent, but that won’t affect economic stability, if it’s clear that after a year it will return to 60 per cent.”