Forbes columnist and analyst Jesse Colombo, a young man who is not yet 30, wrote an in-depth analysis of the Israeli economy at the beginning of the month. It included a clear warning about the bursting of the real-estate and high-tech bubbles here — once interest rates start to rise.
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The article is entitled: “Why Israel’s Boom Is Actually A Bubble Destined To Pop.” Colombo, an American of French background, styles himself a specialist in identifying potential economic bubbles. His interesting analysis is packed with data on the Israeli economy, and in particular on the real-estate, high-tech and natural-gas sectors.
To sum it up, he says this: Housing prices in Israel have climbed 80% since 2007 thanks to low interest rates locally; the Israeli high-tech sector is flourishing because of low interest rates around the world, which have sent large sums of money looking for investments outside the United States, and Israel, being "Startup Nation," is enjoying the high-tech bubble that in reality is going on the United States. (Colombo provides examples of high-tech firms, such as Twitter, that have miniscule revenues) — and that will one day burst. In this context, he mentions Israeli high-tech firms that have been sold, such as Waze.
For dessert, Colombo pours cold water on what Israel sees as the fount of its future economic prosperity: natural gas. He claims the industry is overestimated and that it is doubtful Israel will turn into a gas exporting superpower in the region.
Rising interest rates, says Colombo, will bring about the following series of events: The real estate bubble will burst and prices will fall, the banks will suffer credit losses in the mortgage market, the high-tech bubble will burst in the United States and Israel at the same time and cause the closing of many startups (mostly in social media and applications), shares of technology firms and banks will fall and bring down the rest of the market with them, economic growth will go into reverse and unemployment will rise.
The view from Israel
Three things came to mind when I read the article. First, what a wonderful choice of profession this Colombo guy made — to travel from country to country and warn of bubbles. Guess correctly, and he is a genius. Guess wrong, and who remembers? Second, there was not much new in what he wrote. It is clear that the low interest rates in Israel and around the world are an explosive recipe for the development of asset bubbles. And third, what prosperity in Israel is he talking about? Does he really think Israel is thriving?
It is hard to argue with his guesses. Housing prices are influenced by a great number of parameters, one of the most important of which is low interest rates. But he ignored the other, no less important reason for rising housing prices: The small supply of land in Israel. Rising interest rates could certainly cool down the housing market, and even possibly bring about lower prices. But the real question is how much they will drop — and in particular, what will happen to unemployment? Here the analysis is much more complicated.
As for the claims of a high-tech bubble, this is also hard to argue with. Things we saw during the bursting of the dot-com bubble at the beginning of the century are happening again. Young companies without business models or significant revenues are being sold for hundreds of millions of dollars — and sometimes even more. American companies are being traded with values in the many billions of dollars even though they are losing money.
Raising interest rates around the globe could let a lot of air out of the real estate bubble, from high-tech and "hot money" moving around the world looking for investments — some of which has found its way to Israel. In many ways, this is something we have no control over here. After all, Israel was forced to institute low interest rates, because interest rates all over the world fell — and this is the only way to prevent hot-money capital from flowing into the Israeli economy and upsetting it. This will also happen when interest rates rise. If the United States and Europe raise rates, then the Bank of Israel will do the same.
Is the Israeli economy really prospering?
So we are left with the question: Is the Israeli economy really prospering? And with another no less important question: What does the Israeli economy need to do to minimize the effects of the bursting of these bubbles in the future?
Contrary to Colombo’s analysis, the Israeli economy has not had real prosperity in recent years. There are certainly good economic figures here compared to the United States and Europe, which are still feeling the global financial crisis. Israeli unemployment is low by historical standards, the banks are stable, startups are selling like hot cakes and many home owners are enjoying a feeling of wealth — but when you examine the data on the national accounts, they are far from meeting the definition of prosperity.
The Israeli economy grew 3.3% in 2013, and after subtracting the effects of natural gas, it grew just 2.5%. Per capita GDP grew just 1.4% — though this is double the OECD average. The growth trend for GDP has been falling for the past three years after rising 4.6% in 2011 and 3.4% in 2012.
The fall in GDP is linked tightly to what is happening in global markets, which have a big influence on Israel's export-dependent economy. As a result, it is clear that changes in world trade and interest rates are critical to Israel’s continued prosperity. The government and the Bank of Israel have no influence over the state of world trade or global interest rates — and it is impossible to control foreign exchange rates forever. But there are a number of things that are relevant to fulfilling Israel’s economic growth potential — and this is what the government needs to focus on.
What the government needs to focus on
Colombo minimizes the importance of natural gas to the Israeli economy. In my opinion, that is a mistake. Since the discovery of the gas fields, the country has been busy with endless questions on the just distribution of wealth, regulating natural gas markets and fending off a monstrous monopoly headed by Yitzhak Tshuva and Noble Energy, which will control the Israeli energy market. This discussion is good and important and essential. But we must also focus on the no-less-important task of identifying business and economic opportunities concealed in the natural gas discoveries and preparing the economy and labor market for them — whether by creating the infrastructure to establish industry based on natural gas or by wise use of the money received from the sale of the gas.
So far, we have not seen any government arrangements to prepare the economy, industry and developers for the gift we received from heaven — cheap, clean and available energy. Everyone is fighting over the question of how much will we export, how much the developers of the gas will profit and how much tax they will pay. But I have not heard any argument or seen any staff work on the question as to which factories can be built here, what promising investments can be made with the money from the gas and which workers need to be trained so as to turn Israel into a country with natural resources.
The potential for Israeli economic prosperity lies not only in natural gas. It can also be found in many other areas. There's the low productivity that permeates the entire economy, which we must boost. There are the inefficient government services, as well as the banks and other financial services that also need to become more efficient to improve the situation of savers and retirees — as well as the allocation of resources in the economy. And there's the low workforce participation of ultra-Orthodox Jews and Arabs, which needs to be reversed.
The Israeli economy is dying for broad economic reforms and long term planning — and here lies our growth potential. These changes would provide the security cushion for the bubbles that will burst in the future, whether they are in real estate, high-tech or any other sector.