What Works for China's Economy Won't Work for Israel

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Hu Jintao, China's president, center in the front row, Jiang Zemin, former president, center right in the front row, and Xi Jinping, vice president, 12th from left in the front row, November 8, 2012. Credit: Bloomberg

Israel’s future depends mainly on the global economy because it is at heart a trading nation, according to Nathan Sussman, director of the Bank of Israel’s research department. This observation was reinforced by events when world markets fell over two days in late August, renewing fears of a global slowdown. If such a crisis occurs, Israel will be hurt, too.

This time, the fear is an economic slowdown among developing nations, particularly China. Disappointing data on Chinese production prompted the current slide, but the slide reflects all developing nations, including Brazil, Malaysia, South Africa and Indonesia, which grew rapidly for two decades and are now perhaps slowing down. These countries drew the global cart through the 2008 crisis. If the developing locomotive stops, the whole world will slow down with it – and Israel will suffer due to the importance of its exports.

As of late August, the signs aren’t heartwarming. Oil prices and trade were at multi-year lows, signaling weak demand for raw industrial materials. The currencies of developing nations plummeted because investors are fleeing. Their markets suffered sharp declines.

In Israel, the latest data indicate that the economy is stagnating. Our standard of living, it emerges, depends on they way Chinese President Xi Jinping and other developing-world leaders run their countries, no less and perhaps more so than what Prime Minister Benjamin Netanyahu does.

Real warning sign

But where’s the problem? China grew at a fast clip the past 20 years. Every time someone doubted its ability to grow 7-10% annually, China pleasantly surprised. This time, Western economists doubt the reliability of the numbers the Chinese government is publishing. The current fear is that the real data, if available, would show growth slower than the current official rate of 6-7%.

Why does this time look like a real warning sign? Why did the markets this time lose faith in the Chinese giant? The answer is corruption, democracy and the strength of interest groups close to power in developing nations. The economies of these countries indeed leapt in the last generation due to the low starting point and exploitation of natural resources. But the moment economic challenges began accumulating, it became clear they have no political culture and capability to do the right thing by adopting themselves to public and economic needs.

China, a non-democratic country, intervenes in markets in an almost laughable way, such as forbidding investment houses from selling shares to stop price dives. China is also unable to control its government monopolies, which prevent competition and thriving small and medium-sized businesses, the necessary next stage of a capitalist economy.

And what about countries considered “democratic”? Bill Emmott, former editor-in-chief of The Economist, put it this way last month: “The democracies of Brazil, Indonesia, Turkey and South Africa are all currently failing to perform what is a basic task for any political system: to mediate smoothly between competing interest groups and power blocs in order to permit a broader public interest to prevail. By that is meant essentially a public interest in allowing the economy to evolve flexibly, so that resources move from uses that have become unprofitable to ones that have a higher potential. A clogged up economy, one that does not permit such creative destruction and adaptation to new circumstances, is one that will not grow sustainably.”

He concluded: “The bottom line is that unless emerging economies can ensure that they remain flexible and adaptable, they will not continue to ‘emerge.’ And the determinant of that flexibility and ability to adapt lies in political institutions and their willingness to challenge interest groups, mediate social conflicts and maintain the rule of law. It’s the politics, stupid.”

Can a corrupt country with interest groups gobbling up the lion’s share of production and the added value an economy generates really grow sustainably? That’s the main problem of developing markets, and the basic reason for the recent market shake-ups.

This reality impacts Israel and the public in two ways. First, the slowdown in developing countries clearly will halt the West’s budding recovery, and us by extension. In fact, the slowdown has arrived – which we saw in Q2 data showing fewer deals, less trade, fewer exports and fewer investments, possibly leading to higher unemployment. Pension and investment portfolios are also in danger.

The second type of impact is more complex, deriving from the following question: How different is the governance structure and the hold of interest groups in developing countries different from what happens in Israel? Our government is also busy with political survival, and the public interest and wider economy are the last things that interest it. Our government also doesn’t make critical adjustments to the challenging economic reality, instead divvying out funds to political associates and power groups, such as in the gas deal approved earlier this month.

In parallel, the government is torpedoing attempts to do the right thing, even when it initiated the move, like the minister burying the Locker report on defense pensions. We’ll see in coming weeks which side the government takes in the struggle to be over the Strum Committee recommendations on bank and credit card competition.

Israel loves to see itself as a developed Western country. Our per capita GDP indeed rivals this club, but if the test of developed countries is its ability to deal with pressure groups, adapt the rules of the game to changing conditions and implement public and economic reform, sometimes on the backs of the few belonging to strong interest groups. Israel is probably not much better than China, Turkey or Russia.

The prime minster and his coalition perhaps suddenly fell in love with the political survivability of many leaders in these corrupt countries, but individual political interest cannot be a reason to harm the economy and public. What somehow works in China and Turkey can’t work in a small country surrounded by enemies.

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