Why Is the Israeli Economy Stuck?

Before we bet on economic growth, we need to examine who enjoys it. Real estate goes to property owners, business to monopolies, the public sector to Faina Kirshenbaum.

Eytan Avriel
Eytan Avriel
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New upscale housing under construction in north Tel Aviv.
New upscale housing under construction in north Tel Aviv. Credit: Nir Keidar
Eytan Avriel
Eytan Avriel

The Israeli economy is stuck. Since 2008 the captains of the ship of state have tended to begin every speech by saying, “Israel came out of the crisis in better shape and is growing faster than any other Western nation,” but that hasn’t been true since the end of 2012.

Even before the summer’s military operation in Gaza, Israel’s economy was faltering. Per capita growth, the number that should interest the public, nearly stopped. Operation Protective Edge halted growth for a full quarter, curbing per capita growth for all of 2014 to just 0.7%, about half the Organization for Economic Cooperation and Development average. The Bank of Israel forecasts slightly faster growth in 2015, possibly approaching the average again, but the growth engine Israel had been riding has stalled.

Israel can now look at itself in the mirror and admit that we’re like everyone else. Like everyone else, we’re dependent on the global economy, we have serious structural problems, we are inefficient and we don’t have a panacea. High-tech is keeping the growth rate at around average, mostly thanks to the Nasdaq index that returned to the 5,000 level and created demand for Israeli technology companies. But who knows what will happen when this global bubble collapses as well. If this were not depressing enough, Israel faces chronic political instability, security challenges and threats of an international economic boycott. The country’s social solidarity is fraying and the education system is weak.

Now, slightly more than two months before the election, is the right time to ask what can be done about the economy and whether any Israeli politician is fluent in the language of economics.

In theory, the starting point is obvious: The cost of living in general and housing prices in particular are too high, job security is too low. It is hard to find a decent job, with a take-home pay that will last through the month. The solution offered by everyone — economists, politicians, tycoons and their lackeys — is quite simple, on the face of it: We need faster growth. If only we could achieve that, the standard of living would rise and the Messiah would come as well, to boot.

Most of the policy proposals start here. They analyze why economic growth has slowed and what isn’t working, and try to fix the machine. The recipes are the same in every industrialized nation.

In a recent article Michael Spence, a Nobel Prize-winning economist who studied the issue of competition between states, identified five reasons for slow growth since the 2008 global financial crisis, as follows.

1. The underutilization of fiscal intervention, in other words governments are not spending enough money.

2. A lack of structural flexibility and excess capacity. He says the former is more of a problem in Europe than in the United States.

3. The disparity between the behavior of financial markets and the economy: Stock markets are climbing, but no one knows whether this rise in asset prices contributes to growth or simply generates greater inequality.

4. The quality of government, that is governments that fail to solve problems or to manage their affairs well.

5. Most important of all is the drop in aggregate demand.

Israel in Mind

Spence thinks that if only countries would act to solve these problems, mostly by investing in public infrastructure, Western economies would return to higher growth rates.

Many of these points could have been written specifically with Israel in mind.

But maybe this discussion is starting in the wrong place. What if Israel’s sluggish growth is not the cause of its high costs and low standards of living?

This unorthodox thought arises from looking at the countries that always top the lists of “best places to live” or “happiest people.” Per capita growth in Sweden, Denmark, Finland, Canada and Germany is not higher than in Israel, so why are Israelis applying for foreign passports and considering a move to Berlin, Toronto or New York? Economic growth rates in these places are not significantly different than Israel, even if they are starting with an advantage.

One possibility is that in Israel, economic growth is not distributed equally. Most of it goes to small groups who are close to the trough, rather than to ordinary citizens who are being strangled by the high cost of living. In other words: The story isn’t the growth rate, over which the government has little influence in any case, but how the benefits of that growth are divvied up.

For example, take housing. Home prices in Israel have risen by tens of percent in recent years. But if the only target of the government’s economic policy is growth, then the rise in housing prices must be considered desirable.

Rising home cost push up all the national account data, boosting GDP and the growth rate. Every additional rise in housing prices adds to the growth in related sectors, and they are legion. The problem is that the profits in all these associated businesses remain in the hands of a relatively small group of rich people. Young people who want to own their home are pushed out of the market.

The rise in home prices may increase growth, therefore, but happiness, economic security and living standards slip further out of reach. The same mechanism operates in areas other than real estate, where the state has a monopoly on land ownership. It operates in every sector where there is a monopoly, a lack of competition or “VIP lanes” where those with clout can obtain funding more easily.

The situation is similar in the public sector. Government spending has risen in Israel in recent years, as is reflected in the national accounts and growth figures. The real story in Israel’s labor market is that in the past two years nearly all the new jobs created in the country were in the public sector, while private-sector jobs growth has stagnated. When high-tech is removed from the equation, the number of jobs in the private sector actually declined.

Public spending creates economic growth, but the same question must be asked: Why don’t Israelis feel this growth in reduced living costs and better public services?

The answer is the same. The spending and growth benefits only a few, whether it’s employees of Israel Electric Corporation, who could paralyze the company with a strike, or those with political influence. Along the way various middlemen and corrupt groups take their cut. We have seen recently how hundreds of millions have been, allegedly, transferred to institutions connected to Yisrael Beiteinu, and how some of that money made its way into the pockets of politicians and their families.

In other words, for every dollar the government spends, a large share reaches interest groups and middlemen, and only a small portion reaches the general public. Growth due to public investment? It exists, but it remains in the hands of the few.

There is no doubt growth is important, and everything must be done to encourage it. But in order to lower the cost of living and raise the standard of living, the question of how that growth is divvied up is no less important. Is there a politician who understand this and is willing to change the rules of the game?

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