Shimon Peres: Father of the New Israeli Economy

Reluctant at first, he steered the Economic Stabilization Program through the cabinet in 1985, bringing an end to Israel’s hyperinflation — and to the state’s socialist economy

Meirav Arlosoroff
Meirav Arlosoroff
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Shimon Peres holding a news conference outside the Prime Minister's Office, July 1985.
Shimon Peres holding a news conference outside the Prime Minister's Office, July 1985.Credit: GPO
Meirav Arlosoroff
Meirav Arlosoroff

The modern Israeli economy was born on July 1, 1985. That was the day the cabinet adopted a broad program aimed at ending hyperinflation and saving Israel’s rapidly disappearing foreign currency reserves.

But it was also the day when the socialist economy of the 1950s and ‘60s gave way to capitalism. Shimon Peres, who was prime minister at the time, was indisputably the man who did it.

“All of us were the architects of the stabilization program, but without a doubt the program had one commander in chief — Shimon Peres,” said Amnon Neubach. Today the chairman of the Tel Aviv Stock Exchange, in 1985 he was an economic adviser to the prime minister.

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The economy was in dire straits. Inflation was climbing rapidly and in the weeks before the stabilization program went into effect had neared 1,000%. Individuals and businesses were preoccupied with protecting their earnings and savings from being eaten up by spiraling prices.

The government’s budget deficit was equal to 12% to 15% of the gross domestic product (as opposed to under 3% today). The national debt was equal to 220% of GDP.(Greece’s debt-to-GDP ratio on the eve of its financial crisis in 2010 was just 180%.)The need to finance the deficit meant the government had nearly monopolized the capital markets to borrow money, leaving the private sector struggling for capital.

The stock market itself had crashed in 1983 and four of Israel’s five biggest banks had been nationalized. Foreign currency reserves were disappearing rapidly.

Like the political leaders who preceded him, Peres feared taking the stern measures that would be needed to right things. But in the end a combination of desperation, the work of a team of bright young economists headed by Eitan Berglas and American pressure — as well as a promise from Washington for $1.5 billion in aid money — brought Peres around.

The economic stabilization program had five key elements. The first was a price freeze. The second was slashing the budget by about 8% of GDP, a reduction made even more painful because it came mostly from eliminating food subsidizes. Food prices shot up but the third element of the plan led to wages dropping by 12% to 14%.

The fourth element was a devaluation of the shekel and a program to link it to the dollar, and the fifth was to raise interest rates to punishing levels of 30% to 80% after inflation.

Prime Minister Yitzhak Shamir and Foreign Minister Shimon Peres look amused during the Mimouna celebrations, Jerusalem, Israel, March 15, 1988.Credit: Harnik Nati / GPO

The program worked quickly and effectively. By the end of the year, inflation was down to just 20%. (It would end up being 450% for the whole year as a result of the hyperinflation in the first half.) Unemployment rose, but only from 5.9% in 1984 to 7.1% in 1986. The shekel stabilized and the state budget was balanced.

There was a price to pay, as Israel slid into recession. Businesses went under and kibbutzim saw their debts pile up to unsustainable levels. But the program is studied to this day as a model for other economies in crisis.

Stanley Fischer, who was a U.S. adviser to Israel on the stabilization plan, prior to serving as Bank of Israel governor, noted in a 2001 speech that the program contained elements of orthodox economic policy, like the big budget cuts, and heterodox policy, like freezing prices.

“The heterodox elements played an important part in bringing inflation down almost immediately, after the initial price shock associated with the devaluation, and were certainly critical to the political acceptability of a very tough program,” he said. “By the standards of such programs, the stabilization was a great success.”

Peres was hesitant to go ahead with the plan. He was head of the Labor Party, but his national unity government with Likud gave him the premiership for the first two years. The measures would be politically unpopular and Likud ministers would be happy to see the government fall in the hope that new elections would bring a decisive Likud victory.

“He was afraid we would lead him into the political abyss,” Neubach recalled. “So we used the Americans to exert pressure on him. The American economists — Stanley Fischer and Herbert Stein — agreed with the Israeli economists, mainly Michael Bruno and Eitan Berglas, and used [the Americans’] long arm.”

As the economists drafted a program, Peres played for time. He reached two separate deals with the Histadrut labor federation to bring down inflation, both of which failed miserably and undermined public confidence in the government. He then waited until after the Histadrut election, in which a Labor slate headed by Yisrael Kessar was running, before acting.

But in the end it was Peres who took sole political responsibility and won the cabinet’s backing. Likud Finance Minister Yitzhak Moda’i kept himself out of the picture, nor was the Bank of Israel involved because of its acrimonious relations with the treasury.

Many ideas were killed, like one that Attorney General Yitzhak Zamir vetoed that would have reduced private savings by government order, Neubach recalled. But Zamir did approve the bundling of several draft laws into a single Knesset bill, a practice that survives to this day in the controversial Economic Arrangements Bill.

The climax came as the cabinet met to approve the plan, where Peres’ political skills were put to what would be the greatest test of his long career. The ministers met for 19 straight hours as the prime minister shuttled from room to room, one time persuading a reluctant Kessar to back the program and threatening him with a government order to cut wages if he didn’t, another time cajoling Likud ministers to come on board.

Peres speaks to the media outside the White House in Washington, following his meeting with Obama. June 25, 2014.Credit: AP

When the cabinet voted at dawn, Peres had his majority: Three Likud ministers — Moda’i, Yitzhak Shamir and Haim Corfu — voted yes, as did all the Labor ministers, except one. Defense Minister Yitzhak Rabin abstained in protest over the big cuts in defense spending (although he succeeded in getting some of them rolled back).

It’s doubtful whether any Israeli leader before or after would have had the courage and skills to pull it off.

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