70 Years On: Thoughts on Israel’s Imperfect Capitalism

Surgery on socialism in 1985 was a success, but side effects of poverty, inequality still felt

Sami Peretz
Sami Peretz
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A man looks at AHAVA Dead Sea cosmetic products manufactured in the Israeli Kibbutz settlement of Mitzpe Shalem in the Dead Sea resort of Kalya.
A man looks at AHAVA Dead Sea cosmetic products manufactured in the Israeli Kibbutz settlement of Mitzpe Shalem in the Dead Sea resort of Kalya.Credit: אי־אף־פי
Sami Peretz
Sami Peretz

The biggest event in 70 years of Israeli economic history occurred on July 1, 1985. On that day the economy underwent nothing less than a sex change – dramatic transition from a socialist economy to the capitalist one we know today.

“If a man is not a socialist by the time he is 20, he has no heart. If he is not a conservative by the time he is 40, he has no brain,” is a quote often (though incorrectly) attributed to Winston Churchill. Nevertheless, in Israel’s case there is some truth to it.

The state would not have been created or survived in its early years without the solidarity created by a socialist economy and the government’s deep involvement in economic and social life. By the same token, Israel would not have survived into maturity if it didn’t surrender its youthful romanticism for pragmatic policies.

Until 1985, Israel was a socialist economy with all the anomalies this entailed. Its transition to capitalism was a success by most measures but it also came with side effects that we haven’t solved to this day – wider social gaps, more poverty and more concerns about social justice.

Israel was born as a socialist state, with its kibbutzim, cooperatives and deep government involvement in all aspects of daily life, but it would not have survived without the surgery done in 1985. The future belonged to those with a capitalist soul – the entrepreneur, the financiers and industrialists. At least the Jews know how to do all this well. Today Israel is the 19th-ranked country on the UN index of human development.

In its first decade, Israel was a welfare state. It took in millions of immigrants and established hundreds of communities and kibbutzim based on agriculture. Afterwards came the development towns, and in the 1960s a massive infrastructure-construction drive with grand projects like the National Water Carrier and Ashdod Port.

But during that whole period, no one ever asked what should be the limits to government involvement; this was the time to build a state, not to ask questions. So the government found itself managing the exchange rate, bank credit and foreign trade. Everything was run by government officials.

The breakneck rate of growth in the first decades was due to immigration and population increase, which created demand for housing, food, services and trade. The domestic economy had no way of financing this growth and so it turned to support from abroad.

And so was born the schnorrer (Yiddish for beggar) economy, with loans and grants from the United States, reparations from Germany, donations from Diaspora Jewry and Israel Bonds. It was the birth of cronyism, nepotism and the black market. But in the end, it also allowed the Jews’ capitalist DNA to burst forth.

But first Israel had to undergo a real crisis. The long stretch starting with the Yom Kippur War and the global oil crisis, which only ended in the middle 1980s, were lost years for the Israeli economy. Defense costs ate up 30% of gross domestic product, compared to 6% today. Inflation accelerated into triple digits and budget deficits ballooned. The banks manipulated their own shares and the Histadrut and kibbutzim got into speculation.

The government became even more deeply involved in the economy, as its deficits required more borrowing, inflation heightened the need for more price controls and trade deficits encouraged the state to subsidize exporters and block imports.

By the early 1980s, Israeli was a sick man needing surgery, and this came in the form of the now legendary Economic Stabilization Program. The economy was opened to imports, the currency market was liberalized, the government exited the capital market, the budget deficit was slashed, state-owned enterprises were privatized, and price controls and subsidies were eliminated.

The patient was saved and on its 70th birthday is playing the violin again. Israel is now among the top 25 countries in the world on a GDP per capita basis. Its financial markets are stable, inflation is close to zero and unemployment is at a record low.

If Israel still has problems of excessive rates of poverty, income inequality, uncompetitive markets and a tycoon class that tests the limits of the capitalist system, at least today the country has the resources to address those problems – if it chooses.

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