Five Myths

Israel's economic history is being rewritten, and fast. On the eve of the Passover holiday, the Bank of Israel released a report presenting Israel's economy as being stronger than ever, with a budget deficit dropping to all-time record lows, and surplus tax revenues (compared with expectations). Clearly, all that remains is to correct a few mistakes the government made in recent years when cutting welfare stipends.

The farther we get from the financial crisis of 2002, the more people believe that Israel's economic problems result from a specific socio-economic policy, and that all that needs to be done is to abandon it and choose the right path.

The Bank of Israel report is a good opportunity to examine some of the myths taking root, with the help of the long-term view. It may not sound like an appealing task, but it may prove valuable as Kadima, Shas and Labor battle over economic policy.

Myth 1: Poverty in Israel was created in the last three years.

Reality: Even though the National Insurance Institute has eagerly adopted this theory as a weapon in its perennial war with the Finance Ministry, the NII's own long-term figures tell another story.

Poverty began to climb at frightening speed in the early 1980s. By the start of the 1990s, it had risen from 27% of households to 35%, before tax and transfer payments. Welfare payments and other government handouts hid the truth: from the 1980s, these have grown from 27% of government expenditure to 56% in 2001. The biggest increase was in transfer payments to households, which grew from 7.6% of GDP to 12.2%.

But transfer payments could not grow enough to hide the spread of poverty forever.

Myth 2: The welfare cuts of three and hour years ago were unnecessary.

Reality: In the years 1994 to 1999, the government's transfer payments grew by 3.7% per capita a year. In 2000 and 2001, the pace shot up to 8.9% a year, per capita. Then the recession struck and government policy crashed into economic reality.

In 2002, the government ran a mammoth deficit of 9% of GDP, if measured by international standards, not warped local ones. That is 10 times the deficit level of the OECD nations. Government spending reached 58.6% of GDP, compared with an average of 45% in the OECD countries. The result was that investors fled Israel and the international marketplace shut itself off o the Israeli economy.

3. Myth: Stipends and unilateral transfers are integral to reducing poverty.

Reality: Poverty in Israel remained steady at about 17% to 18% of the population between 1994 to 2002, though transfer payments and other stipends grew faster than the population, by about 5% a year. The conclusion: There was no progress in the structural process that created poverty in Israel, though the sums allocated for support increased impressively, to the point of bankrupting the nation.

Myth 4: The government had to cut welfare in general, especially to the old, because of the economic crisis.

Reality: Cutting unemployment benefits and a part of the child allowance was designed to abolish disincentives to work. But slashing stipends for the aged was cruel and unnecessary. Other cuts could have been made. The budget for the public sector remains coated in flab but the prime ministers over the ages have refused to do anything about it.

For instance - Bank of Israel figures show that after Iraq's collapse, Israel's security situation spending shot up from 22% of GDP to 25%. Clearly there is no connection between actual security threats and defense spending.

Myth 5: Gigantic budget surpluses have built up in the last year because of economic growth coupled with government underspending. The government can afford to increase allowances again.

Reality: Israel's economy perennially lags far behind the economies of the developed world. In the last two years it has narrowed some of the gaps, but it has a long way to go. Israel's government debt has shrunk only by 1% in the last ten years while during that time, the OECD nations reduced their deficits by 4.7%. The countries that (like us) chronically suffer from high deficits lowered their deficits by 6.1%.

If Ehud Olmert and whatever finance minister he appoints hurry to adopt the wrong theory that the government is flush with cash and increase spending, Israel will miss a historic opportunity to significantly advance its economic development.

Allowances for the truly weak should be increased, but the way is through changing priorities in government spending. Flab must be gradually abolished and the public sector made more efficient. Deviating from the path of quickly reducing the national debt and taxes would sow the seeds of the next disaster. In the next recession the prime minister would face the same dilemmas and their solutions would be the same: take from the old, then the sick, and then from the unemployed and the poor.

What we need is a five-year plan to reduce Israel's national debt to 80% or 85% of GDP. It could be achieved by adhering to the plan of increasing government spending by no more than 1% a year, to prepare for the "day after", the day the U.S. loan guarantees run out and is has to cope based on its own economic parameters, and them alone.