Where the Shekel Stops / Netanyahu, Barak and a Moment of Keynesian Economics

Fiscal credibility and gravity, it turns out, comes with a price, and in the era of market rule, nations behaving irresponsibly get punished mercilessly and fast.

"It's true that it's impossible to live beyond one's means over years," he acknowledged. "But that doesn't mean one has to cut one's nose off to spite one's face. When the roof is leaking, the leak has to be fixed because by its very existence, it causes damage. Only then does one ask how much it cost. A government has to act just like the ant: to save in the summer, when plenty abounds, so one can spend more in the winter."

Defense Minister Ehud Barak has an MBA, majoring in systems analysis, from Stanford University in California, and a BSc in physics and mathematics from the Hebrew University of Jerusalem. No question about it, Barak sees himself as understanding business and economics, and takes a keen interest in both.

Ehud Barak - Eliahu Hershkovitz - 07122011
Eliahu Hershkovitz

Barak studiously reads the articles penned by Nobel laureate Paul Krugman, who these days is preaching budgetary expansion, a Keynesian policy, to fight the global financial crisis. Barak has obediently migrated these policies to the State of Israel.

He isn't the only Israeli minister who purports to possess a profound grasp of economics. The first among equals, Prime Minister Benjamin Netanyahu also possesses an MBA, in his case from the Massachusetts Institute of Technology, as prestigious an institution as Stanford.

Freshwater and saltwater fish

In one of his most famed articles, Krugman talks about the difference between the freshwater school of economics and the saltwater school. Freshwater economists, from the University of Chicago, are neoliberals who advocate nonintervention by government. Saltwater economists (Harvard University, near Boston ) urge the government to intervene (Keynesian economics ).

This territorial division by water qualities, it turns out, stops at the shores of the United States. In Israel, it's the scion of saltwater origin, the graduate of MIT, who holds the neoliberal views, while the freshwater product from Stanford propounds Keynesian theory.

Israel's surprised business reporters were treated to an hour-long lecture by Barak this week, describing the guidelines of his pro-Keynesian theories. No harm would come to Israel if it increased its spending by 0.9% a year over five years, the defense minister said (which translates into NIS 35 billion of extra spending and would expand the deficit to 4% of GDP ).

According to Barak, expanding the budget would enable Israel to contend with all its budgetary needs to execute the Trajtenberg recommendations (from the committee headed by Manuel Trajtenberg on Israel's ills and what to do about them ). It would also enable Israel to continue investing in defense, without paying a heavy price. According to Barak, warnings that budget expansion would reduce us to the state of, say, Italy or Greece, are balderdash.

Magnificently, Barak analyzed the mistakes that reduced Greece, Italy, Spain and Ireland to the pits: They neglected to expand their budgets enough when the financial crisis broke out in 2008. They were therefore unable to hold back the waters of crisis. As a result, they lost the faith of the markets and now have to inject prodigious amounts of money into their economies, "like into a black hole," in a desperate attempt to regain the faith that was lost.

Barak's conclusion: The way to contend with the oncoming crisis of 2012 is to expand the budget and deficit, not reduce them. Israel will thus ride the wave ahead of any crisis; it will prevent one from developing, instead of being dragged along by the undercurrents of budget injections after a recession has broken out and investors have lost their faith.

It hardly bears saying that his proposal would negate any need to cut the defense budget to pay for the Trajtenberg recommendations. According to Barak, there's plenty of money for everything if one just chooses to increase the deficit - and en route Israel would deflect the oncoming global crisis.

John Maynard Keynes, 1883-1946, died 65 years ago. It's hard to say what he would have thought if he'd known his theories were causing a dispute between the defense minister and prime minister of a country founded after his death. In fact it's hard to say what Keynes would have thought about his own theory in this global age, with the markets terrorizing governments that dare to increase their deficits and refusing to let them have a stab at Keynesian expansionary policy.

Therefore, it's far from clear that Barak's proposal to increase the budget in the spirit of Keynes as a cure for Israel's economic ills (and while about it, make the defense cuts go away ) is even feasible, given the markets' terroristic bent. Nor is it clear that we need a dose of Keynesian economics, given that Israel is not in a crisis.

Keynes, to recap, discussed the need for budgetary expansion at a time of recession, so demand by the state would compensate for declining demand by the people. It's a sort of bitter pill to be taken when the patient is deathly ill.

The State of Israel, insofar as is known, is not deathly ill. It will end 2011 with economic growth between 4% and 5%. Forecasts for 2012 speak of lower figures but are still in positive territory - 2% to 3.5%.

It's true that Barak is suggesting an ounce of prevention, not a pound of cure. But the defense minister is ignoring the side effects of that ounce of prevention: damaging Israel's credibility; falling victim to the terrorism of the markets, which will jack up Israel's borrowing costs; and even impairing Israel's very financial stability.

One doesn't need to go far to prove the point. In June 2002, at the height of the second intifada and recession, the interest that the markets demanded from Israel on government bonds climbed to 12.5%. At the height of the crisis in 2009, the markets were satisfied with 4.1% interest on Israeli government bonds.

Fiscal credibility and gravity, it turns out, comes with a price, and in the era of market rule, nations behaving irresponsibly get punished mercilessly and fast. Before doing anything rash, that cost needs to be considered.