Flug's Formula: Spend, Spend, Spend

Has the governor of the Bank of Israel's approach to stimulating the economy proved itself?

Nehemia Shtrasler
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It was only a matter of time before Karnit Flug and Benjamin Netanyahu butted heads. For many years, the Bank of Israel governor has had a clear agenda that supports increasing the state budget, and this is in stark opposition to Netanyahu’s outlook, which calls for putting the “fat man” -- the public sector – on a diet. The blowup happened this week when Flug presented her approach at an economic conference. Is she right, or is Netanyahu?

Flug talked about a problematic economy whose growth rate is on the decline due to an aging population and an increase in the number of ultra-Orthodox Jews and Arabs, who join the work force in very small numbers. Her solution is to raise the tax burden on all those who do work, so as to be able to expand the budgets for education, health, welfare and infrastructure.

This has always been Flug’s answer: Increase spending and raise taxes. But what about increasing efficiency, savings, reforms and changes? That’s only good for the private sector, apparently.

In 2003, Netanyahu, as finance minister, presented a plan for saving the economy that included steep cuts in government spending, a reduction in allowances, lower taxes and important reforms. Flug, who served as head of the Bank of Israel’s research department at the time, came out against the plan, against the cuts and against the decrease in taxes. But the plan succeeded. The economy emerged from a steep recession and attained a rapid annual growth rate of 5 percent, and there was a significant decrease in unemployment. Netanyahu was right. Flug was wrong.

Another round in this battle took place in regard to the fiscal rule that was formulated in 2010 and went into effect in 2011. Flug supported an expansive fiscal rule that greatly increased government spending. The result was a severe budget crisis in 2013, which forced Yair Lapid to make major spending cuts and to raise taxes. Here, again, Flug was wrong.

Flug is not a populist. She believes in what she says, but increasing spending and raising taxes is the easy – and wrong – solution. More spending and more taxes spell death to investment and growth. The Bank of Israel doesn’t understand that Israelis are not a “captive public” that will pay whatever is imposed on them. We live in an open world in which, at any point in time, businesses, workers and investors may choose to work abroad. The Bank of Israel also fails to see the obvious: that increasing spending and raising taxes, a process that began in 2011, caused a steep drop in growth, a reduction in investment and a recession that still exists today in many parts of the economy.

The right solution to the problems that Flug cited is completely different. The state budget needs to be gone over with a fine-tooth comb to see where it can be streamlined and adjusted, just as is done in the private sector. For much more can be done with the same budget. The defense budget should be cut and the education, health, welfare and infrastructure budgets should be streamlined – rather than just pouring more money into them. In the public sector there are thousands of extraneous workers; there are numerous redundancies and plenty of wastefulness. How can there only be layoffs in the private sector and not in the public sector? Who ever said that the Education Ministry must continue to maintain six unnecessary districts, for instance? Who said that it should take 40 years to build a subway in Tel Aviv, and there still is no train?

But as I write these lines, I don’t know whether to laugh or cry. Just whom am I asking to talk about efficiency and savings? The Bank of Israel – that mother of all wasteful and monopolistic public sector institutions, with its surplus of manpower, inflated salaries, excessive pension budgets, superfluous departments, and a grandiose plan to renovate the bank headquarters at a cost of NIS 177 million (which will surely double) and calls for the transfer of its 700 workers (What do 700 people do there?) to a rented building in Jerusalem for three years so they won’t have to endure the noise while the renovations are going on.

So who said that higher budgets and more taxes aren’t needed to pad the public sector?

Karnit Flug, Bank of Israel governor.Credit: Tomer Appelbaum