The Deficit Delusion

The incredible lightness with which the finance minister is prepared to raise the budget deficit will take a heavy toll, hitting the middle class and weakest sectors of Israeli society especially hard.

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Bank Leumi CEO Rakefet Russak-Aminoach
Bank Leumi CEO Rakefet Russak-AminoachCredit: Nir Keidar

Imagine a scene at Bank Leumi in which the CFO walks into the office of CEO Rakefet Russak-Aminoach and announces: I have completed the work plan for 2015 and it turns out we will finish the year with huge losses. But don’t worry, I hope that in the future we will succeed in moving into a profit.

Russak-Aminoach looks at him sideways with a sour expression and shows him the door. Losses? Here? Go find yourself a job elsewhere. I want a CFO who won’t even dream of losses but rather will do what is required: savings, efficiency, entrepreneurship and innovations. We are not prepared to lose money!

So why, when it comes to the national budget is that same Russak-Aminoach prepared to lose money in a big way? Why did she say this week: “I am not afraid of increasing the budget deficit” and even added she is opposed to raising taxes, that just like Finance Minister Yair Lapid? Is she, incidentally, also opposed to raising the banks’ service charges and interest rates? This is an interesting psychological phenomenon. Talented executives in the private sector, like Russak-Aminoach, who know how to save, increase efficiency and make money become as soft as butter and as charitable as Mother Teresa when it comes to public money – nobody’s money.

There are those who will try to attribute extraneous motives to Russak-Aminoach’s remarks, connected to Lapid’s attack on senior executive pay at Bank Leumi. I don’t think this is the case. I make do with macro-economics. Amnoach says the economy is in a recession (which it is) and therefore it is appropriate to increase the deficit next year in order to give a “boost” to the economy and down the line the deficit will close.

This is an error. The moment the deficit reaches 3.5%, it is impossible to close it. After all, this is a matter of nearly NIS 40 billion, when the increase in expenditures is permanent, the finance minister is committed to not raising taxes and the economy is in a slowdown. This is a clear picture: A big structural deficit that will only get bigger. It is true that management of a company (micro-economics) is different from managing fiscal policy (macro-economics) but they are similar in many ways. It is also true that a state can allow itself a small deficit in the budget now and then but giving a “boost” to the economy by means of a large deficit is an outdated and incorrect approach. It relies on the Keynesian model that has long been obsolete. That model was first proposed 79 years ago in the context of the worldwide great depression, when the world economy was closed and movements of capital few.

Today the international situation is completely different. There is a global, open economy with tremendous international trade and huge movements of capital. The correct macro-economic theory for today is the one expounded by Professor Robert Barro of Harvard University: the rational expectations model. This is a theory that proves well why it is a bad idea to increase a deficit. It is sufficient to recall Benjamin Netanyahu’s policy as finance minister in 2003, when he extracted the economy from the deep recession with the help of a cut in expenditures, a reduction in tax rates and a series of reforms. At that time the economy emerged from the hole to rapid growth, a drop in unemployment and a low deficit. The deep cut in expenditures Netanyahu carried out is the exact opposite of what Lapid and Russak-Aminoach are recommending.

The public also needs to understand that it is having the wool pulled over its eyes. Increasing the deficit is the imposition of hidden taxes on the weakest parts of the population. The moment the deficit reaches 3.5%, Israel’s credit rating will go down, interest rates will go up, investments will shrivel, consumption will shrink and the slowdown will get deeper. The first to be fired will be the weakest. They will pay the price immediately. Further along in the destructive process, the structural deficit will grow until there will be no alternative but early elections and the implementation of an “emergency economic plan,” the price of which will once again be imposed on the middle class that Lapid so wants to please.

This happened to former finance minister Yuval Steinitz just two years ago. Have we already forgotten?

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