Fischer Tells the Story of Israel 2010

BoI chief is upbeat: Euro bloc will prevail (but Israel shouldn't join it )

LONDON - Stanley Fischer is in his element at international economic forums. On Thursday the governor of the Bank of Israel began his day at a breakfast with investors, after which he popped over to deliver the keynote address at the Tel Aviv Stock Exchange annual investor conference before meetings with England's economic leaders. Toward evening he spoke at an event hosted by the Israel-British Chambers of Commerce.

As long as one avoids the topics of poverty, economic inequality and education (which Fischer reserved for the end of his address ) and sticks to macroeconomics, Israel's story has never been an easier sale. As Wall Street melted down and crisis shook Europe, Israel was a bastion of stability, conservatism and responsible economic policy.

Fischer began his presentation with a warning: Based on developments in the markets in recent weeks and on new information reaching the Bank of Israel, the level of uncertainty and risk are growing. Then his address turned positive. He discussed the economic parameters that distinguished Israel from the West in 2009: how private consumption grew in Israel while taking a hard fall in the rest of the world. In the world, investments collapsed; in Israel the decline was moderate.

The Israeli labor market is flexible, Fischer said: While economists tend to frown on trade unions, he thinks the Histadrut labor federation behaved cleverly during the crisis. Also, many workers chose to scale back their working hours by 5% to 6% on average rather than lose their jobs, he said.

He also lavished praise on the banks: As Israelis can't talk about the weather - it never changes - they talk about their overdrafts, he quipped. Yet overdrafts haven't become an economic burden, and Israelis are among the biggest savers in the world - one of the main reasons that Israel weathered the global economic crisis so well, Fischer said. (The interest on overdrafts in Israel is relatively low, he added. ) No Israeli mortgage bank would lend more than 60% to 70% of the price of the property, Fischer told his British audience: You won't find a mortgage worth 105% of the asset value in Israel, as had been extended in the West. Thus, he said, Israel never developed a real-estate bubble.

The enemy is us

Regarding the Bank of Israel's massive intervention in the forex market in the past two years, Fischer admitted that a 10-year rule had been broken. There was no choice: The Bank of Israel could hardly sit by as the shekel shot skyward and exports were threatened. It also gave the central bank an opportunity to increase Israel's foreign currency reserves.

Asked to identify the main cause of the shekel's appreciation, Fischer replied with a quote from the American cartoonist Walt Kelly: "We have met the enemy and he is us." The influx of foreign currency into Israel as the global economic crisis abated didn't originate with speculators, he said, but rather with was Israelis winding down their overseas investments and repatriating their money.

Fischer lauded Israeli high tech, which is responsible for 51% of exports, up from 36% fifteen years ago, and praised Finance Ministry Director General Haim Shani for his plan to protect the sector's competitive edge. Yet Israeli growth can't depend solely on the growth of high tech, Fischer cautioned.

What to do when crisis hits exports? "Israel should do what the Chinese do," while adjusting for Israel's rather smaller size, he said, and encourage domestic demand. He shared his opinions on a wide range of topics with TheMarker, in an interview that was conducted in Hebrew.

If exporters take a hit

You suggest a new paradigm for macroeconomic policy. Since Israel's establishment, economic policy has focused on exports and on foreign currency. You're saying we can think in two directions, export and the domestic market?

Fischer: "Yes. For years we've run a large current account surplus, therefore we can generate growth from domestic demand even when export declines or slows. We can continue growing even when global demand is weak. Of course it is important to improve constantly Israel's competitive edge, but we can also think about domestic demand, for instance the government's plan to develop infrastructure."

Do you say this because you think the global economy may dip into recession again?

"The situation in Europe is less good than we had hoped. That doesn't mean European economic growth will necessarily be low. The euro's depreciation will help the European economy. Some countries will benefit greatly from it, such as Germany and France. The problem is that Europe as an important target for global exports will weaken, which will hurt global economic growth. Nor is the pace of the U.S. recovery clear."

Government debt in most countries is growing quickly. Are you concerned about a huge sovereign debt crisis?

"No, I don't think that will happen. I can't say that one or two countries won't default by the decade's end, but I don't see a big global sovereign debt crisis."

One or two countries - you mean small ones, not big ones like Britain, where debt has also grown quickly.

"No, I don't mean Britain. The new government understands well what to do, and is acting swiftly."

No, we shouldn't join the euro bloc

You disagree with your colleague, former International Monetary Fund chief economist Kenneth Rogoff, about sovereign debt crisis?

"Rogoff was concerned when macroeconomic policy in many nations was to step on the fiscal gas as hard as possible, increasing deficits. He was right to be concerned then, but now the issue is being addressed. The question is whether all the countries can make the necessary changes, but we see a change in direction."

The United States usually convinces everyone to do its bidding. Yet over the past month, Fischer said, Washington tried to persuade the Europeans not to step on the fiscal brakes and to continue building up deficits, but the Europeans said no. As Greece tottered, they may have realized that some countries had to rein in monetary expansion, the governor explained.

Has the danger of the euro bloc disintegrating passed?

"Yes. I think in the future the euro bloc will have more countries than it does today."

Many people still think the monetary union can't work, that it doesn't leave the sovereign nations with enough flexibility to solve their unique problems.

"Everyone says that the euro was a political project and that economic issues were sidelined. But it isn't just political: People forget that Europe had serious problems before the euro's establishment. From 1970 Europe suffered from fluctuations in the currency exchange rates of the bloc members. They had all sorts of arrangements to resolve the exchange rate problem but by and large it was a mess. Every time a country depreciated its currency it destabilized the system. The monetary union had economic and not only political justification. Some say that Greece wouldn't have reached this situation if it hadn't been part of the euro bloc, but it's a mistake to think that without the euro its life would have been easier. Italy, for instance, was in a complete mess until it joined the euro bloc."

If you support the euro so strongly, do you think Israel should join the bloc one day?

"That is a political question first and an economic one second."

OK, let's leave politics out of it and look at the economics.

"Economically, we have a big advantage in economic freedom of movement. I think that in the future there will be big changes among the dollar and the euro and the Chinese yuan. Our trade is highly balanced, geographically. In the future our exports will be divided as follows: a third to the United States, a third to Europe and a third to the Far East... the trading pattern of euro bloc members is tightly focused on the bloc. Therefore, [joining] wouldn't be a big advantage for us."

Tighten supervision

The Bank of Israel is highly focused on the stability of the financial system. Who'll take care of competition, the consumer and the investor? Without competition, how can we generate productivity and economic growth?

"That is a burning issue. We can look at the Dutch model. There, the consumer protection part is separate from the central bank. As for competition, that's a more dangerous issue. In a small economy the banks have size advantages, and one must be careful when supervising competition between them. Competition must be encouraged without comprising their stability. You can't handle one without handling the other, because the cost of a mistake in respect to stability can be terrible, as we have seen in the last two years. Therefore, I don't think the answer lies in increasing the number of banks, but rather in supervising them more, instituting more rules and regulations."

In the Bank of Israel report you warned about the concentration of economic power in Israel. Since then we haven't seen any measures.

"There are two kinds of problems here, the economic one and the wider one, the political and democratic problem of the impact on the entire country. This is a matter for the government to decide, not the Bank of Israel."

Let's move on from burning issues to strategy. What should Israel's economic strategy be in the next five to 10 years?

"There is no question that education, including higher education, is crucial to the economy's future. If we don't do something to address it, it will be a great threat. If we act, it will be an opportunity. We have to preserve Israel's relative advantage as an advanced industrial, entrepreneurial nation. In that respect I believe in the plans presented by Finance Minister Yuval Steinitz together with Prof. Manuel Trajtenberg of the Council for Higher Education, and [Haim Shani's] plan to encourage high tech."

It is also crucial to make it easier to simply do business in Israel, Fischer added.

You haven't mentioned the quality of management in the public sector, and governance.

"I don't think you need me for that. You know the answers yourself. We have to look at our situation from an international perspective. Maybe joining the OECD will help us to learn from places where governance is more efficient."