Gold Medal for Economic Growth

There are not many countries in the world that have made such a major leap in 60 years: from a per capita income of $3,100 to a level of $25,000 today; from a country of 600,000 people to one of 7.3 million; and from a country whose main export was citrus fruits to a high-tech superpower.

In six decades, Israel has experienced a complete economic revolution: from an obsolete and closed socialist economy with total government control to an open and competitive market economy. Over the last few years, the state of the economy has improved dramatically. Since 2004, it has grown at a rate of around 5% annually, which raised the gross national product to a level of $180 billion (based on an exchange rate of NIS 4 to the dollar).

The rapid growth rate also improved the employment situation. Some 440,000 people have joined the labor force in these years, and unemployment dropped from 11.2 percent to a welcome low of 6.5 percent, the lowest level in over 15 years. In sum, there is good news for our 60th Independence Day celebrations.

The State of Israel came into being thanks to two revolutions: the Zionist revolution and the socialist revolution. The founding fathers did not want to establish just another state, but a unique country that would be socialist and just, with equal rights for all, that would provide Jews with a haven from persecution and pogroms and would be "a light unto the nations." They advocated a socialist economy directed from above, with the government controlling all the elements of production - capital, labor and land - and distributing them as it saw fit, "for the benefit of the public," of course.

They believed that the Jew needed to undergo a comprehensive revolution in order to rid himself of the Diaspora mentality. The goal was to transform him from a small merchant, or occasionally a realtor, lawyer or doctor, into someone who earns his living from physical labor, preferably from agriculture. So the kibbutzim became the crowning glory of the Zionist enterprise: They were cooperative ventures that practiced socialism; they also determined the borders of the state and defended them; and in addition, they engaged in manual labor, and specifically in agriculture, which was the pride of the Zionist enterprise.

In the early 1980s, however, the economy suffered hyperinflation that reached its peak in 1984, with an inflation rate of 444.9% (!) a year. The budget deficit was enormous and the public lost its faith in the shekel. Everyone ran for the dollar and the foreign currency reserves gradually dwindled.

In this crisis situation, on the brink of "the last dollar," the government forced through an emergency economic recovery program to stabilize the economy. The plan was launched in July 1985. Its objectives were reining in hyperinflation, improving the balance of payments and restoring economic growth. These objectives were achieved with the help of a series of reforms that completely changed the face of the economy over the ensuing 23 years.

The main problem was the huge budget deficit, which reached 15% of gross domestic product. Therefore, the first and most important reform was introducing fiscal responsibility. For that purpose, a law was passed prohibiting the Bank of Israel from printing money, which forced the government to exercise budgetary discipline. The result was that the deficit shrank to a tolerable level of 1% to 2% annually, and the annual growth in government spending was moderate. These changes enabled the private sector to flourish and encouraged economic growth.

In order to halt the hyperinflation, the Bank of Israel also instituted a strict monetary policy, with very high interest rates - "mafia interest," as it was called at the time. Yet even so, getting down to Western inflation levels was no easy matter. Fourteen years elapsed before we achieved the sought-after objective of price stability. Since 1999, however, the Israeli economy has been in an era of price stability.

Initially, the founding fathers believed that a high employment rate could be achieved by providing total protection for domestic products. They imposed high customs duties and hindered imports in many other ways as well. But they realized fairly quickly that excessive protection causes inefficiency, hinders development and reduces people's standard of living.

Thus efforts to expose the economy to imports started as early as 1962, and they progressed slowly over the years, including the signing of trade agreements with the European Common Market (1975) and later with the United States (1985). Only in 1991, however, did the revolutionary program that opened Israel to free trade with the entire world, including China and India, emerge. The result was that prices fell, the variety of goods on the shelves increased and the economy was forced to shift to more sophisticated industries. That is how we gained an international reputation in high-tech.

Until 1985, the government had unhindered control of the capital markets, which were in effect nationalized. The government would raise capital from the public with the banks' help and then afterward distribute it based on its own priorities. It set interest rates and determined the amount of capital that each industry and even each individual plant received. All of this changed in 1985. The capital market underwent a process of liberalization and the banks started providing loans based on business considerations, without any government involvement at all.

A similar process also took place in the foreign exchange market. Once it was illegal to hold a bank account abroad, but today there is a free flow of capital into and out of Israel.

During the state's first 40 years, economic power was concentrated in three entities: the government, the Histadrut labor federation and the banks. The level of centralization was huge and the level of competition low.

During the second half of the 1980s, the government, the Histadrut and the banks started selling off the giant companies they held, and new and powerful players entered the market: local and foreign investors who acquired these companies and thereby decentralized economic power, increased the level of competition, improved services and caused prices to fall.

The series of reforms described here transformed the economy from a socialist economy managed from above into a modern market economy that is open, competitive and capable of exploiting the process of globalization for its own benefit.

But alongside the accomplishments, there remains a great and troublesome problem: poverty and social gaps. Some 20% of Israeli families live below the poverty line, which is a high and even frightening percentage. This problem must be dealt with promptly, because a society cannot remain healthy and stable over the long-term with so many impoverished people in its midst.