Taking Stock / Capitalist Piggishness

The main achievement Finance Minister Benjamin Netanyahu recently boasts about is restraining public spending and meeting deficit targets - two sides of the same coin. His control compares with the two years preceding his appointment when policy was irresponsible.

However, not everyone is blown away by this achievement. Some see the cuts in spending as capitalist piggishness at worst, or failed economic policy at best. One such is Professor Yaakov Kop, manager of the Taub Center for Social Policy Studies.

On Monday Kop issued a press release suggesting the government should stop shrinking the public sector and focus instead on stimulating economic growth and achieving equality in services.

Kop says that in the last decade misguided policy has taken hold of the economic reins and made contraction of the public sector a top priority - sometimes, the only priority. The professor recommends restoring economic growth to the top rung.

"The early 1990s demonstrated that in a fast-growing economy, a secondary goal of reducing government expenditure proportional to GDP can be achieved," Kop wrote. He says it would be a colossal mistake to place the health system in the hands of the business sector, as the Americans did. On social services, Israel should learn from Europe, which seeks social justice more than America does, he says.

Not Jewish

His opinion is backed by his colleagues Arnon Gafny, who had been a Bank of Israel governor, and Professor Zvi Sussman, one of Israel's most esteemed veteran economists. The vision of "scaling back the public sector" looks persuasive, they explain, but it fails to withstand the tests of expert analysis. It does not suit the conditions of the Israeli economy, and it flies in the face of Jewish tradition.

Moreover, the economic policy is generating more and more poverty and widening gaps. Growth is not reducing poverty and narrowing gaps, and labor does not save people from penury. Almost half of Israel's poor live in families with a breadwinner - and that is especially true of people with poor education.

Prof. Sussman points to a policy of "starving" the public of health and education - in the decade from 1990 to 2000, the consumption of health and education services jumped 15 percent per capita compared to a 35 percent increase in private consumption.

Some of the claims Kop, Gafny and Sussman raise make sense, but the claim that cutting public spending would impair growth - one gaining in popularity - does not meet the test of reality. It is usually based on obsolete economic models, mainly that formulated by John Maynard Keynes.

In practice, the world is littered with examples of non-Keynesian growth. In Israel, for instance, in 2001 and 2002 the government deficit and public expenditure shot up, while the economy shrank at a frightening speed.

Proving the opposite

However, in 2003 and 2004, public expenditure was slashed and growth was restored. The correlation is not coincidental - the accountant-general at the treasury, Dr. Yaron Zelekha, studied the subject and found a clear correlation between falling public spending an economic growth.

Reducing government expenditure is not a goal, it is a main tool available to restore economic growth. Today, sheltered by U.S. loan guarantees, with the world recovering and the treasury reducing public spending, Israel's economic stability seems mundane. But two years ago it was anything but that.

The moves to cut public expenditure were not based on political ideology, but on immediate need forced on us by the markets. If Netanyahu had not heeded the market's call, Israel would have faced a very real and immediate risk of financial meltdown. It was in December 2002, not December 1973, when the incumbent central bank governor warned that a big Israeli bank could fail.

Two years ago public expenditure peaked at 55 percent of GDP. The only way to continue financing public expenditure was to increase government debt. The problem was that investors in Israel and abroad were not prepared to continue lending money to the Israeli government.

Why? Precisely because they did not believe, as Kop does, that additional government spending would encourage inflation growth, enabling the government to finance the interest and principal on the debts it was accruing.

Dangerous flab

The Taub center economists are right that budget cuts hurt many segments of the population, and that important budgets such as health were breached. That is the main problem with the budget cuts carried out so far - as always, the treasury failed to attack the pork barrels, including massive waste in the army, sky-high salaries in local authorities and monopolies, dozens of government enterprises feeding at the taxpayer's table.

Sussman and Gafny say the policy of budget cuts does not suit the conditions of Israel's economy. The same claim gets raised time and again, as though the Land of Zion had unique economic laws all of its own.

Chosen People we may be, but we evidently don't have a Chosen Economy and universal economic truisms apply here too.

Take inflation. Until five years ago the pundits claimed that Israel suffered from "structural inflation" or "inflation of costs". But after consistent deflationary monetary policy was applied it transpired that Israeli inflation, like inflation anywhere else, responds to interest rates, and ultimately price stability was achieved using the usual tools.

As for claims about poverty and social gaps, that is true - but the theorists forget that the gaps in gross pay between the richest and poorest have been steadily widening for 20 years. What hid that fact was massive allowances paid to the weak, some of which discourage working. The tremendous infusions kept the net gaps stable, but in gross terms, they grew and grew.

But two years ago the time arrived when the state couldn't do it any more, couldn't keep financing those massive payments which just kept growing from year to year. So we were all sitting on a ticking time bomb jammed in the gaps the government couldn't finance any more.

Why couldn't the government finance them any more? Because investors at home and abroad refused to keep lending money to a government that spent bigger and bigger chunks of its budget each year on unilateral transfers, while its public debt just grew, and grew, and grew.