Taking Stock / Macro Misapprehensions

1. This week the Central Bureau of Statistics published updated figures for growth in the first quarter of 2003. The amended numbers proved quite a surprise: the government statistician said gross domestic product grew by 3.6 percent in annual terms.

Don't fall off your seat. Except for exports, which shot up thanks to the devaluation of the shekel last year, by most parameters the economy continued to decline during the first quarter.

Private consumption was particularly alarming, contracting by 8.4 percent due to the persisting recession and the war with Iraq.

Another hair-raising figure was the 6.6 percent "growth" in public consumption. That is the mirror image of the government's giant budget deficit, which is expected to reach an all-time high of NIS 30-32 billion this year.

Exports will apparently remain the only engine driving growth this year. But that engine will be enfeebled by the steep appreciation of recent months and the slowing global economy.

2. Given the surfeit of negative indicators, it is worrying to learn that the Finance Ministry is planning to base Israel's budget for 2004 on assumed economic growth of 2.5 percent to 3.5 percent.

True, the peace process could gain momentum, the global economy could rally, tourism might suddenly return and pigs could sprout wings. But the odds aren't good, and the cost of a substantial deviation from the treasury's assumed target could be heavy.

Incumbent Finance Minister Benjamin Netanyahu would do well to recall the mistake of his predecessor, Silvan Shalom, who during 2001, insisted on adhering to a ridiculous growth assumption of 4 percent for 2002. Everybody told him there was no way the economy would expand by 4 percent in 2002, but he stuck to his guns. That mistake destroyed the Finance Ministry's credibility and led to three budget amendments within the space of a year. That macroeconomic mistake does not bear repeating.

3. How are optimistic growth estimates born? Using sophisticated economic models? Don't be silly. Every last analyst knows that economic forecasting is a highly imprecise science. Forecasts are born of intuition at best, or vested interests usually.

Previous overly rosy treasury estimates were designed to solve the intractable problem of presenting a budget that would ostensibly enable the government to meet its deficit target. It is easier to predict that the economy will expand by 1 percent or 2 percent than to slash billions from ministerial budgets.

It was therefore doubly worrying to learn this week that the treasury's budget director says the 2004 budget only needs a seven to nine billion shekel cut. That is enough for the government to meet its 2004 deficit target of 2.5 percent to 3 percent of GDP, Ori Yogev said.

Firstly, according to most analysts, the budget needs to be cut by NIS 10-12 billion at least, to meet that deficit target.

Secondly, if the treasury is starting with a NIS 7-9 billion budget cut, it will end up with an NIS 5-7 billion budget cut at best. Its starting point in its budget debate is disquieting. It leaves the impression that it's relying on miracles and American loan guarantees.

4. While the deficit target for 2004 seems ever more jeopardized, this week the treasury chose to throw the spotlight on another issue altogether - the inflation target for 2004, which, anyway, is the Bank of Israel's province.

Unofficial reports say the treasury wants to raise the 2004 inflation target from 1-3 percent to 2-3 percent to facilitate faster interest rate cuts.

One would think that after 10 years of wrestling with the Bank of Israel over monetary policy, the treasury people would know that raising the inflation target will translate, generally, into higher interest rates.

When the inflation target rises, it automatically lifts the public's inflation expectations. That forces the Bank of Israel to maintain high real interest rates.

Benjamin Netanyahu knows the deal. In a meeting with economic editors right after taking the reins at the Finance Ministry, he himself explained that the deficit and inflation tend to spiral upward when reaching levels of 5-6 percent, so it is easier to keep them steady over time at lower levels.

5. Attorney Moshe Drucker, a renowned tax consultant, told Haaretz this week that high-paid employees won't rush to disband companies they established to evade taxes, because of the prevailing uncertainty. Abolishing the ceiling on national insurance and health tax induced thousands of salaried employees to turn into savvy tax dodgers, until further notice.

Drucker is right, and we'd like to know, sir: A young lad who did his internship at your offices and grew up to become the finance minister was the one who decided to abolish those ceilings in the first place. So why, when he raised that dreadful idea two years ago, didn't you stop him?