Taking Stock / Sea Change at the Treasury

Capitalism, privatization, tax cuts.

Those are the catch-words that have been associated with the Finance Ministry and Finance Minister Benjamin Netanyahu during the last two years.

But to really grasp the change in the gang's economic concepts, you have to search for two other expressions that have all but disappeared from the debate over there: "exports" and "anti-cyclical."

The treasury's latest tax-cut plan, announced last week, is the product of a sharp change in the economic ideas ruling the ministry and government policy. Underlying the plan is the concept that treasury Accountant General Yaron Zelekha first presented to the minister six months ago: Economic activity is slowing and steps need to be taken quickly to accelerate growth.

In the past, many economists, both at and outside the treasury, believed there were two main ways to stimulate economic growth. One, the fast cure, was to loosen budgetary restraint. The second way was to use government money for investment. This second method, which falls under long-term strategy, supports exports and industry, which have traditionally been considered the only drivers of sustainable growth.

The great experiment

The accountant general wields considerable influence over the finance minister, and Yaron Zelekha's economic concepts are 180 degrees from the traditional approach outlined above. Unlike senior bureaucrats at the Finance Ministry over the years, Zelekha has a Ph.D. in economics and very clear ideas, some based on his own research. One of his studies, carried out under the supervision of Meir Sokoler - today deputy governor of the Bank of Israel - was on the impact of the national budget on economic activity.

In his study, Zelekha claimed that Israel's economy was non-Keynesian. Ergo, the Keynesian approach of increasing government expenditure to spur economic growth doesn't work here, he decided; if anything, it has the opposite effect. The way to stimulate growth in Israel, Zelekha concluded, was by reducing government expenditure in order to reduce taxes.

The great experiment that Netanyahu and Zelekha have conducted in the last two years worked. In 2003 and 2004 they slashed government spending by the greatest amount since the great economic stabilization program of 1985, and economic growth increased.

Growth based on private consumption

How do tax cuts spur economic growth? Here is where the second conceptual revolution at the Finance Ministry comes into play. The tax cuts are designed primarily to stimulate private consumption and domestic trade. Finance Minister Benjamin Netanyahu has been saying so, all but explicitly, for weeks.

This is another revolution: Netanyahu is proposing economic growth driven by consumption and trade, growth that until now had been considered relatively dangerous.

Just ten years ago, economists working for the treasury, Bank of Israel and business sector were warning about a recurrence of the 1994-1995 growth spike, which was caused by a jump in private consumption. Growth of that kind is considered unsustainable and is believed to threaten financial stability.

Growth through private consumption is what has fueled the world's largest economy, the American one. In Israel, the conventional wisdom has been that private consumption cannot drive growth, because the economy is too small and dependent on imports.

Today, different voices have taken over the mike, at the treasury and the Bank of Israel too. Today, Israel has no problem regarding foreign currency, or the balance of payments either. "Encouraging exports" and industry are no longer sacred cows: the economy's structure can allow growth over time through increasing private consumption, which stimulates trade and small/medium businesses.

The industrialists' and exporters' lobby won't like the change. As long as exports grew fast because of rapid global economic expansion, they kept quiet. Now, the public debate is likely to shift. For ages it focused on taxes, entitlements and privatization. Now we can expect a storm to break out over what can and should drive growth in the years to come.