Space Cadets at the IMF

It's hard to understand how economists reached the conclusion that Israel is now the fastest growing country in the world

Here's a riddle: Which country will have the fastest rate of growth next year among Western nations, with declining unemployment, inflation of only 2 percent and an improved balance of payments? France? Norway? Germany? Switzerland? Not at all. It's Israel - according to the International Monetary Fund's annual report on world economies in 2002.

The IMF says that the world economy will expand by 3.5 percent on average, with high-tech returning to play a central role and world trade heading back upward. Israel will derive the full benefits from this projected recovery next year: an amazing 5.4 percent rate of economic growth and unemployment down to 8.6 percent. Silvan Shalom would kiss the hands of the IMF economists who wrote this report - if he believed that there is a one-in-a-thousand chance of this actually happening.

This is not the first time that the forecasts and recommendations of the IMF reflect the work of a group of space cadets floating contentedly in the ether, globe-trotting in first-class style to all sorts of countries, staying for two to three weeks (at the Jerusalem Hilton when in Israel) and composing a report that is only remotely linked to reality.

The members of the IMF delegation who visit Israel cannot conduct a serious study to understand the country's special economic structure. They cannot understand the role of the Histadrut labor federation, the power of the agriculture lobby, the control of the banks over the capital market, the strength of Shas in the Knesset and government, or the system of linking salaries between various sectors. This is why they can be so mistaken.

They meet with the top officials of the Finance Ministry and Bank of Israel, with members of the Manufacturers' Association and Histadrut, and after hearing all of these sides, sit down to write their "verdict."

The latest IMF report covers 180 economies throughout the world. It was to be released at the annual conference of the IMF and World Bank that was scheduled to be held now in Washington. The conference was canceled following the terror attack in the United States. How could it be that the IMF's forecasts for the Israeli economy are so detached from reality? Even the Finance Ministry, which is the most optimistic group around, projects economic growth of 4 percent in 2002, while the Bank of Israel expects growth of only 2 to 3 percent.

The answer lies in the work method of the IMF economists. They have a special econometric model that they apply to all 180 countries - without addressing the special conditions in each individual country. The model gives considerable weight to a variable called "the growth gap." According to this model, if an economy experiences a slowdown during a given year and falls below its growth potential, it will compensate the following year with an especially quick spurt of growth.

The reason for this is the change in relative prices that occurs during the economic slowdown. That is, a real devaluation is expected to take place, together with the lowering of interest rates. This, in turn, encourages growth and exports in the year following the slowdown.

These two phenomena indeed occurred this year - both a real devaluation and a reduction of interest rates. The IMF concludes, therefore, that if growth this year amounts to only 0.7 percent, Israel should enjoy a substantial "compensation" next year that will translate into rapid growth of 5.4 percent and a reduction in the unemployment rolls.

But the IMF economists did not take into consideration Israel's special conditions. They did not consider the fact that the ongoing intifada is continuing to weigh heavily on the Israeli economy. They did not address the profound breakdown in the construction industry, or the unprecedented slump in tourism. They also did not take into consideration the terror attack against the United States or the danger of a regional war, even though Israeli exports are dependent on the economic situation in the United States, which does not look particularly good.

The authors of the IMF report did not seem interested in the fact that the crisis in America's capital markets and Nasdaq has made it impossible to raise funds for the Israeli start-up and high-tech industries.

Nonetheless, when will the IMF's rosy projections come true? It will happen when the intifada ends and Sharon sits with Arafat at diplomatic negotiations. It will happen if the serious effects of the attack against the Twin Towers are erased, if international terror is dealt a knockout blow by the Unites States, if the start-up and high-tech industries again take off and it becomes easy once more to raise capital in the United States, if world trade expands, if the real devaluation is maintained, and if inflation stays low.

If all this transpires, the Israeli economy will grow next year by 5.4 percent and unemployment will indeed decline. But to believe that all this will actually happen, one must be an IMF space cadet.