The Governor Blinked First

Israeli governments have an odd tradition. Whenever a new government is installed it decides to change the target budget deficit - and it's always upward.

Israeli governments have an odd tradition. Whenever a new government is installed it decides to change the target budget deficit - and it's always upward.

And why is this an odd tradition? Just because a government changes doesn't mean the laws of economics also do - so why should the previous government's decisions be changed? The answer is simple - it is because politicians are always looking for an excuse to spend more and a change of government is as good a reason as any. So a "reconsideration" that always ends with an increased deficit.

Sometimes the government excuse is "an increase in the number of immigrants," and other times it's "necessary wage corrections. Sometimes, like this time, the excuse is "recession."

If it's possible to understand the interests of politicians who always want more money to prove they are "doing" something, it is difficult to understand what happened to the governor of the Bank of Israel who this week changed his mind and began backing an increase in the deficit.

According to the new David Klein, the planned deficit for 2002 is no longer a sacred number. He agrees to raise it from 1.5 to 2 percent of the GDP. The difference gives the government NIS 2.2 billion more to spend next year. The treasury applauded when they heard Klein's view, because if the bank governor - presumably the watchdog over government - agrees to increase the deficit by half a percent, why shouldn't the finance minister propose another half percent and raise the deficit to 2.5 percent. After all, once the framework is broken, 2 percent is good as is 2.5 percent - and the higher the better.

But the governor apparently didn't feel so comfortable with breaking the principle of credibility, so he said he was ready to increase the deficit on condition the government set it to decline over the next four years so that by 2005, it's only 1 percent. That's making a mockery of the situation.

The Israeli politician's maximum planning horizon is the next election and he's talking about four years? There's nothing easier than agreeing today to such a commitment and then breaking it when the next government is elected or when the current one finds the right excuse.

So, Klein offers another restraint. A distinction between the operational budget and the development budget will guarantee that all the additional expenditure is for infrastructure only, projects that nobody disputes, like roads, trains, water and sewage.

But the governor doesn't take account of the nature of the crafty politicians he's dealing with. They'll easily accept the definition "infrastructure," but will expand it to a whole new meaning. Everything will become infrastructure - teachers' salaries are educational infrastructure, synagogues cultural. Marketing and research grants will be industrial infrastructure, and increasing the departments in hospitals will be medical infrastructure. Improving conditions for career soldiers will be security infrastructure, and building weekend cottages in the Galilee will be tourism infrastructure. Strengthening the settlements will of course be Zionist infrastructure.

As soon as ministers realize they can enlarge the deficit, nobody will be able to ask them to annul the law giving NIS 500 million to families with more than five children or the tax abatements to the south, at the tune of NIS 650 million a year. It will also be much harder to demand that they cut their ministry budgets since there's a new-old trick to make money - increase the deficit.

So it's important to remind everyone of some basic truths of Israeli economics. The national debt is too big, the government's weight in the economy is too heavy, and taxes are too high. Increasing the deficit is a fundamental mistake. Those tempted to do so anyway may get some short term artificial growth, but it won't be healthy and won't last long. Indeed, it will end badly.

Increased government spending brings all the dangerous side effects - rising interest rates, rising domestic debt, declining international credit rating for Israel, rejection by foreign investors who don't like governments that change the rules for its convenience, increased trade deficit, instability, inflation, uncontrolled devaluation, and the permanent fear of financial crisis.

It's still possible to avoid all those evils by sticking to the original plan - back to the responsible path of a 1.5 percent budget deficit for 2002.