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Israel's economic miracle: Where do we go now?
By CORINNE SAUER
25/04/2012
Liberalization, competition and free markets are the best Independence Day gifts we could receive.
 
Israel has grown so much in the past 64 years that it is difficult to comprehend the extent of the economic miracle that has taken place in the Jewish homeland.

It was undoubtedly a combination of genius, necessity, creativity and entrepreneurship that unleashed such incredible economic growth. However, Israelis should not fall into the trap of becoming complacent.

Israel is facing powerful counter forces that prevent its economy from fully blossoming and reaching its unimaginable potential. Although exponentially better off than 64 years ago, Israelis still maintain a lower standard of living than individuals in most developed countries. One could say that the Israeli economic miracle is accompanied by an Israeli economic paradox.

While we are world leaders in scientific discoveries and hi-tech innovation, we are also stymied by exorbitantly high prices, lack of variety, and frustratingly low disposable income levels.

The Israeli economic paradox can be easily traced back to the origin of the state and its socialist heritage. In 1948, the unions and the government controlled most of the Israeli economy. The focus of economic policy was on absorbing immigrants, encouraging investment by Jewish entrepreneurs from abroad, and protecting local industries. Despite several praiseworthy but fleeting attempts to liberalize the economy (especially in the late 1970s), protectionism, union domination, and massive expenditures by the central government (including necessarily high defense outlays) continued unabated.

This unsustainable situation inevitably led to an enormous public debt burden, monetization and hyperinflation. By 1985, Israel had no choice but to introduce a radical and comprehensive stabilization program, which finally recognized the need for more free trade and the establishment of a modern market economy. Since 1985, several sectors of the economy have been successfully liberalized, helping Israel to become a world leader.

Yet public and private monopolies still loom too large, as do the vestiges of a Soviet-style bureaucracy. These latter forces inhibit the ability of immense levels of human capital to be exploited more widely, preventing the Israeli economic miracle from reaching new heights to the benefit of rich and poor alike.

Turning 64, Israelis need to once again find the energy and determination to overcome daunting economic challenges.

If we fail to break free of economic concentration, public and private monopolies and the sprawling land bureaucracy, they will continue to hold down economic growth and our standard of living.

Israeli income per capita stands at around $32,000, approximately the same level as in Spain and Cyprus. But with our capabilities, we could easily reach the $50,000 mark, closing the gap with countries like Singapore and the Netherlands.

In order to reach these attainable heights, an economic fight must be fought, especially with particularly powerful special interest groups. Israeli oligarchs have little incentive to support public policies that increase competition and lower prices, because it cuts directly into their profits. The oligarchs’ natural partners are the unions and government bureaucrats. These latter two protected groups also enjoy extravagant benefits and unreasonably high salaries on the back of the Israeli public.

The oligarchs (often referred to as the “five families”) control the production and the distribution of many basic products, enabling them to charge high prices without any fear of losing customers. Their control extends deep down the chain of production, even to the banking sector. So when a potential competitor needs a loan it can easily have it refused and eliminate the potential competition at the source.

The fact that 70 percent of all loans are awarded to 1% of the borrowers illustrates this unchecked power of the tycoons. Their influence within political circles also allows them to lobby in favor of protectionist laws that prevent imports (e.g., milk) or render them prohibitively expensive through high tariffs (e.g., honey, cheese and cars). This is at the heart of why Israelis pay much more for basic items than residents of other countries.

In January, the Bank of Israel confirmed that prices in Israel are indeed much higher than in the rest of the OECD. The products with the biggest price markups are cars (70%), milk and eggs (44%), meat (28%), non-alcoholic drinks (48%), bread and cereals (17%) and fish (17%). In fact, Israelis pay less for two items only: fresh fruit and vegetables (13%) and telecommunications (4%). It is not a coincidence that the relatively lower prices are found in competitive industries. If the telecommunications sector had not been decentralized and open to competition, Israelis would have been paying high prices in that sector as well.

Another unjustifiably costly item is housing. Currently, it takes Israelis almost 11 years of salary to buy an apartment, while it takes eight years on average for other members of the OECD. According to the World Bank, it also takes four times longer to obtain building permits and register property than in other OECD countries.

The land, 93% of which is owned by the state, and fully controlled by government bureaucrats, must be released more freely for construction. By restricting the number of building permits, public officials manipulate the cost of housing and keep it artificially high. Increasing the supply of land available for construction will bring housing costs down to a more reasonable level. Unfortunately, it is nothing but narrow-minded special interests that hold the rest of the Israeli public as economic hostages.

Liberalization, competition and free markets are the best Independence Day gifts Israelis could receive from their leaders. This gift would make our exceptionally talented 64-year-old ready to face all future challenges. We still have not reached anything near our potential. The way forward is clear. For Israel, the sky is the limit.

The writer is co-founder and director of the Jerusalem Institute for Market Studies, an economic policy think-tank.

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