Netanyahu’s tough challenge

The decision to hold elections in September does not leave much time for Netanyahu to implement the vital recommendation of the anti-concentration commission he endorsed. With the Knesset disbanding and its members busy electioneering it is hard to imagine them pushing a reform that the tycoons and their powerful lobbyists are bound to resist with all their considerable might.

With a small population of about seven-and-a-half million people, Israel has an extraordinary concentration of human capital and more start-ups than all of Europe. It should be one of the richest countries in the world. But Israel is also a model of the problems afflicting all distributive democracies, especially those with socialist pasts. Socialism’s legacy and a phony privatization program that consisted of selling former government and labor union assets to cronies, left behind in Israel a strong statist system, an extensive entitlement system and an unholy alliance between powerful political elites, crony tycoons and monopoly labor unions that impoverish the country.

These groups wield an extraordinary concentration of political and economic power. Government bureaucracies make the cost of doing business in Israel forbidding while the tycoons’ monopolies exact huge monopoly rents, doubling or even tripling prices of most consumer goods and services.

They curb competition and efficiency so that the productivity of the capable Israeli worker is only two thirds that of the American worker.

Low salaries of about $2,400 a month on average, and prices that are higher than in New York City make it impossible for hundreds of thousands of Israeli families to make ends meet.

Unfortunately Netanyahu’s appointed “anti-concentration” commission was chiefly composed of regulators who failed in the past to curb concentration, and of academicians who were denying the problem since it did not neatly fit their mathematical models.

Consequently, despite the recommendations of Prof. Lucian Babchuk, the world renown expert, they did not forbid, as the US does, pyramid-structured holding companies in which owners control third-tier subsidiaries with only 16 percent of capital (the rest being provided by pension funds with no voice in management). Rather, they allowed existing pyramids to keep their three-tier structure but limited new ones to only two tiers. They did call, however, for improvements in the governance of these businesses in the not-so-realistic hope that this way they could protect the public’s investment.

They also called for a separation of ownership between non-financial and financial firms, although they fixed too high a threshold for such a separation. Still, even their tepid recommendations could do much to improve Israeli credit allocation and competitiveness.

Netanyahu’s government subsequently appointed a legal group to legislate their implementation.

Again, this group is composed mostly of regulators who are half-hearted about the reform. Since the recommendations will also face a tough battle in the Knesset where the tycoons and their powerful lobbyists will do their best to annul or erode them, it is not clear how effectively the reform will be implemented.

THE PROBLEM of rapacious elites blocking progress is of course neither new nor unique to Israel. Elites manage to secure for themselves privileges that erect entry barriers to new enterprises, curb competition and efficiency and lower productivity. They create wide income gaps with negative social and political consequences.

Recently, in Why Nations Fail, Daron Acemoglu and James Robinson defined the power of what they described as “inclusive” political institutions as opposed to “extractive” ones to determine a country’s sustained economic growth. Generally impoverished Islamic countries are extreme examples of the ravages caused by such “extractive” elites.

In Israel, “the existence of small, concentrated elites of politicians and tycoons wields enormous power and control monopolies, cartels and privileges creating a tough economic problem. It not only increases the already high cost of living and reduces political equality but also inhibits growth and economic development,” lamented Guy Rolnik, editor of The Marker, Israel’s foremost business publication.

Israel recently celebrated its 64th birthday. It has had to fight seven wars and two revolts, face the militant animosity of hundreds of millions of Muslims and has received little empathy from the rest of the world. It has absorbed five times the number of its original population, including close to a million-and-a-half Jews who were expelled from Arab countries with only the shirts on their backs, over a million from the former Soviet Union, and close to a million from impoverished cultures such as South America or Ethiopia. It is not surprising that the struggle against its powerful statist heritage was not a top priority.

Netanyahu, who has been facing the tough challenges from a nuclear-armed Iran, from a less than friendly American administration and from a nearly ungovernable Israeli political system, has nevertheless seized several opportunities to boldly reform Israel’s anti-productive economic, and especially financial system, with spectacular results: five years of high growth.

With elections coming up in September, he will have to overcome the lack of zeal and the inertia of his own bureaucracy and the resistance of several of his own coalition’s members who are pressured by powerful vested interests. Still because of the coming elections few Knesset members will dare oppose his reforms. So this is Netanyahu’s historic chance to convene a special Knesset session before the elections and institute some of the reforms he deems so vital. We are confident he will not miss it.

The writer is founder and director of The Israel Center for Social and Economic Progress and fellow of The Middle East Forum.