Admirable Resilience (Extract)

By ZIV HELLMAN
Extract of an article in Issue 2, May 12, 2008 of The Jerusalem Report. To subscribe to The Jerusalem Report click here. Israel Bank Deputy Governor Zvi Eckstein says the economy is on the right track At first glance, the graph seems to demonstrate an undeniable success story - the kind one would point to in a celebratory retrospective on the accomplishments of Zionism. One curve, plotting Israel's per-capita GDP (Gross Domestic Product) indicates steady growth from the 1922 equivalent of only a few thousand shekels per person per year to well over 80,000 shekels today. But superimposed on that curve is another one, comparing Israeli per capita GDP to that of the United States, showing that relative to U.S. growth, the Israeli economy peaked in 1972, and compared to the average American, the average Israeli is worse off today than he or she was 35 years ago. "That is the biggest disappointment of Israeli economic history," says the deputy governor of the Bank of Israel Prof. Zvi Eckstein, "and it is the result of many years of bad macro-economic decisions. Only relatively recently have we gone back to the growth [rates] we should have had in the lost years." The graph Eckstein has pulled out of a drawer in his spacious top-floor office in the Bank of Israel's impressive inverted ziggurat building in Jerusalem shows that from the beginning of the British Mandate to its dissolution in 1948, average per capita GDP rises from an initial paltry 15 percent of American per capita GDP to 25 percent. After the State of Israel is established, the numbers leap astonishingly, passing 60 percent by 1960 - an achievement all the more impressive considering this was when the United States was experiencing a long post-war economic boom. In 1972-1973, Israeli per-capita GDP reaches 70 percent of America's. And then the rise grinds to a halt, even dipping in some years. The amiable Eckstein, a native Israeli aged 59, exhibits a passion for the subject of the Israeli economy, as illustrated by the depth of detail he goes into in researching the economic history of the country. Eckstein, who since June 2006 has served as deputy to Stanley Fischer, the governor of Israel's central bank, has a broad professional background in a wide range of economic fields, having held positions in academia, the public sector and banking. He stills holds positions as professor of economics at the universities of Tel Aviv and Minnesota, and is well-regarded as an expert in labor economics, monetary policy, and macro-economics. Eckstein refers to economic statistics dating back to 1922, explaining, "that's when the gates to immigration from Eastern Europe to the United States were closed and Jews began coming here in larger numbers. That's when the relevant economic history really began." He dismisses a common perception of the Israeli economy as progressing from a socialist-orientation under prime minister David Ben-Gurion in the country's first decade to embracing a completely different free-market liberal model in recent years. "The foundations of the economy predate the state and were characterized by a very market-oriented regime. If anything, the early Israeli administrations continued that liberal legacy." Based on macro-economic statistics, contends Eckstein, Israel's socialist period actually began in the late 1960s, when public spending became an increasingly substantial portion of GDP. Eckstein divides the past 60 years into four periods. The first period, between 1948 to 1967, was marked by relatively small governments committed to stable and responsible economic policies. Military spending comprised less than 10 percent of public spending, public budget deficits and debt were maintained at a low level, and government expenditure was less than 50 percent of GDP. "It is true that the governments then declared themselves to be socialist," says Eckstein, "and that they owned a lot of industrial concerns. But they also invested a lot in the real economy. The government used reparations money [from Germany] to good effect, building up industry and the infrastructure of the country." The Six-Day War in 1967 marks a turning point. Although the immediate post-war period is often regarded as one of energy and optimism, Eckstein is convinced that priorities at the macro-economic level became misguided. "Government spending grew substantially, taxation levels rose, military spending as a percentage of the budget expanded tremendously, and public debt ballooned." That just set the stage for the next period, beginning after the Yom Kippur War, in late 1973 and 1974, "the lost decade" as Eckstein puts it, of runaway hyper-inflation and economic stagnation. The fiscal figures for that period are off the charts, with public spending exceeding 75 percent of GDP in some years [compared to 45 percent today] along with deficits of 15 percent of GDP [down to virtually zero today]. Defence spending grew to nearly a quarter of the government budget. The debt to GDP ratio reached a whopping 274 percent in 1974, compared to today's 82.7 percent. It was only in the middle of the 1980s, with the implementation of an emergency economic stabilization program under then-prime minister Shimon Peres that the governments began to rectify the damage, leading to the situation where in the past several years government expenditure relative to GDP has been cut to below 50 percent - as in the early years of the state - and the Israeli economy has again blossomed. Growth has consistently been at impressive rates of four to five percent a year, which Eckstein believes is sustainable if the right policies are maintained - namely macro-economic stability and transparency in economic policies. Stability in this context means consistently meeting macro-economic targets such as public spending relative to GDP, budget deficits and inflation rates, and transparency means clearly explaining what the government's economic goals are and how they will be met. Just how solid the Israeli economy has become is evident in the dizzying strengthening of the shekel in recent months, as financial turmoil has rocked world markets and the U.S. is apparently entering what is predicted to be a painful recession. Since the summer of 2007, the euro has fallen 6 percent against the shekel, and the U.S. dollar and the pound sterling have each lost about 20 percent of their value relative to the Israeli shekel. According to Eckstein, there is no way to describe this other than as "a flight to the shekel," as strange as that may sound to Israelis who remember the days of hyper-inflation when no one in his or her right mind would hold on to Israeli currency in a search for stability. "The current situation in world economics is very peculiar, marked by a lot of financial uncertainty," explains Eckstein. "And there are a lot of geopolitical risks in our geographic area. But, despite this, Israel is actually a net lender to the world at this point in time, with more assets held abroad by Israelis than debt owed to the rest of the world. In a period of uncertainty, they are selling those assets and bringing the capital back home from a risky world." The shekel strengthened to such an extent that Israeli exporters began complaining loudly about the double damage it was causing them, by making Israeli products more expensive, and therefore less competitive, in foreign markets, while reducing income earned from overseas sales when translated into shekel terms. This threatens Israel's impressive export-driven, 5 percent-plus growth rate of recent years. Consequently, in March, the Bank of Israel intervened in the currency markets for the first time since the 1990s, purchasing hundreds of millions of dollars in one day and announcing its intention to buy $25 million a day for the next two years, in order to increase the Bank's foreign reserves. Extract of an article in Issue 2, May 12, 2008 of The Jerusalem Report. To subscribe to The Jerusalem Report click here.