Israel: The history of an economic miracle

The country has reaped the rewards of privatization and globalization.

tase building 88 298 (photo credit: Courtesy  Photo)
tase building 88 298
(photo credit: Courtesy Photo)
In Israel at 60, we are witness to an economy which has proven its prowess and competitiveness on the global scale, as evidenced by a shekel which is one of the world's strongest currencies, backed by a surplus in the balance of payments. A closer look at many of Israel's companies shows numerous examples of the successful transformation from local enterprise to multinational firm. While one used to speak exclusively about hi-tech and startups, today one sees Israelis involved in all sorts of ventures, displaying impressive managerial and entrepreneurial skill. Last year, the Tel Aviv Stock Exchange chose five companies traded on the exchange that exemplify the trend towards global excellence. Teva, the world's largest generic drug maker, is headquartered in Israel, while Strauss Group, which began as a family dairy, has expanded to Latin America, Eastern Europe and elsewhere. Elbit, a defense electronics maker, understanding that countries purchase arms only from "local" companies, set up international subsidiaries. Ormat, the geothermal energy producer, has manufacturing and research centers in the country while the actual power plants are built overseas, and Israel Chemicals exports the country's natural resources around the world. Aside from manufacturing and hi-tech, Israelis are also active overseas in real estate, with Israeli magnates involved in projects in London, Toronto, Eastern Europe and the US. And bankers, lawyers and accountants are intimately involved in overseas dealings. This article will deal with the miraculous transformation of Israel's economy over the past two or three decades. "The lost decade" Israel underwent a wrenching economic crisis in the early 1980's whose roots were in the 1973 Yom Kippur War and the ensuing oil embargo but which continued until 1985. This "lost decade" of the Israeli economy saw near-zero per capita growth, inflation at dozens or even hundreds of points a year, and terrifying deficit and national debt levels. During this time, both the business sector and the quasi-governmental sector (health insurance, pension plans, kibbutzim) became completely inefficient and almost entirely dependant on the government, which at the time accounted for 70% of GDP. Israeli industry received generous credit subsidies and tariff protection, while the financial sector was largely nationalized (with "special [government] bonds" receiving large tax breaks) while the markets were all but closed. Israelis generally refrained from foreign commerce, while foreign investors shied from commitments in the politically and economically unstable atmosphere. At that point, the popular joke had it that the only way to make a small fortune in Israel was to come here with a large one. By the height of the crisis, in 1984-5, Israel was a total economic failure, requiring two major reforms to get the country back on track. Stabilization program - 1985 The stabilization program passed by the government in 1985 managed to rein-in inflation from some 400% to a more manageable 20%, stabilized the balance of payments, but most importantly brought the deficit down from 15% of GDP to a surplus of 1%. By 1986, government expenditures had been cut back, and the government was legally prohibited from printing money to cover deficits, forcing it to rely on publicly traded bonds. The massive reduction in spending forced the private and quasi-public sectors to become more efficient, as the government could no longer be relied on to provide funding. The years 1985-90 saw the private sector make great strides in efficiency and worker productivity while the labor unions were weakened and management was given the capability to fire employees at its own discretion. Market liberalization 1991-2004 In 1991, Israel made a major strategic decision to gradually open the sectors of consumer goods, currency and investment to international competition. Customs were slowly decreased to the point that the effective tariff protection today is less than one percent. Meanwhile, currency markets and, later, investments were also liberalized, and in 2004 Israel equalized taxation on foreign and domestic investment. The liberalization of financial markets was finalized with the advancement of the stock exchange, as all financial instruments, including retirement funds, were made completely market-dependent. Such areas as telecommunications, the port system and the banking system were privatized. The effects of globalization Over the past five years, the Israeli market has become totally globalized, and the success has been impressive. The Israeli entrepreneur and businessman have taken full advantage of the possibilities of global commerce. The government has kept to policies of a stable budget, debt reduction and low inflation, while foreign investors have begun viewing Israel as a prime investment target. The country's success can also be seen in its performance in leading economic indicators: Number one in per capita R&D investment, and number one in startups, per capita. The business sector is also ranked very high (8th in the world) in measures of creativity and business savvy, as well as technological-readiness, widespread higher education and more. Challenges ahead Despite these impressive achievements, Israel faces serious economic challenges, primarily from the ongoing global financial crisis, which seriously affects globalized economies like Israel. Israel will face a test of fire for the entrepreneurial and commercial skills of its business leadership. Another challenge is the reform of the public sector, which, while financially stable, has shown poor results in such areas as educational achievement (40 in a ranking of 57 countries), infrastructure and environmental protection. The social inequality in Israel's workforce is one of the worst in the world, and there is a low level of economic participation. The revamping of the public sector is critical to the nation's economic success - it is one of our key challenges in the coming years. Yoram Gabbai is the chairman of the board of Peilim Investments and a former head of the State Revenue Administration in the Ministry of Finance.