Ex-Bank of Israel chief warns: Judicial reform could weaken economy, standard of living

Prof. Karnit Flug said that the reforms could lead to a weaker economy, lower incomes and a reduced standard of living.

Tech workers protesting against the government's judicial reforms  using the slogan 'No democracy, no hi-tech,' in Tel Aviv on January 24, 2023. (photo credit: AVSHALOM SASSONI/MAARIV)
Tech workers protesting against the government's judicial reforms using the slogan 'No democracy, no hi-tech,' in Tel Aviv on January 24, 2023.
(photo credit: AVSHALOM SASSONI/MAARIV)

A strong sovereign credit rating is vital for a country's economic stability and growth, as it reflects the country's ability to repay its debt and manage its finances. A high rating can attract foreign investment and lower borrowing costs, while a low rating can lead to higher interest rates and a lack of investor confidence.

According to Prof. Karnit Flug, Vice President of the Israel Democracy Institute and former Governor of the Bank of Israel, the proposed judicial reform posed by the new Netanyahu government — which would harshly undermine the High Court’s authority within the legal system and concentrate the power of the government — is likely to negatively impact Israel’s credit rating, leading to lower incomes and a reduced standard of living due to its destabilizing effect on the Israeli economy.

Dissipating credit rating

“Based on the experience of some other countries that went in the same direction, if the government goes ahead with the judicial reform as it intends, we definitely have a heightened risk of reducing our sovereign credit rating,” explained Flug.

She recalled that in the last few days senior officials from rating agencies have stated that the strength of checks and balances between institutions are an important element that they consider when ranking countries.

This is further highlighted by examples of other nations which have similarly gone through with weakening their judicial systems in recent years. “Look at what happened to Hungary and Poland, and certainly Turkey: we see that a decline in their credit ratings came about, when the process of weakening the judiciary system occurred,” Flug said, adding that these countries’ credit ratings aren’t the only facets of their economies that were affected by the move.

 Prof. Karnit Flug, Vice President of the Israel Democracy Institute and former Governor of the Bank of Israel. (credit: ISRAEL DEMOCRACY INSTITUTE) Prof. Karnit Flug, Vice President of the Israel Democracy Institute and former Governor of the Bank of Israel. (credit: ISRAEL DEMOCRACY INSTITUTE)

Start-ups heading for the hills

“If you look at what's happened to the countries that went the same path, you can also see what happened to their foreign direct investment. After they weakened their institutions, their performance in regards to foreign direct investment was much weaker in comparison to other countries,” she pointed out. “It's not surprising: when investors are much less sure about the protection of the rule of law — the protection of property rights, the stability of the rules of the game, the ability to get to the court, if they have a dispute — they're much more reluctant to invest.”

Not only that, but if foreign investment plummets in the holy land, entrepreneurs may be more likely to up and leave in search of greener pastures and paychecks. “Because of this heightened uncertainty resulting from the weakening of the system, start-ups may actually move their companies to other locations,” Flug said. “There is a risk of some of Israel’s high tech companies moving away from Israel, if investors would be reluctant to invest in Israeli companies because of the erosion of the strength of the legal system.”

Dire economic consequences

Based on other national examples and the research that the IDI has done, Flug warned of dire economic consequences from the judicial reform. “If this controversial and very extreme reform goes through, I’m afraid the risks are high that it will have consequences in terms of Israel’s rating, which will impact both the government and the general public,” she said.

“It means less resources will flow to the economy, so certainly less capital will flow to the hi-tech sector. And that means that the economy as a whole and individuals in Israel are going to suffer from a much weaker economy and incomes, and that will have a detrimental effect on the standard of living,” Flug said.

There are not many ways to prevent the potential damage posed to the economy, “Other than trying to convey [to the government] that making such far-reaching changes, without really discussing them and reaching broad support," Flug admitted.

To that end, the Israeli public has certainly been trying hard to raise the flag of concern, with protests and strikes occurring with increasing frequency over the issue. Said Flug: “I have never before seen such self-mobilization from a variety of groups that include divergent political views to try to convince the government not to go down a certain path — I hope they will listen.”