‘The idea was to use the crisis to strengthen the economy’

Finance Minister Yuval Steinitz takes stock of a roller-coaster year.

yuval steinitz 311 (photo credit: Ariel Jerozolimski)
yuval steinitz 311
(photo credit: Ariel Jerozolimski)
As the global economy emerges from one of the worst crises since the 1930s, Yuval Steinitz is concluding one year as finance minister maneuvering the local economy through a dramatic period. The first days of his term were as unpredictable and uncertain as the crisis itself. He had to deal with an economy in recession, rising unemployment and a growing government deficit.
Now everything looks different. The economy has come out of the crisis with the least possible damage. It is on a positive growth trend, unemployment is declining and taxes are coming down.
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At the same time, however, there are growing segments of the population, mainly Arabs and haredim, who are not part of the labor force, which contributes to widening social and economic gaps. In recent surveys, much concern has been raised that the country is bound in the long term to turn into a society in which whole sectors of the population do not receive a modern education and therefore don’t have the tools to be able to work.
In an exclusive interview with The Jerusalem Post, Steinitz outlines the ministry’s plans to deal with these issues and future challenges, including the formulation of a new economic plan to turn Israel into a technology center serving the financial world.
How do you sum up your first year in office?
About three weeks ago I concluded my first year in office. This was one of the most dramatic years in the economy. When I took up my position on March 31 last year, the Israeli economy, like those of the rest of the world, was falling into a crisis. There was a feeling of panic and great uncertainty for a very long time. For the first time in the last 30 years we had significant negative growth and there were predictions that unemployment could rise above 10 percent in the summer of 2009.
Government deficit for 2008 and 2009 together amounted to NIS 86 billion, the largest in Israel’s history, and exports plunged by 32 percent, which is a catastrophe for every country, but in particular for a country like Israel, where exports generate 50% of gross domestic product compared with 20% in the US. So if you lose a third of nearly 50% of your economy, this is a catastrophe, and therefore the forecasts for unemployment, deficit and the debt-to-GDP ratio were so grim that there were many people, including leading figures in the economy, who advised me not to take up the post, deeming it a lost cause.
We ended the last quarter of 2009 with nearly 5% positive growth. Although we don’t yet have final figures for the first three months of this year, I can say that it looks like the first quarter was as successful as the last quarter of 2009. We are one of the very few countries, together with Switzerland, which showed positive growth for the whole of 2009, despite a difficult beginning. We managed to slow down the fast rise of unemployment at the end of last summer, at which point it started to decline to a current rate of under 7.5%, while exports recovered by 25%.
In the world, whether by the International Monetary Fund, the Organization of Economic Cooperation and Development or international investment banks, Israel is seen as a success story in its management of the crisis, next to Norway and Australia. 
Since the first quarter of last year when the economy contracted at an annualized rate of 3.1%, it started to recover, growing at an annualized 1.2% in the second quarter and 3% in the third quarter. Driven by accelerated growth in the last quarter of 2009, which was revised upward from a preliminary 4.4% in annualized terms to 4.8%, the economy expanded at a rate of 0.7% in the full year, opposite 4% in 2008 and 5.2% in 2007. In comparison, member economies of the OECD contracted at an average rate of 3.5% in 2009. In light of the strong economic indicators, the Bank of Israel recently raised its growth forecast for 2010 to 3.5% from 2.5%.
How did Israel cope with the global crisis?
The economic policies we launched to deal with the global crisis were completely different from the rest of the world. In most countries at the end of 2008, the feeling was that the economy was dying, there was a credit crunch, growth was significantly slowing down and the first priority was the need for emergency treatment through the provision of oxygen. In the economy, oxygen means pouring money to renew growth based on the Keynesian model, which was done in three ways: by cutting taxes, bailing out companies or banks and stimulus plans.
The problem with this policy is that money costs a lot of money. Even if you succeed in saving the economy, you have sold the future of the country and society to take steps to save the present, and hence you will pay the price in the future and recovery will be very slow. Countries will be faced with a high deficit and they will have to raise taxes to finance it. So, most countries faced with a situation of panic, in effect, sold the future to save the present. We did the opposite.
We decided to save the economy not by implementing short-term emergency plans but our priority was to formulate long-term plans for the next two, three or four years. For us the best stimulus plan was not a matter of pouring money into the economy but the opposite, by showing that we can plan a better future after the crisis, which in turn will assist the recovery in the present. The idea was to use the crisis to strengthen the economy.
One of the best examples is that we managed during a crisis period to pass a two-year budget for 2009-2010 for the first time in Israel’s history. We formulated a five-year declining deficit plan to gradually bring down the deficit from 6% in 2009 to 3% in 2012 to 1.5% in 2013 and 1% in 2014. As other countries – the US and in Europe and Asia – cut taxes, we raised taxes. Last summer we temporarily increased VAT by 1% to 16.5% for 2009 and 2010, and we raised taxes on gas and cigarettes.
As many countries are now beginning to increase taxes over the next year, we have a plan to start to cut taxes. The plan is to gradually bring down income and corporate taxes until 2016 by 1% more or less each year starting from January this year. Income taxes will be cut from 46% to 39% and corporate taxes will decline from 26% to 18%.
Our methodology to deal with the crisis was to build long-term plans on the assumption that in the economy not only the present has an impact on the future but the future also has an impact on the present. We took the theory of backward causation to the extreme and transformed it into our motto and ideology to deal with the crisis. As a result we have managed to come out of the crisis with the cheapest and most effective stimulus plan because we didn’t spend money.   
Looking ahead, how is the Treasury using this crisis to strengthen the economy?
We are in a situation in which the economy can grow stronger since we have succeeded in coming out of this crisis in an advantageous situation in three perspectives. Firstly, regarding unemployment: In most countries in the Western world, unemployment has risen to over 10%, and even after the crisis it will take years to reduce unemployment. In the US, for example, expectations are that it will take five to six years to bring unemployment back to pre-crisis levels.
While we are today more or less 1% above the unemployment rate of before the crisis, we expect unemployment to further come down and reach pre-crisis level at the beginning of 2011, if not at the end of 2010.
Secondly our debt-to-GDP ratio has risen very modestly to around 80% from 78%, compared with other countries where the ratio has increased more than 10%. If everything goes well, we will return to a ratio of 78% at the end of 2010 or even lower – 77% or 76%. Hence, while other countries will be in a worse debt situation, we are likely to be in a better situation than before the crisis by the end of this year.
Thirdly, the country’s management of the crisis has strengthened the standing of our economy in the world and this is an asset. Global rating agencies have not downgraded our country rating. At the height of the crisis we were upgraded to the MSCI Index of developed countries. At the same time, we finished all the entry requirements and processes for joining the OECD at the beginning of this year, and we only need to get past the formalities over the next few months. Furthermore, the International Monetary Fund has given our economy very high grades, and it is even considering recommending that all countries adopt our two-year budget plan.
Now our main target is to take advantage of the benefits accrued in the crisis in a way which will create a basis for strong economic growth for the coming years. At the moment, we are in the process of formulating a new economic plan, which will be completed within three to four months prior to the next budget submission.
What are the main pillars of the Treasury’s new economic plan?
First of all, after the crisis we are going to enter into a very competitive environment, since all countries will try to improve their economies. Many countries have decided to shift their economies from traditional industries to advanced or hi-tech industries and therefore competition will be fiercer. On the other hand we already have advantages of expectations of a low-tax environment which will be more attractive for investment.
In the new economic plan we will put a focus on further developing and accelerating growth of advanced industries, that is hi-tech in the broad sense. Not just hi-tech relating to computers and information, but hi-tech across a broad spectrum, including biotech, defense industries, agritech and medical devices.
In addition, we are going to support the development of advanced systems and technology services for the financial and banking world. It is a very big and growing sector. We want Israel to turn into a center which also provides technology services on a global level to banks, financial institutions, insurance companies and investment banks. We are also considering bringing financial services here and turning the country into a financial center – not a financial center that will compete with London or New York, but as reinforcement.
What is the Treasury doing to advance the new economic plan and broaden the scope of technological innovation?
Measures under consideration include regulations to encourage foreign companies to set up branches or subsidiaries here, as we are seeing a trend of more and more companies, not only from the US but also from Europe and China, which are interested as they understand that to be in the technology forefront they need to have a research and development center in Israel, like Google, Intel, Microsoft, Cisco or Motorola. Not only among hi-tech companies but also train, plane or infrastructure companies and even banks. 
We are reviewing changes to the Capital Investment Encouragement Law. We are working with the chief scientist to launch programs which will assist technology development targets. We have already announced the establishment of a NIS 1 billion public-private biotech fund for start-ups. We set up a committee with the aim of finding solutions to ease doing business here by simplifying bureaucratic processes and removing bureaucratic barriers, including setting up a business so that Israel can become more attractive for foreign investment.
We will also consider tax benefits and grant programs and enlarged budgets for academic research and universities in an effort to be more competitive opposite academia in the US. The government recently passed a decision to open academic excellence centers in the country at a budget of NIS 500 million, which aims to bring back 500 Israeli professors and PhDs mainly from the US.
Despite the relative success of the economy in coping with the economic crisis and a declining trend in the rate of unemployment, there are still large parts of the population which are not participating in the national labor force and are not contributing to the modern economy we have developed. The latest report by the Taub Center shows that we are turning more and more into a society where parts of the population, mainly haredim and Arabs, are not receiving a modern education, don’t have the tools and therefore are not able to work. How do we cope with this problem?
There is a problem here, which is also a social problem. Yes, we have two sectors of the population, Arabs and haredim, with a low participation in the labor force, which creates poverty and is also an economic problem. I agree that in the long-term future, we need to integrate these two sectors. We don’t have a choice as we don’t want the past economic growth cycle to further widen social gaps between Arabs and haredim on the one side and the rest of the population on the other, which very much benefited and grew stronger.
Dealing with this situation, in particular with the integration of Arabs and haredim into the labor force, is the other side of the coin of our economic plan after creating engines of growth. We are looking into the model of Modi’in Illit, where hi-tech centers for integrating the haredi sector, mainly women, have been created with the support of the government. There is a lot of goodwill for integrating haredim, if done in cooperation, in the hi-tech sector, which is mainly in the low-tech of the hi-tech, such as outsourcing and office work.
We are working on programs for the integration of haredi women and men into the labor force. They have good basic qualities and a sound work ethic. What we need to do is to adapt education institutions and the workplace and environment to their needs, including convenient working hours. When you look at the haredi communities in New York, about 80% work, also men. The model in Modi’in Illit has proven itself as a model for a working haredi community with a work ethic and we need to develop it and adapt it to other places in the country.
With regard to the Arab sector, the problem is different. The allocation of a budget of NIS 800m. for a number of Arab centers to create employment and develop the economy, which was passed by the government about a month ago, is the first step in our efforts. We have set up a NIS 160m. fund which will finance investments in hi-tech and start-ups in the Arab sector. There are many Arab academics who are unemployed and can enter the hi-tech sector, whether it is for outsourcing or office work for Israeli or foreign companies. We are now talking about seriously placing Arabs and haredim in advanced industries so that salaries will be sound. The idea is to further open the Israeli Silicon Valley, which is currently located between Kiryat Gat and Ashdod on one side and Haifa on the other, to Galilee and the Negev and to the haredi and Arab communities.
A very recent Bank of Israel report showed that although more people are joining the labor force, the number of working poor, who don’t earn enough to sustain their families, has also risen. What has gone wrong?
Firstly we need to check the figures more closely. Partly the figures don’t provide a full picture since, for example, some people work part-time and others are engaged in illegal employment so that salaries are not necessarily close to reality. In this context one of the main issues we are dealing with is the reduction of the number of illegal foreign workers, which will lead to growth and help to narrow social gaps over the next five years.
Foreign workers, whether from Thailand, the Philippines or Africa, are taking the jobs of Israeli workers, in particular low-paid jobs, such as cleaners, restaurant, hotel and elderly care staff. We are No. 2 in the Western world in the percentage of foreign workers, who make up 8.5% of the labor force, after Austria with 11% and an average of 5.5% in OECD countries. On the other hand, growth accompanied by a large influx of foreign workers into the flourishing country is bound to widen gaps.
In general, everyone in the economy should be able to benefit equally from stronger growth whether it is the computer engineer, the cleaner, the cook or the security guard. While the hi-tech engineer over the past 20 years has been earning more and more, since the sector is earning more, the cleaner wiping the floor, who also ought to be earning more, is faced with the influx of more than 300,000 foreign workers who come to compete mainly for these low-paid jobs. As a result the latter will not be earning more simply because if he were to ask for a raise, he would take the risk of being replaced by a cheaper worker. Hence, a great part of the problem of widening social gaps over the past 20 years can be explained by the entry of a growing number of foreign workers, leading to unequal growth of salaries in the labor market.
With apartment prices rising to record highs over the past year amid a shortage in housing, in particular affordable housing, there have been a number of proposals in the Knesset, including the cancellation of tax exemptions, all aimed at lowering housing prices. One of the most recent suggestions that are being reviewed is the cancellation of the capital gains tax exemption on the sale of residential and investment apartments.
Is the Finance Ministry looking into the possibility of canceling the capital gains tax on real estate? Do you support the proposal?
I have not yet discussed this question at the Treasury. We have internal discussions at the Finance Ministry in the different divisions all the time, and it is our duty to consider various ideas, and naturally there are different opinions in one direction or the other. But there is no concrete outcome on this issue. Therefore, at the moment I cannot say whether I fully support the proposal since I haven’t yet fully examined the issue.
Is the Treasury examining other steps to bring down real-estate prices?
We have already started to take action and we are seeing signs of a slowdown in the rise in property prices in the first months of this year. We are taking steps to increase the supply of housing by marketing more land. In 2009 we marketed more land than in 2008, and in 2010, with the help of the Finance Ministry, the Israel Lands Administration will release more land tenders than in 2009.
To ease property prices, we took two steps. We raised interest rates, which lowers the attractiveness of buying apartments for the purpose of investment. This could in turn bring down property prices as people are buying an apartment because they need to and not necessarily for investment. One of the main reasons for booming prices in the real estate market was the low interest rate. When cheap money is available, people buy everything, shares on the stock market as well as apartments. Secondly, the 0.5% VAT reduction, which came into effect at the beginning of January, also helped to a certain extent to stem the rise in prices.
Is there a bubble developing in the local real-estate market?
I don’t think there is bubble developing in the property market. It isnot a bubble, but an increase in real prices which is a result of realdemand and supply. However, it doesn’t mean that it is less worrying;maybe it is even more worrying. If it were a bubble, it is a fiction.But here we have a situation of a rise in real prices because of a realshortage of supply.
What about using vast spaces in the Negev? With the right infrastructure?
Thisis part of the reform we are planning, including the implementation ofbetter infrastructure for the Negev and Galilee. After an argument wehad with the prime minister and the transportation minister over thebudget of between NIS 100 billion and NIS 200b., we managed to come toa sound compromise, which will improve transportation connections viaroads and railways to the Negev and Galilee. This in turn will help tobring residential housing to these areas.