Mazal Tov

But I’m afraid your newborn is now NIS 85,000 in debt.

New shekel notes 370 (photo credit: Courtesy Bank of Israel)
New shekel notes 370
(photo credit: Courtesy Bank of Israel)
Finance Minister Yair Lapid’s recent push to allow the budget deficit to reach 4.65 percent of GDP in 2013 was an ill-advised and economically dangerous move. The fact that the new Cabinet ratified Lapid’s economic irresponsibility is even more worrisome for the future state of the Israeli economy. It is no wonder Standard & Poor’s saw fit to smack Israel on the cheek and downgrade its local currency credit rating.
In everyday terms, upping the budget deficit target to 4.65%, from its previous limit of 3%, translates into a NIS 2,300 increase in the average Israeli’s debt burden. Every baby born in Israel today must now start his/her life owing more than NIS 85,000 to mostly international creditors.
As confirmed by the S&P downgrade, the numbers are beginning to reach levels that engender real concern. In 2012, Israeli state debt stood at NIS 666.8 billion, compared to NIS 633b. at the end of 2011. Allowing the deficit to balloon to 4.65% of GDP will cause the national debt to exceed NIS 700b. A negative economic shock in the near future could now conceivably put Israel at risk of bankruptcy.
Our politicians are mostly unmoved by these figures and dire warnings. Of course, they do not like to face difficult decisions that might entail budget cuts. It is simply easier to tax and borrow as if there were no tomorrow. This is because tomorrow they may not be in power. Ironically, making responsible decisions in the fiscal realm would most probably hurt their chances of political survival, meaning that our children will have to foot the bill left to them by our myopic and self-interested politicians.
A quick look at the annual budget starkly reveals the extent of government profligacy. More than 35% of Israel’s national budget goes to pay for the interest and principal on past loans. Have those past loans improved our standard of living? In 2012, the average Israeli had to work 68 days of the year just to cover the debt-service payments on these loans. To put this in perspective, consider that we only work 27 days a year to meet defense spending. Overall, Israelis work a total of 192 days of the year to support Israel’s excessive government expenditures.
So how would an enlightened, benevolent government manage its finances? Perhaps it should just raise taxes rather than increase the national debt? The reality is that both tax-and-spend and borrowand- spend fiscal policies are incapable of sustaining economic growth. They are both losing propositions.
A policy of raising taxes won’t help the economy because it reduces the incentive to invest and punishes hard work. Why would a company invest in Israel if corporate tax rates are higher here than in other comparable countries? Why would anyone work an additional hour if the government grabs 50% of the extra pay? An influential study by Christina and David Romer, published in the American Economic Review in 2010, quantifies the extent of the problem with taxand- spend policies. They find that an increase in taxes of 1% of GDP lowers GDP by almost 3%.
The main reason underlying this oft-ignored negative relationship between taxes and growth is that the public sector is relatively unproductive and wasteful. Competition in the private sector incentivizes individuals and businesses, and pushes an economy upwards.
Israel is no exception to the rule.
In the Global Competitiveness Index produced yearly by the World Economic Forum, Israel received its higher score in private sector activities such as innovation (3rd) and business sophistication (16th). It ranks near the bottom of countries in areas associated with the public sector, i.e., in the categories of budget balance (88th) and government debt (121th).
The same reasoning explains why borrow-and-spend policies are just as futile. Governments have a poor track record when it comes to investing borrowed money in fruitful public projects. Moreover, most borrowed money isn’t invested at all, but rather goes to questionable entitlement programs with very little promise of future productivity and economic growth. A recent estimate by Tullet Prebon quantifies the problem with borrow-andspend policies in the UK. From 1998-2008, the UK government borrowed £2.18 to produce £1 of economic growth.
So what would an enlightened finance minister have done in the face of soaring budget deficits? A finance minister with vision would have looked beyond his own self-interest and simultaneously cut taxes, borrowing and government spending. Although the cut in government expenditures is painful and unpopular in the short run, it would have signaled that the new government really does represent a new era in Israeli politics, that the new coalition prides itself on vision, fiscal responsibility and a willingness to take a different and more promising path capable of increasing Israel’s standard of living.
Perhaps a month ago Finance Minister Yair Lapid would have agreed with the “alternative approach.” He had initially called for decreased defense expenditures and child allowances and a freeze on public sector wages. However, it seems that after a difficult meeting with Histadrut labor federation chairman Ofer Eini, the finance minister got cold feet and backed down at the threat of national strikes. Does Minister Lapid find it easier to increase a newborn’s lifetime debt burden than to stare down the Histadrut? Sadly, when it comes to management of the Israeli economy, it seems the status quo is solidly entrenched and set to continue well into the future.

Corinne Sauer and Robert Sauer cofounders of the Jerusalem Institute for Market Studies. (JIMS).