The Treasury's pessimism is underdone

Avi Temkin

The austerity budget is based on wishful thinking about a better future, with no political will for any alternative.

Last week, fairly quietly and without too many accompanying headlines, the Ministry of Finance published its economic forecast for 2013-2014. On the face of it, this is a technical document, of the kind that shouldn't attract too much attention, since it adds little to what we already know. But behind the facade of familiar routine, there is a complex, dismal reality, raising question marks over the ability of the government's economic policy to deal with the distress in which the Israeli economy finds itself.

According to the Ministry of Finance, economic growth will reach 3.8% this year and 3.3% next. Given the characteristics of the economy, with annual population growth of nearly 2%, 3% growth in GDP in effect means a slowdown, with zero growth in employment, and low tax collection. When growth is 2%, it can be called recession, and unemployment rises.

So the 3.3% growth forecast for 2014 means that the Ministry of Finance assumes a future in which the economy is in fact in a slowdown. If we take into account that the forecast includes the effect of the gas discoveries, which adds 0.5% to growth in 2014, then the economy, excluding the gas sector, will enter a real slowdown.

It should be stressed that the Ministry of Finance has made an effort to stay in touch with reality over the assumptions underlying the construction of the forecast. So, for example, it assumes that private consumption and exports, the two possible engines of GDP growth, will expand by 3% and 4.7% respectively. These numbers are based on the expected results of the austerity measures in the budget and the economic crisis in Europe.

Even so, the gloomy forecast may in the end prove too optimistic. The reason for that is that the policy itself is liable to generate a negative dynamic that will bring in train an economic crisis, because the Ministry of Finance provides no detailed explanation of the forces that are supposed to turn the economy round from slowdown to growth. More worrying still is the fact that there is no answer to the more important question of what is to prevent slowdown deteriorating into recession. What will happen if, for example, consumers react to the government's measures with a further contraction in consumption, and what will happen if the assumptions about global growth fail to materialize?

The Ministry of Finance's statements about policy this year are a sort of morality tale, in which the financial markets reward economic policy for its good character, with investment and demand. If we try hard, we can give this belief an underpinning of economic theory whereby the decline in the fiscal deficit will lead to a fall in long-term interest rates, which will boost investor confidence, leading in turn to accelerated activity. To this explanation it is customary to add statements such as that this will be "healthier growth", without us understanding what the economic mechanism is that is meant to get this process going.

Only there is no substance to the morality tale. The Ministry of Finance's fiscal policy is mostly based on measures that will exert downward pressure on the free income of most workers. The make-up of the (notional) coalition prevents any other possibility, because of the lack of the will or the ability to base fiscal policy on other foundations, of cuts in political expenditures such as spending beyond the Green Line, of a genuine review of the tax system for individuals and corporations, of cuts in defense. The upshot is liable to be that the growth in consumption will be smaller than expected, with all that that means for growth in GDP.

What happens if we slide into recession? In the absence of any real plan for avoiding this, it remains to hope that something will change in the external circumstances, as happened in 2003, when a rise in overseas demand pulled Israel out of recession. But unexpected changes can go either way. Private consumption is liable to expand by less than planned. The sharp drop in the Globes Consumer Confidence Index, 22 points in one month, is an indication of what is liable to happen as a result of prolonged pressure on free income.

If there are unexpected developments, we must ask whether the Ministry of Finance has a contingency plan in the event that we do slide into recession. What do we do if growth in 2014 is 2.5%, amid a sharp fall in tax receipts? Will we then resort to "further cuts" in order to avoid a worsening of the fiscal deficit, and what is the danger that we will enter a vicious circle that will push us into a real crisis?

The price that the Israeli economy might have to pay for the Ministry of Finance's wishful thinking is too high. As long as it was possible to assume expansion in overseas demand and rapid growth in private consumption, it was also possible to draw up fiscal austerity programs such as the Ministry of Finance is launching today. Exports and consumption were the safety cushions of economic growth. But that is not the situation now, and it probably will not be the situation in the near future. The problem is that, in the absence of any alternative, next year we will probably see another document promising us that if we continue to suffer in silence, in the end, at some undetermined date, things will get better.

Published by Globes [online], Israel business news - - on June 18, 2013

© Copyright of Globes Publisher Itonut (1983) Ltd. 2013

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