"The new government's discussion of its economic
agenda must begin where the previous government left off.
While there are admittedly some thorny problems, there
were also not inconsiderable achievements. Any agenda
must also relate to a plan for the next few years, which
is to say, the government must state what it wishes to
achieve in its present term of office.
"As a matter of fact, I would like to start with the
achievements of the previous government. The leaders of
the economy prided themselves on rapid growth.
Outstripping that of the industrialised states, it was
itself overtaken only by the growth rate of east Asian
countries. A very big wave of immigration was absorbed,
and this absorption was felt to be more or less
successful, even if there is a problem whereby immigrants
are not employed in their own professions. Inflation,
too, was lower than it had been a few years before.
Domestic and foreign debt are down, in relation to
product. Here I must add the reservation that, looking at
productivity, and especially overall productivity,
meaning the increase in product relative to the increase
in production concerns, the results are far less
impressive: productivity rose on average by about half a
percent per annum, a very low rate in terms of
international comparison.
"It is worth recalling what brought about these
achievements: to begin with there was the stabilisation
plan which, starting from the mid-'eighties, produced
relative stability. Secondly, there was the big wave of
immigration from the former Soviet Union. Thirdly, there
was the advent of an era of regional peace. This was very
prominently highlighted in the way the world looked at
Israel. There was a considerable improvement, due to geo-
political causes, in Israel's credit risk rating.
Foreign investors arrived once the political climate
changed. In terms of technology, Israel is a success
story. We are `the world's second Silicon Valley'.
Success stories have been recorded in various fields such
as courseware and hi-tech. But this supply of
technological potential was also in existence before.
Demand, which is to say, preparedness on the part of
investors to come to Israel, followed the signing of
agreements. There can be no doubt that progress in the
making of peace with Jordan, Egypt and the Palestinians
contributed its share.
Regional peace, it must be clearly understood, is not
`in the bag'. I believe Benjamin Netanyahu understands
the situation. His comments since being elected reinforce
the trend. Progress with the peace process will be
helpful to the economy. The deepening of peace
arrangements, regardless of different outlook, is helpful
to the economy.
What problems are the Netanyahu government
inheriting from the previous government?
"The new government is inheriting some tough problems
in the short term. The previous government has left two
difficult inter-connected principal legacies: a big
budget deficit and a big deficit in the current account
of the balance of payments. There were fat years of rapid
growth that temporarily augmented tax receipts. The
problem was that the previous government instituted a
permanent increase in its expenses. As, for example, the
increase in inflation-adjusted pay in the public sector,
whereas the increase in tax collection was temporary.
"The new government must commit to a significant
reduction of the deficit and of its own expenses. This
must be done straight away, even though it isn't easy to
change direction in the middle of the budget year. The
level of expenditure must obviously be reduced by NIS 4-6
billion, at latest off the 1997 budget. A balanced budget
must be achieved by the end of the government's term of
office, while the slash must be instituted, for the most
part, even now. Now is the time to make such a move,
there by contributing to both the balance of payments and
the restraint of inflation".
Where can cut-backs be made? Should the new
government consider raising taxes?
"No additional taxes should be imposed. The tax burden
is such that it should definitely not be increased. Thus
any slash should be in the expense column. True, this
will be no easy task for the new finance minister, or for
the prime minister, who will have to give it his
backing. While instituting the slash, care must be taken
to preserve expenditure designed to correct social
inequality. It is quite possible to cut back on social
budgets and still achieve the goal of greater equality,
by modifying the composition of the social budgets. This
week we learned of an increase in the government's
deficit in the first four months of 1996. Which, of
course, makes things very difficult for any beginner
government or novice finance minister".
Do you consider such a cut-back possible in the
coalition that seems to be taking shape?
People in Israel are sufficiently experienced to
realise that a balanced budget is very important for the
future of the economy, for the growth of the private
sector and for preventing the rise of the prime rate. If
the budget is not slashed, the interest rate will climb:
even if the Bank of Israel itself does not raise the
prime rate, a big deficit will crowd out the private
sector's financing potential".
Must the slash be accompanied by a package of
measures relating to the interest rate and the exchange
rate?
"This sort of arrangement depends on the size of the
initial cut-back. The bigger the slash, the more
indulgent the monetary policy can be. It must be made
clear that if the level of public expenditure is slashed
appropriately, this will automatically exert a downward
pressure on the prime rate. The shekel exchange rate will
get back to mid-range, there is sufficient margin around
the mid-range for the rate of exchange to correct
itself".
Will the cut-back also constitute a response to the
current account deficit?
"The current account deficit exists independently of
the state budget deficit. Israel has a big deficit in
current account - $4 billion or more - which is to a not
inconsiderable degree covered by short-term capital
movements. The economy has no basic problem, inasmuch as
its reserves are high and its foreign debt is low, the
economy can borrow from abroad, and the American
guarantees are still in existence. However, since the
end of 1984, short-term credit has grown rapidly, and
now approximates the volume of the state's foreign
currency reserves. This shows that the present course is
not sustainable and a budget slash thus becomes
obligatory. This will increase public savings and reduce
the current account deficit. The lowering of the prime
rate will also enable the rate of exchange to be
modified, while also improving the competitive edge of
Israeli export".
What about unemployment and inflation?
"In the short term, substitution takes place between
wages and employment. From that point of view, the
economy has undergone a change in recent years and there
is greater flexibility in the business sector. Public
sector pay has still not rigidified. As to inflation, it
is true that the rise of the exchange rate produces a
price increase in the economy, but one must distinguish
between a non-recurring rise of the price level, and
increase at an inflationary pace, which depends on
linkage mechanisms and expectations deriving from the
budget deficit. To prevent the inflation rate from
increasing, a systematic approach must be taken, instead
of just relying on the monetary policy. There are issues
of wage creep and linkage mechanisms. The Bank of Israel
must be independent in the use of the tools available to
it, and my views on the need for the Bank's independence
are well known. But the government and the Bank must
reach agreement beforehand as to the inflation
target.
What else should the new government do?
"Capital market reform should also figure on the
government's agenda as a main item, although not
necessarily the first item. A whole series of capital
market issues need correcting - such as pension
arrangements and the government's commitment to the
yield on debentures held by the pension funds.
"Certain structural changes are however necessary.
The capital investments encouragement law must be
modified and the subsidy given by way of development
grants but be reduced. The most extreme example was the
grant to Intel for setting up a plant in Kiryat-Gat -
which is to say, in central Israel. I am not taking about
a cut-back in the support allowed to technological
hothouses, but of the law for the encouragement of
capital investments.
"The new government also has to cope with the big
deficits it is inheriting in several enterprises and
institutions such as the Military Industries, Rafael
(Israel Armaments Development Authority) and Israel
Aircraft Industries. Also, in the medium range, a reform
will be needed in the public service, jobs and roles must
be redefined. The principle of maintaining the same level
of payroll expenditure but dividing it among fewer
employees must be put into practice. The World Economic
Forum has published its rating of states based on indices
of competitiveness, government intervention and size of
government. We placed only 24th out of 46, and there are
some tiger states in Asia that are ahead of us.
Do we have grounds for declaring the shekel a
convertible currency?
"Technically, the shekel can be made convertible even
tomorrow morning. The question is whether all the
ingredients exist for ensuring the success of such a
move. This should obviously be a medium-range goal,
provided we reach sufficiently low levels of inflation
and attain a domestic system appropriate for that
reality. Today, I would not be in a hurry to implement
such a move".