Editor’s Notes: Economic growth, or else

By David Horovitz April 18, 2008

The Israeli economy simply has to keep growing, insists Bank of Israel Governor Stanley Fischer. Why? Because otherwise we won’t have the resources necessary to defend ourselves

(With Sharon Wrobel)

Coming up on three years into his job as governor of the Bank of Israel, and with the 60th Independence Day around the corner, there was one theme that Stanley Fischer was patently at pains to emphasize when we interviewed him in his central bank offices recently: Come what may, the Israeli economy simply has to keep growing.

Yes, he acknowledged, Israel suffers from social inequalities. Yes, there is poverty here, notably in the haredi and Arab sectors. And there is a range of measures that can be followed in the short- and the long-run to try to grapple with this.

But not at the expense of growth. ‘I wouldn’t significantly hold back the economy and the growth of the leading sectors in the economy to deal with our large social gaps,’ he insisted.

Why? Because to summarize the thrust of Fischer’s argument, Israel is beset by ‘a substantial security challenge,’ and if the economy doesn’t grow, we won’t have the resources to meet it. ‘We have to grow fast because neighboring economies are also growing fast,’ he said bluntly, ‘and we have to be certain that we can maintain our relative strength.’

Economic growth is transformative, he argued. ‘Higher growth would change every aspect of life for everybody’ – from education to culture, through to our very survival. ‘That’s why I worry,’ he said, ‘that we may sometimes emphasize our serious current problems without focusing sufficiently on the need to maintain economic growth.’

Fischer, who is 64, was born and grew up in what was then Rhodesia and is now Zambia. He said he had always contemplated making aliya, and very nearly did so in 1974, when the Hebrew University narrowly lost out on his services to MIT, one of his alma maters.

From there, in 1988, he went to the World Bank, as vice president and chief economist. Then he was deputy managing director of the International Monetary Fund from September 1994 to August 2001. He was finally wooed to Israel, to the Bank of Israel, during Binyamin Netanyahu’s term as finance minister, after three years at Citigroup.

He garnered immediate appreciation for insisting on speaking Hebrew from the start, and gradual, growing respect for his astute stewardship. The public knows that he didn’t take the job for personal gain; the international community knows that Israel has a stable, responsible central bank chief.

Within the bank, too, Fischer has been effective, pushing to carry out a number of reforms, streamlining operations, trimming staff and salaries and reaching a wage agreement with the workers’ union.

When his term is over, he hopes to stay in Israel for good. And it is good here, he made clear.

‘When I was chief economist of the World Bank in the late ’80s, quite involved in the Israeli economy,’ he recalled, ‘one of the rating agencies gave Israel a ridiculously low rating. I got in touch with them and asked why. Their best argument was that Israel might get into a war. I said, ‘Do you know how many wars Israel has been through? Did the government ever fail to make a debt payment? Did the economy ever stop working?” Presumably the agency in question, chastened, reconsidered its decision.

Sounding almost paternal, he went on, ‘Israelis, and with them the Israeli economy, have lived through a lot. And here we are, with a thriving economy.’

True, it’s not an economy at the per capita level of the United States, Germany or France, he acknowledged. But it is at the level of the less wealthy European countries, ‘despite a defense budget that is [relatively speaking] five times larger.’

And if Israel can weather the current global slowdown, maintain its budgetary discipline and keep its best brains here, he stressed, the potential for further growth is immense.

How concerned are you by the widening haves and have- nots divide – people even employed in serious jobs who cannot get through the month?

The increase in social gaps is virtually a global phenomenon… Research in the US has led to the conclusion that it’s primarily a change in the nature of technology. The rewards to people who have skills are much higher than they used to be and it’s a problem that everybody is struggling with…

Relative poverty is a serious social issue; it’s also a very complicated social issue.

The poverty is concentrated in two populations, haredim and Arabs… Poverty among these two groups has gone up enormously in the past decade, from between 35 and 40 percent to 60%. In each group, labor force participation is low: among the haredim, only a small proportion of the men work; among the Arab population, the participation rate of women is very low. This means that these groups have less opportunity to increase their incomes as the economy grows.

[Another complicating factor] is summarized by a statement I heard at one Herzliya conference: ‘If we want to get rid of poverty in this country we should close the hi-tech sector.’ Why? Because poverty in Israel is a measure of inequality; it’s people who are below half the median income. You can reduce the top incomes by getting rid of the parts that are prospering, and quite likely you’ll reduce the relative poverty rate.

The moment you say that, you realize there are certain ways we won’t be willing to try to reduce poverty. So that pushes you to longer term policies to help increase the incomes of lower income groups and reduce social gaps, primarily improving the quality of education, and other structural reforms that we all talk about, including infrastructure, improving the efficiency of government, and so on.

In the near term, we need to encourage those who can work to do so – and we also need to help those who work to receive a reasonable income, which is where the negative income tax comes in. Then there are some groups, particularly the elderly and others who cannot work, who should probably receive larger transfer payments – a process that is already under way for the elderly…

We have to try to reduce poverty in Israel. But I wouldn’t significantly hold back the economy and the growth of the leading sectors in the economy to deal with our large social gaps.

The solution is to try to raise the standard of living in the lower sectors, not to reduce the standard of living in the higher sectors.

Well, of course.

It’s not an ‘of course.’ Consider proposals to [more heavily] tax higher income earners. That would probably reduce the after tax social gaps – and it would also probably reduce the number of people doing well who want to live in Israel, including in the hi-tech sector.

So you oppose imposing any further burden on the highest earners?

We might have to do that in a national emergency. But if you are going to impose a higher burden on taxpayers, you had better understand what you’re doing, why, and what the consequences are likely to be.

Give us your overview of the key challenges facing the economy.

The long run situation is that our economy needs to grow at a significant rate over a long period of time. A significant rate is one that will take us closer to the standards of living in Western Europe within one to two decades, say a growth rate of at least 5%, preferably 6% or more. We are already at the standard of living of countries like Greece and Portugal and our income level is close to that of Spain. We’re not a poor country, but we’re far from our potential. We have many social problems, but we also have a remarkable mixture of people in this country – highly talented, highly educated people, excellent entrepreneurs, lots of people with tremendous ideas, and a skilled labor force.

With the right policies, and the right security situation, we can grow. We did very well for the last four years, with growth at above 5% a year… And we can reach the income levels of the advanced Western European countries within a little over a decade if we have the right conditions, including relative peace and security.

Why do we need to do that? Because we can all have a better life if the average level of income rises substantially: We’ll be able to deal better with poverty and its many manifestations, with the need to educate our people better, to spend more on health and the environment, and to deal with the other problems in our country that are susceptible to being treated through the budget.

Not least, we need our economy to grow because we face a substantial security challenge: We have to be able to pay the unfortunately high price that it costs us to defend ourselves.

We have to grow fast because neighboring economies are also growing fast, and we have to be certain that we can maintain our relative strength.

If we can make progress towards peace with our neighbors, the price of defending ourselves will gradually fall to a level closer to that paid by other countries, and one day we will even have a peace dividend.

We need the economy to grow fast also because the issues of emigration from Israel and immigration to Israel are extremely important. People educated in this country can go anywhere. And the unfortunate fact is that many of the highly skilled are going elsewhere. Dan Ben-David at Tel Aviv University has published interesting and worrying work on this issue. We’ve got to reverse the brain drain trend if we are to continue to thrive, and to do that we have to invest more in the human capital that is virtually our only natural resource. That means investing more in the educational system, which will help both reduce poverty and encourage growth.

Of course, it’s not just a matter of money. We need to undertake reforms in the educational system as well. As we’ve seen with the reception the Shochat Committee report received, that will not be easy. But it’s essential…

Keeping the emphasis on growth is appropriate, but it’s hard, because the government operates under enormous pressure to deal generously and immediately with a host of problems. Nonetheless, the Israeli government has succeeded in keeping budget discipline at least since the middle of 2003…

What the economy cannot afford now is to let the budget get out of control; we will pay a high price in terms of higher interest rates and a loss of confidence in the economy and its management if we do that…

We cannot afford to let the debt to GDP ratio rise. People kept saying in the past couple of years, ‘We’re growing so nicely, why shouldn’t we spend the extra tax receipts, why do you want to reduce the debt?’ Precisely to avoid the situation we’re now in.

The situation we’re in now is one in which we cannot use fiscal policy to deal with the growth slowdown that is on the horizon. Why? Because our debt to GDP ratio is 80%, well above acceptable standards. If we increase the budget deficit now – other than because tax receipts decline and transfer payments go up, the so-called automatic stabilizers – we’ll start adding excessively to the debt and we’ll put ourselves in a position where instead of the debt declining to an internationally acceptable level, we’d be back in a very serious situation with a higher debt and higher interest rates, with diminished capacity to borrow – like the situation in 2003.

In 2003 we asked the US government to provide guarantees of our international borrowing. In the meantime our debt rating has gone up, and it would be a real setback if we were to end up again having to ask for US guarantees. We need another five or six years of growth and strong budgets until we can get our debt ratio to be low enough so that we can be like other countries that get into a recession and can use an active budgetary policy to help stabilize the economy.

The exporters understand what they have to do. With the dollar weakening worldwide, and with the US economy slowing, exporting to the US is much more difficult than it was. However the shekel has not strengthened by much against the euro, and so exporting to Europe should be more attractive than exporting to the US – and everyone is aware that the Asian economies are growing rapidly. So the exporters have to reorient in the directions of Europe and Asia, without forgetting that the US will continue to be a huge market, and that recovery will start there this year or next.

We see from the data that the exporters are already shifting the direction of their exports, which is encouraging. The more difficult question is whether the political system will withstand the pressures to spend that it is likely to face.

Can you factor in the potential developments vis–vis Iran, with regards to the Israeli economy – in terms of oil markets and other economic implications?

There’s an ongoing global effort to impose economic sanctions on Iran, which are clearly having an impact on the Iranian economy. But high oil prices help the Iranian government withstand both the impact of the sanctions and their own economic mismanagement.

The shekel has been gaining ground as a strong and stable currency compared to many years ago. But prices such as apartment rentals are still fixed in dollars. Is this changing?

It’s clearly changing. We see it in the data on the percentage of new rental contracts denominated in dollars, which dropped from about 85% in 2007 to around 50% now. This is a very good thing overall because until now our monetary policy has had to be related to the behavior of the exchange rate. Because important prices were quoted in dollars (not only housing, but also the fees of lawyers and accountants, and catering), every time the exchange rate changed, the inflation rate changed. Because we target inflation, we had to react very rapidly to changes in the exchange rate. We were one of the countries whose inflation was most, and most rapidly, affected by what happened to the exchange rate…

However rapidly we grow, we’ll always be a relatively small economy. We’re seven million people. Our GDP is a bit above 1% that of the United States economy today. If we get to grow very rapidly, we’ll be 2%. So we’ll never be independent of economic developments in the rest of the world.

But as regards the weakening of the link between the exchange rate and prices in Israel, that process is ongoing. The fact is that the value of the shekel is far more stable in terms of what Israelis buy than is the dollar. It’s not very logical to fix prices in dollars. I expect the process to continue, to the point where relatively few prices will be quoted in foreign currencies.

Why, despite all the regional challenges, does our stock market soar?

Our market is behaving very much like global stock markets. The Tel Aviv 100 was at around 1,200 some months ago, and it’s now around 1,000. Our price-earnings ratios are in fact lower than those abroad – the stock price relative to the earnings – which indicates that there is a risk factor in Israeli stocks, although not a big one…

The fact is that we have a surplus in the balance of payments, that we have a balanced budget, that we’ve been growing fast, that inflation is basically under control,… and this is after a very tough period, with the second intifada and the deep recession of 2001-2003.

I don’t want to be complacent. The economy can grow even in the absence of peace. But we could grow significantly better if we did have peace. We’ve been growing at 5%. We could have been growing at 6% or more. And higher growth would change every aspect of life for everybody. Economic growth is more than material well- being, it can also support education, culture, society, the reduction of social gaps, human relations.


Yes, it’s also about long-term survival…

How bad have you found corruption to be in public administration here?

There are a lot of things going on that are very questionable. You read about them in the newspapers, and unfortunately many of the accusations turn out to be true. But there is also an unfortunate tendency for accusations of corruption to leak into the newspapers long before the evidence has been developed. I guess that the ratio of corruption accusations to convictions must be lower in Israel than in most countries – and that’s not because the Justice Ministry or the courts forgive cases of corruption. It’s because sometimes the accusations that hit the media with a great amount of noise aren’t borne out. These unfounded charges and the attendant publicity damage our reputation.

The prospect of a global recession following the subprime mortgage crisis is worrying. How will Israel be affected?

The world economy will keep growing. China and India will both grow at rates that are the envy of the rest of the world. Europe is expected to grow. We will grow. We’ll have a slowdown in global growth that will impact us. But if the political system keeps its nerve, if the Bank of Israel keeps its nerve, if our businessmen keep their nerves and consumers do the same, we can grow at a reasonable rate.

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