The Blog

Israel at a Crossroads

Economic reform is in Sharon's hands.

12:00 AM, Oct 7, 2004 • By DANIEL DORON
Widget tooltip
Single Page Print Larger Text Smaller Text Alerts

ISRAELIS RECENTLY OBSERVED the 31st anniversary of the 1973 Yom Kippur war. This anniversary is made much of, because Israel's near defeat revealed some basic flaws in its system of governance. The debates about these flaws are still going on, gradually transforming Israeli society in profound and painful ways.

In that war, Ariel Sharon, then a division commander, played a critical role. Many believe he saved Israel from ruin.

In 1973 Israel was simultaneously attacked by overwhelming Soviet-trained and equipped Egyptian and Syrian forces. Its tank corps and air force, the two pillars of its military superiority, were virtually neutralized. If not for the personal bravery of Israel's middle rank and file, who literally stopped the enemy with their bodies, the surprise could have turned into a rout. Most of Israel's top political and military leaders were so confused and depressed by the war's initial setbacks they were virtually paralyzed.

Not the cool-headed Sharon. In a daring and risky move, he had his tattered, relatively small force cross the Suez Canal. They outflanked much larger Egyptian forces, and eventually forced them to sue for a ceasefire.

Sharon is faced now with a similarly consequential peacetime decision. He has to decide whether to throw his weight behind a bold economic reform plan elaborated by his finance minister, Benjamin Netanyahu, or let it languish. It is a reform--especially of financial markets--that far transcends its concrete objectives. It might mark Israel's crossing of a Rubicon, from a centralized, government-dominated, and monopoly-ridden dysfunctional economy to an efficient, competitive market system that allows Israelis to fulfill their enormous potential.

It is certainly not as dramatic a decision as that taken during a crucial battle. Still, it is a decision that will affect Israelis' future no less than a victory in war. For Israel, economic growth is not merely about a better standard of living, but about survival. Israel cannot hope to keep its young at home for long on the measly $1,200 a month salary most Israelis earn (while prices for most consumer goods and services are higher than in the United States); nor will Israel be able to foot its spiraling defense costs (and a strong army will always be required) if its economy keeps lagging.

There are many reasons why the Israeli economy under-performs so badly. Neither Israel's manpower resources, nor its land, nor its capital, is deployed in an economically sound manner. The failure of Israel's financial intermediation sector to generate productive investments is, however, most glaring of all.

Israeli banks are even more concentrated and monopolistic than their notorious Japanese counterparts. They too have tentacles reaching into every sector of the economy, and symbiotic relationships with government bureaucracies (many top bank managers are former high government officials) and with the interlocking monopolies that dominate Israel's economy. This gives the banks tremendous political clout, which they enhance by giving loans to political parties and members of the Knesset and by deploying an army of lobbyists.

The banks have become the linchpin of a culture of cronyism perpetuating Israel's Socialist and statist heritage. Through government-granted tax privileges, the banks have come to control over 80 percent of Israeli savings. They lend 70 percent of their loans to 1 percent of borrowers, who are their partners and cronies. These non-recourse subsidized loans, not covered by adequate collateral, were spent on highly speculative and leveraged investments in entertainment ventures (cable TV and such) and shopping malls, most of which flopped. The banks now admit that they carry $13.6 billion in "problematic" loans (their capital base is only $10 billion). This has forced them to curtail their lending, creating a dangerous credit crunch that nearly plunged Israel into an Argentine-like crisis a year and a half ago.

The banks make up their heavy losses on loans by gouging Israeli households and small businesses. They charge hundreds of commissions and exact usurious rates on the overdrafts of struggling families. The spread between the exorbitant rates charged on household loans and the interest paid on savings (some 5 percentage points) is a major source of profit for the bank monopoly. Low interest on savings also results in a huge wealth transfer from productive Israelis to the 16 or so families and entities that control the banks and most assets in Israel. As for small businesses, in the last two years alone, 75,000 of them folded up, many for lack of credit. Many thousands more never took off because getting a start-up loan from a bank was mission impossible.