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Israel at a Crossroads

Economic reform is in Sharon's hands.

12:00 AM, Oct 7, 2004 • By DANIEL DORON
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The squandering of 20 years' worth of savings by the banks and the subsequent credit crunch is probably the main reason for the lack of growth in Israeli per capita productivity in the last decade (a better indicator of growth than GNP, which also reflects non-productive and even anti-productive activities of the government and of Israel's many interlocking monopolies). Recently, the trend has been downward.

But this is only one of the disasters that a distorted banking system has inflicted on Israel. Since the 1980s, when the bankers were caught massively manipulating their own shares--and had to be bailed out by the government (costing the economy $7 billion in direct, and many more billions in collateral, damage)--Israeli bankers have engaged in adventurous practices that brought them to the brink of bankruptcy at least twice more. Each time, their adventurism and irresponsibility cost the Israeli taxpayer billions.

Their failure to generate productive investment may also account for Israel's massive unemployment--with all its attendant social ills, including the mushrooming of the government deficit caused by skyrocketing transfer payments, which now make up over a third of the $60 billion plus budget. Self-inflicted economic hardships that come on top of a very difficult security environment are a major cause of the despondency plaguing so many Israelis.

Over 20 years ago, the famous Beijsky commission recommended breaking up the banks' monopoly by forcing them to sell their holdings in provident and mutual funds that now amount to 21 percent of all savings. These holdings cause severe conflicts of interest, since the banks habitually sell the funds they control shares in companies they float (the banks also act as underwriters) at exorbitant prices. (This may be one reason the bank-owned funds have an average yield of 4.5 percent, far below that of privately-held funds.)

Essentially the same steps have apparently been recommended by the Bachar treasury task force appointed recently by Finance Minister Netanyahu. Yet for over two decades the bankers managed to frustrate reform by using their political clout to preserve their stranglehold over the Israeli economy. They are now mounting a huge effort, costing millions, to nix the current treasury recommendations.

Netanyahu is virtually alone among Israeli leaders in understanding economics. He also realizes the enormous damage, counted in the many billions of dollars annually, that monopolies generally, and the bank duopoly in particular, inflict on the Israeli economy. Netanyahu is the first politician to tackle Israel's powerful monopolies, chief among them the Histadrut, the Labor Federation that mainly serves the interests of the public monopoly unions in the electricity, water, transportation, and energy industries and the banking unions. All these sectors suffer from featherbedding, nepotism, corruption, low productivity, and salaries three to four times the national average. The Histadrut never hesitates to call a general strike to protect the interests of privileged monopoly union workers, even when it comes at the expense of all other workers.

Netanyahu's struggle with the Histadrut is just beginning, yet he simultaneously took on the powerful bank monopoly. True, the solution his task force recommends is not the classical liberal prescription: trust market forces to establish competition and break up undue market domination. That is because, in Israel, the concentration of economic power in the hands of extremely few entities, and the enormous political power this grants them, is such that government intervention is required to correct a political "market failure" (created, of course by government). Government must break the banks' domination of financial markets before competition can do its work.

The reform program must be presented to the cabinet for approval before being made public. Sharon has not yet presented it, though it was scheduled for presentation a few weeks ago. Undoubtedly, Sharon will eventually support the reform. He must know that the Israeli government has committed itself to this and other reforms, as well as to budgetary restraints, as a condition for receiving U.S. loan guarantees. The question is when and how.

Sharon has known in the past how to handle complex situations by keeping his eye on the target. It will be tragic if at this crucial stage he lets extraneous considerations defeat a reform plan that may turn out to be the greatest achievement of his government. For if this reform were to bring about the liberation of Israelis from their disabling economic system from a system that has enslaved and impoverished a talented and energetic people and kept it from realizing its enormous potential--it will indeed become his crowning achievement.