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Land of Economic Miracles

11:50 AM, Apr 22, 2013 • By DANIEL DORON
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Israel is facing numerous security threats, and yet the country’s most recent round of elections in January focused not on security but on the need to reform a dysfunctional economy and liberate the enterprising spirit of a nation that boasts more startups than Europe. Paradoxically, it was the success of Prime Minister Benjamin Netanyahu in stopping West Bank terrorism that gave Israelis the respite to finally tackle economic issues. Nonetheless, Netanyahu's party, Likud, lost about 25 percent of its voters because of the perception that it had failed to advance necessary reforms.

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The election’s big winners were two parties committed to economic reform: the new, middle class, mostly secular "Yesh Atid" (We Have a Future) led by the charismatic Yair Lapid, and the reconstituted observant and patriotic party, "Habayit Hayehudi" (the Jewish Home), led by the successful high-tech entrepreneur, and former Netanyahu chief of staff, Naftali Bennett. Lapid was named finance minister and Bennett now heads the Ministry of the Economy and Trade, which until now mostly assisted Israeli monopolies under the pretext of protecting Israeli jobs. If they manage to coordinate efforts, and get Netanyahu's backing, they can finally enable Israel's economy to realize its enormous potential.

Israel’s politically dominated economy, shaped by decades of Socialism and statism, had created an unholy alliance between politicians, top bureaucrats, and a few highly leveraged, pyramid-structured monopolies owned by about a dozen or so tycoons. The big banks massively misallocated credit, erected entry barriers that choked competition and generally lowered efficiency. The heavy monopoly rents inflated costs and prices and badly distorted Israel's capital, labor, and real estate markets.

Consequently most Israeli workers earn a relatively low $1,200 a month, while most goods and services are costlier than in the U.S. Israelis pay eleven years of salary to buy a small apartment. A medium sized family car costs the equivalent of a Lexus in the U.S.

Most grating is the fact that while most Israelis barely make ends meet, a few rapacious oligarchs have become ostentatious billionaires, and their large army of facilitators, political operators, managers, lawyers, accountants, journalists, and PR people live in clover.

This wide income gap ignited the massive social protests of the summer of 2011. When leftist activists, heavily funded by the New Israel Fund, and supported by the media, attempted to take over the protests and demanded a return to socialism and the resignation of Netanyahu and his “capitalist” government, most Israelis rejected it and the demonstrations petered out. In the ensuing elections, most Israelis supported parties advocating less government interference.

Attempts by the Bank of Israel and Netanyahu to dismantle the pyramid structured monopolies and the tycoons' hold on financial institution and credit allocation have been so far stymied by protectionist Knesset members, bureaucrats and regulators. While conceding that the dangerously leveraged pyramids pose a great risk to the economy and have already cost Israeli savers billions of Shekels in losses, their putative solutions preserve the status quo.

Netanyahu’s new government, especially Finance Minister Lapid and Economic and Commerce Minister Bennett, faces overwhelming challenges. Lapid must cut 14 billion shekels from a profligate 280 billion government budget. The temptation will be to symbolically cut some outrageous expenses, and then raise taxes on citizens who are already taxed by nearly 37 percent of GNP. But raising taxes just to finance highly wasteful government expenditures will undermine growth. Instead, Bennett and Lapid should launch a bold, growth-stimulating initiative that deregulates small enterprises, grants them access to credit now unavailable and frees them from a tax system that treats small businessmen as cheats even while it allows big business to pay very little taxes.

Lapid and Bennett could borrow a page from Netanyahu's 2005 successful financial market reforms that broke the Ha'Poalim-Le'umi bank duopoly which had misallocated credit so badly to loss-making cronies that for at least a decade, the Israeli economy did not grow. That reform propelled a dramatic five-year 5 percent growth rate and saw the public's assets double.

Similarly now, Lapid and Bennett’s task is to stop the government from repressing enterprise. The economic future of Israel now rests in the hands of two serious, bright politicians. They will need strong support from an overburdened prime minister. His ability to give them support and encouragement, and their ability to master in a short time, how to navigate the treacherous shoals of Israeli politics, despite their lack of experience, will determine whether they will succeed in fulfilling the most difficult and complex mission of liberating Israel's economy.

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