Sharon’s second chance to salvage the economy

All democracies are in crisis because the political process has become too dominant, and governments have become too powerful and therefore corrupt. In Israel, where politics, or government, entirely dominate the economy, great fortunes are made mostly through government favor and political connections. The intensifying struggle over government grants radicalizes and brutalizes politics.

Sharon can change much of this – and save Israel from an impending economic crisis – by finally liberating the economy from political domination.

Sharon was aware that the economy was one of the great challenges facing Israel already in 2001 when in his inauguration speech he came out with the most surprising endorsement of an open competitive market economy (not Tuesday night, unfortunately). A former Mapainik (some say the last remaining one), with strong Statist proclivities, Sharon nevertheless promised in his speech to preserve price stability, to keep the government and its budget deficit in strict restraint to reduce taxes and encourage enterprise and growth.

Perhaps because he was so preoccupied with security, Sharon did not follow up on his bold economic promises. Despite strong misgivings by many knowledgeable parties he appointed Silvan Shalom as his finance minister, sacrificing prudent economic policy to political expediency. Had Sharon really understood the great political significance of economic growth -its salutary impact on employment and wages – he could still have exercised leadership and cajoled his reluctant Finance Minister to launch desperately needed reforms. Had he realized that our economic stagnation undermines both social stamina and national security, he would have allocated more of his attention to vital economic reforms, and not paid attention to the economy only when it faced a dangerous crisis.

It could have foreseen that the protracted low level war that the Palestinians were waging against Israel would not only cost the economy dearly in lost business and reduced productivity, but that it would also require increased resources to finance growing security expenditures. It is also obvious that an impending war with Iraq will cost Israel a mint. As the Prime Minister responsible for the overall performance of government Sharon needs devote more attention to crucial economic issues.

Competitive economic performance should greatly concern Sharon because the Israeli economy is heavily dependent on foreign trade (over half of our GNP is traded) and because consequently Israel has been hardest hit by the worldwide slump.

But competitive economic performance and growth cannot be achieved unless the role of government and of the huge, wasteful public sector can be drastically cut. They not only gobble up more than 55% of the GNP, but also impose on the economy unbearable costs through heavy-handed regulation and unnecessary interference. It takes on the average six years for any real estate project to go through the bureaucratic mills, increasing enormously costs of capital and implementation. Since construction is still an engine of growth in the Israeli economy – as the car industry used to be in America – getting it out of the slump was essential.

More ominously, Israel’s “goose that lays the golden eggs”, its high tech sector, has progressively laid much smaller eggs. Some of it simply shriveled as many firms migrated from Israel to where the costs of doing business are reasonable. The shrinking of high tech is only party due to the world slump. Much of it is the result of self-made Israeli obstacles in the forms of impossible incorporation laws and tax regulations that reduce the competitiveness of this industry (as government regulation generally does to Israeli industry). For over two years the government dilly-dallied with these problems because the Finance Minister and his tax mavens could not get their act together. Sharon needs to put his foot down and see to it that the problems are resolved, immediately.

Sharon should also take responsibility and insist that the government cut not only its excessive and dangerous budget deficits, but actually make deep cuts in its wasteful 70 billion dollar budget. Israel cannot afford such an immensely wasteful and obstructive government. Resources must also be shifted from the over 30% the budget now allocates to anti-productive transfer payments, that nullify the incentive to work, and moved to investments in infrastructure. Politically this is not easy, but as former Prime Minister Binyamin Netanyahu proved, where there is political courage a significant cut in the budget can be attained (indeed when he finally decided to put his foot down Sharon got his cuts too).

Political constrains have also prevented vitally needed reforms in financial markets, and the elimination of the stranglehold the Bank duolopoly has over financial intermediation. Credit is the lifeblood of an economy. Too much of it is being allocated by the bank oligarchy to cronies who have been using it for dangerously leveraged buyouts of privatized government assets. Such recklessness has not only threatened the banks’ solvency -too many eggs were put in too few baskets – but also increased the deplorable concentration of assets in the hands of a few families (over 44% of all assets are in the hands of only four entities) thus extending the reach of our lumbering monopolies and further curtailing competition. Monopolies exact a 30% to 50% “rent” on everything consumed, reducing the purchasing power of Israelis with meager salaries by about a half!

Discriminatory credit allocation has also inhibited the growth of small businesses, the engines of growth in the economy, especially in the Negev and the Galilee. The “periphery” cannot grow because it is credit starved which leads to ruinous unemployment.

High marginal taxes starting a very low income levels and amounting (with social security, health care taxes and VAT) to as much as 60% of income, have cut savings and reduced employment creating investments. The recent tax reform, constrained by the demand that it remain revenue neutral, namely preserve the government bloated income, has failed to lower taxes. In fact it may have increased them. What is needed is a basic reform that will cut government income and expenditures and leave more resources to job creating individual consumption and savings. Israel’s negative productivity growth will not be reversed until its Byzantine labor markets – fashioned by Socialist governments at the behest of the Histadrut – are finally reformed. Wages should reward productivity rather than featherbedding and idleness.

Last but not least, a drive must be launched for the total deregulation and the opening of Israel to foreign imports. Only this way can we have in a small economy enough efficiency generating competition, higher productivity and yes, higher and better employment. It will take much of Sharon’s “bulldozer” skills and political savvy to push such reforms. But if he will not meet these challenges it will be an economic crisis, not security threats that will undo him and his government. If he will, he will deservedly be crowned as Israel’s true savior.