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2010 Annual Assessment

There still exist several considerable risk factors regarding continued growth and its contribution to Israeli national resilience.

  1. The global economic situation and its effect on exports. Indeed, Israeli high-tech has almost returned to the level of activity before the crisis, but it is not insulated from the local and global economy and as such, the expected rate of growth in exports is expected to steeply decline in 2011, as mentioned above. On the other hand, the financial crisis has severely harmed the funding sources of Israeli high-tech research and development, which threatens the growth of this sector.
  2. The security situation. Peace talks between Israel and the Palestinians are currently in crisis. In order to reach rates of growth that will close the gap between Israel and the most developed countries, peace, which will permit the reduction of the burden of security on the economy, is required. Moving away from peace does not bode well for the economy. Also, war or an intifada involve financial risk which can hurt the economy, just like in the Second Intifada (although in the Second Lebanon War this risk was not realized).12
  3. The political situation. Political isolation of Israel can turn into economic isolation. This is, apparently, a long-term threat, since currently the trend is opposite, as evident in Israel becoming a member of the OECD.
  4. The structural problems of the foreign currency market. Since its inception, Israel has suffered from a chronic lack of foreign currency. In the past few years this trend has reversed itself: exports are growing faster than imports and there is a surplus in the current BOP. This surplus creates pressure for a revaluation of the Shekel. Due to home bias (the preference of investing in the local capital market), this surplus does not find its way abroad in the form of investments of the institutional bodies. This preference is strengthened by the good performance of the local market in recent years. Therefore, there is concern that the blessing will turn into a curse, since continued growth depends on the leading sector, which is exports, which, in turn, requires a comfortable rate of exchange. The probability of a significant increase in foreign currency savings due to the offshore natural gas discoveries greatly aggravates this problem. The Bank of Israel cannot continue to buy foreign currency without limit, and therefore a government-sponsored fund must be established, which will invest the surplus abroad to the benefit of the younger generations. Recently, it has been reported that the government is indeed examining the possibility of establishing a fund for government investment abroad in which part of the income from the natural gas discoveries will be invested.
  5. Government functioning. The Carmel conflagration at the end of 2010 focused public attention on this structural problem, which constitutes a long-term risk for growth. The fire showed that the government is sometimes incapable of dealing with long-term issues, although the need was clear and there were government decisions concerning this matter. The dysfunction of the government in matters such as the firefighting service is also a security problem, as it is estimated that in the next war the home front will be attacked by thousands of missiles.
  6. Structural problems. The structural problems of the Israeli economy have been discussed for years without any actual improvement. The OECD report notes many of them: the education system – elementary and secondary schools as well as the university level – is in crisis; transportation and water infrastructure have fallen behind; and the electrical infrastructure is also at risk due to the inadequate capital structure of the Israel Electric Corporation. There are massive gaps, which include the lack of integration of Arabs and the ultra-Orthodox in the economy; housing prices have risen by 40% in the past two years and have made housing for young couples extremely difficult to attain; and a decrease in perceptions of personal security due to insufficient policing.
  7. The final two items, 5 and 6 are related. Economic growth permits allocation of resources to these issues, although this has not happened in the past few years owing to the government’s inability to deal with them.

The decline of the public sector and the problem in government functioning

The weakening of the public sector is a strategic threat to Israeli society. A society that is at peace and does not have enemies on its borders can allow itself to weaken the government’s ability to act in an organized manner at all levels, from the central government to the local government. This is the situation in the United States, Britain, and Europe. But in adopting American and British approaches, one must take into account the country’s unique geopolitical situation.

The root of the problem seems to be that the Israel governmental process has increasingly shown itself as being incapable of weighing costs and benefits across several dimensions effectively and within both the short and long-term time frames. This problem is systemic, having to do with the structures of government but also is a reflection of the changing needs of Israel as it grows and is transformed, and occurs within most if not all of the major institutions of the Israeli governing system. When dealing with an issue of sufficient complexity that it requires a cross-agency process and response, the entire system enters paralysis. Crucial decisions are put off for decades, or are hastily taken on an ad hoc basis, or even, too often, both. In response to this paralysis, the Budget office of the Ministry of Finance takes over the decision making power and makes decisions concerning the entire governmental system.13 Naturally, it makes those decisions based upon its point of view and perspective which is that of reducing the role of government in the economy, balancing the budget, cutting taxes, removing barriers to competition, including in the labor market and in the export and import markets, and so on.

The failure to deal with the large fire in the Carmel in December 2010 exemplifies the problem. In the absence of a set procedure for implementing cross agency decisions, the attempt to implement reforms in the firefighting service turned into a standoff between the firefighters and the Ministry of Finance, with the firefighters demanding large improvements in their pay and benefits in exchange for giving up the right to strike and the Finance Ministry withholding all funding for expanding and improving the firefighting service until the personnel issue had been resolved. Similar standoffs occurred in regard to the prosecutors’ strike and the strike in the Foreign Ministry. The prosecutors’ strike caused severe damage including the release from custody of those accused of severe crimes, among other reasons, because the Ministry of Finance refused to even talk to the strikers. The strike in the Foreign Ministry caused damage to foreign policy, brought about the cancellation of the visit of the President Medvedev of Russia and caused disruption in the provision of consular services to citizens.

In this connection, it is of note that two former senior officials of the Bank of Israel, Prof. Ben Bassat and Dr. Momi Dahan wrote a book for the Israel Democracy Institute (Ben Bassat & Dahan, 2006) in which they detail the need to decrease the elaborate control that the Ministry of Finance has over the government. They explain the technique through which the Ministry of Finance has taken over the entire civil service, including the prime minister’s role in this process, and they suggest strengthening the Economic Council in the Prime Minister’s Office so that it will constitute a counterweight to the Budget Department in the Ministry of Finance during preparation of the national budget.