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News Analysis: Experts Warn Israel Must Change Budget Process to Sustain Growth

September 29, 1999
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The captains of Israel’s economy this week told world economic leaders at the annual conference of the International Monetary Fund that Israel’s sluggish economy is set for a revival after a three-year slowdown.

Rosy government forecasts have been backed by a series of recent reports issued by leading financial analysts, who see Israel’s economy pulling out of the slowdown that has pushed unemployment up to nearly 9 percent since 1997.

But at the same time, some economic experts are warning that despite signs of an upturn, the prospects of Israel enjoying sustainable long-term growth are unlikely without a serious change in the composition of the budget and the political framework that creates it.

Speaking to the Ha’aretz daily newspaper from the Washington conference, Avraham Shochat, Israel’s finance minister, said he believes Israel has turned the corner.

“One cannot say for sure that we have already reached rapid growth,” Shohat said. “I feel that we’re passed the lowest point. It depends on a lot of factors but there are definitely positive indicators.”

Shohat said he believes the economy will grow at about 3 percent next year. Israel’s gross domestic product — the total amount of goods and services produced in an economy and a standard measure of economic growth — grew only about 2 percent in both 1997 and 1998, and a mere 0.3 percent during the first half of this year. In contrast, the gross domestic product grew at a rapid rate of about 6 percent a year during the mid-1990s.

Shohat’s optimism was confirmed by reports released last week by Salomon Smith Barney and Morgan Stanley Dean Witter, two leading investment banks, which argued that Israel’s credit ratings should be raised. These ratings are measures of an economy’s overall status and stability, and higher ratings can help a country raise funds at lower interest rates.

Both reports cited Prime Minister Ehud Barak’s recent election, and his determination to forge regional peace and to maintain stable economic policies. Salomon Smith Barney said Israel’s leaders have decided “that the country’s future lies in deeper and broader integration with the world economy” and praised the government’s “commitment to prudent economic policies and structural reforms.”

The reports were referring to the Israeli Cabinet’s decision to approve a budget for the year 2000 based on cuts of about $1.4 billion to projected spending for next year. This allayed fears that Shochat, who served as finance minister under the previous Labor-led government from 1992 to 1996, would continue his previous policy of high government spending, which fuels inflation.

However, when Knesset members and ministers return from their Sukkot vacations next week, the annual slugfest over the budget will promptly begin. The budget is scheduled to be raised for the first of three parliamentary readings by mid- October, and must be approved by year’s end.

This, say some critics, is the real problem. Even if the budget framework is reasonable, they say, political pressures prevent a distribution of funds to sectors that can give a boost to the economy and create jobs. The way to boost growth, they say, is not a matter of how much is spent, but how it is spent.

For example, government investment in public works projects such as roads and infrastructure is considered a key to economic revival.

Although the government has pledged to increase such spending, it is still unclear to what extent this will be reflected in the budget.

Pinchas Landau, a veteran Israeli economic commentator, said the current Israeli political system, in which every faction fights for funds without considering the bigger picture, has created a “warped and flawed” budget composition in which Israeli government expenditures will always rise — and in the wrong directions.

In a study published by the Israel Center for Social and Economic Progress, a liberal economic think tank, Landau argues that this trend means that despite the rosy reports in recent days, Israel will not reach sustainable long-term growth if the budget composition is not addressed by the government.

The study shows that while defense spending has steadily fallen, from 30 percent of the gross domestic product in 1980 to about 15 percent today, the overall level of government spending remains very high compared to most Western economies. This is because at the same time, welfare spending — also known as transfer payments — have climbed from about 20 percent of the gross domestic product to more than 30 percent. Meanwhile, to support perpetually high spending, the government is now considering levying new taxes — a move that also bodes ill for the prospects of reviving growth.

Although some welfare payments are important to address social problems such as poverty and unemployment, in many cases high welfare payments are not crucial, critics say. For example, the government provides child allowances often reaching hundreds of dollars to all Israeli families regardless of their income. During the recent budget talks, a proposal to scrap the payments for families with middle to high incomes was quickly shot down, indicating the political pressures even on moves to reduce welfare payments.

“Transfer payments have now become the biggest single item in the budget,” Landau said, noting that the rise of welfare spending parallels the rise of the fervently Orthodox Shas Party as a political force that depends on welfare spending to boost its power base.

In the long term, he said, this will be unsustainable: “Either it will just roll on until it blows up — and that is the more likely scenario — or there will be a change in the focus of the government.”

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