Israel in 2015: Admirably Steady, Worryingly Stale

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If a Martian economist were to land in Tel Aviv tomorrow, and were presented with Israel’s macroeconomic data for the past several years, the alien visitor would be hard pressed to identify any signs of major disruption during 2014.

Certainly, many individual Israelis had their lives disrupted for six weeks in July and August by the latest eruption of large-scale hostilities in and around the Gaza Strip. More broadly, the impact of that mini-war on the Israeli economy can be seen reflected in the weak overall data for the third quarter and the ongoing weakness in a few specific sectors, of which tourism is the most important. But in the larger scheme of things, Operation Protective Edge left no significant mark on the Israeli economy, which has continued along a path of stability and moderate growth.

This assessment, already widely shared, received official imprimatur on December 29 with the release of an updated economic forecast from the research department of Israel’s central bank. Whereas the previous quarterly forecast, issued in late September, could only guesstimate the impact of the summer’s fighting, by year’s end, the relevant data was mostly available and a more definitive conclusion was possible.

“Operation Protective Edge … reduced annual GDP by 0.3% in our estimation, primarily via its impact on tourism and private consumption,” the forecast said. The analysis goes on to say that the lost output will be largely offset by relatively faster growth in subsequent quarters, starting with the final quarter of 2014 (for which data is not yet available).

Meanwhile, there have been dramatic developments in the global economy that, the Bank of Israel predicted, will have a net positive effect on the Israeli economy. Although growth in Europe and Japan is slowing, U.S. economic growth continues to accelerate and international trade is set to expand further next year. But of much greater import is the ongoing sharp drop in energy prices, which analysts say will boost both global and Israeli growth in 2015.

“We can get back to 3%, and thus get out of slowdown territory. But we can’t get meaningfully beyond 3% per annum without structural reforms.”–Avi Temkin

Goldilocks and the 3% GDP Growth Rate

All these factors lead the Bank of Israel’s economists to present a Goldilocks scenario for the Israeli economy. GDP growth will rise from the 2.5% expected for 2014 by Israel’s Central Bureau of Statistics to 3.2% in 2015, and will ease to 3% the following year. This will be supported by a steady rate of increase in private consumption, of around 3.3% per annum, while the key drivers of overall expansion will be stronger growth in both investments and exports.

This growth will help keep unemployment below 6% in the next two years, the central bank forecast predicted, despite an ongoing expansion of the labor force, while inflation — ostensibly the primary concern of the central bank and its direct responsibility — will recover from a negative level in 2014, estimated at -0.2%, to more than 1% in 2015 and 2% in 2016. These levels are significant, given the central bank’s target range of 1% to 3% per annum increases in inflation: The forecast conveniently sees inflation re-entering the target range in 2015, before hitting a sweet spot in the middle of that range in 2016.

This outlook, the bank admitted, is far more optimistic than those of private sector forecasters, or the expected rate of inflation as reflected by the price differentials between index-linked and unlinked government bonds. But the bank bases its inflation predictions on the calculation that the rapid devaluation of the Israeli shekel that occurred during the second half of 2014 will — if it is not eroded — generate higher inflation next year and thereby offset the disinflationary impact of price cuts in electricity, water and, of course, gasoline that will take effect in January and filter through the economy in subsequent months.

Nice outlook, if you can get it — and it’s certainly one that many European countries would love to emulate. Yet what is interesting in the domestic Israeli context is that although independent economists largely accept the picture the central bank presents, they view its meaning from totally different perspectives.

GDP Growth and Population Growth

Avi Temkin, senior economic commentator at Globes, Israel’s leading business daily, rejects the common tendency among Israeli economists to simply compare Israel’s GDP growth numbers with those of Europe and bask in the glow of apparently higher achievement. Instead he focuses on GDP growth per capita, because Israel’s population is experiencing population growth of some 2% per year, far more than almost all European countries — some of which are actually shrinking.

“I have two lines, in terms of GDP growth,” Temkin says. “The first line is the 3% per annum level, with anything below that representing a sluggish economy. The second is at the 2% level — anything below that means the economy is effectively in a recession — because growth per capita is negative.” Given this framework, Temkin regards the economy’s performance in 2014 and much of 2013 as anomalous, or at least unusual, because “we have been stuck in the band between 2% and 3% growth and this is rare. Normally, the economy passes through this band quickly, on its way up or down.”

While he agrees with the Bank of Israel that export-led growth — which the data shows began in the latter part of 2014 — is leading overall GDP growth back toward the 3% level, Temkin does not share the central bank’s apparent satisfaction at that prospect. “We can get back to 3%, and thus get out of slowdown territory. But we can’t get meaningfully beyond 3% per annum without structural reforms.”

“These governments deserve credit for not ruining the positive trends at work, but no more than that.”Zvi Eckstein

In other words, the point at which Temkin and some other economists, in and outside of academia, part ways with the official (rather smug) line is in how they relate to 3% growth. Is it good news, because other countries can’t get there? Or bad news because Israel could in theory do much better? And if it can do better, what is preventing it?

Zvi Eckstein has viewed economic policy from both sides, as one of the country’s leading academic economists and as a senior policymaker, serving as deputy governor of the Bank of Israel from 2006 to 2011. Today, back in academia as dean of the Arison Business School at the Interdisciplinary Center Herzliya, he has become a sharp critic of many aspects of government policy.

Nevertheless, when asked to review the state of the economy, Eckstein, a visiting finance professor at Wharton, started from the consensus position by noting that “the key data are good.” Unlike many of his peers, he even had some kind words about the nation’s fiscal policy: The 2014 budget is ending with a reasonable deficit, and the proposed budget for 2015 — which was killed when the government fell in December and the country geared up for general election in mid-March — was also built around a reasonable deficit target, he says.

Labor Market Scores

A key component of Israel’s economic success over the past decade, Eckstein notes, has been the performance of the labor market: Israel has been “one of the only developed economies in which the rate of employment among the key working-age cohort of 25- to 54-year-olds has risen consistently.” Precisely because of this long-term perspective, he refuses to award the credit for this achievement to the outgoing government, which took office in April 2013, or even to its predecessor, also led by Benjamin Netanyahu, which held office for the four previous years.

“These governments deserve credit for not ruining the positive trends at work, but no more than that.  Twitter They did not initiate these trends, which go back 10 years to the major reforms instituted in 2003-2005,” Eckstein says. Those were the years when Netanyahu served as finance minister in a government led by the late Ariel Sharon — but Eckstein notes that it was Sharon who set the tone, while Netanyahu enthusiastically followed up with the implementation of the key policy ideas.

In any event, Eckstein sees the achievements of recent years as still stemming from the impact of those reforms, which led to a sharp increase in labor force participation, especially among two population groups hitherto characterized by very low employment rates: ultra-Orthodox men and Arab-Israeli women. The potential of these reforms is not yet exhausted, as the continuing expansion of the labor force shows, he adds.

But the momentum has flagged and the economy is now in dire need of additional structural reforms. Eckstein and Temkin, despite their different vantage points, concur that an absence of such reforms is holding Israel back from the higher levels of growth it is capable of achieving — and that it actually achieved from 2004 through 2011, with only a minor hiccup in 2009 due to the impact of the global recession.

“We are witnessing a growing crisis of confidence on the part of the general public vis-à-vis the political system as a whole.”–Avi Temkin

Eckstein calls the performance of Prime Minister Netanyahu “a total failure in promoting new initiatives, he and his people love to talk, but don’t get things done,” as well as that of outgoing Finance Minister Yair Lapid, whose secular center-left Yesh Atid party was the sensation of the previous elections. Eckstein was one of Lapid’s advisers in that period, but now says that Lapid has stopped listening to mainstream economists and, more generally, has not brought any important new ideas to the economic policy debate. Instead, he and Netanyahu are competing to scatter populist promises that, if implemented, would cause harm, Eckstein notes.

What needs to be done? Eckstein emphasizes that the labor market needs further attention, with the aim of not merely increasing the number of employed Haredim (ultra-Orthodox Jewish men) and Arab women, but also raising the quality of jobs they qualify for through better education and training. In this context, he points to the two ministers from Lapid’s Yesh Atid party whom he feels were on the way to achieving important reforms in their areas of responsibility — Yael German at the health ministry and Shai Piron at education. But the collapse of the government left their proposals hanging in midair.

Eckstein would like to see German and Piron’s successors pick up where they left off and complete their efforts, but there is no guarantee that the political and ideological leanings of the new ministers will deliver this outcome.

Temkin takes a more somber view of the political imbroglio in which the country now finds itself. “There is severe political uncertainty as to the composition of the next government,” he says, “and, even more so, its stability and functionality. Beyond that, we are witnessing a growing crisis of confidence on the part of the general public vis-à-vis the political system as a whole. There is growing pressure on politicians of all stripes to increase spending on ‘civilian’ concerns and, irrespective of the outcome of the election, these demands will have to be addressed by the next government — whoever forms it and serves in it.”

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