Israel’s elections — held in September for the second time this year — are stuck in stalemate following inconclusive results. Prime minister Benjamin Netanyahu has been asked to form the government but, according to media reports, he may fail to do so. Netanyahu is scheduled to meet this week with his main rival, former military chief Benny Gantz of the Blue and White Party. Both will try to cobble together a so-called national unity government. If they fail to strike a deal, will a third round of elections become necessary?
This is just one of many questions that hover over Israel. Others concern the economic implications of the elections. The country, which has long been lauded as a “start-up nation” focused on innovation and entrepreneurship, faces several economic challenges. Among them: How will Israel deal with high inequality and lagging productivity? What should be done about poverty and rising housing costs? And if the world economy slides into a recession, as many signs seem to indicate, how should Israel respond?
To help answer these questions and more, Knowledge at Wharton spoke with Zvi Eckstein, former deputy governor of the Bank of Israel and a visiting professor at Wharton. He is also the dean of the Tiomkin School of Economics and head of the Aaron Institute at IDC Herzliya. Eckstein shared his insights on the Knowledge at Wharton radio show on SiriusXM channel 132. (Listen to the podcast at the top of this page.)
An edited transcript of the conversation follows.
Knowledge at Wharton: With the timeframe set to broker a deal, is there a path for Netanyahu to be able to try to form a unity government?
Zvi Eckstein: We hope there will be a government, but as things look at this stage, we are running into a third election, [which] will be probably at the beginning of 2020. Most likely, Netanyahu will not form a joint government because he doesn’t really ask for what is called a “joint government” of the Likud Party and the Blue and White Party. He brings all his right-wing policies together, and that isn’t going to work with just Blue and White. Therefore, it seems that Netanyahu will [acknowledge his inability] to the president by the end of this week.
Knowledge at Wharton: What factors have led to the current situation becoming what it is?
Eckstein: Israeli politics is usually divided into three dimensions. One is a very strong ethnic background related to certain parties. [They are] the ultra-Orthodox, the Orthodox, and the Likud, a center-right party, which also has some ethnic background.
[The second political dimension] is the left, which also has an ethnic background. Related to that is the political [balance] between right and left, meaning [that between] those who are more hawkish on finding solutions, [such as] Netanyahu on the right, and the left.
The [third] dimension — the [current] deadlock is related to that — [emerges from] the [likelihood of] three indictments [against] Netanyahu for [allegedly] violating the law. The [potential for those] indictments led the entire left to [adopt] the general view in Israel, [which is] that a prime minister with potential indictments cannot run the country. Since Netanyahu and the right insist that he will be the next prime minister or the candidate for prime minister from the right, it has split the country. The first election [this year in April] was about that. The second election [in September] is also about that, and we are probably [headed] to the third election fully related to this issue.
Knowledge at Wharton: If we could take a step back, Benjamin Netanyahu has been such an enduring presence in Israeli politics for the past decade, but as you just explained, he [is likely to be] indicted on a few of his actions. What has led Israeli voters to turn away from Netanyahu, and what do you think this means for the balance of power in Israel?
Eckstein: There are two [factors]. A minority among the Jewish voters and a full majority among the Arab voters oppose Netanyahu’s hawkish view on the peace process [with Iran]. On top of it, we have the [issue of the] indictments. The indictments split the voters and the parties into two camps — those who think that [a sitting] prime minister could actually go to trial, [and those who think he may] be immune.
[The first camp] went into the April election on the idea that they could reduce the power of the Supreme Court and change the laws [to ensure] that a prime minister who violates the law will not be indicted while in his elected office. These two proposals did not get the majority — not in the previous election or this time. That has generated the big deadlock that is going on.
But we have to understand that Israel is a democracy. There is a budget. The budget is working. The bureaucrats are running the country. The government is in power. Political decisions are being made. International policies are in charge. All the defense issues are taken care of. We have a prime minister. He is also the defense minister. So, it’s a situation where the only [limitation] is that the government cannot take new actions.
Knowledge at Wharton: What’s the state of Israel’s economy right now?
“One bomb in the center of Tel Aviv or even in a small town can change the whole outcome in one day.”
Eckstein: The economy is running very well on what I would say is a “long-time trend” that is positive. The economy is growing at more than 3% — a very high growth rate. Per capita, the growth rate is equivalent or a little lower than the average top OECD countries. However, population growth in Israel is close to 2% — the highest among OECD countries. The unemployment rate is less than 4%. Employment rates are higher than in the U.S. and are close to those in top OECD countries like Austria, Sweden, etc. Incomes of the lower [strata] of the population have risen substantially in the last 10 years. Inequality has been going down, so overall, [voters] on both sides feel the economy is running well. Geopolitically, we have the most supportive U.S. president [with regard] to Israel. In fact, the split among the Arabs does not enable us even to argue about [a potential] solution, because no one talks about solutions.
So, overall, the situation of the incumbent prime minister is good. The key issue is the three indictments [against Netanyahu].
Knowledge at Wharton: If there is a third election, what is likely to happen?
Eckstein: It’s hard to make a prediction on the election, because as we know, voters’ decisions, especially in a situation like this, sometimes are made on the last day. Even in the surveys, it is hard to [predict the outcome].
The question is whether the trend we have seen in the last election would continue. What we have seen is that [within] a “soft right-wing group” that belonged to the Likud, 1% or 2% decided not to vote. Some of them belonged to [Kulanu], a small party led by finance minister Moshe Kahlon that had joined the Likud — they probably did not vote for the Likud. [Benny Begin], the son of [former prime minister and founder of Likud] Menachem Begin, announced a week before the [September] election that for the first time in his life he will not vote for the Likud. [He had said his decision was] not about [the party’s] economic policy, its foreign policy, or its social policies, [but that it was] all about the fact that the prime minister cannot [continue in his role] given the indictments ahead of him. [Those voters] represent a small segment, [but] that may become larger in the next election.
[Also], as we say, things may change in the Middle East. There is uncertainty out there. One bomb in the center of Tel Aviv or even in a small town can change the whole outcome in one day.
Knowledge at Wharton: Coming back to the economic implications of Israel’s elections, I saw that you wrote an interesting article in Foreign Policy that was published earlier this month. You had an observation there that Israeli citizens care about economic issues, but Israeli voters do not. If that is the case, could you explain it?
Eckstein: The situation is like that — there has been no real difference between the main parties. The Likud, the Blue and White party, the Labor party, all have center-right, mainline policies. They all identify the main problems of Israel. No matter who is in charge, they probably would implement what I would say are mainline policies.
Knowledge at Wharton: The other thing I find very interesting about Israel is that the country has been known as a “startup nation” and has attracted tremendous investment from some of the leading companies around the world. Now, depending on what happens after the new government is formed, what implications do you think it could have for innovation and entrepreneurship in Israel?
“The key one is probably some adjustment in taxes that is needed in order to solve the deficit.”
Eckstein: No matter what government [is formed], it will be a government that will support the continuation of [being a] startup nation. In Israel, high tech companies and innovation [account for] about 8% of the labor force. In the U.S., that is 5%, and in most European countries, it’s even less. Some of those small firms have become large. The best example is Waze, (a GPS navigation software firm founded by Israeli entrepreneurs that Google bought in 2013). A lot of what we don’t see on the iPhone, but is in the iPhone, is produced by Israeli knowledge.
By the way, some high-tech company leaders generated a collective call that was anti-Netanyahu. On the other hand, Netanyahu tried to make the claim that he’s responsible for the [success of] high tech [firms in Israel], and most people don’t disagree.
The weaknesses and the strengths of Israel are widely agreed upon, and we need a good, stable government to implement good policies.
Knowledge at Wharton: Are the tech sector companies the ones with the most influence right now in Israel, in terms of having contacts with the government and being able to lay the framework for either supporting Netanyahu or not supporting him?
Eckstein: Not really. [The tech companies] are not influential with the public. Their leaders [aired] their views as [individual] persons. If you look at the vote in Tel Aviv and Herzliya, where most of these companies are located, the percentage against Netanyahu is the loudest. Most of the people who voted for Netanyahu are the lower-income people in towns where incomes are lower. However, that is not related to economic issues. It’s related more to what I would call the tribal aspect of Israeli politics.
Knowledge at Wharton: I’m glad you mentioned the low-income people, because the Israeli economy does face challenges, and poverty is one of them. High and rising costs of housing is another issue. Based on your understanding of the Israeli economy, how do you expect these issues to be resolved with the new government that comes to power?
Eckstein: Let’s start with the poverty aspect. There has been a consensus [within the] current government and previous governments over more than 15 years, that the key way to solve the poverty issue is to put people to work and increase productivity. And that has been done. Israel has increased employment among the lower-income, the Orthodox, the ultra-Orthodox in particular, and the Arab population.
I’ll tell you something most people don’t know. The Netanyahu government decided three years ago to make the largest ever investment in the Arab community — not in sum, but [in terms] of proportion. Those were policies of putting [members of] the Arab population to work, helping them to find jobs, and helping them to improve their quality [of life]. Vocational training is a key reform. I believe no matter which [party forms] the government, it will adopt those reforms. The view that this is a key issue, and that the labor market and the quality of the worker are the solution, would continue.
In the housing market, Netanyahu, his government and his ministers follow populist solutions, all of which have failed. For 10 years, Netanyahu [has told] us that he will solve the housing problem, but he never wanted to tackle the problem. That is not because he didn’t understand what the problems were. Ten years ago there was no speaker better than Netanyahu in explaining the problems [related to] privatizing land [ownership] and making land available to build, and how they have to be changed. But there has not been a prime minister that was worse than Netanyahu in implementing the same policies that he was preaching to the country. Netanyahu was a great preacher also on over-regulation and over-bureaucracy; [on how reforms there could] prevent a lot of the housing problems; the productivity issue, and the poverty of the lower-income [segments of the population].
I was deputy governor [of the Bank of Israel, the central bank of the country] when Netanyahu was elected. I was very hopeful and worked with him and with the government to implement those policies. Unfortunately that has not been done. I hope that the next government will take the right actions.
Knowledge at Wharton: So what should the new government be doing that the previous one didn’t?
Eckstein: [We have] to follow what has been done in Europe and in the U.S. in reducing excess bureaucracy and excess regulation, and to let the private sector invest. We are lagging in private investment, and especially in commerce and in retail, where our productivity is extremely low. The second one is the digitization of the economy. Israel is lagging any Western country in digitization. Those are low-cost issues, and not big problems. We had designed a vocational training program that should go on. Most important is investment in public transportation. We are lagging big time [in that area]. We need a metro for the Tel Aviv metro area. This is a big decision, and it’s ready for the next government.
The key one is probably some adjustment in taxes that is needed in order to solve the deficit. The deficit has grown from 3% [of GDP] to almost 4%. Increased taxes or decreasing expenditures could reduce the deficit by around 1% of GDP. I believe any government that will come will do it. The question is whether they will do it in the right places. Israel actually has a relatively good tax system.
Knowledge at Wharton: Is there a business sector that is already established in Israel that is potentially that next great growth opportunity?
“Most of our high-tech sector provides R&D for all the large companies in the world for which we gain a lot [in terms of] high salaries, but we don’t really build big companies.”
Eckstein: It is hard to identify that. The next [growth opportunity] could be in the high-tech sector — to move it [to higher levels] from small startups with venture capital that then are sold. Most of our high-tech sector provides R&D for all the large companies in the world for which we gain a lot [in terms of] high salaries, but we don’t really build big companies.
The only example where we succeeded was with Intel. Intel is the largest foreign company in Israel. They have about 3,000 people in R&D. To take some of [our high-tech] companies and to [grow them into] an Intel or a Nokia is potentially the most successful Israeli industry.
Knowledge at Wharton: What is the state of education in Israel right now?
Eckstein: Israel has been extremely successful in generating academic schools and colleges. We have about 50% of the people who finish high school go to what we call “academic jobs.” It’s both subsidized and private.
Israel has been unsuccessful and doesn’t do much to produce the [other] 50%. What I mean is vocational training and community colleges for the people who did not do very well in high school.
I was appointed to a government committee about two years ago, and we proposed reforms almost a year ago. Unfortunately, our minister was indicted two months ago, and we couldn’t even give the government the proposal. But I believe that our proposal could generate huge positive reforms in Israel, especially to the Arab, ultra-Orthodox and low-skilled people who had a bad high school to begin with.
Knowledge at Wharton: There is the recognition by those in government in Israel that these are changes that need to occur to have the economy of Israel take that next step.
Eckstein: Yes, there is a recognition of that in the government. Amir Yaron, Wharton professor [of finance] was appointed last year in December as the governor of the Bank of Israel. Two months ago, the Bank of Israel issued a full report on its main policies. Almost everything I have said is consistent with that report led by Amir Yaron.
Knowledge at Wharton: There are signs that a new global recession might be on the way. Do you think Israel is prepared for it? What should the Israeli government do to prepare for it?
Eckstein: We certainly have to be worried about it, especially since a lot of the recession has to do with uncertainty regarding trade. A lot is related to China and the U.S., and Israel is involved there because Chinese corporations have invested in Israel. The American administration is not very happy that [Chinese investors] bought our largest metal producers and our fertilizer producers, and they invested in our underground train system, in our roads, et cetera. So far we haven’t seen a big negative impact, and Israeli companies, including high tech companies continue working with the Chinese government. Hopefully President [Trump] will reach some agreement with China soon, and the threat will disappear.