Vision to Reality: The Reut Blog

Israel is in the midst of an economic downturn. While the country may squeak out some growth, GDP per capita will most certainly shrink. The social consequences in terms of unemployment and inequality are a huge challenge for policy makers, especially considering that Israel’s large national debt leaves very little room for a big stimulus package.

This post will try to describe the effects of the global financial crisis on Israel’s economy and outline some of the policy prescriptions that have been floated. Most of the content comes from speeches at the 9th Herzliya Conference.

The underlying cause of this downturn is the collapse of Israel’s chief export markets. The United States and Europe buy most of Israel’s high-quality goods, and the economic crisis resulting from the meltdown of their financial sectors has left many of Israel’s exporters without buyers. Israeli non-profits, who also depend on “revenues” from US donors, are suffering similarly.

Israel’s financial system is solvent, and regulators insist that no banks will collapse, but liquidity is hard to come by for business, households, and the government. Foreign banks have reined in their lending. Domestic banks are lending, but the troubles of domestic firms put pressure on their loan portfolios. Moreover, Israel’s debt markets have dried up. The flight to safe US Treasury bonds in international financial markets makes the cost of issuing debt prohibitive for Israeli firms and the government.

So, what to do?

Preserving the skills of Israel’s exporters – Zvi Eckstein, deputy governor of the Bank of Israel, makes the point that Israel’s high-tech exports will be at the leading edge of Israel’s recovery. Assuming that demand for Israel’s particular blend of exports will return once the global economy reorganizes itself, something that isn’t necessarily guaranteed, preserving exporters’ ability to be the first out-of-the-gate when foreign demand returns is paramount. Recommendations include increasing the government’s subsidies to all sorts of R&D and training to improve the human capital of our workers.

Temporarily increasing domestic demand – Local consumption will not be able to compensate completely for the drop-off in foreign demand, but if applied correctly, it can provide a temporary stimulus while investing in the foundations of future growth. Recommendations have included public sector investment in infrastructure, housing, education, welfare, and support for non-profits. The consumption could also come from the private sector in the form of tax refunds and transfer payments aimed at segments of the population/business community that are most likely to spend the extra cash.

Containing the social costs – Policies like investment in infrastructure, subsidies for R&D, or tax cuts and transfer payments serve the additional purpose of creating jobs and preventing the unemployed from slipping into poverty.

Easing liquidity constraints – Businesses, homeowners, and even the government are having difficulty accessing cheap credit. Recommendations have included using the remaining US loan guarantees to get better rates on government bonds, providing loan guarantees to key sectors of the business community, purchasing government bonds to drive down long-term interest rates, and a public-private investment fund to drive down rates on corporate bonds.

These programs may not be enough though. Manuel Trajtenberg, head of the National Economic Council, makes that point that Israel won’t recover fully until foreign demand returns and expectations for the future become positive.