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PINHAS LANDAU:
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When wishful thinking met reality

The outgoing Jewish year will neither be missed, nor fondly remembered by most Israelis. It represented the third, and hence critical, year of struggle and hardship, both in the sphere of security and defense, and in that of economics and business.

Perhaps fittingly, the year is ending on a down note, after periods of hope that a fundamental change of direction was in the offing gave way to renewed gloom and pessimism.

Why was this year critical? Simply because it was the third straight year of crisis, making it impossible for even the most determined ostrich to bury his head in the sand and pretend that things will work out somehow.

The year 5763 has been characterized by a serious effort to adjust to the new and unpleasant realities that the country faces — not only in the present, but as far into the (admittedly obscure) future as one can see. This article will focus on how this adjustment process is developing in the economic and business spheres.

However, it should be obvious that the local (Israeli-Palestinian), regional (Iraq et al) and global (the war of and on Islamic terror) background is an omnipresent factor in the trends and decisions made by governments, corporations and even households.

The best way to begin is by considering the key data. This is especially true with regard to Israel’s current economic crisis, because it is totally different from the numerous crises that the Israeli economy weathered in the first 50 years of its history.

LET’S START with the bad news: The severity of the current downturn is unmatched, not merely in Israel’s history, but also among developed economies anywhere, since the Second World War.

Graph 1 illustrates what has happened, by showing the rate of change of GDP — the overall measure of a country’s economic output — over recent years, together with GDP per capita, i.e. the overall change, adjusted for population growth. The economic term "GDP per capita‘ is best translated in plain English as ’standard of living."

It’s important to note that the economy was under-performing even in the late 1990s — before the "triple whammy" landed during the second half of 2000 (in chronological order:

o the collapse of the hi-tech boom o the intifada/suicide terror campaign o the global recession of 2001-2002.

True, GDP was rising, but once this growth was adjusted for population increase, it disappeared: On a per capita basis, there was no growth in 1998-99. In 2000 there was a burst of rapid growth — and that, as we now know, was mostly an illusion, caused by the mania that accompanied the hi-tech bubble. Nevertheless, the fact remains that until 2000, Israel had only once suffered a year of "negative growth" in GDP, i.e one in which the overall economy shrank. That was in 1953, when there wasn’t much of an economy to speak of, anyway.

But in both 2001 and 2002, GDP fell — something that had hitherto been not merely unprecedented, but also unthinkable. At the same time, during these years, overall population continued to expand, albeit at a slower rate. Consequently, GDP per capita (read "living standards") fell sharply in 2001 and 2002. Even this year, when GDP will probably eke out a fractional gain, GDP per capita will fall again, for the third year running. Regrettably, this is a stunning, horrendous achievement.

No large, developed economy has undergone a similar experience this side of the Great Depression — not even Japan in the 1990s, or other East Asian countries in the wake of the 1997 collapse, or Western countries in the 1970s. The cumulative decline of GDP per capita, since October 2000, is now in the order of 10 percent. This means that the standard of living of the average person or family has fallen by that amount.

However, as we all know, averages are a façade — the burden is not distributed evenly, but very unevenly.

The result of three years of economic retreat is, therefore, that many people — indeed, entire chunks of the population — have suffered large, in some cases massive, cuts in their income and hence in their standard of living. Many middle-class families have been shoved ruthlessly down the socio-economic ladder; working-class families which were already barely scraping by, have joined the swelling underclass.

In sociological terms, many people have become poor over the last three years: They are no longer self-sufficient, but have become needy or, worse, destitute. Poverty, hunger, charity and soup-kitchens became the buzz-words of 5763, and the pathetic attempts by officials — from the prime minister down — to pretend that this was not the case, were simply drowned out by the increasingly raucous cries from the streets.

Yet, having said all that, this economic crisis is also different from all its predecessors in another respect, this one very positive. The "classic‘ Israeli economic crisis was caused by the economy ’overheating": consumption grew too fast, leading to a boom in imports and a growing deficit in trade and on the balance of payments. This meant that the country was on course for going bust, because it would run out of foreign exchange and be unable to pay its bills.

IN THESE circumstances, the government would adopt drastic measures, notably devaluation and tax hikes, all aimed at cutting consumption, reducing imports and getting the country’s "foreign sector" back into some kind of balance. In the current crisis, there is no problem with regard to the foreign sector.

This extraordinary fact is largely overlooked. Graphs 2 and 3 provide the hard evidence regarding the stability — i.e. lack of crisis — in the foreign sector. Graph 2 shows the data regarding Israel’s foreign trade and its annual deficit on the overall balance of payments, which includes "unilateral transfers" such as US government aid and contributions from world Jewry.

The size of these deficits has been fairly low in recent years — especially as a percentage of GDP — and has actually been falling sharply in 2002-2003, because the deepening recession has cut into demand for imports. On the basis of these data alone, one would have to assume that the country concerned was enjoying stability, with no special problems.

More extraordinary still is graph 3, which shows the country’s foreign exchange reserves climbing to unprecedented levels, and holding them over recent years. This suggests that the country is not only stable, but rich. We could go further down this path, by showing that Israel’s net foreign debt — how much we owe abroad, less our own assets overseas — has fallen to zero over recent years.

The point should be clear by now: This crisis is unprecedented not just in severity, but in substance.

Because the "old-style‘ crises were focused on the external sector, they were often summarized by the cynical saying, ’this is a poor country, full of rich people." The current crisis is almost diametrically opposite, because it involves a seemingly rich country, full of poor people.

If the description of Israel as "a rich country full of poor people" grates on your ears, you should ask yourself why. The key macro-economic data, presented above, certainly support that idea, yet it seems very strange.

The answer to the apparent disparity between what the data show and what we think we know is very simple: We have to stop thinking of Israel as a single, cohesive entity.

There are, in fact, two quite distinct sub-countries, that together comprise the political entity called Israel. They are distinct in almost every important way — economically, sociologically, culturally, religiously, behaviorally and geographically. In crude terms, the rich sub-country covers the area from Netanya/Kfar Saba to Rishon Lezion/Yavne; the poor sub-country is all the rest.

Of course, this split is not cut-and-dried. There are rich enclaves in and around Haifa, Beersheba and even in the rapidly-declining capital city of Jerusalem, just as there are significant pockets of poverty in metropolitan Tel Aviv and its environs (indeed, one of the component units of Gush Dan, Bnei Brak, is overwhelmingly poor).

However, all the data confirm this division, roughly along those fault lines. The great bulk of the country’s wealth is produced, accumulated and spent in the rich sub-country, so that living standards there are much higher and jobs easier to find. "The rest‘ — the periphery, plus Jerusalem and the former industrial center around Haifa Bay — is decoupling from the rich center, which is part of the rich ’first world,‘ and sinking to the levels and standards associated with poor ’third world" countries.

The reason 5763 may well be remembered as an important year in Israeli history is because this was when this reality — that the country is actually two different countries, moving in different directions — finally took hold. Indeed, not only did the realization hit home, but people started doing something about it. True, the rich/poor divide began to emerge starkly during the hi-tech boom of the late 1990s. But, at that point it was possible to believe that the hi-tech miracle would generate enough wealth to make the rich even richer, whilst also enabling the government to siphon off money from the haves, to enable the have-nots to continue getting by.

This tied in nicely with the culture of welfare hand-outs that had been steadily built up since the 1970s, and that was expanded dramatically in the 1990s.

But the bursting of the hi-tech bubble ended that illusion. Money, income and wealth all became harder to achieve and preserve, even for the haves. Not surprisingly, they were less and less disposed to sharing it with the have-nots.

This change of attitude had been building up for many years, but it was catalyzed by the economic crunch that began in late 2000.

SINCE ISRAEL is a democracy, these shocks inevitably found expression in the two processes that democracies use to translate changes in public perceptions into political and practical reality — elections to the representative body, and the development and implementation of government policy.

In that sense, it is not surprising that the two key developments of 5763 were the upheavals in the legislative and administrative branches. The general election of January 2003 was by far the most positive development in Israeli public life this past year.

This is because it ended a period of at least seven years (some would argue longer) of governmental dysfunctionality — in plain language, paralysis and anarchy. This paralysis stemmed from the change implemented in the electoral system in 1992, which took effect in 1996 and which required voters to vote both for a prime ministerial candidate and for a party.

Whatever the hopes and intentions behind this "reform," the result was the collapse of the large parties and the consequent inability of successive governments to actually govern the country.

The effect of abolishing this change and reverting to the old electoral system, with all its imperfections, is immediately clear from the 2003 results and is depicted in diagram 4. For the first time since 1992, it became possible to form a coalition in which the dominant party had a clear majority; by extension, the coalition was based on a clear and stable Knesset majority. As a corollary, it became possible to form a government with a clear domestic policy direction — in other words, if the government knew what it wanted to do, it would be able to actually do it, something that hadn’t been feasible for years.

The other dramatic feature of the 2003 election was the rise of Shinui. In many respects, Shinui is merely the Israeli version of the center-right parties that have sprung up in virtually every European country in recent years, with platforms based on anti-immigrant and generally xenophobic feelings. Shinui’s version of this recipe is virulent anti-haredi rhetoric, with a good dash of anti-Arab and anti-Mizrahi (Sephardi) sentiment thrown in.

Propelling this middle-class, secular Ashkenazi backlash were clear and simple socio-economic messages: "We are fed up with paying heavy tax rates and doing long stints of reserve duty, whilst others (especially haredim) not only do neither, but sponge massively off the state — i.e. us taxpayers — to maintain their parasitic lifestyles."

Shinui, therefore, represents a protest vote and a tax revolt — in effect, the Israeli version of the Boston Tea Party.

These developments were long considered impossible by most political pundits — obsessed as they are with the issues of the Palestinians and the settlements — but, lo and behold, they happened.

Two processes helped ensure that this backlash would occur — and succeed. One was the shortsightedness of the haredi political echelon, which had assumed that its place in government was permanently secure, and its ability to squeeze the budget for more funding was endless. The second was the blithering ineptitude of Silvan Shalom, finance minister in the first Sharon government.

Shalom’s pathetic efforts to address the deepening budget crisis — first wasting a year "in denial," then switching to sporadic tax increases and budget cuts that were always too little and too late — were a significant home-grown contribution to the economic slump.

In February 2003, Ariel Sharon used his emphatic victory and the Likud’s dominant parliamentary position to eject the haredim from government — for the first time in a generation — replacing them with their nemesis, Shinui. He also replaced the hapless Shalom with his antithesis, Binyamin Netanyahu.

Sharon knew what he was doing with these moves, whilst Netanyahu knew what he wanted to do. The haphazard cuts in welfare spending that Shalom had initiated, now became a doctrinaire, across-the-board assault, underpinned by a clear, Thatcherite rationale.

It is important to emphasize that the welfare cuts were quite inevitable. Whoever would have been finance minister this year would have been obliged to hack away at the tangled jungle of welfare payments that had taken root over the last 10-15 years.

The haredim, who had become the largest beneficiaries of this corrupt system, were inevitably going to be the main victims. However, the combination of Sharon’s underlying disgust with the haredim, Netanyahu’s ideological commitment to move welfare recipients back into Israel’s denuded labor force, and Shinui’s overt loathing toward both those groups, have generated a huge socio-economic upheaval — which is only just getting underway.

NETANYAHU IS correct in noting that the reforms he has instigated — not just in welfare, but also in pensions and other aspects of the labor and capital markets — are irreversible. But beyond that, their impact remains a matter of conjecture, because — unlike the famous Economic Stabilization Plan of July 1985 — the Netanyahu reforms go far beyond economics.

One obvious example is religion: the haredi attempt to create a new brand of Judaism — in effect, "welfare-state Judaism" — in which the state transfers ever-growing sums from irreligious Israelis to ultra-Orthodox Jews, enabling the latter to have very large families and (supposedly) devote their lives to study, has come to an abrupt and brutal end.

Yet the collapse of the "voodoo economics" that underpinned welfare-state Judaism, is merely the most dramatic example of the impact of harsh reality on wishful thinking, that has been the underlying theme of 5763. The entire complex of welfare payments, paid as of right to entire classes of people without regard to individual circumstance or public morality, is under assault and in retreat.

The longer the economic and budget crises go on, the fewer such payments and eligibilities will survive. The list of potential adjustments extends far beyond welfare, as the defense establishment and its army of pensioners and early retirees is now beginning to discover. Indeed, once the key fortress of defense surrenders to the new economic reality and social attitudes, the entire array of government spending will be exposed.

It is probably true that, although the shakeout and reforms of 5763 were overdue, the way they are being strongly implemented suggests overkill. However, unless Netanyahu can deliver on his promises to restore the economy to growth — or, implausibly, if Sharon delivers on his "peace and security" pledge — it is more than likely that we will see more of the same, with perhaps even greater intensity and insensitivity, in the year ahead.