From Challenge # 66   
March-April 2001economy

The Price of Going Global

When America Stumbles, Israel Falls 

After an upsurge in most of the year 2000, Israel's economic growth dropped by almost 10% in the last quarter, while unemployment kept mounting. The al-Aksa intifada has aggravated the downturn. A new factor, however, will make it even harder to emerge from the mire, namely, a slowdown or recession in the US.
In the last seven years, as East Asian economies wobbled and Europe's languished, America's made great strides. Inflation was held at bay while unemployment remained under 4%, compared to 10% in Europe (Herald Tribune, February 2, 2001). Always, however, there remained the question, Will the good times last? There were bothersome observations. In July 1999, for example, The Economist quoted Robert Gordon as saying that the acceleration in US productivity since 1995 had all happened in a single industry alone, the manufacture of computers (1% of the economy), and this did not seem to be carrying other industries with it. (The Economist, July 24-30, 1999, p. 15.) 

Now the bubble appears to be bursting. The high-tech stock market, NASDAQ, has plummeted since March 2000 by 50%. American families and companies are heavily in debt, and they are wary of further spending. Wall Street is on a downturn. In the last decade Israel has tied its economy firmly to Wall Street. It has more companies represented there than any other foreign land except Canada. Most Israeli shares, in fact, are traded abroad (Israel Yearbook and Almanac [henceforth, Almanac] 2000, IBRT, Jerusalem, p. 87). The new downward trend is likely to hurt this country (along with Mexico and Canada) much more than it will Europe or Japan, who refrained from putting all their eggs in the glittering American basket.
Israel, however, whose economy is many times smaller than those of Europe and Japan, has been charging toward the so-called "new economy" while dismantling, one after another, the foundations of the old. The result has been unemployment and recession. On the one hand, the country has tried to meet the demands of global financial institutions, while on the other, emulating the American success story. It hasn't worked.

Yaakov Frenkel, Governor of the Bank of Israel through most of the 90's (and former official of the World Bank), carried this policy to an extreme. He kept the interest rate high, with the result that people refrained from borrowing and demand stayed low, subduing inflation to zero. If we look at the real interest rate (i.e., the rate after adjusting for inflation), we find that it rose steadily from 1.3% in 1993 to 7.3% in 1999. This is among the highest rates in the industrialized world. It has succeeded in keeping local economic activity moribund. Frenkel and his successor, David Klein, have also taken care not to let the government deficit exceed 2% of the GDP. It is the underlying assumption of this policy that a privatized economy with low inflation, where the state has almost no involvement in welfare, subsidies or labor relations, has the best chance of attracting foreign investors. 

The new economy and the Oslo Agreement

In laying itself open for globalization, the Israeli economy vitally needed the Oslo Accords. The opening began, however, eight years before Oslo in 1985, in the time of a national-unity government. Shimon Peres (Prime Minister from Labor) and Yitzhak Moda'i (Finance Minister, Likud) put forth an Economic Stabilization Plan. Israel was then on the verge of economic collapse. The inflation rate had topped 400%, the balance-of-payments deficit had grown so big that foreign aid could not close the gap, lines of credit were strained, and the government printed money. Foreign reserves had dipped below the $3 billion danger line.
In this situation Israel had no choice but to normalize its relations with the external world. Its economy, by 1985, combined elements of fortress and welfare state. On the one hand, it had lopsided military expenditures - at one point a third of the national budget. On the other, there were large subsidies for basic staples and many more jobs than actual work to be done. In effect, the state was bribing its citizens to keep them from leaving (though hundreds of thousands did). Peres and Moda'i decided to push the economy in an entirely different - and irreversible - direction. They slashed the subsidies and cut the budget. They issued a new currency, devalued by 19%. They took most of the army out of Lebanon and began trimming military expenses. Peres signed a free-trade agreement with the US. He began selling off the industries of the Histadrut (the national trade union). He readied the economy for high-tech. The new direction bore fruit. Inflation dropped into the teens. The foreign deficit became a surplus. The shekel gained credibility. Israel was able to enter the new world. By 1990, 60% of its exports consisted of computer parts, medical equipment, solar energy units, irrigation technology and agrochemical products. The GDP was climbing by an annual average of 6%. Defense expenditures were cut to 10% of GDP.

In Head to Head, published just before the Oslo Agreement, the American economist Lester Thurow wrote as follows: "Those not producing oil in the region should be making goods and services for those who sell oil. Israel should bring technology, middle-waged industries and organizational abilities to the table. But none of that can happen unless and until the political and military disputes between Israel and the Arab world are settled." (New York, Warner Books, 1992-93, pp. 216-17.)
The first two years of the Oslo Agreement saw strong rises in the GDP, in accordance with Thurow's scenario. The absorption of a million immigrants from Russia also had a major effect on the turn to a new economy. Backed by $10 billion in loan guarantees from the US, the government set about finding work for the immigrants. This included an "industrial incubator program" aimed to involve Russian scientists and engineers in startup enterprises. Almost 500 new companies took advantage of it.
The backbone of Israeli high-tech is the startup sector. From 1991 until 1998, the government provided 40% of all spending for research and development. The rest came largely from VC (venture-capital) funds. Of this money, 70% was from non-residents, mainly American institutional investors. Less than 1% of VC capital came from Israeli institutions in 1998. In other words, the country's leading export sector is extremely dependent on infusion from abroad, especially from American firms that invest in high-tech. (Almanac 2000, p. 83) The Morgan Stanley Investment Bank, for instance, has recently invested about $50 million in four Israeli startups (Ha'aretz , February 2, 2001).

For startups and post-startups, acquisition by foreign firms is a major goal. America-On-Line put up $287 million to buy an Israeli firm named Mirabilis, which had developed a program allowing Internet users to exchange messages in real time. Platinum Technology, Inc. bought Memco, which specializes in information security, for $400 million. (Almanac 1999, p. 105) Such blessings are mixed. On the one hand, high tech is the sole Israeli industrial sector that is really growing. Its share of industrial exports now verges on 80%. Electronics exports grew by 17%-20% annually through most of the 90's. Software is big. Biotechnology too: its sales grew by 20% in 1998, following 42% in 1997. (Almanac 1999, p. 103) On the other hand, the locomotive does not seem to be pulling the train. Since the new technology requires a high level of education, it does not create jobs for those who've been laid off, and the unemployment rate remains high. Rather than trickle down, most of the wealth either returns to Wall Street or stays in the pockets of a group too tiny to move the economy forward.

The turn to high-tech also brings new international vulnerability. Little American venture capital leaves the US, but much of this little goes to Israel. In the world economic crisis of 1997-98, when Israel had as many as 3000 startup ventures underway, the flow dried up. The semi-conductor industry was going strong till mid-1997, but its markets were in the Far East. Came the collapse, and orders stopped. For the first time there were layoffs in high-tech. (Almanac 1999, pp. 103, 105) Since March 2000, given the decline at NASDAQ, the drought has come again. Investors have become cautious. Once more we hear of layoffs and shut-downs.

The Contradictions in the Israeli Economy

2. Had Oslo succeeded, the Territories would have continued to be, for Israel, a natural market both for buying cheap labor and for selling low-tech products. Instead, Oslo failed to find support among the people. The Islamic opposition grew stronger. In addition, Israel's continuing policy of closure had a boomerang effect. After shutting its borders to the Palestinian work force, it was compelled to bring in foreign workers. They number, today, about 300,000 (5% of Israel's population), half of them illegal. They work in branches that used to employ Palestinians: 70% in construction, 20% in agriculture, and 10% in services.
As a result, in the Territories the standard of living has dropped since the days before the PA - the days of direct Occupation - by 30%. The poverty line (half of median income) is only $2 per person per day, but according to UN envoy Terje Larsen, 32% of the population now lives below it. The rate of unemployment stands at about 30% in the West Bank and 50% in Gaza (38% overall). (Quoted by Aluf Benn in Ha'aretz February 15).
Arabs in Israel are also affected. The decline of low-tech industry hits them first. Also, by hiring foreign workers instead, employers can undercut the minimum wage and avoid paying social benefits. The unemployment rate of Arabs in Israel is 18%, twice the national average. The new intifada - continuing in the Territories, on hold for the moment in Israel - reflects the inability of Oslo to include the Arab side in the relative economic prosperity that marked the country's last decade.

3. Because of its anomalous political situation, Israel needs a population that is mobilized and united. In the attempt to stabilize and globalize, however, the government cut subsidies and jobs. At the same time it shifted investment from traditional labor-intensive industries to high-tech. These developments have left behind another group that has long suffered from discrimination: the Mizrahi Jews. Class differences have grown. An Ashkenazi worker today earns 1.5 times more than a Mizrahi and twice as much as an Arab. In 1988, the upper tenth of the population received 8.6 times more than the lower tenth. In 1998 the figure was 11.8. The upper 20%, in 1998, received almost half the total income earned in the country. Among wage earners, the proportion of families below the poverty line (which is set at less than half the median income) grew from 21% in 1989 to 32% in 1998. (Source: www.adva.org )

These data go a long way toward explaining the meteoric rise of the fundamentalist orthodox Mizrahi party, Shas. It entered into the social vacuum that the state had created, attracting many voters who had previously supported Likud or Labor. By means of its parliamentary clout, Shas has always been able to get government money, which it distributes to its members through a broad network of social services, including its own alternative educational system. Thus, what the government took away with one hand it returned with another, clad in black. The political price has been heavy. The Shas constituency is right wing and fundamentalist. This party played the key role in the downfall of Barak - first pulling out of his coalition, then mobilizing its voters against him. Shas has distanced Israel from the goal of becoming a modernized player in the economics of the Middle East.

The loss of economic independence

Because of such economic vulnerability, Israel is losing its political independence. Fifteen years ago it began the journey toward a global economy. This journey led it to Oslo, which was supposed to relieve it of its responsibility for solving the Palestinian problem, while preserving its superiority over the Arab world. Having chosen the PA as strategic partner, Israel now finds itself without options. Oslo has crumbled, bringing down the PA along with it. The Israeli economy falters, and the means to save it are no longer in the government's hands. The time has come, in short, when this country must pay the bill for its entry into the new global order, where a pure and merciless capitalism reigns. The Zionist project has entered a crisis that threatens its very existence.