In the middle of August 1985, Minister of Science and Development Gideon Pat called on the Israeli public to disregard government declarations that the shekel would not be devaluated. The minister, on national radio, advised the public to purchase American dollars. The broadcast was aired on Friday night, during prime time. Pat’s advice was unprecedented, since trading in US dollars is a violation of Israeli law. Pat is a member of the Liberal Party, which is part of the Likud and represents merchants, industrialists and businessmen. The leader of the Liberal Party, Treasury Minister Yitzhak Modai, demanded that Prime Minister Shimon Peres fire Pat. Pat argued that his statement was taken out of context and he remained in the cabinet.

The conflict between the two ministers from the same party indicates the severity of disagreements within the government over the economic policy it formulated in November 1984. This policy consists of a series of “package deals” signed once every three months between the government, the industrialists, and the labor unions. Each time, “last-minute” deliberations about the package lasted whole nights. The parties to these negotiations share a consensus regarding the essence of the agreements. They are divided only on the question of the degree to which local industry and the business sector would be affected and on how to achieve the main goals of the economic policy. As to the effect of the policy on the labor sector, the disagreements are marginal, about tactics rather than strategy. Taking all this into consideration, one could easily understand Minister Pat’s declarations.

Government declarations about upcoming devaluations often lead to mass purchasing of dollars by the public. This forces the government to devaluate the shekel further to prevent deterioration in Israeli foreign currency reserves. The devaluations of September 1983 and August 1984 are cases in point. These had no real economic utility. Indeed, the government later admitted that their only purpose was to head off growing public panic.

Pat’s declaration was meant to serve the local industry (mainly the export industry) which benefits from devaluations and suffers from freezing the value of the dollar. For example, if an Israeli shirt is sold in the United States for $10, these $10 could be worth 15,000 Israeli shekels or, with a devaluation of 20 percent, 18,000. This difference is eventually closed by inflation, but as long as the process lasts the industrialists end up with sizeable profits. Therefore exporters are interested in frequent devaluations. These devaluations also serve importers. A person who purchased a car in Europe for 10,000 euros can sell it for a larger paper profit if a devaluation occurs and the various tax-fee mechanisms designed to transfer part of these profits to the state treasury are no longer effective.

Herb’s Ten Points

The guidelines of Israel’s new economic policy were, in effect, formulated in Washington. A team comprising two American economists, Stanley Fisher and Herbert Stein, together with Israeli economists Michael Bruno, Eitan Berglass, Ephraim Ben-Shahar, former Central Bank chairman Moshe Zanbar, Deputy Treasury Minister Adi Amorai and others, worked on the plan for several months. During these months, the American economists visited Israel at least twice. The most succinct formulation of the plan was drafted by Stein. His document was leaked to the Israeli press, which dubbed it “Herb’s ten points.” It outlines a system in which the government would manage the inflation rate, since inflation serves important economic and political purposes, without allowing it to get out of hand and turn into hyperinflation. The regulation of inflation is accomplished through these steps: freezing the exchange rate of Israeli currency; eliminating linkage of inflation to wages; partially eliminating indexing of the public’s savings; limiting credit by the central bank; cutting the government budget by $1.5 billion (out of $22 billion); and freezing all prices.

In Israel there is general awareness of how inflation is used to erode wages and the national debt. Former Deputy Director-General of the Central Bank of Israel Yakir Plassner openly admitted as much. It is important to state this clearly: the new economic program is not designed to stop inflation, nor to reduce it to prevailing rates in the industrial countries. The planners intend inflation to fluctuate between 100 and 200 percent.

The Israeli use of inflation to regulate the main components of the economy — prices, wages, taxes, foreign trade, government budget and state debts — probably dates to 1979. Over the previous decade, inflation was relatively moderate, running between 10 and 50 percent annually. In 1974, following the October war, inflation reached a 56 percent high, In 1979, inflation suddenly skyrocketed from 48.1 percent in 1978 to 111.4 percent. Until 1983, the inflation ranged between 100 and 200 percent.

The central factor causing inflation to exceed this range was wages. At the beginning of the inflationary process, wages decreased in real terms. Toward the end of the process, indexing improved under Histadrut pressure, resulting in an increase in real wages. At the end of 1983, the inflation rate stood at 191 percent. This same year witnessed two severe financial crises — the crash of the stock market early in the year and the plummeting of bank shares in October.

In 1984, inflation reached 445 percent. It was now evident to Israeli leaders that they had lost control. First, decision makers in government, industry and finance circles realized that indexing, worker demands and other political pressures prevented high inflation from eroding wages. In fact, during 1984 there was a increase in real wages. Most of this increase could be attributed to election year favors. Second, they discovered that the accelerated pace of inflation decreased real tax revenues. Furthermore, hyperinflation caused overreaction throughout the financial system, on the part of both the public and large financial organizations.

Since the government refuses to openly admit that it regulates inflation, the public views the government as “losing control over the economy.” One result is overconsumption, due to the lack of public trust in the currency. For the same reason, the public invests in foreign currency and in foreign-linked financial instruments. The managers of the major institutions who anticipate the public’s overreaction continue to allow the public to invest in these instruments, thus accelerating the process. The consequences are a growth in the deficit and a sharp decline in foreign currency reserves.

Recognition of the serious damage wrought by the inflation at its current level led to the wage-price “package deals” starting in November 1984. Their purpose was to confine inflation to the relatively safe 100 percent annual rate that prevailed prior to 1983-1984. The treasury and the employers were careful that by reducing inflation they would still enjoy its benefits, especially continuing erosion of wages.

During the first stage of the package deals, until the approval of the new economic program in July, it became evident that the plan had achieved only partial success. Inflation was stabilizing at 350 percent — still unacceptably high. Therefore, the next stage was designed to bring inflation below 200 percent, and subsequently to under 150 percent. The new inflation policy is also accompanied by a policy of austerity.

Austerity has far-reaching consequences for the Israeli economy. There are quite a few bankruptcies and factories are being shut down. The textile factory Ata, one of the largest factories in Israel, was closed down and the thousands of workers were fired. Midsize businesses and factories were closed down as well: the Plado factory in Bet Shan, Magen Goldman in Petah Tikva and the travel agency Kopel, to name but a few. Other enterprises face difficulties, such as Elscint, Zim (the national shipping company) and the fishing company Atlantic, as well as the government companies which specialize in military production, like Mispanot Israel (the Israeli shipyard) and the jet-engine factory in Bet Shemesh. One of the smaller banks is on the verge of closing down and an insurance company already went out of business. Many other factories and firms are also firing their employees.

Centralization

The result of this policy of restraint will probably be a further increase in the degree of centralization in the Israeli economy. It was the recession of the 1960s which caused the crystallization of a few conglomerates in the Israeli economy. The three largest banks already control more than 90 percent of total banking business in Israel. Two of them, Bank Leumi and Bank Discount, control two of the three largest insurance companies. Bank Discount and Bank Hapoalim control the Klal Corporation, the second largest industrial conglomerate in Israel. Bank Discount controls the third largest industrial corporation which is part of its investment company. The third largest corporation, Koor, and the largest insurance company are under the control of the labor unions, which also own Bank Hapoalim.

In the industrial sphere, there are monopolies in all the main areas. The privately owned Elit monopoly controls coffee and sweets. The privately owned Ossem monopoly controls pastas and soups. The Shemen monopoly, owned by the labor unions, controls cooking oils and their derivatives, as well as margarine and mayonnaise; the Tnuva monopoly, controlled by the kibbutzim and moshavim, supplies agricultural products. Steel is controlled by two companies — one private, the other owned by the labor unions. All these monopolies were formed in the period after the 1966 recession. Now it seems that this trend will accelerate.

The main purpose of regulating inflation was not to restructure the economy, but to reduce wages quickly and to reduce the savings of the wage earners in the long run. This is the real basis of the economic program. There are myriad speculations about the main motive underlying this effort. The most credible interpretation is that lower wages are meant to attract foreign investment. Although the government is careful not to hurt local industries, neither does it leave in the hands of Israeli industrialists much of the profits gleaned from lower labor costs. The government simultaneously enacted a variety of tax benefits for foreign companies. For example, a company which establishes a factory in Israel with capital from abroad is exempt from paying income tax. This new economic program is inextricably linked to the free trade zone agreement between Israel and the US, which will remove, within six years, all tariff barriers between Israel and the US. The final outcome will be the transformation of Israel into a branch of the American economy. A very beneficial branch. The average monthly salary in July 1984 was $650. Within one year, the average monthly wage in Israel before taxes will decline to $350, a fifth of the American average salary. The Israeli industrial workers are highly motivated, experienced and dedicated. Not only multinational corporations but also private investors representing medium-size capital will find Israel a worthwhile investment ground. According to this scenario, Israel would become a Middle Eastern version of Taiwan or the Philippines.

Even the architects of this plan admit that it entails large risks. How low can wages and benefits be pressed without producing massive unrest and emigration? The risk is that unrest and migration would frighten the very investors the program is trying to attract.

One main reason for the lack of clarity about economic planning in Israel is that inflation has caused the virtual collapse of the statistical system which is supposed to supply the decision makers with the empirical base upon which they forecast and plan. Inflation allows thousands of companies and hundreds of thousands of businessmen to declare false earnings. Inflation distorts all wage and budget calculations. A shekel is worth more at the beginning of the month than a shekel at the end of the month; a shekel at the beginning of the year is worth several times more than one at the end of the year. Tax returns contain shekels with their year-end value. The statistical office is attempting to overcome this difficulty, but its calculations are guesses at best.

The GNP and the Budget

In 1984, the gross national product amounted to $22.2 billion. Private consumption was $14.4 billion and public consumption was $8.1 billion. Gross investment amounted to $4.9 billion. Total transactions thus amounted to $27.4 billion. The difference between total transactions and total product is the excess of imports ($15.7 billion) over exports ($10.5 billion).

The decisive factor in the Israeli economy is the structure of public consumption: $2.7 billion for the civilian budget and $5.4 for the military budget. The excess of imports consists mainly of imported military hardware from the US. Military aid to Israel in 1984 amounted to $2.6 billion.

The Israeli government budget for FY 1985-196 was $23 billion, slightly higher than the GNP. Of this sum, 30 percent is reserved for debt repayment in Israel and abroad. Almost 24 percent is for interest payments to the Israeli central bank. About 18 percent is for social services, development and subsidized credit to local industry. Almost 18 percent is channeled to the defense budget, and 19 percent covers a variety of other expenditures. planned budget deficit was 5 percent of the total, or more than a billion dollars. When the government discussed the new economic plan, it agreed that this amount would be cut from the budget. So far there are no indications that this will happen.

The main budget component is military. In addition to the regular defense budget of more than $4 billion, military expenditures also appear in many other categories. Some are hidden in the budgets of various ministries — police and municipalities, for instance. A sizable sum appears in the external debt and interest payments for loans taken in the past to finance the defense budget. The acceptable estimate among Israeli economists is that the real defense budget amounts to about $8 billion, some 40 percent of the budget. This unparalleled sum is the largest defense budget in the world per capita, even counting countries currently engaged in wars, such as Iran or Iraq.

Military expenditures are of ultimate importance in understanding Israel’s economic situation. These expenditures have multiplied fourfold in less than 20 years. This process had two components. One was the monumental increase in the size of the military industry inside Israel. The second was a comparable increase in the amount of grants and loans received from the United States, which were used almost exclusively to purchase weapons manufactured in the United States.

The first component is represented in four industrial sectors: metals, chemicals, electric equipment and transportation equipment. In 1984,149,000 workers were employed in these sectors — 49 percent of the total industrial work force. The total sales of these industries during that year amounted to 1,838 trillion shekels, or 51 percent of total industrial output.

In 1970, the total exports of these four industries amounted to $120 million, or 30 percent of industrial exports. In 1984, these industries contributed to $2.4 billion, or 61 percent of total exports. Between 1970 and 1984, industrial exports rose 10 times in dollar value. Exports of the industries which include military exports rose 20 times.

How much of this is weapons? No information on this subject is published in Israel. Journals outside Israel report that Israeli weapons exports amounted to $1.2 billion — half of the exports in the relevant industries. It is plausible to assume that the local market — the IDF — buys about $2 billion worth from these industries. This coincides with defense budget figures for local purchases. In conclusion, it is safe to assume that 30 to 40 percent of industrial production is in fact military production.

The variety of Israeli weapons and munitions is tremendous. Israeli industry manufactures the Galil assault rifle along with ammunition for other assault rifles in use by the IDF such as the M-16 and the Uzi submachine gun. Israel produces mortars, heavy artillery, the Merkava main battle tank and sophisticated auxilliary items such as optical equipment. The Israeli navy uses attack boats and sea-to-sea missiles made in Israel. The air force is using the locally manufactured Kfir jet, and is developing the Lavie fighter.

The Aid Factor

During the last 15 years an economic transformation has occurred in Israel, with a tremendous focus on one industry. The need to sustain this industry in order to prevent industrial crisis and mass unemployment is an important determinant of Israeli economic policy.

The second component of this process is the growing American aid. American military support of Israel began in 1959, when Israel received a military loan for $400,000. The first substantial increase in American aid occurred in 1966-1967, when the loan suddenly increased from $13 million to $90 million. Another marked increase occurred in 1971 when the loan reached $543 million. Still another increase was registered in 1974, following the October War. Israel received $982.7 million, and for the first time a grant was introduced for military purchases in the amount of $1.5 billion. This enormous military grant has been a feature every year since.

Since 1974, Israel has received military loans totalling $10 billion from the US and an additional $9 billion in the form of grants. In 1983, US military aid was $1.7 billion, half as a loan and half as a grant. Beginning this year, it is all in grant form. Israel’s total outstanding loans at the end of 1984 amounted to $24 billion. Out of this, $20 billion is owed to the United States government and private banks. Half of this debt — $10 billion — can be attributed to military loans. Israel is advertised in the US as “the only democracy in the Middle East.” In Israel, the US is portrayed as a savior of the Israeli economy.

In reality, Israel is forced to accept American aid, especially military aid. Almost all the dollars stay in the United States. In effect, the US treasury writes a check in Israel’s name and gives it to the Israeli military attache in Washington. The attache simply endorses the check over to a variety of US weapons manufacturers. Israel is, in a sense, part of a circuit whereby the US government subsidizes the American weapons industry, complete with customary overcharges, plus interest.

In 1984, the total principal and interest which Israel had to repay American banks for past loans equaled the amount of the entire aid for that year — about $2.6 billion. Thus now the Israeli military and commercial attaches sign their names on the back of the checks they receive and immediately hand these checks over to US banks as debt repayment. And this will be the scenario for years to come.

It seems clear why the US is satisfied with this process. Why the Israeli government seems equally satisfied is another issue. The reasons are not economic but rather political. Israel seeks to preserve and strengthen its ties with the US due to its deep sense of isolation in the Middle East. The United States supports Israeli policies in the West Bank and Gaza. In order to preserve this cozy relationship, Israeli leaders are willing to pay a heavy price — at the expense of their citizenry, of course.

The huge defense expenditures are also inextricably linked to the process of centralization in the Israeli economy. The three main industrial corporations which control a quarter of Israeli industry, and the industrial companies owned by the government which comprise an additional quarter of Israeli industry, have concentrated since the early 1970s on military manufactures. The majority of military goods are manufactured by these three large corporations and the government companies. This is Israel’s military-industrial complex. Former generals occupy the top positions in these private and state corporations. Five former generals, four of whom are former chiefs of staff, hold senior positions in the cabinet. The power concentrated in the hands of this group negates the possibility of any structural change in the industrial base or the political process, either in terms of domestic or foreign policy.

Translated from Hebrew by Yehuda Lukacs

How to cite this article:

Shlomo Frenkel "Israel’s Economic Crisis," Middle East Report 136/137 ( ).
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