Many have already written obituaries for Israel’s legendary warrior Ariel Sharon. For the most part, they have covered his military career, his tenure as defense minister, and his time as prime minister. Few have considered his impact on the Israeli economy.
Ariel Sharon inherited an economy that was entering terrible recession, but by the time he slipped into his deep sleep, the Israeli economy was well on its way to a robust and sustained recovery.
It’s necessary to first consider the severity of the recession of the early 2000s. To paraphrase the Passover Haggadah, why was this recession different from all the other recessions?
Most recessions in America are “nominal” (or demand-side) recessions, which means that they are the result of decreases in total spending. At the outset of the Great Recession, for example, the housing bubble burst, which caused people’s incomes to decrease. Less income means less spending, which means a weaker economy. (For simplicity and brevity, this account of the Great Recession purposefully leaves out many other factors.)
Israel’s recession of the early 2000s, on the other hand, was a “real” (or supply-side) recession. This means that Israel’s ability to produce goods and services actually declined. Supply-side recessions usually occur when a country is ravaged by wars, famines, natural disasters, or, in the case of the 1970s, oil shocks.
It might seem cruel to focus on the economic consequences of the Second Intifada, which officially began in September 2000, when so many innocent civilians were dying, but the dead are no longer able to contribute to the economy. Palestinian terrorists also destroyed buses and cars, restaurants and hotels, and countless other forms of Israeli infrastructure. Terrorism affects us both emotionally and economically.
This destruction took its toll on the Israeli economy, which had been accelerating at 10 percent in the third quarter of 2000, before the Intifada. Once the fighting began, the economy dropped precipitously, and fell into negative territory.
A leading economic indicator is the unemployment rate, which is linked to economic growth. The Israeli unemployment rate stood at an already elevated 8.8 percent in January 2000. Over the next three years, the unemployment rate surged all the way up to 10.7 percent.
During nominal recessions, prices tend to fall, because decreases in aggregate demand result in lower prices. During real recessions, however, prices tend to rise, since declines in supply cause higher prices. Inflation in Israel was fairly stable, chugging along around 2 percent during the summer of 2000. One year later, prices were rising at a rate of 7 percent. This was well short of Israel’s hyperinflation of the 1980s, but still far from ideal.
Interest rates on Israeli government debt rose to new heights during the Intifada, as well. The interest rate on a ten year security hovered around 11 percent throughout much of 2002 and 2003. By comparison, the interest rate on a ten year security had been between 3.5 and 5.5 percent during the second half of the 1990s. Higher interest rates had a deleterious effect on Israel, since it raised the price of financing security measures, like a barrier between Israel and Palestinian lands. (All numbers used above come from the Federal Reserve Bank of St. Louis.)
Since the end of the Intifada, the Israeli economy has recovered extremely well, and has weathered the Great Recession better than did most industrialized nations. What accounts for this dramatic change in fortunes?
The most obvious reason for Israel’s economic revival is its success is stopping terrorism. Ensuring basic security is a prerequisite for economic well-being.
Another explanation is Israel’s national character. Dan Senor and Saul Singer famously expounded on this point in their book, Start-up Nation.
The third reason, which I find most persuasive, is quite simple: Israel pursued wise economic policies. No one will remember Ariel Sharon as an insightful economic mind, but he seemed to recognize the insights of others.
Largely for domestic political considerations, Sharon appointed Benjamin Netanyahu as Finance Minister in 2003. Netanyahu, with Sharon’s approval, pushed for economic liberalization. Among his accomplishments were lower taxes, budgetary restraint, privatization, and an expansion of the labor force of 240,000 workers.
Sharon’s pick for Governor of the Bank of Israel, Stanley Fischer, was also exceedingly wise. So wise, in fact, that President Obama copied it, selecting Fischer to be Vice Chairman of the Federal Reserve. Fischer’s academic credentials are impeccable, as he served as dissertation advisor to Ben Bernanke and Mario Draghi, the President of the European Central Bank. Dylan Matthews of The Washington Post hailed Fischer as the man who “saved Israel from the Great Recession.”
We should never forget where Israel’s economy was when Sharon took over, and what it took to turn it around.