Barry Topf
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The hidden economic costs of the judicial upheaval

The damage of what may happen to harm the economy is nothing compared to the damage of all the things that won't happen
Illustrative (iStock)
Illustrative (iStock)

If you think what we have seen so far – the weakening shekel, the underperforming stock market, and reports of capital flight — are the worst of the damage wrought by the judicial upheaval, you are in for a nasty surprise. As serious as those blows are, they are just the tip of the iceberg.

The hasty and belligerent way in which the so-called judicial “reform” is being enacted has already caused short-term damage to the economy. Nevertheless, it is the long-term dangers, the hidden costs, the damage we don’t yet see and that may never be observable, which is the greater danger to Israel.

What will not happen is in many ways the real cost the government’s plans are inflicting on Israel’s economy. Investments that will never be made, ventures that will not be launched, entrepreneurs who will not arrive, jobs that will not be created, markets not developed, taxes and income forfeited.

The judicial revolution will drive away investors, entrepreneurs, and potential cooperation with the private sector and governments. Perhaps the greatest loss will be immigrants who do not arrive and Israelis living abroad who will not return to a country where rights cannot be protected by an independent judiciary.

A successful economy depends on a complex interaction of human capital, social cohesiveness, stability, strong institutions, and good governance. Absolute power of government creates a toxic environment. Given Israel’s lack of a formal constitution and absence of checks and balances, the loss of judicial independence will be disastrous for the rule of law. The consequences for Israel’s economy — small, open, export-oriented, and dependent on the knowledge sector — will be especially harmful.

One of the major and growing trends in international investment is Environmental, Social and Governance – ESG – investing, based on assessing those three factors as well as more traditional financial measures. Israel will struggle to attract investors basing themselves on ESG criteria. Already, the Norwegian Sovereign Wealth Fund, the largest in the world, (which has invested billions of dollars in over 70 Israeli firms) will not invest in some Israeli firms on ESG grounds. The judicial upheaval will gravely damage the social and governance ratings accorded to Israel. As more and more private and public decisions are made on ESG grounds, Israel will pay a high price in lost financing and investment.

Given all the risks, including security issues, that investment in Israel entails, doubts regarding the protection of property rights and lack of judicial oversight could easily sway future investment decisions. Take Intel, for example, which accounts for 11 percent of Israel’s high-tech exports. To be competitive, constant investment and modernizations are necessary. Intel has experienced difficulties lately and decided to establish its most advanced facility in Ireland rather than Israel. Considering the pace of change in the industry, not investing even for a few years in Intel’s Israeli facilities could make them obsolete. And then what will happen to workers in Kiryat Gat, where Intel is a major employer?

Many legislative proposals that have not received adequate attention will have long-lasting and harmful effects on the economy. For example, the government wants to abolish the “nivcheret directorim” (pool of qualified candidates), the process by which directors of government corporations are selected in a non-partisan fashion according to professional criteria and competence. The system was developed to replace the previous situation where directors were chosen on a partisan political basis.

Undoing this merit-based system is a clear attempt to give jobs to party loyalists, regardless of qualification, and a slippery slope that can lead to corruption. The result would be poor management of important government corporations. But the damage would not stop there: once it is clear that selection would no longer be on merit but rather through political connections, talented men and women will no longer make careers in government companies, with their place being taken by flunkies.

The government’s conduct is already harming Israel. The US government, which has made clear its opposition to the judicial upheaval, can create substantial difficulties for Israeli businesses. A leading Israeli cybersecurity firm has already been placed on a US government blacklist, severely damaging the company. Irresponsible statements by Minister of Finance Bezalel Smotrich have been vociferously condemned by Washington and made him persona non grata. Can there be a more harmful – and absurd – situation than having our senior economic minister unable to hold discussions with our most critical ally, the source of foreign aid, political support, vital markets, and investments? What message does that signal to the business community?

Naturally, attention until now has focused on dramatic, observable, and short-term damage caused by the government’s reckless proposals. But for those concerned with Israel’s future, it is time to assess the long-term and hidden dangers posed by the judicial upheaval before it is too late. Enough damage has already been done.

About the Author
Barry Topf was a member of the Bank of Israel’s senior Management from 2001 until 2013. He was a member of the Monetary Policy Committee in 2011-2013. As a consultant for multinational organizations, he has advised more than 25 countries on macroeconomic and monetary policy.
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