The reckless endangerment of Start-Up Nation

As a veteran Israeli economist, I have seen close-up Israel’s remarkable transformation from an economic basket-case, plagued by hyperinflation and chronic shortages of foreign currency, to the start-up nation of innovation and entrepreneurship.

Today, though, along with the vast majority of my fellow economists, I fear that this success is in great danger. While previous governments made mistakes, never has there been a government so recklessly pursuing policies that will gravely damage Israel’s economy and its citizens’ prosperity. That threat stems from the government’s misnamed “judicial reform” – more like a revolution in our system of governance.

For all its strengths, Israel’s economy could pay a very high price – in lower standards of living, unemployment and reduced opportunities – due to ill-advised legislation proposed by short-sighted politicians for dubious motives.

In a democracy, economic success depends on the strength of its institutions, including its legal system, governance, and central bank. Investors will not invest, entrepreneurs will not innovate, if their rights are not ensured. Any business person needs to see a respected, impartial and independent judiciary to which he or she can turn if the need arises. Separation of powers and checks and balances are essential.

But the proposed legislation would abolish all review or limits on the government’s powers. It would limit the Supreme Court’s use of legal principles that have played a key role in eliminating public corruption. This will erode property rights and harm Israel’s attractiveness as a place to work or do business, damaging Israel’s ability to attract investors that will be difficult to reverse.

Short-termism

Harming public institutions will have severe long-term effects. An example is the need for an independent central bank to ensure financial stability and appropriate monetary policies. Unlike politicians, whose electoral-cycle horizons might lead them to take steps that are popular but ruinous, the central bank must be free of political pressures, able to pursue policies that will benefit the country in the long term. The Bank of Israel has used its independence to maintain an enviable record – yet legislation has been proposed that would tie the Bank’s hands in decision-making. The loss of credibility in monetary policy could damage price and financial stability. The result would hurt citizens in their pocketbooks and gravely damage Israel’s economy.

Another example of partisan short-termism damaging Israel’s economy is coalition moves to undermine the Israel Citizen’s Fund, a Sovereign Wealth Fund (SWF) established to invest revenue from natural resources. The principles behind Israel’s SWF, like other SWFs, are to invest funds overseas and to protect the domestic economy explicitly for the benefit of future generations. Yet in an unprecedented move, the coalition agreement includes a provision to withdraw funds to augment the government’s budget. If a government whim can change the very nature of an important institution, a stable business environment is lost.

Israel’s economy is strong, but any economy can be damaged by bad policies. The claim that Israel’s economy will benefit from the reform is not true; the claim that Israel’s economy is invulnerable is pure hubris. Israel is a small economy dependent upon the international economy for investment, trade, raw materials, production inputs, consumer goods, know-how and cooperation. The internal market is small, and we are dependent on exports for growth. Our exports are not well diversified, but depend on high tech, which relies on international markets and cooperation.

And the elements of our success are mobile and easily moved. Unlike factories and manufacturing, which are fixed, innovators with a computer can board a plane to more attractive settings whenever the mood changes. We need foreign direct investment to catalyze the economy. And investment needs a stable, secure and positive society to prosper.

Absurd comparison

Defenders of the government’s plan claim that a vibrant democracy is not necessary for economic success and cite the example of China. The comparison is absurd. To begin with, there is the small matter of size: China has an internal market that cannot be ignored, as opposed to Israel’s tiny internal market. Moreover, China’s success has been built on being the world’s “factory:” Its plants and supply chains are vital to the global economy and cannot easily be replaced. And there is the vast difference in the international standing of the two nations: China is a permanent member of the UN Security Council, while Israel is constantly under diplomatic attack.

Finally, there is the phenomenon of “friend shoring” – that is, relocating supply chains to countries where the risk of disruption from political chaos is low. If even China needs to be mindful of how its internal stability is perceived abroad, can Israel ignore the effects of its own political disruption?

The process by which the proposed reforms are being imposed is already damaging. Regime change needs careful consideration, consultation, and consensus building. Instead, the proposed changes are being implemented through a hasty and uncompromising legislative process. While hundreds of leading economists and business leaders in Israel and abroad, along with former heads of Israel’s security services, have warned that judicial upheaval will harm Israel, the coalition has had difficulty finding any serious economists to support the reforms. And yet the bulldozer approach continues.

If such overwhelming expert opinion is ignored when it runs counter to partisan political goals, then trust in the solidity of the system disappears. And trust, credibility and good decision-making are the basis of economic success.

The start-up nation’s success was built on decades of hard work that established the foundations of a successful economy. Power-hungry politicians, oblivious to economic realities, can easily destroy that achievement. Israel and its citizens will pay a heavy price for their folly.