Israel's economy, 60 years on

Israel's economy, 60 years on
Out of a rough beginning comes prosperity, and some global respect

By Amotz Asa-El
Last update: 7:00 p.m. EDT May 11, 2008

TEL AVIV (MarketWatch) -- Israel was born not only into war, carnage and controversy but also into shortage. Shorn of cash and goods, it had to ration meat, eggs and cooking oil through a coupon system that soon generated undernourishment, bread lines and a thriving black market.

Worse, lacking allies, trade partners and natural resources while swamped by poor immigrants, the Israeli economy was also burdened by its leaders' rigorous socialism. Central planning initially generated growth, but Israel's protectionist duties, sclerotic financial system, high labor costs, bloated public sector and exorbitant defense spending soon proved untenable. By the 1980s the stock market had collapsed, the major banks were nationalized, inflation hit 440% and foreign-currency reserves all but vanished.

As Israel celebrates its 60th birthday memories of this economic desolation seem exotic.

The shekel is now one of the strongest currencies in the world, inflation is 2.5%, last year's 5% growth was the developed world's highest for the fifth consecutive year, while unemployment slid to a 15-year low of 6.5%. While analogous in some ways to other economic miracles, Israel's is still politically, socially and culturally unique.

First, Israel's politicians produced a shock therapy unprecedented in its severity and effect. It came in two installments: first, in 1985 the government of Shimon Peres abolished overnight a slew of food subsidies; froze by decree all retail prices as well as public-sector wages and hiring; slashed the defense budget by 20%; hiked interest rates, and then allowed the Bank of Israel to manage monetary policy independently. The government also began to slash duties, sell assets and de-regulate the bond market.

The second phase came this decade, as the government of Ariel Sharon and his Treasurer Benjamin Netanyahu -- responding to a harsh recession -- abruptly cut child allowances, single-mother wages and much of the rest of an elaborate social safety net. Then they sold major state assets like the El Al airliner and the Bezeq telecoms giant; slashed public-sector wages; raised the pension age; took the big pension funds away from the unions; abolished the banks' control of the long-term savings industry; began to cut taxes; and made the three national seaports compete with each other.

While the reforms of the 1980s stabilized the currency and began the retreat from socialism, these measures globalized Israel's economy. With the budget deficit shrinking within five years from 7% to 0.8% of GDP, and with the debt-to-GDP ratio reaching a 40-year-low of 81%, the global financial community began to understand that Israel means business.

Yet there were factors at play that transcended macro-economic policymaking.
One is, paradoxically, Israel's defense burden. Though in every other respect a liability, Israel's initial lack of arms suppliers compelled it to build its own military industry, which eventually climbed from manufacturing bullets to inventing submachine guns and finally developing tanks, battleships and fighter jets.

The arms industry -- led by aerospace giant Israel Air Industries -- not only became a major exporter, it also mass-produced technicians, engineers and inventors. In the late-1980s, when Israel was forced to cancel an overly ambitious fighter-jet project, thousands of suddenly-jobless engineers and programmers unwittingly launched the hi-tech start-up industry that soon became the darling of foreign investors.

Already then, well before any of them made his first million, Israeli techies came to epitomize the daring, mobility and originality that have historically been hallmarks of invention in general, and of Jewish commerce in particular.
Fortunately for Israel, all this coincided with the end of the Cold War.

First, huge parts of the world that had ostracized Israel, including Russia and China, suddenly traded with it, and nearby India and Turkey emerged as strategic trade partners. More importantly, a million immigrants thronged to Israel. These bought with them entrepreneurial energy, professional skills and a consumerist hunger that produced the world's largest per-capita rate of engineers and scientists, a massive retail expansion and a spectacular housing boom.

All these combined made the hi-tech industry take off. By last year its $32 billion in exports comprised half of all Israeli industrial exports. Meanwhile multinationals like Microsoft Corp., Hewlett-Packard, Motorola, Inc. and Google, Inc. set up R&D centers in Israel, and foreign buyouts of companies like software developer Mirabilis by AOL, now owned by Time Warner Inc., for $407 million in 1998; or printing-technology developer Indigo by HP for $719 million in 2002; or disc-on-key inventor M-Systems by SanDisk Corp. for $1.5 billion in 2006 -- have become so common that they are no longer front-page news.

Success was not exclusive to the technology sector. Teva Pharmaceuticals Industries , Tnuva Food Industries, the largest dairy products manufacturer in Israel, food giant Strauss Group and Iscar Metalworking, are but some instances of multi-billion-dollar companies excelling in such traditional industries as pharmaceuticals, food production and machine-tool manufacturing. Yet unlike the typical hi-tech success story, they employ thousands and focus on manufacture rather than invention.

Fairly or not, they are not automatically associated with the high-tech entrepreneur who has become a teen-ager's role model and the stereotypical Jewish Mother's dream child, unseating the historic doctor and lawyer.

Sixty years on, Israel's GDP is scratching $200 billion, nearly six times its original, relative per-capita level, while skyscrapers crowd Tel Aviv, multilane thruways, tunnels, fast trains and spaghetti junctions crisscross the country, and some 80 malls, the first of which only opened in 1986, are brimming with customers, turnovers and luxuries -- probably the happiest, and starkest, contrast to 1949's bread lines.