Commentary Magazine


Israel's Economic Crisis: What Israel Must Do

This year a new chapter will be written in the history of the unique relationship between America and Israel, one of the world’s largest democracies and one of its smallest—a chapter which will see the initiation of even closer and more intimate ties or the possible unleashing of a new round of bitterness and recrimination. Israel, by seeking $800 million in emergency assistance for U.S. Fiscal Year (USFY) 1985, on top of the $2.6 billion in military and economic aid already being supplied this year, and $4.05 billion for USFY 1986, has not only asked for more money than ever before, and at a time of budgetary restraint in this country, but has put the United States in a position to do something quite unprecedented: namely, to place economic conditions on its foreign aid.

The U.S. has occasionally conditioned foreign assistance on considerations such as compliance with human rights (as with El Salvador during the Reagan administration and certain other Latin American nations during the Carter administration), but not on the carrying out of internal economic reforms by the recipient nation. Yet this is what the Reagan administration will effectively do, in deed if not in word, if it grants the major increase in U.S. funds that Israel seeks. In so doing it will replicate the approach of the International Monetary Fund (IMF), which provides financial assistance and supervision to Third World nations in economic duress, on the condition that the recipient nations undertake difficult and often painful internal programs of economic adjustment.

How have Israel and the United States come to this point—a point which seems to promise a new and still undefined change in their evolving relationship?

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I

Between 1946 and 1971, total U.S. aid to Israel averaged slightly more than $60 million per year for a total of $1.5 billion overall, of which $1.35 billion was economic and only $162 million was military in nature. All the military aid and all but $370 million of the economic aid took the form of loans rather than grants.

Starting in 1961 a much deeper and closer relation began to develop between the U.S. and Israel, maturing into a warmth and mutual political understanding not seen during the Eisenhower years (which were punctuated by U.S. pressure on Israel to withdraw unilaterally from Suez without commensurate Egyptian concessions). President John F. Kennedy signaled the deepening relationship with his historic decision to break the arms embargo which had been in force since 1948 and to sell Hawk anti-aircraft missiles to Israel. While pains were taken to describe these missiles as purely defensive, the ice had been broken. And what Kennedy began, President Lyndon Johnson moved forward with giant, Texas-sized strides.

But it was really with the Yom Kippur War of 1973 and thereafter that U.S. military and economic assistance began to assume large and predictable levels. For USFY 1973, before the war, Israel received $417 million in U.S. assistance; this figure, while well above the levels of the 1950’s and early 1960’s, pales in comparison with what followed. As a student of the subject has described it, “Late in 1973, Congress voted an emergency appropriation of $2.2 billion to Israel, including a $1.5 billion grant in military aid. So began the new era.”1

Between 1974 and 1981, total U.S. aid to Israel amounted to $18 billion—twelve times more than the country had received from 1948 to 1973, a period three-and-one-half times as long. Of this amount, $12.8 billion was for military assistance and $5.2 billion for economic aid. The 1970’s also witnessed a variety of foreign-aid concessions to help Israel and to strengthen the bilateral relationship. To enumerate: since 1974, Israel has been allowed to pay for its U.S. weapons purchases in installments, something many countries may not do; whereas foreign countries must normally spend their grant and loan money proportionately, Israel is authorized to spend all of its U.S. grants before using its loan money; since 1975, all of Israel’s economic aid has been provided by direct cash transfer rather than being earmarked for specific projects or purposes, thus giving Israel more discretion in using its aid; since 1979, Israel has been able to bid on U.S. defense contracts for overseas projects; and Israel is permitted to reduce the costs of weapons by offset arrangements under which it asks U.S. defense contractors selling to Israel to buy Israeli goods in return.2

The Carter years saw yet another advance in the bilateral relationship. While there were periods of tension between President Carter and Prime Minister Begin, aid levels continued to rise. And in 1980, President Carter negotiated a fifteen-year agreement to guarantee Israel’s oil supply in the event of a cutoff—the only such agreement the U.S. has extended to any country.

With the advent of the Reagan administration, another change occurred: Israel was no longer seen as simply a moral obligation for the U.S., or a burden to be balanced against America’s interest in the Arab world. It came to be viewed by significant elements of the Reagan administration (including the President himself and each of his Secretaries of State) as a strategic asset. Indeed, after a brief, ill-fated effort early in the Reagan first term to form a strategic alliance not just with Israel but with Western-oriented Arab countries as well, Israel came to be accorded virtually the same privileges as America’s closest allies. In 1981 a historic Memorandum of Understanding was signed in which, for the first time, the U.S. publicly noted the “mutual security relationship which exists between the two nations” and joined with Israel in strategic cooperation to deter “the threat to peace and security of the region caused by the Soviet Union or Soviet-controlled forces from outside the region introduced into the region.”

In addition to the Memorandum of Understanding, other positive steps were taken. Israel was permitted to use U.S. funds, now totaling $900 million, to develop the Lavi fighter, even though it might compete with a U.S.-made fighter. (Normally, U.S. foreign aid must be used to buy weapons and services from the U.S.) Israel was given greater access to U.S. defense procurement. And joint U.S.-Israeli military exercises were instituted and have been performed.

Improvement could also be measured in increases in U.S. military and economic aid, from $1.7 billion in 1977 to $2.6 billion in 1985. Equally important, in 1984 all loans were converted to grants, both for military and economic assistance, in order to help relieve Israel of its future foreign-debt obligations. Beginning with USFY 1984, Israel has gotten all of its economic aid at the beginning of the year, rather than in quarterly payments like most nations. Finally, in 1984 the Senate passed the Inouye-Kasten-Cranston amendment which stipulates that Israel’s assistance level in any fiscal year should never fall below the level of its debt repayments. Likewise in 1984, the Free Trade Agreement, the first such in U.S. history, was passed by large majorities in the House and Senate over substantial opposition from unions and various industries.

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II

The Israeli economy has manifested built-in structural problems since the earliest days of the state: wage indexation, inadequate monetary controls, huge budget demands for a new nation imbued with the ideal of gathering in exiles and reclaiming the desert. Yet despite these problems, and even despite the toll of repeated wars, for a long period of time the economy was able to hold its own—although not without developing some of the symptoms that have now assumed epidemic proportions.

Thus, from 1960 to 1965, GNP growth was 9.6 percent, inflation increased at less than 7 percent annually, and unemployment was only 3.8 percent. In 1964, however, with inflation running at nearly 10 percent, restrictive economic measures were instituted to reduce it. The result was Israel’s most severe recession, with unemployment rising from 4 to 11 percent. From this recession, one can mark the beginning of Israel’s net emigration and the social phenomenon of yordim—emigrants—leaving the Jewish homeland to live elsewhere, in particular the U.S.

But the restrictive measures worked: the recession dropped inflation back to the 6-percent range and reduced net imports from 22 percent of GNP in 1964 to 14 percent in 1966. The growth in GNP from 1967 to 1970 was 14.6 percent and inflation 2 percent. Unfortunately, inflation began to rise again as the economy continued to boom from 1970 to 1973, and was over 20 percent annually in 1973 before the Yom Kippur War.

The impact of the two wars of 1967 and 1973, the two oil-price shocks of 1973-74 and 1979-80, and the cost of the Egyptian peace treaty of 1977 added new burdens to the Israeli economy.

Much of the increased military funding from the U.S. after the two wars was in the form of loans, and this substantially aggravated Israel’s foreign debt. (One-third of Israel’s $23 billion foreign debt is owed to the U.S. on loans for weapons purchased since the 1973 war.) Defense spending, which in the early 1960’s took less than 10 percent of Israel’s GNP, increased by almost 10 percent of GNP after each of the two wars. It was especially after the 1973 war that Israel’s military costs rose sharply, causing economic growth rates to decline from 10 percent per year to 2-3 percent per year. Between 1968 and 1973, defense expenditures and defense imports averaged 22 percent of Israel’s GNP; in 1973, 1974, and 1975, they soared to 32.7 percent, 31 percent, and 34 percent.

In addition, the Israeli government, which from the beginning of the state had played a heavy role in the economy, was becoming an ever-larger employer—increasing its share from 23 percent of the labor force in 1973 to 30 percent in 1980—and thereby adding to the public cost.

The drain of the 1973 war, which cost Israel $12 billion, was accompanied by the OPEC oil shock in which prices quadrupled, imposing a particular burden on Israel since it has no indigenous oil supply and increasing the cost of imported oil by over 3 percent of Israel’s GNP. The growth in GNP plummeted from 9 percent in the three years preceding the Yom Kippur War to only 2.6 percent from 1973 to 1977.

The budget deficit, which was less than 1 percent of GNP from 1960 to 1964 and only 5.2 percent from 1965 to 1967 (roughly the U.S. average), skyrocketed to 17.6 percent of GNP from 1974 to 1977, and the share of taxes rose from about 30 percent of GNP in 1965-67 to 45 percent between 1978 and 1980 (it is under 20 percent in the U.S.).

Government subsidies for goods and services and direct social-welfare payments increased rapidly in the early 1970’s. The resulting deficits were “paid for” by printing more money (which increased inflation) and by borrowing (which added to Israel’s foreign debt). Israel’s domestic debt as a percentage of GNP more than doubled from 1973 to 1983.

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As the 1970’s progressed, the growth in Israel’s GNP grew less quickly than the consumption rate, contributing to greater inflationary pressures and higher balance-of-payment deficits, as demand outstripped domestic supply.

All of this was exacerbated by the Israeli-Egyptian peace treaty. The costs of the removal of Israeli forces and air bases from the Sinai were staggering, and only partially overcome by U.S. assistance provided by President Carter. The loss of the Egyptian oil fields further added to the burdens of Israeli society. So, too, the termination of West German reparations payments for the Holocaust removed another source of foreign capital to finance Israel’s balance-of-payments deficit.

Despite the grim conditions, however, some progress was made. From 1974 to 1977, large reductions were effected in Israel’s balance-of-payment deficit, and by the middle of 1977 inflation was at 30 percent per year, “lower than it had been for several years.”3 But then, just as Israel’s economy seemed poised to recover from the lingering effects of the 1973 war and the oil-price shocks, a series of steps was taken which lifted the lid on inflation, from 71 percent in 1977-79, to 123 percent in 1979-83, to 402 percent in 1983-84.

A great gap was created between the amount Israel consumed and the amount it produced; from 1980 to 1983, Israel’s consumption increased 21 percent but its production only 6 percent.4 To fill this gap, Israel relied on gifts from Jews around the world, on borrowing from foreign banks and lenders, and on U.S. government loans and grants. The foreign-debt obligation grew so large—about $23 billion by the end of 1984, of which $11.5 billion was owed to the U.S. government—that servicing it alone took a large slice of the budget and 7-8 percent of the GNP. Israel’s reserves for paying its foreign debt came dangerously close to the “red line.”

The Begin government set out to close the production-consumption gap by trying, rightly, to liberalize the Israeli economy. At the end of 1979 capital controls were lifted, permitting Israelis to hold foreign currency and foreign bank accounts. At the same time, however, in an effort to help the lower middle class, which had formed the backbone of its electoral constituency, the Begin government also increased spending and ran an expansionary fiscal policy. The currency was devalued by 43 percent to help exports. Because these moves were not accompanied by cuts in spending and by a restrictive monetary policy, they ended by fueling inflation.

At the end of 1979, a new Finance Minister, Yigal Hurwitz, attempted to reverse the government’s course by means of monetary restraint, subsidy cuts, reductions in government employment, and tax hikes. The results were predictable: the number of unemployed more than doubled, GNP fell, and real wages declined in the first half of 1980, but the balance of trade improved. Inflation, however, showed little improvement, and with the 1981 election nearing, Hurwitz and his austerity program were replaced after only nine months.

The policies of his successor as Finance Minister, Yoram Aridor, triggered still higher levels of inflation. Both before and after the 1981 election he encouraged a new wave of private consumption by reducing tariffs on imports and consumer goods while continuing government spending at a high rate. Indexing was made on a quarterly rather than a semi-annual basis and subsidies were increased on a variety of products. The real exchange rate appreciated and the balance-of-payments deficit increased.

The war in Lebanon further burdened Israel’s budget and its economy, with the occupation of southern Lebanon costing $1.2 million a day.

To summarize: over the last seven years private consumption in Israel has grown 43 percent while the GNP has grown at only half the rate; the trade deficit has widened; real personal income has declined dramatically; foreign-currency reserves have fallen rapidly; and inflation has taken off into a triple-digit stratosphere, running by the end of 1984 well in excess of 400 percent on an annualized basis.

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III

There can be no doubt that Israel needs additional help. The question is, what kind?

A strong argument can be made that as America’s most reliable ally in the Middle East, and as a major strategic asset in one of the world’s most unstable and yet critical regions, Israel should receive the additional assistance from the United States forthwith and without onerous conditions. If it is worth $33 billion per year for the U.S. to support NATO, is it not worth $4 billion to support Israel, particularly at a time of economic hardship? It is in America’s national interest, after all, to have an economically viable Israel.

This argument is all the more compelling when it is recognized that some of Israel’s economic burdens have been induced by its need to keep ahead of its increasingly well-armed Arab neighbors—many of whom are supplied by the U.S. itself. Israel, moreover, has faithfully repaid the assistance it has received over the years in the form of loans; indeed, Israel’s annual interest repayments to the U.S. roughly equal the annual level of economic assistance from the U.S., and will exceed it by the late 1980’s.

But while there is a strong bipartisan consensus that Israel is, in fact, one of America’s most important and most dependable allies; while support for Israel in the U.S. public matches that for virtually any other foreign commitment; and while there is a desire both by the Reagan administration and large majorities in Congress to help Israel overcome its economic difficulties, the plain fact is that neither the President nor the Congress will provide anything approaching the massive increases that have been requested without significant economic changes in Israel itself. The administration will not impose a defined plan on the country, but neither will it support a major increase in aid or assent to any restructuring of Israel’s debt until it sees an Israeli plan which it believes can end the economic crisis if put together with a U.S. aid package.

Nor will it be easy for Israel to circumvent the administration and achieve a no-strings-attached deal from Congress. It is true that Congress has traditionally been more favorably disposed to Israel than has the Presidency, and has constantly raised the levels of foreign assistance to Israel even above the Reagan administration’s proposals. But there are strong grounds for believing that this year Congress will follow the administration’s lead and condition any major increase in U.S. economic aid on an acceptable, Israeli-initiated restructuring program.

The overall battle of the budget in the United States will be fierce this year. The administration projects a deficit in the coming fiscal year, USFY 1986, of over $200 billion if there are no further spending reductions—and this is an optimistic figure. It has responded by proposing drastic cuts (over $40 billion) in spending and the elimination of many popular programs. Congress is likely to give the President less in the way of domestic and social cuts (although still very substantial reductions) while significantly reducing his defense proposals, and will ultimately attempt to raise taxes. In such an environment, when U.S. citizens are being asked to sacrifice, a major increase in foreign aid to Israel will be a difficult proposition to sell. If Israel cannot show that its citizens are sharing in the sacrifice, not just the administration but Congress too will be reluctant to support its emergency-aid requests.

Moreover, an influential staff report of the Senate Committee on Foreign Relations states categorically that while “American foreign assistance can help Israel cope with its difficulties,” it “cannot by itself arrest Israel’s problems of hyper-inflation, labor unrest, low productivity, declining revenues, growing unemployment, and sluggish exports.” The report calls for “[m]ajor domestic economic reform and deep budget cuts.” This report will have an important role in convincing Congress that to be successful, aid must be tied to an Israeli austerity program.5

There are other considerations, too. Since levels of foreign aid to Egypt tend to follow those of Israel in a tandem relationship, the administration and Congress would find it hard to increase assistance to Israel without favorable consideration of an increase to Egypt. The government of Egypt is already asking for $1 billion in addition to its already existing level of $2.2 billion in military and economic aid. Such an increase would mean that Egypt and Israel together would account for almost 50 percent of the entire foreign-assistance program of the United States, itself the least popular account in the budget. All the more need, then, for Israel to make a convincing case of its willingness to sacrifice.

It must be borne in mind as well that the U.S. government is unlikely to do for a foreign country what it has not done for its own people. The recent precedents in which direct federal assistance was provided to a U.S. corporation and a U.S. city in distress were undertaken only after strict conditions were imposed. The Carter administration responded to the threat of the Chrysler Corporation’s bankruptcy and New York City’s insolvency by providing federal loan guarantees and other assistance—in both cases over substantial congressional opposition—but only when major internal reforms were promised and when oversight mechanisms were created to assure compliance with the promised changes. In each case, the guiding principle was to impose conditions sufficiently stiff to assure that the aid did not go into the same mismanaged coffers, and to discourage numerous other cities and corporations from similarly seeking federal aid. It would be highly unrealistic to expect the President to help a foreign government, even a trusted ally, without similar concessions.

In general, the free-market orientation which informs the Reagan administration’s economic policy in the U.S. leads it to be less sensitive to the historically greater role of the state in the economy of Israel. There is a built-in desire to act according to classic conservative doctrines and to require less government involvement in the economy. The administration’s attitude toward Israel’s economic plight is altogether more heavily influenced by economists than by politicians or diplomats. Secretary of State George Shultz is himself a professional economist of considerable repute, who has held academic appointments in economics and served as Secretary of the Treasury. He believes it would be a disservice both to the United States and to Israel to agree to a huge increase in aid without the type of reforms in Israel which would make that aid efficacious.

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Secretary shultz, indeed, has appointed four eminent American economists—Herbert Stein, Stanley Fischer, Paul McCracken, and Abe Siegel—to review Israel’s proposed economic reforms and advise him on their adequacy. A joint working group, consisting of these outside economists and top State Department and Treasury Department officials, has been meeting regularly with key Israeli economic officials. There is broad agreement as to what steps should be taken to deal with the unprecedented crisis. Some of them are absolutely necessary in order to win administration support, while others are desirable but not essential. The “mandatory” actions include the following:

  • Real budget cuts of some $2 billion for the Israeli fiscal year beginning April 1, 1985. This would be a substantial reduction in an overall budget of $23 billion, particularly when it is recognized that the budget has only around $13 billion in discretionary expenditures, net of debt repayments. But government expenditures are now over 60 percent of GNP (compared to about 24 percent in the U.S.) and the deficit over 15 percent of GNP (compared to over 5 percent in the U.S.). The cuts would leave the budget deficit at a manageable level. But they would also almost certainly lead to significant unemployment, especially in Israel’s bloated public sector, and, temporarily, to a real drop in the standard of living.

The case for large infusions of U.S. aid is premised on the need to provide a cushion for the impact of these budget cuts, since the sharp rise in unemployment to which they will lead will not be immediately absorbed by the private sector in increased exports. This increased aid, together with reduced consumption of imports, would help close the balance-of-payments gap. But the aid is viewed purely as transition assistance.

  • Additional reductions in subsidies on a variety of products, to reduce the artificial stimulus for consumption. Israel’s “Package II” program of major subsidy cuts, effective this February, is an important step in the direction desired by the administration.
  • Further devaluation of the shekel relative to the U.S. dollar. While this will have a temporary inflationary impact, devaluation is considered essential to the push for additional exports, since it will make Israeli products less expensive and more attractive in world markets.
  • Continued wage restraint, led by the Histadrut. American officials are calling for a reduction in inflation-adjusted wages for Israeli workers. This will mean direct and personal sacrifice, but American experts note that real wages in Israel increased 16 percent between 1980 and 1983, and that of this only about one-third must be “undone.” The sweeping new wage-and-price-control agreement signed on January 24 between the Histadrut and Israel’s Manufacturers Association should help here. Wage restraint can substitute in part for still higher levels of unemployment to fight inflation. Like devaluation, it also will help lower the cost of Israeli goods and make them more competitive abroad. The Reagan administration, however, views wage-price controls with little enthusiasm, and is likely to be more impressed by deep cuts in government subsidies of basic consumer products such as milk, bread, butter, cooking oil, and gasoline.

I can also testify from my own White House experience—the Carter administration employed voluntary wage and price guidelines in 1979-80—that such controls are not effective in the long run unless accompanied by more fundamental actions like budget cuts, reductions in aggregate demand, and monetary reform. Otherwise the controls become meaningless at worst or targets to be cleverly avoided at best. Indeed, it is fundamentally unfair to workers to keep their wages controlled if the government is unwilling to lower demand by other measures in order to reduce inflationary pressures on prices.

  • Some modifications in indexation. American officials place greater emphasis on ending the indexation of assets and government bonds than on ending the indexation of wages. Since indexation increases the shekel value of liquid assets, stopping the issuance of new indexed assets will dissipate the problem over time.
  • Monetary reform that will give the Bank of Israel greater independence from political pressures and end the requirement that the Bank print money to cover the government’s budget deficit. This would impose a tougher discipline on Israel, reduce the amount of money in circulation, and fight inflation. Of all the “mandatory” steps, this one is likely to have the greatest long-term impact.

Among the actions which some American officials and some Israelis feel are desirable for the health of the Israeli economy but are not essential preconditions of additional U.S. aid are an end to or modification of wage-and-salary indexation and “dollarization” of the shekel.

Some U.S. experts see dollarization as the best method to assure the soundness of the shekel and the surest way to eliminate excessive inflationary pressures, while others are skeptical of the notion of tying the value of the currency of a small nation which must export to survive to that of a mammoth economy (whose dollar is already overvalued). But if opinion is divided on the issue of dollarization, there is agreement that the exchange rate of the shekel must be stabilized. An alternative to pegging it to the dollar would be to peg it to a basket of currencies including the dollar.

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IV

Even if Israel proposes a plan which the administration can bless, important issues remain which can yet strain U.S.-Israel relations if not handled with care on both sides.

One is the problem of monitoring compliance with the plan. Neither the administration nor the Congress is likely to approve a massive aid increase without some assurance that the Israeli program is actually being effectuated. Budget cuts, for instance, must not simply be announced but must be actually implemented by departments of government. Israel’s credibility on this score has already been challenged, both by critics (like Rowland Evans and Robert Novak, “How Much Aid for Israel?,” Washington Post, December 26, 1984) and more importantly, by friends (like William Safire, “Passing the Shekel,” New York Times, December 27, 1984, and Irving Kristol, “Even in Israel, No Economic Miracles,” Wall Street Journal, January 25, 1985) who cannot locate the over $1 billion in budget cuts already promised.

It has been suggested that, since the U.S. government cannot adequately monitor the Israeli plan, the staff of the IMF provide the expertise for “surveillance.” Any monitoring plan will involve some surrender of control by Israel over its own freedom of economic decision-making; but this is an inevitable price for ending the crisis.

A second problem has to do with the level of aid which will actually be provided, assuming that the U.S. approves of an Israeli plan. Israel is seeking $800 million in emergency aid in the current fiscal year and a total of $4.05 billion in economic and military aid in USFY 1986. Over the next three years Israel has told the U.S. it needs $12 billion in economic and military aid, all in the form of grants.

The administration’s new budget request for USFY 1986 will include about $1.8 billion in military assistance, up from $1.4 billion in 1985. (Israel had requested $2.2 billion.) In economic aid, the President’s budget shows an unprecedented blank, awaiting submission of an acceptable Israeli plan. But in any event the administration wants the additional assistance to come in the form of a supplemental request to the current year’s budget, with payments spread out over 1985-86. The administration does not want to add this amount to its 1986 budget, because this would make it even more difficult to cut 1986 spending and would permanently raise the base level of Israel’s aid figure—something Israel might prefer but which the administration stoutly opposes.

Moreover, there is a growing feeling in Congress and the administration that the additional money should be dispensed over time, rather than in one lump sum as Israel would like, and should be premised on the achievement of certain “milestones” in Israel’s reform plan. Thus, for example, Israel might receive $750 million immediately with increments of $250 million spread over USFYs 1985 and 1986, depending on satisfactory progress toward certain defined goals. This too raises obvious problems from Israel’s perspective, but again can be justified on the grounds that the U.S. is being asked to assume the role of the IMF.

A third problem, more ominous, has to do with the possible linking of such large increases to implicit political conditions. I do not mean by this any pressuring of Israel to accept the 1982 Reagan peace initiative or any attempt to impose restraints on Israeli action on the West Bank—I do not believe these are in the offing. But the release of additional aid might well be timed to coincide with congressional consideration of arms-sales packages to Saudi Arabia or Jordan. This would make it harder for Israel and its friends in Washington to fight such a sale, even though it might pose a real security threat to Israel.

As difficult as these issues are, they pale in comparison to the dilemma that will face both Israel and the U.S. if Israel is unable to propose a plan of sufficient boldness to warrant administration approval. It is unlikely, for reasons already discussed, that Israel would then be able to make an “end-run,” bypassing the President and the State Department and going to Congress directly. But if it were to attempt to do so nevertheless, and were even to succeed, after a prolonged struggle, in winning some of the additional emergency funds it seeks, what would it have won? Such a course of action would almost certainly leave a residue of bitterness in an administration that has been generally friendly toward Israel, and at the beginning of a new four-year term; it could cause a loss of good will among the American public, seeing large amounts of additional foreign aid going to a nation, albeit a valiant ally, that has declined to make the sacrifices asked of it; and it would leave scars in Congress after the battle. Perhaps the worst scenario of all would be for Israel to receive the additional funds from Congress, over the administration’s objections, and then fail to pull itself out of its difficulties because the necessary internal steps were never taken.

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V

My own experience as a member of an American administration that did not deal successfully with inflation (which, while low by current Israeli standards, was high for the United States), has left some indelible impressions.

Severe inflation can only be attacked successfully by sustained, early actions that inevitably bring sacrifice, pain, and suffering. The Carter administration was unprepared to take such steps, in part because the inflationary pressures occurred late in the administration, as an election loomed, and in part because of a recognition that the people who would suffer the most from the anti-inflation medicine would be those toward the bottom of the economic ladder who formed the bulk of the Democratic party’s constituency.

President Reagan, by contrast, sustained a hard recession early in his term in order to achieve results later which led to his landslide reelection. The recession of 1981-82 was the most severe since the Great Depression of the 1930’s, with unemployment soaring to almost 11 percent. But it helped wring double-digit inflation out of the system and produce strong growth (over 6 percent in 1984), moderate inflation (4 percent in 1984), and lower unemployment (just over 7 percent at the end of 1984).

The lesson for Israel’s unity government is that it must act promptly, at the beginning of its tenure when sacrifice can be more easily asked and longer sustained, not later when elections are on everyone’s mind. If it bends to pressures and eases off as the bite of sacrifice takes hold, it will have inflicted pain on the public without reaping the benefits—precisely what happened with the Carter administration’s policy.

The Carter administration feared unemployment more than it did inflation, until inflation got so far out of control that it could not be restrained without deliberate efforts to slow the economy. No one can lightly advise Israel to accept higher unemployment in order to reduce inflation, but the sad truth is that in the short term there is an inexorable trade-off between these two. Israel, unfortunately, will not rid itself of triple-digit inflation without a substantial short-term rise in unemployment.

Inflation cannot be treated through half-measures and gradualism; its back must be broken with firm and decisive steps—the kind any democracy, and particularly one with Israel’s grave burdens and responsibilities, finds it difficult to undertake. Moreover, there is always a lag between tough anti-inflation measures and visible success. This is as true in the U.S., where the restrictive monetary policies at the end of the Carter and beginning of the Reagan administrations did not show results for well over a year, as it is in Israel. That is why the Israeli public must be told frankly that a significant sacrifice will be needed for considerably longer than a year, but also that the sacrifice will lead to sustained non-inflationary growth in the future. Unless the public is prepared, it will soon become disenchanted with the immediate, negative results of austerity and this will undercut the support the government needs to pursue tough policies until they succeed—as they will if they are given enough time. Israel, which has made so many valiant sacrifices on the field of battle, must be equally willing to sacrifice at home to preserve a strong economy.

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VI

The decisions that will be taken by the American and Israeli governments in 1985 have within them the capacity to alter, permanently for the better, the entire U.S.-Israel relationship. The political relationship is already one of mutual affection, respect, and admiration, both between governments and between peoples. And as political ties continue to improve, so too can the climate of economic cooperation. Negotiations have just successfully concluded on the Free Trade Area, which will open up the entire U.S. market to Israeli goods duty-free. Increased foreign investment in Israel should now be stimulated, and additional Israeli products developed to take advantage of the openness of the world’s largest market. The competition from increased U.S. imports into Israel will help make Israeli industry more productive and efficient.

The year 1985 is a propitious time for Israel to take the bold action required. The U.S. economy is now into its third year of strong recovery. While Europe has been slower to recover from the recession of the early 1980’s, there too an economic uplift is beginning. Inflationary pressures worldwide are easing. Oil prices are plunging. Israel, with its great human resources, its well-educated workforce, some of the world’s premier scientists and engineers, and a strong technological base, is in a position to take advantage of all this.

There is, as well, a growing recognition among American Jews that donations to the United Jewish Appeal, important as they are, do not suffice to help Israel’s economy. Various American Jewish businessmen are discussing joint ventures with Israeli firms, direct investment in Israel, and a capital fund aimed at helping Israel become the world’s next mecca for high technology. Israel has the capability to see this through.

But so much of this bright future depends on taking tough steps and then sticking with them until they work. Israel has a legitimate concern that the short-term consequences of the actions it is being advised to adopt will be painful and difficult. But the consequences of failing to do what is necessary are far greater—for they will inevitably mean more economic and social suffering later, and a loss of control over the future.

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Footnotes

1 Kenneth Jacobson, U.S. Aid to the Middle East: A Look Back, A Look Ahead, Anti-Defamation League of B'nai B'rith (January 1983).

2 Congressional Quarterly, December 29, 1984.

3 Stanley Fischer, “Israeli Inflation and Indexation” (prepared for a conference on “Inflation and Indexation,” Washington, D.C. December 6-8, 1984). I have relied on this work throughout.

4 I am indebted to Professor Herbert Stein for this discussion of Israel's debt problem.

5 See U.S. Senate Foreign Relations Committee Staff Report, “The Economic Crisis in Israel,” 98th Congress, Second Session, November 1984, by Michael Kraft and Gerald Connolly, which I have used extensively for this article.

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