ECONOMIC MEETING IN CAESAREA - 25-Jun-95

ECONOMIC MEETING IN CAESAREA

(COMMUNICATED BY GPO ECONOMICS DESK)

The Prime Minister, government ministers and officials, members of Knesset, leading figures in the business, banking, financial, and industrial communities, and academics, participated in a roundtable discussion on the state of the Israeli economy, held 22-23 June in Caesarea. The conference, sponsored by the Israel Democracy Institute, provided a forum for exchanging views on the management of the economy, the roles of various government and private bodies in economic planning, and the budget process. It was generally agreed that reform of existing economic structure was key to furthering economic growth.

Topics covered at the conference included: * Changes in Israel's Economy During the Previous Two Years * Dilemmas of Monetary Policy for 1996 * The Budget in an Election Year * Towards a GDP per capita of $20,000 * Economic Reforms: Structural Changes in Taxation and Capital Markets * Infrastructure Investment: Manpower, Physical, R&D, and Privatization * International Influence on Economic Development

Prime Minister Yitzhak Rabin told the participants that the peace process is providing Israel with an economic advantage, and we must reform our economic system to take advantage of peace's great potential. However, he warned that a number of problems will have to be overcome in the near future in order to ensure economic growth. He raised the question of whether Israel has enough political will and the organizational capabilities, to overhaul the economy in order to strengthen it for the future.

The PM noted the connection between the economy and political issues and said that the peace process carries a high economic cost. He noted that the Government had sufficient financial resources to fund the first stage of the agreement with the PLO, but that the next stage - the interim agreement - would be very expensive, and Israel does not have the resources to pay for the second stage unless it was at the expense of other items in the budget. He acknowledged that this would be very divisive politically, but argued it would be even more harmful were Israel to halt the peace process.

According to his assessment, U.S. aid to Israel will, in all likelihood, be cut within two to three years. He noted Israel, with its own resources, must be prepared to function without it. The question is how to balance the need to increase Israel's budget while adjusting to a different international assistance situation, he said.

Rabin noted the dilemmas of the budget allocation. He said that Finance Minister Shohat had presented him with the need to invest in tourism, industrial R&D, and industrial inputs, but he reiterated, the budget cannot be adjusted to accommodate every need. Even now, he noted, some laws passed by the Knesset do not have funding, and therefore have not been implemented. He criticized the political parties, Labor included, for their excessive budget demands.

PM Rabin spoke positively about recent investments by foreign concerns in Israel. He specifically noted the recent investment in Koor by the U.S. investment firm, Shamrock, and the magnesium metal production facility joint venture between the Dead Sea Works and Germany's Volkswagen. He noted, however, that bureaucratic difficulties made it very difficult for foreign investors.

Many of the participants focused upon the Bank of Israel's monetary policies and the Finance Ministry's fiscal policies. Elements that were criticized included the slow pace of liberalization; public sector wage agreements; lack of coordination of between the Treasury's fiscal instruments and the Bank of Israel's monetary instruments including exchange rate, interest rate and inflation fighting mechanisms; budget control during an election year; balance of payment problems; subsidies; the security burden; pension funds; technical education; lack of R&D spending; and reasons for decreasing industrial productivity.

Finance Ministry Director-General David Brodet placed responsibility for the Tel Aviv Stock Exchange's problems during the past few years on the Bank of Israel's "zig-zag" monetary policies. Brodet argued that the Bank kept interest rates too low in 1993, raised them too high in 1994, and did not adjust them appropriately in 1995. Bank of Israel Governor Jacob Frenkel responded that the Bank's policies are based on long term goals, and as such, management of the country's money supply, fighting inflation, and ensuring growth are the Bank's objectives. Frenkel said the Government's main thrust should now be on reducing the growing trade deficit and the country's growing balance of payments deficit, specifically the current accounts deficit.

Prof. Zvi Zussman attacked the Bank's monetary policy saying that Israel could not deal with both inflation and the growing current accounts deficit concurrently. Prof. Assaf Razin, of the Israel Democracy Institute, said the Treasury's public sector wage agreements acted to prevent savings, while Prof. Leon Lederman, of Tel Aviv University, demanded the Government and the Bank take steps to enhance private sector saving. Frenkel reflected that a national savings plan would help the economy, although expansion of the capital markets and investment sources are in his view, the most crucial elements to encouraging savings.

Prof. Haim Harari, of the Weizmann Institute, also attacked what he saw as politically motivated wage agreements that occurred immediately before Histadrut elections, calling for the reversal of these agreements. Director of Wages at the Treasury, Yossi Kutchik, agreed and called for serious reforms in public sector wage agreements, though Histadrut Treasurer MK Haim Oron (Meretz) played down the impact of the new wage agreements.

Avi Ben-Bassat, Senior Director for Research and Foreign Exchange Operations at the Bank of Israel, said that the main problem facing Israel now is its current accounts deficit and the growing trade deficit. He also said that current inadequacies in savings must be corrected in order for growth to continue and restrain unemployment. He said the Government must cut spending and subsidies, whose existence create inefficiency. David Klein, Senior Director for the Monetary Department and Comptroller of Foreign Exchange at the Bank of Israel, called for further financial market reforms, though he warned that the Bank and the Treasury must move slowly so as not to destabilize the economy. A number of participants, including MK Gedalia Gal (Labor) and MK Dan Meridor (Likud), agreed with Ben-Bassat calling for more open competition, and for solutions to the pension and kibbutz crises, but they also called for more rapid structural reforms in order to encourage savings.

Prof. Dan Galai, of Hebrew University, said that the country's capital markets are a critical element in Israel's economy and as such, more rapid liberalization of foreign currency controls should be adopted as well as a reduction in interest rates. Danny Gillerman, President of the Federation of Israel Chambers of Commerce, agreed that liberalization should be more rapid, and together with MK Silvan Shalom (Likud), called for better coordination between the Bank of Israel and the Treasury in their use of monetary and fiscal instruments.

Finance Minister Avraham Shohat told the conference that the IDF needs to be made aware that not all of its budget needs will be met during this period of budget cutting, and in the midst of the peace process. "Not every request by the Security Establishment is regarded as the Gospel," said Shohat. MK Meir Shetreet (Likud) said that security costs are too high, though he argued that spending on military R&D must be increased. Liora Meridor, Director of the Bank of Israel's Research Department, also warned of an increase in the defense burden, noting that in a time of budget restraints - if the military's budget increases - other elements of the budget be reduced to compensate.