The Israeli Economy -
by David Klein,
Governor - Bank of Israel
(December 7, 2000)
The Israeli economy has undergone a major
transformation in the last decade:
GDP per capita, that stood at around US$ 11,000 in
1990, increased by more than 50% to reach US$ 17,000 in the year
The population of Israel increased in this
decade by 35%, from 4.7 million in 1990 to 6.3 million in 2000,
due mainly to a large wave of immigration following the collapse
of the Soviet Union.
Despite the rapid increase in the labor force,
the unemployment rate declined from a peak of 11% in 1992 to less
than 9% in 2000 while, at the same time, the number of foreign
workers has also increased to reach 15% of the business sector
employees, compared with 10% at the beginning of the decade.
Foreign investors discovered Israel in the
'90s - at a turning point in the peace process in the region.
External capital - a trickle before the '90s - started to flow in
towards the middle of the decade, mostly as direct investment and
partly as financial investment. It may reach a peak of some US$ 8
billion in 2000, roughly 7% of GDP.
Foreigners invest in Israel not only in the
high - tech industry, but also in the so-called traditional
industries like food and textile, and find active interest in
financial institutions. Altogether, Israeli assets held by
foreign residents amounted, at mid 2000, to US$ 123 billion,
somewhat more than our GDP. Most of it, 59%, reflects investment
in the non-bank private sector; one quarter - in government of
Israel foreign obligations; and the rest - in foreign currency
deposits in Israeli banks.
In terms of international trade Israel is an
open economy, and it has become more so. Exports and imports
amounted to 80% of GDP in 1990, and 88% in 2000. The deficit in
the balance of payments has increased to reach a peak of 6% of
GDP at the middle of the decade but declined to roughly 1% at its
The nature of our manufacturing exports has
changed dramatically in the last decade. Out of the total
increase in industrial exports, 88% were due to advanced,
Foreign exchange reserves amount this year to
some 40% of our imports, compared to some 30% ten years ago,
while the exchange rate regime has gone most of the way from fix
to floating rate. In addition, our short-term foreign assets are
almost twice the level of our short-term foreign liabilities - a
vast improvement over the surplus of some 20% that we had in the
mid '90s, a comfortable ratio by itself. Furthermore, the ratio
of our net foreign debt to GDP stood at 9% in mid 2000, compared
with 25% in the middle of the '90s.
The banking system is a solid and conservative
one; the last crisis took place 17 years ago. All Israeli banks
weathered well the financial crisis that swept South East Asia,
Russia, Latin America and the hedge funds industry in the second
half of the '90s. Unlike some European and American banks,
Israeli banks did not lend to, or invest in emerging markets, and
therefore did not incur losses, due to their activity there.
Inflation, endemic and unwielding for a
quarter of a century, was brought down to a low one-digit level,
despite the persistent assertion of many Israeli economists that
the structure of the economy is too rigid to allow it.
These results are not an accident or a result of
sheer luck. They are due to a long-term strategy, adopted by all
Israeli governments, starting in the second half of the '80s. The
core of this strategy is, of course, neither new nor unique: distance
the government, as much as possible, from economic activity. In the
case of the government of Israel, that was an awesome agenda. We have
not yet finished the job, but we have gone a long way:
A rather thorough change was implemented in
our international trade area. Customs and non-tariff barriers
were abolished or reduced significantly, and free trade treaties
were signed with the EU and the US. That had an overwhelming
impact on the structure of the Israeli industry. It relies now
more on advanced, skilled labor based, technology and less on
traditional, low wage labor, industries.
A similar change was effected in the financial
area. The money and capital markets were deregulated to a large
extent, and almost all exchange controls were lifted. At the same
time, the exchange rate regime was gradually rendered more
flexible, and the daily rate is determined in the interbank
market without any involvement of the central bank. The foreign
currency market thus created attracts also foreign financial
institutions, and its average daily turnover now reaches US&
At the beginning of the '90s the government
embarked on the long-term road of fiscal discipline. Each new
government fixed a multi-year, declining, deficit target. The
most recent government decision will lead us to attain the
European standard, namely a general government deficit of 3% to
GDP, by 2003. Hence, it should not be surprising that after a
decade of implementing that policy, the government debt ratio
declined from 132% to GDP in 1990 to less than 100% at year-end
2000. We are all aware of the need to further reduce the
government debt burden towards the 60% Maastricht benchmark and
government policies ensure that we are heading in that direction.
Apart from putting a declining cap on the
relative size of its deficit, the government has been engaged in
privatizing its business corporations. A lot has been
accomplished already, and the government is weighing now the
options of privatizing the two remaining commercial banks it
still partly owns, allowing also privately supplied electricity,
and opening the telecom business for additional providers.
Finally, the government decided, in August
2000, to adopt a price stability target, and defined it to be at
the range of 1%-3%. We are already operating within that range
and our challenge is to maintain it, as we will.
Based on this performance, the international
credit-rating of Israel was upgraded through the last decade. S
& P, for example, raised it from BBB- to A-.
A decade of structural changes and macro-economic
strategy for stability, resulted in the current year being one of the
best in our recent history.
Until the third quarter of 2000 the economy was
growing at an annual rate of some 6%, led by the hi-tech sector.
Exports are estimated to increase by 20%, reflecting also the
acquisition of start-ups by foreign companies. Industrial exports are
likely to increase this year by 25%.
At the same time the standard of living also
bounced. Private consumption per capita is estimated to increase this
year by 3% in real terms - compared with 1% per-annum only in the
previous two years.
Investment in equipment and machinery is
increasing this year by 7%, indicating positive prospects for further
growth in the future.
The higher-than-expected growth of the economy
increased government tax revenues and reduced the budget deficit by
more than 50% compared to the planned one. As a result, the public
debt burden will further decline, reducing government interest
The last quarter of this year, as we all know, is
going to be different. However, assessment of the likely
repercussions, for the Israeli economy, of the rising military
tension in the area, requires some perspective. Three comments are
First, as far as one can tell, the recent tension
is not going to lead to a reversal of the peace process in our
region. It is certainly a serious distraction, but judging by the way
the various sides handle it, they clearly are mindful of the need to
Second, it affects the Israeli economy in a
specific way. A decline in tourism is clearly visible, and the
absence of the Palestinian workers is affecting activity in
construction and agriculture. The implications for the rest of the
economy are indirect and a lot less significant. Tentative
assessments, prepared by our Research Department, talk about a
one-time reduction of 1%-2% of GDP from the previous estimate for
2001, which was 5%-6%. On the other hand the unemployment rate is
likely to decline because of the increased demand for labor,
especially low-skilled - most of the unemployed in Israel, to replace
the Palestinian workers.
Domestic financial markets, so far, lend support
to the view that the Israeli economy will return to normal operation
after a while. In particular, the yield on long-term government bonds
hardly budged, and the reaction of the foreign currency market was
relatively benign. This may be a sign that our commitment to maintain
stability is still credible, but it should not be taken for granted.
Third, overall economic policy over the last
decade resulted in a significant improvement in the economy's
capability to compete on world markets. Hence, its ability to weather
a disturbance like the one we are experiencing now, was greatly
enhanced. After all, we know by now rather well that integration in
the global economy may also subject us to external shocks. We have
learned, as a result, that adjustments in our behavior are called for
from time to time.
That does not mean that our overall economic
strategy should change. I believe that it won't. Based on our past
performance it is very likely that any future government will carry
forward the economic strategy that proved to be so successful in the
last decade, namely:
Price stability; and
We know that this is the key to make progress in
the global economy and, hence, the road for a durable growth.