Opening Remarks at the Strategic Forums Sponsored by Paul Merage

25 Jun ’07
Strategic Forums Sponsored by Paul Merage

“Before I continue with my remarks, let me sound an optimistic note,” said Daniel Doron, ICSEP President, in his opening remarks to the Strategic Forums Sponsored by Paul Merage.

“You will hear voices say that attempts to reform Israel are futile, that you cannot initiate significant changes here.

“We know better.”

The high-powered conference was held to explore ways of encouraging Israeli high-tech to meet the serious challenges facing it and to continue flourishing.

Dear Friends and Colleagues,

My remarks also represent the views of Izhak Devash, a financier who cooperated with us in ICSEP on capital market reforms; and of Prof. Yuval Rabani of the Technion, who works with us on reforms in higher education.

First, many thanks to Paul Merage and to the devoted Foundation team for inviting me to address this important conference.

And thanks to the many distinguished participants who launched the earlier discussions and wrote the papers that we shall be studying and discussing this week. They have analyzed some pivotal problems and tackled some central issues, trying to help us grapple with the serious challenges facing our hi-tech sector and our business school programs essential for its continued growth.

Before I continue with my remarks let me sound an optimistic note. You will hear voices say that attempts to reform Israel are futile. That you cannot initiate significant changes here. We know better. Three years ago, ICSEP, which I direct, formed a working group led by the late Prof. Marshall Sarnat, Israel’s foremost banking expert, Prof. David Levhari, Izhak Devash and David Boas. We formulated a capital market reform package and presented it to then Finance Minister Benjamin Netanyahu.

Despite the huge political risks inherent in this plan Netanyahu immediately embraced it and delegated the director of his ministry, Yossie Bachar to implement it. I shall not tire you with the details of the great fight the banks put up in order to block the reform and the huge effort it took to overcome their powerful resistance. The reform passed. While breaking a bank duopoly that was more damaging to the Israeli economy than the Japanese banks were to Japan’s, the reform shifted over 700 billion shekels from the control of the banks and the labor union to other players. It introduced some competition that greatly improved the performance of our capital markets. According to the World Bank and to the Davos Economic forum this reform was the reason Israel overcame twenty years of slow growth and recession and moved into spectacular high growth. This despite the war of terror and the war in Lebanon. So yes, it is possible to affect significant change in Israel, provided the reform plan is well thought out and provided we are willing to engage in a continuous effort to see it through the legislative process and to create public support for it.

Back to our conference. The deliberation that preceded it has clearly defined the overall mission of our conference: “To contribute to the continued growth of Israel’s R&D and hi-tech sector as well as to permit this sector to contribute to increased economic opportunity for all Israelis, and to define … a set of reforms that will enhance higher education in Israel,” particularly in its business schools.

Underlying these deliberations was the assumption that the attainment of the conference’s goals is dependent on positive government action. Therefore most of the deliberations have been devoted to fashioning better government policies.

So let us first examine the government of Israel, on whose wish and ability to implement policy and generate change our conference pins such high hopes.

The budget of the Israeli government is about 300 billion shekels, of which about a third is devoted to the return of debt, interest and principle; another third to the cost of labor and pensions; and the last third to defense, education, health care and transfer payments.

The government’s annual payments on its 550-billion shekel debt is approximately 100 billion. It must also pay about 100 billion to 750,000 workers—that’s every third worker in Israel—whose productivity is abysmally low since governments can neither fire nor reward them. This leaves government very little wiggle room, even less so since many of its programs and handouts are vigorously defended by politically powerful vested interests. Small wonder then that over 70% of all government resolutions are never implemented and most of the energy of government is consumed by infighting over politically driven distribution of shrinking resources.

The conference’s participants wish to devise better policies for government is an eloquent witness to their dissatisfaction with its performance. Since we know how governments operate we know what are the chances of making government act more effectively. Many of us have partaken in similar efforts in the past and we know what the results usually are.

We should therefore not put all our eggs in one torn basket and hope too fervently that improved government policies will significantly enhance the prospects of our hi-tech sector or our higher education.

Yet many of the policy improvements that this conference considers do just that. Therefore the conference’s ambitious mission goals raise many questions both substantially and regarding the assumptions underlying them.

The time is short, so I will raise just a small number of such questions. I hope that by addressing them we will arrive at better formulated and more implementable goals.

The first and perhaps the most encompassing question is why, if our objective is to enable “Israel to compete successfully in an increasingly global market place,” we are not fully focused on policy reforms that can increase Israel’s competitiveness. Why are we not devoting more attention to removing excessive government intervention in the economy and to eliminating the many cost-inflating monopolies—especially in financial markets—that government intervention has sprouted? These monopolies and costly government regulation make the costs of doing business in Israel prohibitive, so that Israeli firms are less able to compete in the global marketplace.

Why don’t we propose ways to make government smaller and more efficient so that it can encourage economic growth rather than hinder it?

Why don’t we propose a reduction in taxes so that resources can be freed for productive private investment and Israelis are not chocked by excessive taxation as when they are forced to pay 110% tax on cars? Why not recommend for Israel a low flat rate tax that worked so successfully for Russia, Poland, Estonia and Slovakia?

Why don’t we push for the implementation of the additional reforms in financial markets that will make credit available for small entrepreneurs in hi-tech and other sectors? The lack of access to credit, incidentally, is a chief reason why the Negev and the Galilee stagnate economically.

Why don’t we push for breaking the land, building materials and construction monopolies that double the cost of housing in Israel so that Israelis have to work for 9 years in order to buy a small apartment?

Why don’t we formulate policies that will enable small businesses in Israel to thrive rather than choke? Why not reduce excessive regulation and improve their access to credit?

Why don’t we fight restraints on trade that make all consumer goods so costly so that yogurt costs here double of what it costs in the US if you compare salaries and purchasing power?

Why do we tolerate that the price of water, electricity, credit, education, health and whatnot is so inflated and why don’t we do something to help reduce them, which is a more effective way of helping the poor than income redistribution?

Why do we not recommend the introduction of economic considerations and competition to our educational system which like any rigid cartel is degenerating?

Instead, our deliberations seem to mostly focus on how to make government better direct the hi-tech sector. This, twenty years after the whole notion of industrial policy has been discredited? (Recall the notorious case of Japan’s Ministry for Industrial Policy, MITI, which resisted the development of a car and an electronic industry for fear it could not compete with US and European giants in those fields.)

We seem to be still wedded to the notion that government can “assist”, namely protect, certain sectors by subsidies, reducing risks. Yet, it is increasingly evident that risk and its management are a vital component of healthy growth.

We have had ample time to learn that all government direction and subsidy result in government employees picking favorites and discriminating against those with less political pull and less access to government favor, yet we encourage such direction. In parenthesis it may be remarked that the lack of balanced development in Israeli hi-tech bemoaned by these forums may be due precisely to distortions created by so called government direction and “assistance”.

Altogether, after almost sixty years of massive government intervention that mostly led to massive failures and waste (in so-called national projects like the Negev or Galilee development or in the encouragement of certain sectors in the private sphere), why do certain policy makers, who ought to know better, still advocate increased government spending and budget deficits? Why recommend a shift of resources from a more efficient private sector to a grossly inefficient and distorting public sector?

In hi-tech specifically, can anyone point to credible studies that affirm that government “encouragement” had ever a consistent, rather than a sporadic, positive role? Government sometimes has to intervene, as when it was imperative that Israel quickly develop electronic warfare capabilities, and in other such cases involving public goods, such as basic research. But even episodic government successes appear differently if one calculates the total cost of government intervention.

Government bureaucrats are usually risk averse and they are susceptible to political manipulation. Government action involves very high “opportunity costs”. Draconian taxes needed to finance government programs cut investment by private parties. Yet diffused private investment leads to competition and therefore to better decision making, to lesser risk and to greater accountability by those who allocate credit. It also provides better access by smaller firms to capital, and a better spread and a better management of risk.

The pre-conference call to fashion policies that will correct putative imbalances in growth is also problematic. Can anyone really define what balanced growth is? Even if we seem to discern imbalances during certain time periods, does this mean that we know how to define them or by what scale to measure them, or that we know by what means and in what time frame we can correct such putative imbalances?

There is the myth that so-called “market failures” (usually caused by government interference) can be corrected by government. But we have yet to find examples where market failures have indeed been corrected by government. This is hardly surprising, since government’s innate failures, though less often analyzed, are far more common, pernicious, dangerous and costly. Therefore those who advocate government interference must bear the burden of proof that what they recommend is efficient or indeed doable. In sum, should we not use our valuable time pursuing better defined and more doable goals?

The problematic nature of our goals is even more pronounced in the case of the second major goal defined in our Overall Mission, namely that hi-tech growth must “contribute to increased economic opportunity for all Israelis” to wit that hi-tech must “reduce current income disparities” since, it is claimed, “a rising tide does not float all ships equally.”

Can anyone explain why a rising tide must float all boats equally or whether it can really do so when different sized boats—to stick to the metaphor—will naturally be affected differently by a rising tide?

It is almost impossible to define what equality really is, unless one thinks of strict equality in wages, a notion discredited long ago. Nor can anyone suggest how it may be attained. And why is hi-tech particularly suited to attaining such a goal? What makes hi-tech people in any way more qualified to address the complex problems of poverty than others? Is not their job of profitably running a complex business hard and demanding enough? Does it not occupy most of their time?

Moreover, can anyone really argue that by massively lowering higher wages or taxing them to reduce income disparity (a step that will be particularly damaging to hi-tech workers and entrepreneurs) we can still assure incentives to higher productivity or significantly improve the lot of the poor? And can anyone really figure out the costs such redistributive efforts impose and whether such costs will not reduce rather than increase the general welfare?

Despite all the fashionable talk about the putative “social responsibility” of business to assure “social justice” (conceived as “equality”, a highly problematical concept to begin with) it is not clear at all what we mean to accomplish by narrowing income disparities—besides reducing envy, perhaps.

All these redistributive fantasies, all this defining of the public good in terms of static “social welfare needs” have been tried over and over again and they always fail. The issue of poverty is too tragic and serious to be tackled by slogans and addressed by failed old policies. Poverty is a complex phenomenon. It requires minute attention to detail and the understanding of the differences between various states of poverty, its long term dynamics. Poverty cannot be understood or effectively addressed by annual poverty festivals in which the welfare lobby provides its bleeding-heart allies with photo opportunities and fake poverty statistics, so it can lobby for more funds to sustain what has become a growing poverty industry.

Why not think positively in terms of increasing growth. True, growth may not distribute its benefits evenly, and it may take time to trickle down. But growth has proven itself by making dramatic changes in the standard of living of the poor, a spectacular achievement which distributive economies failed miserably to achieve. All they managed to do is spread misery and poverty more widely, while the Nomenclatura—the bureaucracy and the ruling oligarchy—skim the cream off the little milk such regimes manage to produce.

Incidentally, if we are really serious about alleviating poverty we can do so quickly and efficiently by disbanding the monopolies which inflate the price of all consumer goods in Israel by 30 to 50%. As in telephony the breakup of these consumer goods monopolies could reduce costs quickly and significantly, thus raising the purchasing power of the lower income strata, pulling most of them above the putative poverty line. Higher purchasing power would quickly translate into growing demand, expanding employment, higher productivity and better wages. But none of the pro-poor lobbies has advocated or supported this simple and effective solution because it is politically dangerous to fight our ruling oligarchy, as Finance Minister Benjamin Netanyahu learned to his chagrin after he made his dramatic reform in financial markets and was defeated in the polls. Our oligarchy and its partners in the bureaucracy, in politics and the media protect our monopoly-ridden economy. They are not about to give up their ability to make a mint by exploiting Israeli consumers, and especially the weaker strata.

In summation we could do so much better to focus on concrete reform proposals that liberate markets, such as the good suggestions for further reforms to strengthen our capital markets, rather than spend so much energy on the lost cause of better government direction of hi-tech and improved support for it. We should also discard fashionable slogans that promise to solve the problem of wide impoverishment in Israel by socialist means such as closing income disparities.

It is precisely such past socialist policies that mutated into statist control of the economy that made a most talented nation economically lame, so that despite over three hundred billion dollars in foreign aid our economy cannot provide most of our talented workforce more than a measly 7000 shekels a month, making so many families unable to make ends meet. Our distributive system is also the reason our political system is so torn by constant strife over the division of government handouts and why growth has been stymied.

Let us look elsewhere for solutions. Let us trust freer markets to deliver the prosperity they have delivered everywhere they have been tried, and let us work toward this worthy goal of more freedom from government rather than more or better government direction and aid.

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All recent program activities

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ICSEP has circulated the following letter together with a PowerPoint presentation: “A Competitive Capital Market – A Growth Engine for the Israeli Economy”.

Dear friends,

Enclosed is a draft document on the reform of financial markets in Israel. We hope it explains why such a reform is so vital for Israel’s viability, and why Israel needs a strong economy to meet the extraordinary threats and challenges facing it.