$Unique_ID{COW01875} $Pretitle{225} $Title{Israel Chapter 4A. The Economy} $Subtitle{} $Author{Richard F. Nyrop} $Affiliation{HQ, Department of the Army} $Subject{percent government economy economic immigrants national labor large gnp institutions} $Date{1979} $Log{Design From Israeli Coin*0187501.scf } Country: Israel Book: Israel, A Country Study Author: Richard F. Nyrop Affiliation: HQ, Department of the Army Date: 1979 Chapter 4A. The Economy [See Design From Israeli Coin: Design derived from an Israeli coin] The Israeli economy made impressive progress after independence in May 1948, from producing olive oil and flour to manufacturing jet fighters and sophisticated guided missiles. Even farming in an arid land achieved remarkable results and, because of different institutions, capital inputs, and specialization, went far beyond that attained in surrounding Arab areas. Economic growth was stimulated by a large influx of immigrants (the population increased almost four- and one-half times by the beginning of 1977) and a substantial flow of capital from abroad. World Jewry financed a considerable part of the development of the country. Even though the economy had expanded far beyond the legacy of the British Mandate period, exports still remained considerably below imports. By the late 1970s the country was nearly as dependent on foreign support as it had been in the beginning. The social welfare spending, based on the socialist orientation of many Israeli leaders, and the large defense burden considered necessary to guarantee the nation's survival, exceeded available resources after the October 1973 War. Balance-of-payments problems and high rates of inflation have plagued the state ever since. By the late 1970s the time for decision had come. A number of economists, particularly in the central bank, believed that an evaluation of priorities and a restructuring of the economy were imperative to bring spending into line with resources. A start was made on the hard decisions in 1977, but many foreign and domestic observers were not convinced that the new economic policies were enough. The Economy Before Independence When the Jewish settlers began to arrive in the late 1800s, the economy of Palestine was largely semifeudal and semi-self-sufficient agriculture. Production techniques were those of generations past, and output was hardly more than the family consumed. The exchange of goods was limited, and the use of money even more limited. Towns were few and not large. Manufacturing was by artisans in small shops. With the arrival of the early Zionist settlers from Europe-particularly those of the Second Aliyah (see Glossary)-there was a marked effort toward rapid economic development of the Jewish enclave, which contrasted sharply with the traditional economy of the indigenous inhabitants of Palestine. Development of the Jewish economy was helped by a continuous infusion of new immigrants and by the import of capital, much of it belonging to the arriving immigrants. This basic formula for growth was established early and followed up to the present time; another important ingredient was the dedication and acceptance of sacrifice for the goal of a Jewish homeland by the pioneering Zionists. The Jewish settlers brought with them a different approach. In agriculture the emphasis was on commercial farming, high productivity, and labor-saving devices. Foreign capital helped increase irrigation, use of pumps, and experiments to determine the more advantageous crops. The immigrants also brought a variety of skills. The General Federation of Labor (known as Histadrut-see Glossary) was formed in December 1920 and helped spawn a wide range of activities, such as manufacturing, banking, insurance, marketing, transportation, and construction, to use the skills of immigrants and to broaden the Jewish economy. The waves of immigrants set up a pattern that was still discernible in the 1970s, although tremendously diluted because the number of new immigrants had become small compared with the resident population. Immigrants became consumers when they first arrived and economic producers only later after a transitional period. Each wave of immigrants increased demand, which was partially satisfied by imports, but domestic activity was spurred to meet the new demand although increasing output took time. Manufacturing and some other activities usually required increased imports of machinery and equipment. The housing sector was particularly sensitive to immigration, and construction activity often was the first job opening for new arrivals. At times employment in the building trades rose as high as 45 percent of the labor force. As housing needs eased after the wave of immigration, other sectors of the economy usually were expanding providing employment opportunities and the additional goods needed by the larger population. The formula of immigration combined with capital imports produced rapid economic growth in the Jewish enclave before independence. An efficient and varied agricultural sector along with a growing manufacturing sector largely built around consumer goods, such as foods and textiles, but including others such as construction materials, supplied part of the population's needs. Service sectors, such as banking, transportation, and trade supported the production sectors, resulting in a more rounded and modern economy than was common in the Middle East. By the 1940s the Arab economy in the Mandate was far less advanced although changing. Agriculture was still the main activity of Arabs, and farm incomes were increasing. Manufacturing was expanding even though most was confined to shops rather than factories. Urbanization of Arabs was growing. The combined import needs of Arabs and Jews far exceeded the exports available from the Palestine economy. The local currency was linked to the British pound, however, and there were no balance-of-payments problems from the large import surplus. Growth and Structure of the Economy By any measure the Israeli economy grew remarkably after independence. By 1976 gross national product (GNP) amounted to the equivalent of nearly US $12 billion. Between 1950 and 1976 GNP increased by nearly 9 percent a year in constant prices, by 4.7 percent a year on a per capita basis. The Israeli economy, which was about 40 percent of that of Egypt (in GNP terms) after the War of Independence, 1948, was about as large as Egypt's by the mid-1970s although Egypt had a population some ten times as great. By 1976 per capita GNP amounted to nearly US $3,400, higher than that of Italy. The Israeli standard of living was equal to that of some West European countries and exceeded that of East European nations. The engine of growth was the inflow of foreign funds and immigrants; the population increased an average of 5.2 percent a year between independence and 1976. Economic growth was not constant. Between 1965 and 1967 the economy stagnated, and unemployment increased sharply. The 1967-73 period was one of high growth, averaging 10.5 percent a year (in constant prices); investments more than tripled (in constant prices) at the same time that public and private expenditures were rising rapidly. By 1970 the demand on resources became excessive, and inflationary pressures mounted (see Banking and Monetary Policy, this ch.). Between 1974 and 1976 the economy stagnated (growing by an average 3.2 percent a year in constant prices) as the government attempted to contract aggregate demand to control inflation and ease the strains on the balance of payments. GNP increased by 2 percent (in constant prices) in 1975 and only by 1 percent in 1976 and 1977. The economic stagnation since the 1973 war had the biggest impact on investments. Gross domestic capital formation declined after 1973-by 14 percent in 1976 and by 15 percent in 1977; by 1977 it was below the level of 1971. The low level of investments posed a threat to future output and expansion. Private and public consumption remained relatively strong, however, contributing to the continuing high rate of inflation. By the mid-1970s the structure of the economy was similar to that of industrialized countries of Europe. In 1976 agriculture, which had been more important at independence, contributed only 6 percent to GNP (see table 10, Appendix A). Manufacturing's share of GNP, including construction and utilities, amounted to 33 percent. The service sector was the largest part of the economy accounting for 48 percent of GNP. Public and community services, which included the government and the various education and welfare programs, contributed 17 percent of GNP and business and financial services, 11 percent. Labor In 1976 the labor force numbered 1.17 million, nearly 60 percent of which were employed in service industries (see table 11, Appendix A). The service sector has always been large partly because of government and quasi-governmental activity and the trade and transport network associated with a high level of imports. Moreover the service sector was able to assimilate a large number of immigrants relatively easily. By the late 1970s service employment was excessive compared with the needs of the industrial sector, particularly that producing for export. The government was seeking means to entice workers in industries producing for the domestic market and service employees, both of which had underemployed workers, into export industries, which experienced a shortage of labor after 1974. The shift was complicated by the lack of mobility of workers and a wage structure that favored the white-collar employee over the blue-collar worker. Between 1955 and 1977 the labor force nearly doubled, increasing an average of 5.8 per year. Immigration provided most of the increase. Absorption of immigrants was facilitated by a nucleus of such highly trained personnel as scientists, engineers, technicians, managers, industrialists, agronomists, and skilled labor, but the widely differing languages, cultural backgrounds, and work history of the immigrants complicated adjustment to productive labor. For some immigrants extensive training was required before they could obtain jobs and support themselves. There were a number of programs to train immigrants and others in the skills needed in the economy. By the late 1970s shortages loomed in the future for particular skills, which the government attempted to remedy by increasing training and recruitment among Diaspora (see Glossary) Jews. Labor was almost completely organized, primarily in forty nationwide trade unions affiliated with the Histadrut. Histadrut negotiated most wage-benefit agreements for workers, and wages and conditions were relatively standardized throughout the economy. Since 1952 nearly all wage agreements have had clauses calling for increases when the cost of living increased. In the 1970s workers received 70 percent of the rise in the cost of living. The average annual income of urban employees in 1976 was 26,300 Israeli Pounds (for value of the Israeli pound-see Glossary), approximately the same as the average wage in industry and public services-the two main sources of employment. Utilities and transportation and communications were the main sectors where average wages were above the norm. There were frequent strikes and disruptions by labor, but many of them involved only a particular business and a small group of workers. Since the Six-Day War of June 1967 a number of Arab workers from the occupied territories have been drawn to the Israeli economy by the high wages. A survey indicated there were about 60,000 such Arab workers (97 percent males) in 1977, 5 percent of the Israeli labor force. About 40 percent were employed in construction, 25 percent in industry, 15 percent in agriculture, and the remainder in personal services. The survey also indicated that for over half of the Arab workers, their employment in Israel was their first job. Most were young. The number of Arab workers from the occupied territories had dropped from a peak in 1974 (about 70,000) because of economic stagnation, particularly declining construction activity. Unemployment among all workers was a problem primarily in the 1950s during the period of heavy immigration. The unemployment rate was 7.2 percent in 1955 but had fallen below 5 percent by 1960. In the 1960s unemployment remained low, except for the 1965-68 recession period (unemployment reached a peak of 10.4 percent in early 1967). In the early 1970s unemployment virtually disappeared during the boom times, falling below 3 percent. Since the 1973 war economic activity slowed considerably but with relatively few layoffs. By 1976 unemployment was only 3.6 percent. During 1977, however, labor leaders became concerned that the government anti-inflation effort would lead to substantially greater unemployment by 1978 or 1979, perhaps in the magnitude of that in the mid-1960s even though many industries were short of labor in 1978. Role of Government Government performs a key role in the economy. In 1976 the ratio of government expenditures to GNP was 97 percent, and tax revenues were 53 percent of GNP. In the same year public consumption was 40 percent of total consumption and 43 percent of GNP. About half of the labor force was in the public sector, broadly defined to include all levels of government, business partially owned by the government or national institutions, and cooperative organizations. Comparisons between the budget and GNP since the 1973 war tended to exaggerate the government's position in the economy because GNP growth slowed, and the budget was bloated by defense costs and inflation. Nonetheless few noncommunist governments were as large a force in the economy as Israel's. Many factors, historical and contemporary, contribute to the large economic role of the government. One of the most important was the exile of Jews for nearly 2,000 years from what they considered their homeland. With the formation of the State of Israel, the government accepted the obligation to receive and settle Jews returning from the Diaspora and to promote the economic development of the homeland to improve conditions for immigrants. At independence the government faced huge problems that would have taxed even the most experienced and efficient organization. In addition to a war for survival, the flow of food and other products from the surrounding Arab areas ceased. Compounding the shortage of goods was the huge influx of immigrants. The Jewish population more than doubled between independence and the end of 1951, increasing from about 650,000 to 1.4 million. The government intervened directly and forcefully in the economy. Money and immigrants were channeled into agriculture, industry, and construction to increase the supply of goods. Manufacturing was given complete protection from foreign competition. Exchange controls were mounted to mobilize the limited amount of foreign currency reserves and ensure their use for essential imports. Rationing was instituted for goods in short supply. By the mid-1950s the emergency situation had eased, and the government relaxed its direct controls on the economy. The flow of immigrants diminished after 1951 and became a much more manageable economic and social problem. Nonetheless immigrant absorption continued to require substantial expenditures for temporary and permanent housing, education and vocational training, and infrastructure costs associated with the creation of jobs. The government estimated absorption expenses at about US $15,000 per immigrant in 1976, the total amounting to about 2 percent of GNP. Only part of the costs of immigrant absorption was included in the government budget; other costs were borne by national institutions (see National Institutions, ch. 3). Rapid economic development was always an underlying goal of the government and an important part of expenditures, but it was usually not formalized in the kind of multiyear plans so common in developing countries, nor was it primarily dependent on creation of a large public sector. A planning agency was established in 1962 and several development plans prepared. The plans were used largely to pinpoint problems and provide policy guidelines because so many important variables-national security considerations, the flow of immigrants and foreign funds, and conditions in export markets-were beyond the control of government officials. Moreover private funds provided a substantial part of investments, which the government could influence but not direct. In spite of the extensive activity of the government in the economy, there appeared little disposition to concentrate industrial development in state enterprises. The public sector's share of gross fixed investments was about 40 percent during the early 1970s. Government fixed investments were weighted toward infrastructure, such as housing, water projects, roads, and ports and other transportation facilities, and toward industry, such as defense, fuels (related to defense), utilities, and development of the country's few natural resources. The government contributed equity capital toward large projects with other investors, often national institutions. At times the government sold its shares in public companies after they were going concerns in order to raise funds for new development investments. A major focus of government policy was to create the appropriate climate for private investment and growth of output although in directions desired by government planners. A wide range measures were employed, causing a considerable amount of government intervention in economic life. From the excessive protection of domestic production and direct controls in the early 1950s, the trend has been toward more indirect measures, although in the late 1970s a substantial degree of protection remained for manufacturing. Credits, grants, and tax benefits were provided to desired investments, for example. Adjustments to the exchange rates and assistance in foreign marketing were extended to exporters. Numerous subsidies, such as land, water, utilities, and credit, were made available at nominal costs. Increasing help in research and development of new products has been supplied by government funds since the 1960s. The comprehensive package of incentives was roughly calculated to have cost the government about 20 percent of the value of industrial investments in the early 1970s because of charges below cost for services, investment grants, and taxes not collected. Investment incentives contributed to the high level of government expenditures. Although the government had an interest in rapid economic growth, it was not always the dominant policy objective. During much of the 1950s the predominant official concern was settling immigrants, providing jobs, and increasing the availability of goods. In the mid-1960s concern about deterioration of the balance-of-payments led to policies that induced a recession. In the mid-1970s balance-of-payments problems and inflation brought forth measures that caused economic stagnation. An emphasis on social justice, reaching far back through Jewish social institutions to their sacred literature and reinforced by the welfare concepts embodied in the socialist orientation of many of modern Israel's leaders, also thrust the government into economic life. An important share of budget expenditures went for housing, education, health care, and welfare measures. Social equality was largely assumed to flow from a high rate of economic growth and progressive taxation during the 1950s. By the early 1960s the assumption was proved false. Disparities of income distribution became an active political as well as an economic issue after the mid-1960s. Studies of the income distribution pattern in Israel confirmed inequality although less than was common in many developed countries and far less than in nearly all developing nations. In 1974 the lowest 20 percent of the population received 7 percent of the income while the top 20 percent received 39 percent of the income, the approximate pattern found in most industrialized countries. Even though income distribution was not unusual, the inequalities were unsettling in a nation that considered equality one of its important values. Moreover there was a suspicion that, because of tax evasion and fringe benefits, the income statistics did not accurately reflect the distribution pattern. More important, the poorest segment of the population was mostly composed of families from Asia and Africa, particularly the Moroccan immigrants (see The Sephardim: A Disadvantaged Majority, ch. 2). After the mid-1960s government policy made a determined effort to reduce income disparities and to help the disadvantaged. Tax laws were changed to increase their progressive features, that is, to increase the burden on those most able to pay and thus diminish the gap in disposable income between rich and poor. Welfare measures and subsidies were increased and took up a larger share of budget expenditures between the 1967 and 1973 wars. The benefits to the less affluent were substantial in terms of access to schools and health care and reduced costs for such essentials as food, transportation, and utilities. After 1973 government welfare measures continued even though budget pressures and the high rate of inflation gradually reduced the help the government could provide. Nonetheless the Israelis were sensitive to poverty in their midst and the divisive potential it held for the fabric of their society. Security was another primary national goal that caused the government to play a large role in the economy. Defense has always been a substantial portion of government expenditures (about 25 percent), but after the 1967 and 1973 wars, it was substantially higher. In fiscal year 1973-74 (FY 1973) defense jumped to 49 percent and then fell back to about 40 percent of budget expenditures in the FY 1974-76 period. In FY 1977 and FY 1978 defense costs were back down to about 30 percent of government expenditures, but in absolute amounts, proposed military spending in FY 1978 was more than 20 times that in FY 1968. The four major goals-national survival, absorption of immigrants, rapid economic development, and a decent minimum standard of living for all Israelis including narrowing the gaps between groups-caused a rate of public consumption and investment beyond what the domestic economy could provide. Foreign sources, primarily world Jewry and foreign governments, historically supplied the extra resources to finance the government's excess spending. After the 1973 war, however, the magnitude of the imbalances (budgetary and balance of payments) that had to be financed grew tremendously, requiring increased use of short-term commercial credit. Mounting indebtedness meant greater repayments. By the late 1970s it was officially recognized that government spending had to be restrained and structural changes made in the economy. National Institutions Before independence several organizations were formed to carry out limited economic functions connected with settlement in Palestine. At formation of the State of Israel some of these organizations were retained as national institutions. Structurally and usually financially autonomous, they were closely associated with the government in economic activities (see National Institutions, ch. 3). Economic activities of the national institutions were sometimes shown separately in statistics as a quasi-governmental sector. In the late 1970s the Histadrut continued to be the most important of the national institutions in the economy. In its function as a labor organization (of which it was by far the largest) it was open to all workers including the self-employed-such as professionals and members of cooperatives-and even housewives and children could become members. Memberships covered over 90 percent of wage earners and more than 50 percent of the population; many members joined for benefits other than collective bargaining. Histadrut periodically negotiated basic agreements on wages and working conditions with management groups for specific kinds of employment such as the Manufacturers Association of Israel and the government. Because Histadrut covered such a large proportion of workers, there was a high degree of standardization of working conditions throughout the economy. In negotiating wage agreements, Histadrut was in the anomalous position of owning a large number of businesses through a subsidiary holding company and of being the largest employer. Among its affiliates were a bank, an insurance company, constructions firms specializing in housing and large construction (e.g., buildings and ports including jobs overseas), an industrial holding company (Koor Industries, operating plants, such as basic metals, electronics, and chemicals, and maintaining sales offices throughout the world), and a large number of cooperatives in agricultural marketing, kibbutz industries, wholesale and retail trade, and transportation (in which cooperatives had a near monopoly of urban and interurban bus transportation). Histadrut was part owner in the national water company, ocean shipping line, inland air transport company, and the primary agricultural contracting company. By the mid-1970s Histadrut employed over 16 percent of the labor force, and estimates of its economic activity indicated a contribution of 20 percent or more to gross domestic product (GDP). Histadrut's entrepreneurial activities contributed considerably to development of important parts of the economy before and after independence. In addition, Histadrut conducted health, welfare, and educational activities. The most important was a health insurance program (Kupat Holim), which was an important inducement for members. Attempts to establish a national health insurance plan were fought by Histadrut, presumably because it would lose part of its membership; the Histadrut program was the closest thing to a national plan, covering about three-quarters of the population. Critics claimed the program was losing money and would require government funding in the near future. A major economic activity of some national institutions was fundraising abroad. A number of Jewish organizations, including Histadrut, solicited money from Diaspora Jews, but the primary fundraisers were the United Jewish Appeal (in the United States) and Keren Hayesod (in other countries), both arms of the Jewish Agency (see National Institutions, ch. 3). Between 1948 and 1978 they collected more than US $5.7 billion (nearly two-thirds from the United States), primarily for use in Israel. In the thirty years of independence, the Jewish Agency, sometimes in conjunction with other agencies and the government, was active in the absorption of 1.6 million immigrants; it housed 450,000 families, established 513 rural settlements, built twenty-nine new towns, and helped 650,000 workers secure employment. The Jewish National Fund (Keren Kaymeth) was largely responsible for land reclamation and development, the national afforestation program, and some roadbuilding in frontier areas. Several organizations provided welfare and educational services. The economic activities of the national institutions, primarily funded by their own efforts, supplemented the services provided by the government through the budget.