The News Behind the News

Israel as a Bedroom Community

By Ron Tira, Adv.
Originally published by Globes: Israel's Business Arena on 16 May 2000

"Bedroom community" is a US expression, describing a neighbourhood where the residents sleep, but neither work nor conduct any economic activity. A "social conscience" economy in Israel will transform the whole country into such a suburb.

Israel just now is in the throes of a passionate affair with "social reforms" and "conscientious" economic theories. Once the catharsis dies down, and both the economy as a whole and wage earners in particular find themselves worse off, the time will arrive to recognize certain ineluctable truths of the practical world.

The first axiom is that an economy is not an egalitarian world, but is divided into clear-cut classes. Its nobles are the entrepreneurs, those graced with the rare, God-given attribute of being able to conjure business up from scratch. The entrepreneur, together with the investor, who puts up funds to bring the venture into being, is both the fons et origo and the sine qua non. After setting up the business, he will supply a living for the wage earning, supplier, and service providing class. He is also the one who creates the revenues from which the State collects its taxes. This is how the wealth magically generated by the entrepreneur percolates through to the economy and society as a whole.

Without the firm foundation of a strong class of entrepreneurs, connected to available capital, no business will come into being and the economy will grind to a halt. The details of the upper stories, namely the wage conditions or tax brackets applying to the wage-earning masses, are thus not worth discussing.

The world's advanced economies have acknowledged this reality, and the main focus of the global economy is therefore international competition over attracting entrepreneurs and investors. Israel is handicapped in this contest: it lacks any significant domestic market, it is physically and culturally remote from its principal customers, its companies are priced lower than they would be in western markets, it has no natural resources, and its geo-political environment, with or without peace, is not ideal.

Therefore, to compensate for these structural inferiorities, the State must create a more attractive regulatory environment than that found in places such as California or Ireland. To do so, it should institute much lower corporate, capital gains and personal taxation than applied by its rivals.

Israel should also redefine tax events in such a way as to encourage business development, institute tempting investment incentives and refrain from harming benefits extended to foreign investors. It should institute more accommodating anti-trust laws, revive its moribund privatisation drive, and slash government bureaucracy to a minimum.

Populist Israel, by contrast, seeks to come down heavily on entrepreneurs and their investors, putting them to flight.

The second ineluctable truth is that once it has created an environment such as to attract entrepreneurs, the government should simply leave well alone. Only where government claws have been pried loose can an economy thrive and develop.

But the economy's structural cycles can have an injurious effect on the politicians happening to serve during the recessive phases of the cycle. It is not that this or that Prime Minister or Minister of Finance is necessarily better or worse than another one. One government just happens to hold office during the boom phase of the business cycle, while another serves during the inevitable slump.

Obstinate politicians who insist on forcing the political calendar onto the business cycle, are liable to wreak heavy economic damage. Thus, for example, the Ben-Bassat plan, by penalising savings, will encourage consumption. The elimination of advanced training funds will result in an increase in direct pay, with capital being pushed in the direction of countries that are friendlier to the investor and his heirs, resulting in foreign currency demand and a shekel depreciation. Just when the economic position finally enables the interest rate to be reduced, the Ben-Bassat reform is creating tremendous inflationary pressures.

Under the circumstances, and given the interest rate rise in the US and the volatility of global capital markets, the Bank of Israel will have no alternative but to raise the interest rate, sending the Israeli economy back into a further period of recession.

Israel is behaving in a manner inevitably calculated to transform it into a bedroom community. Its regulatory environment, perhaps, is becoming more egalitarian, but growth will be negative and unemployment will increase. Unless, that is, Israel recognizes the fact that the contents of its china-shop can hardly withstand the elephantine ravages of politics, in all their factional diversity.

The author is a director of the Amidex mutual fund of the US.

Published by Israel's Business Arena on 16 May 2000