Fiscal Discipline Alongside Distorted Allocations Culminating in a Summer of Growing Unrest
Author: Taub Center Staff Bulletin Articles

Israel’s unusual success in controlling spending has been accompanied by distorted national priorities favoring politically powerful special interest groups.  In this summer of 2011, public resentment has spilled over into increasing unrest in the form of sit-ins, boycotts and strikes.

In the early 1980’s, Israel’s government was one of the most profligate in the developed world, with public expenditure exceeding 70 percent of national income. The aftermath of the peace treaty with Egypt and the stabilization plan of the mid-1980s led to rapid improvement, but in 1990 Israel’s spending as a share of income reached 55 percent, a share that was higher than in 22 of 23 developed OECD countries (only Sweden spent more). By the year 2000, Israel’s public expenditures fell to 51.5 percent of GDP, still greater than in all but four of the 23 countries.  But as the Taub Center’s Executive Director, Professor Dan Ben-David, shows in the State of the Nation Report 2010, Israel had emerged by 2010 as one of the OECD’s thriftiest governments, with a 45 percent spending to GDP ratio that was lower than that of 16 of the 23 OECD countries.

The primary, and best-known, source of the spending decline has been reductions in defense expenditures as a fraction of GDP, from 12.6 percent in 1990 to 6.9 percent of GDP in 2009. Another four percentage points have been saved by the reduced interest payments on the smaller national debt. It seems, though, that there is little awareness of Israel’s noteworthy record in controlling civilian expenditures (that is, public spending minus defense expenditures and interest payments).

4_3_fig_3_eng

In light of the very volatile events (wars, hyperinflation, massive immigration, political assassination, etc.) that Israel experienced over the past several decades, the relative stability of its civilian public spending – compared to what took place in the West over the same period – might come as a surprise (top panel of the figure). The share of civilian expenditures to GDP in Israel was the same in 2005 as it was in 1990.  In contrast, civilian expenditures (as a share of GDP) in the OECD countries exhibited some major fluctuations. These ranged from increases of 37, 23 and 21 percent in Portugal, Japan and Belgium to spending cuts of 21, 20 and 14 percent in Norway, New Zealand and the Netherlands, respectively.

The past five years have been characterized by a major global recession that affected many countries quite severely. Subsequently, civilian public expenditure rose in all but one of the 23 OECD countries, with an average increase of 12 percent between 2005 and 2010 (bottom panel of the figure). Having experienced its major recession at the beginning of the last decade rather than at its end like most other countries, Israel reduced its civilian expenditures by six percent, standing out – together with Switzerland – as the only countries that cut their spending share in 2005-2010. As a result, Israel’s civilian public expenditures in 2010 were below those in 21 of the 23 OECD countries.

With such low amounts of public funds available for civilian needs, Israel needs to make very judicious use of its resources. There is relatively less available from the overall pot in Israel for special interests and sectoral demands. In a region that is undergoing considerable unrest since the beginning of 2011 – and in light of its history of experiencing several  critical events each decade – Israel needs to preserve the precious few degrees of freedom that it has available in its budget and spend them wisely.

On the one hand, the ability to control spending in such a fluctuating environment, and to do so more rigorously than many other countries that have undergone much less traumatic periods, is a credit to the State of Israel. On the other hand, such fiscal responsibility also mandates a considerably more judicious use of the public’s money. In this realm, the country’s successive governments have been less than successful. This has also been the case with regard to government income, which is raised in a skewed and disproportional manner (as discussed in the companion piece in this Bulletin by Yarom Ariav).

Welfare payments per person have been increasing steadily for over four decades by multiples of the increases in the country’s income per capita. This is unsustainable in the long-run. It has occurred while a very large and growing share of Israel’s population has not been receiving the necessary tools and conditions for working in a modern economy. As a result, the share of families that would have lived under the poverty line today (had they not received assistance) is roughly one-third – compared to “just” one-quarter in 1979.  The resulting personal inability to cope in a global workplace also translates into an increasing national difficulty to assimilate and develop new ideas. Therefore, while Israel has justifiably been referred to as the “Start-Up Nation”, this attribute applies to an ever-shrinking share of Israeli society.

Instead of utilizing the limited resources at its disposal in a manner that could initiate a positive and permanent change in the country’s long-run socioeconomic trajectories, government after government have let an education system – once considered by many to be one of the best internationally – to sink to the depths of the developed world, with all of the growth, poverty and subsequent welfare implications that this has.

As Ben-David points out, many individuals who could work are receiving substantial amounts of government assistance while a large number of elderly and infirm are forced to live in abject poverty. The only systemic education reform passed by the government, a half-decade ago, was abandoned. The healthcare system, still one of the best in the world, is providing increasingly unequal care as the share of public expenditures has steadily fallen since the nationwide reform in the mid-1990s.

Fiscal responsibility is not just about controlling overall spending in unique circumstances. It also requires major, and often politically difficult, decisions regarding allocation. These are called national priorities – and Israel has a considerable distance to go in this realm.

The rising wave of public protests in Israel during this summer of 2011 reflect increasing unrest with the degree of distortion in Israel’s public expenditures that favor special interest groups with tremendous political clout – at the expense of the general public interest in the realms of education, health and housing.

People who read this were also interested in:

Social Welfare Expenditure AUTHOR: Johnny Gal and Shavit Madhala-Brik