A Link in the Chain: Israel's economic problem is politics

Last week, the Jerusalem Post reported on Yechezkel Dror's comments about the problems of the parliamentary system. And while I don't necessarily agree with the solution he suggests, his prognosis is spot on. Without strengthening the capacity to govern, Israel will not be able to carry out an economic leapfrog, something essential to achieve Reut's Top 15 Vision.

Israel's macroeconomic policy has received many compliments from the International Monetary Fund and foreign governments. In recent years, Israel has experienced low deficit and inflation as well as decreased unemployment and national debt. Yet despite this, Israel's problem remains in the weakness of its government system.

While Israel's private sector is one of the most sophisticated in the world, its public sector is one of the weakest among developed states. According to data from the Global Competitiveness Index of the 2006 Economic World Forum, Israel's private sector ranks 8th in the world in terms of its financial sophistication, availability of high-level human capital and level of management. The public sector however, is ranked at the bottom of the list of developed countries in 29th place.

The significance of this data is clear: The engine of growth and prosperity in Israel is the private sector while the public sector actually puts on the breaks. The gap between them is the largest compared to other countries in the developed world.

The significance of this gap is even more serious as a result of the relative size of the public sector. Despite its reduction in recent years, Israel's public sector still constitutes over 45% of its GDP. In other words, Israel's exposure to the weakness of its public sector is very high.

The hi-tech industry is another example of the gap between the two sectors. Israel is ranked first in the world in research and development. The vast majority of this investment is made by the private sector. However, a large part of the knowledge that is developed in Israel ultimately turns into industry in other countries. One reason for this is Israel's distance from international markets. Another however, is the inefficiency of the public sector and the extremely slow and unreliable supply of inputs that are essential to business development such as legislation, regulation, licensing, permits, infrastructure or international agreements. These factors significantly contribute to the decision of many business entrepreneurs not to translate their inventions into industry that can generate large employment.

Another example of the far-reaching consequences of Israel's governmental weakness is the problem of low work force participation. The average GDP per capita in Israel is one of the lowest of all developed countries, even though the average productivity of Israeli workers is quite high. In fact, some estimate that the Israeli worker is of the ten most productive in the world. It's the low participation in the work force that holds Israel back. This problem is mainly political. The main challenge is clear: the employment level within the Ultra Orthodox (Haredi) and Arab sectors must be increased. It is also clear why Israel is dawdling on this issue: the weakness of governance, shortness of political tenures and instability and fragmentation in the government and Knesset.

Recently, Professor Ricardo Hausmann - one of the most prominent economists in the world on the issue of economic growth - visited Israel. In a summary of his remarks he said one of the unique things about Israel is the level of frustration surrounding the government's performance. While in most countries it is normal for the private sector to criticize the public sector's efficiency, in Israel, even senior members of the public sector doubt the Government's ability to efficiently make and implement decisions.

What is the common denominator between dealing with poverty, the weakness of the periphery, the low level of Arab and Ultra Orthodox participation in the work force, the frustrating transportation system, the crisis in education and law enforcement? As I have noted in the past, the answer is that all these issues require ongoing cooperation between different branches of government and its agencies in planning, taking and implementing decisions. All of these issues require a systemic change in priorities and behavioral patterns. Yet in all of them, Israel is dawdling.

Without strengthening the capacity to govern, Israel will find it difficult to leapfrog. If we want to prosper, it is up to us to change the electoral system to ensure longer and more stable tenures and reduce the fragmentation between the legislative and executive branches. Until that is possible, we should improve the management of government offices while neutralizing (to the extent possible) their exposure to political instability.

The main economic problem in Israel does not derive from the Finance Ministry or the Bank of Israel. Over the last 20 years, they have proven their ability to ensure economic stability and moderate growth.

Instead, Israel's biggest economic problem is politics. In order to prosper, we need to change our system of government.