Israel After Begin

14. Israel's Economic Policy in the Post-Begin Era

C H A P T E R F O U R T E E N Israel's Economy in the Post­Begin Era Yakir Plessner zyxwvutsrponmlkihgfedcbaYWUTSR The Background: Israel's Economy Under Begin The most remarkable attribute of Israel's economy during Menachem Begin's premiership concerns not what happened, but rather what did not happen: there were no changes in principle, as compared with the final years of Labor's tenure. In fact, one might say that the only changes that did take place involved the magnifica­ tion of the worst aspects of Labor's policies. The only nominal break with Labor's traditions came in October 1977, when the fresh Likud government implemented the economic zyxwvutsr Mahapach — the Foreign Exchange Reform. The reform concerned two aspects of Israel's foreign exchange policy. First, whereas the exchange rate had been under a crawling peg regime1 since June 1975, it was now put under a regime of free float.2 Secondly, whereas capital flows between Israel and the rest of the world had in the past been tightly controlled by the authorities, the new government abolished most of the restrictions. These acts were touted as a manifestation of the new government's orientation towards a more free economy. In point of fact, the floating of the exchange rate was, under the circumstances, a bad mistake from the monetary standpoint, because it further destablilized the monetary system, thus setting the stage for the superinflation that was to follow. While the float in itself carried no message of economic freedom, the new government did not even contemplate reforming the one component of Israel's economy in which freedom could really be fostered: the capital market. One might therefore conclude that if the Begin government did have an economic philosophy distinct from its predecessors, it managed 291 Yakir Plessner 292 to hide it quite well. Begin had no interest in economic affairs, nor did he understand economics. Therefore, even the attempts that were made to reform Israel's economic system, particularly during Aridor's tenure as minister of Finance, failed to enlist Begin's backing. Worse, Begin did back projects, such as the Lavi fighter and the Mediterranean­to­ Dead Sea canal, which were unanimously opposed by his economic advisers, and rightly so. zyxwvutsrponmlkihgfedcbaYWUTSRPONMLJIHGFED The First Shamir Government: 1983­84 Shamir succeeded Begin as prime minister and stumbled right away into one of Israel's worst financial crises ever: the banking shares collapse. The affair had its origins in the mid­1970s, when Israel's ma­ jor banks began to manipulate their own shares. The incentive to do so resulted from the fact that the banks had to invest most of the deposits in instruments designated by the government, and were seek­ ing sources of finance for lending activites outside government control. The natural source was newly raised equity capital, and the banks were therefore very interested in making their shares as attractive as possi­ ble. The avenue chosen was share price manipulation. By 1983, the market value of the banks' shares was out of any proportion to the banks' actual net worth based on their profits. As share values increased, their manipulation required larger and larger financial resources. The banks mobilized these resources by borrow­ ing abroad, for which purpose they used their subsidiaries, mainly those in the United States. This practice was a dangerous one because it involved the banks in foreign exchange liabilities unmatched by foreign exchange assets. The banks were thus exposing themselves, for example, to devaluation risk. For example, suppose a bank bor­ rowed $1 million to finance the purchase of its own stock, and suppose that this foreign exchange was converted to Israeli curency at a rate of NIS100 to the dollar. Suppose that a devaluation of 25 percent now takes place, so that the banks would now need NIS125 million to repur­ chase the foreign exchange upon debt repayment, instead of the NIS100 million that they received when they sold the foreign exchange upon borrowing it. Unless share values increased by 25 percent as well, so that the banks could mobilize the additional NIS25 million by resell­ ing the purchased shares, the banks would be in trouble. It was only a question of time before such an event would occur, and it did occur in October 1983. On the eve of October 7,1983, the minister of finance announced that the Tel­Aviv Stock Exchange would be closed the following [13.59.36.203] Project MUSE...