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2 O BSTACLES TO G ROWTH: THE ABDUCTED C APITAL M ARKET The Absence of a Free Capital Market Not all economies embedded in political democracies are alike, but it would be hard to find an economist anywhere who would dispute that they are basically capitalist economies. For, although they certainly feature various degrees of institutional restrictions on their market systems, they all have in common the basic ingredient of a capitalist system: a free capital market. This means both free access to capital and the right to own capital assets. On the strength of this test, Israel's economy has been unlike that of any other free country's.1 The central feature characterizing Israel's capital market for as long as Israel has existed is the government's domination of the capital market. The government's involvement transcends anything that is known in politically free countries. The main expression of this involvement is the fact that most of the finances that accumulate in the various savings schemes ... are channeled to the state's budget or allocated by it. The government sets, for every financial instrument, its term, rate of interest , and tax regulations. Since the government is the chief mobilizer of savings, it is also the main allocator of credit. The lion's share of long, and medium-term credit to households (mortgage loans) and the business sector (finance of investment in industry, agriculture, tourism etc.) is allocated by the government through its budget or by other means.2 The focus here will be on the impact of the economic form of organjzation on the system's ability to perform in the sense of providing the environment for the production of economic well-being.3 38 The Poltical Economy ofIsrael The Basic FeaiUres of the Financial System The Capital Market The basic fact of the capital market in Israel is that the government has undertaken to act as the principal capital-market intermediary and to ensure its dominance has imposed very stringent restrictionson the other intermediaries. Considering first the government as an intermediary, let us assume for simplicity that the public employs four channels of saving: deposits in saving accounts with banks, shares in pension funds, purchase of shares of stock, and purchase of corporate or government bonds. When a government sells bonds and uses part or all of the proceeds to finance lending to the private sector, as the government of Israel has indeed been doing, it becomes a capital market intermediary. In this case the government has gone much further. It forced banks and pension funds to use most of the funds raised from the public in either of two ways: purchase non-negotiable government bonds or finance private -sector loans earmarked by the government. For example, as of May 1992, commercial banks stiII had to use anywhere from 30 to I00 percent of funds deposited in indexed time deposits, depending on the type of the account, on government instructions.4 In other words, banks and pension funds are being told by the government what to do with a significant part of the public's savings. To assert its role as allocator of savings, the government had to suppress potential competition from the private sector. To that end it created the overseer of the capital market and insurance in the Ministry of Finance, without whose approval no new security could be issued. The Banking System Israel 's commercial banking system has been shaped overwhelmingly by its subordination to the government, which has controlled the lion's share of both the assets and liabilities of the banks. Jn the first place, the banks have not been free to offer saving schemes to the public. Every saving plan has been subject to approval by the Ministry of Finance's overseer of the capital market. This was, of course, logically consistent with the fact that, once a scheme was approved, the bank had to use most of the funds generated by the new instrument according to government instructions. It follows that most of the profit made by the bank would be the result of the interest-rate spread between what the bank pays to the public and what the government pays to the bank. This contrasts sharply with banking operations in normal, free economies, where the bank both receives interest payments from the borrowing part of the public and makes interest payments to the lending part of the public. When the government sets the terms of savings schemes, it...


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MARC Record
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