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9 THE INFLATIONARY P RESCRIPTION: INSTITUTIONS AND POLICIES In Chapters 2 through 8, an attempt has been made to link the economy 's failure to grow since 1973 to a host of structural problems, all of which emanate in one way or another from a systematic distortion of incentives by excessive government involvement. It was also pointed out that despite the stagnation that gripped the productive side of the economy, consumption kept on growing because of the illusion of wealth, created by the governmentinduced proliferation of real assets and financial assets not backed by real ones. The consequence was a steady deterioration of the balance of payments, with the attendant increase of foreign debt. The government, fearful that Israel might one day find itself insolvent, embarked on policies designed to reduce the deficit in the balance of payments. But instead of dealing with the fundamentals , it has used stopgap measures that only aggravated the situation. The visible component ofthe aggravation was the inflation that raged for a decade, until mid-1985, and has continued since at an excessive, but much more moderate pace. This chapter and the next are devoted to telling the story of inflation , how it came about and why it can be interpreted as the most serious consequence of the obstacles to growth. This chapter is devoted to describing the gathering of the inflationary forces. In particular, attention will be focused on the institutional arrangements and policies that concern the labor market, the monetary system, and the foreign-exchange market. It is mostly in these areas that excessive government involvement created the conditions that proved conducive to the inflationary process. The next chapter is devoted to the inflationary process itself. The Cost-of-Living Allowance The institution of the cost-of-living allowance (COLA) cannot be regarded as an isolated development. It was tied, of course, to the overall attitude toward labor and wages as manifested, for example, by the battle to 194 The Poltical Economy ofIsrael "conquer labor" and the general disregard for profits. This tie will emerge clearly as the story of wage indexation unfolds. The first COLA payments were made as early as I935, and perhaps earlier , but they were confined to public institutions such as the Jewish Agency and the Hebrew University. In July 1936 the Jewish National Fund, the Hebrew University, and the Hadassah Medical Organization wrote a joint letter to Eliezer Kaplan, then the treasurer of the Jewish Agency, complaining that despite the disturbances, otherwise known as the Arab Revolt of 1936-39, the Jewish Agency had decided to keep up the COLA payments. The arguments advanced by the writers, which do not appear in the letter but can be inferred from Kaplan's reply, are exceedingly important. In an oral discussion of the COLA problem that had evidently taken place, the writers pointed out that the rise in the cost of living was occasioned by the disturbances. These were exogenous to the economy and hurt it in general, so that both employer and employee suffered. Hence, they argued, there was no justification for continued compensation. Even though Kaplan acknowledged the facts, he rejected the conclusion, insisting on continued COLA payments.' This implies that the leadership's view was that salaried workers have the right to be compensated regardless ofthe costs to the employers. In October 1939, the first COLA agreement was signed between the M.A. and the Tel-Aviv branch of the Histadrut, the Tel-Aviv Workers Council .2It did not establish an automatic compensation mechanism. Rather, it was perceived as a temporary measure occasioned by the unforeseen developments brought about by World War II. In fact, it applied only to those employers who "enjoyed a prosperity in the wake of the war."3 Furthermore, a commission on which the M.A. and the Histadrut had equal representation was set up to investigate those cases in which employers claimed that their circumstances did not justify the payment. The head of the Jewish Agency's Labor Department played a mediating role in the commission's deliberations.4 In December 1940, a similar agreement was signed with the Histadrut and applied on a countrywide basis. It called for a 20-percent wage increase, a rate that constituted two-thirds of the increase in the cost of living.5 Once again, employers who had not shared in the prosperity caused by the war were allowed to pay a reduced IS-percent supplement and in some cases were exempted altogether.6 All these...


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