Israel Matzav

Can Netanyahu break the cartels?

Many of you will recall that I pooh poohed the 'social protesters' this past summer due to their Leftist leadership. One thing they did succeed in doing was in putting domestic issues on the public agenda. The result was the Trajtenberg Report, whose principle recommendation is to break up Israel's cartels. There's just a small problem: Four of Netanyahu's six coalition partners refuse to pass the report. In fact, Israel Radio just reported (Noon) that the Shas party has said that the report will not pass the full Knesset without its changes, and United Torah Judaism's Moshe Gafni, who chairs the Knesset Finance Committee on the coalition's behalf, has announced that he will not allow the report in its current form to be brought before his committee. And if you follow that last link, you will see that some Likud Ministers are also opposed. But for now, the report will apparently pass because Netanyahu reached a deal with Yisrael Beiteinu and is working on one with Shas... if there is a vote today.

Why is Israel's fast-growing economy such a mess? Evelyn Gordon has written a piece in this month's Commentary Magazine... which is not online except for this way-too-brief excerpt. But I have the full article, and I'd like to reproduce some of it here. I am seeking the author's permission to email copies of the full article to those readers who would like to see it.

The primary issue is the high cost of living. A study published by the BDO Ziv Haft consulting company in 2010 found that an average Israeli home costs the equivalent of 114 average monthly salaries—as compared to 90 in France, 71 in Britain, 60 in the United States, 54 in Germany, 42 in Switzerland, and 30 in Sweden. Rents are similarly high in terms of purchasing power, as are car prices: BDO found that a Mazda 3, one of Israel’s most popular cars, costs an Israeli 14 average monthly salaries, compared to only four monthly salaries in the United States and six in western Europe. Even basic foods are expensive: the Wall Street Journal reported in June that cottage cheese (an Israeli staple) was more than twice as expensive in Israel than at a British supermarket. Consequently, even middle-class families often find it hard to get through the month, and 13.4 percent of working families found themselves under the poverty line last year—almost double the 7.6 percent rate in 1995, according to Tel Aviv University’s Taub Center for Social Policy Studies.

But high prices aren’t the only domestic issue worrying Israelis. Failing schools are another major concern. On the Program for International Student Assessment’s last global exam in 2009, Israeli 15-year-olds ranked below the OECD average in all three subjects. Out of 64 countries, Israel placed 36th in reading and 41st in math and science. Consequently, students enter university poorly prepared: as Technion President Peretz Lavie told Ha’aretz last year, there has been a “huge decline in [college] applicants’ level of scientific knowledge,” as well as in their writing skills. This requires universities to devote more time to remedial instruction rather than imparting new knowledge, so students graduate at a lower level. Israel’s economy depends almost exclusively on its human capital, so this clearly doesn’t bode well.

It also increases the cost of living, as parents who can afford it typically spend thousands of shekels a year on private tutoring to compensate for what their children aren’t learning in school. And that’s on top of the thousands of shekels required by their “free” public education. Israeli public schools don’t provide textbooks, so parents have to buy them; there are also mandatory fees for “extras” such as field trips and class parties.

Health care is a concern as well. An OECD report found that Israeli hospitals have the highest average occupancy rate in the West: 96.3 percent, due mainly to the shortage of hospital beds (only 1.9 per 1,000 people, the third-lowest ratio in the OECD). This means that certain wards, especially pediatrics and internal medicine, are perennially overcrowded. In January, for instance, the Israel Medical Association reported that wards at several hospitals were operating at almost 200 percent capacity. Israel also has only 4.5 nurses per 1,000 people, less than half the OECD average (9.1 per 1,000). Back in 1999, Ehud Barak was elected prime minister in a landslide after promising to “get the old woman out of the hospital corridor,” where overflow patients are routinely stashed. Twelve years later, she’s still there.

Crime is another growing worry. Although Israel’s crime rate isn’t high by international standards (its murder rate, for instance, is similar to Europe’s and lower than America’s), rising organized crime and gross police incompetence have produced rising anxiety. The organized-crime problem grabbed public notice in 2008, when Margarita Lautin was killed while sitting on a beach with her husband and children because a professional hit man’s bullet missed his underworld target. And police incompetence makes headlines repeatedly, as when serial rapist Benny Sela escaped police custody in 2006, or when a policeman stood and watched as a terrorist gunned down high-school students at a Jerusalem yeshiva in 2008. As for property crime, it’s a standing joke in Israel that police complaints are filed only to collect the insurance. Indeed, police admit they solve only 1 in 100 break-ins.

Corruption? Israel ranks in the bottom third of the OECD on Transparency International’s index. Stifling bureaucracy? An OECD study published in July ranked Israel 29 out of 37 countries in terms of the bureaucratic burden on start-ups, behind such luminaries as Italy and Russia. There’s the low workforce participation rate: 57.4 percent last year, compared to an OECD average of 72.4 percent. And the list could go on and on.

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Yet what Israel really needs is more competition and less government control, not the opposite. This is most obvious with regard to the protesters’ main gripe, the high cost of living. Housing prices, for instance, are high largely because the state owns 93 percent of Israel’s land, which it doles out for construction stingily. This is Economics 101: with land in short supply, prices soar. Hence the only economically viable way to reduce housing prices is for the government to free up the land supply. Car prices, too, are high mainly because of government intervention: combined, the various taxes slapped on cars total more than 100 percent of a vehicle’s base price.

The same goes for food. A recent report by Business Data Israel found that at every stage of the production and sales cycle, Israel is more expensive than Europe: tariffs are higher, as are the profit margins of importers, manufacturers, and retailers. Data from the Ministry of Agriculture reveals positively outrageous markups: 683 percent on imported tea, for instance, or 348 percent on imported rice. Such high markups are possible for three reasons. First, Israeli food manufacturers and supermarket chains function as cartels; three local dairy companies, for instance, dominate the dairy market. Second, extremely high tariffs often preclude competition from imports (250 percent on honey, 230 percent on potatoes, 190 percent on beef, etc.). Third, when imports are not loaded with punitive tariffs, the government’s standard practice is to license a sole importer, who then faces no pressure from competitors to sell his product more cheaply. Even worse, this sole importer is often a local manufacturer that makes similar products and thus has no desire to undersell its own brands.

Israel’s entire economy is dominated by cartels. The Bank of Israel’s annual report for 2010 found that “some 20 business groups, nearly all of a family nature and structured in a pronounced pyramid form, continue to control a large proportion of public firms (some 25 percent of firms listed for trading) and about half of market share.” And the World Economic Forum’s Global Competitiveness Report for 2010–2011 ranked Israel 117 out of 139 countries in “extent of market dominance,” right between Mauritius and Burkina Faso. Government monopolies then jack up prices even further: at the state-owned water and power monopolies, for instance, employees’ average salary is 2.5 times the economy-wide average. The unions obtained this exorbitant benefit, which obviously necessitates higher utility rates, by threatening to shut down the nation’s water and power supply.

But lack of competition and excessive government intervention are no less problematic in other fields, such as health care. In July, for instance, Ha’aretz reported that only 60 percent of patients who need inpatient geriatric rehabilitation receive it, because Israel’s public hospitals lack sufficient geriatric rehab beds. Yet a state-of-the-art geriatric rehabilitation ward has been standing empty in a private hospital because the Health Ministry won’t let HMOs send their patients there—even though the public hospitals charge 50 percent more than the private facility does. The ministry also refused to let two other private facilities open geriatric rehab wards in recent years, insisting the beds should instead be added to public facilities. Both health-care professionals and treasury officials told Ha’aretz this policy is apparently aimed at protecting public hospitals from competition that would force them to lower their own rates. Meanwhile, not a single public-hospital bed has been added. So many patients simply go untreated, while HMOs pay 50 percent too much for those who are treated—money that could instead fund other types of care.

Or take education, where the Education Ministry’s agreements with the teachers’ unions make it nearly impossible to fire incompetent teachers. A recent Central Bureau of Statistics study found that more than 50 percent of high-school math teachers don’t have degrees in math or any related field, meaning they are unqualified to teach the subject by the ministry’s own standards. Yet replacing them would be virtually impossible even if qualified replacements could be found, because they can’t be fired. They would have to transfer to jobs elsewhere in the public school system, which would thereby be forced to pay hundreds or thousands of extraneous teachers.

The disconnect between the protesters’ demand for more government control of the economy and Israel’s actual need for a freer market poses several dangers. First, to placate the protesters, the government might adopt some of their problematic proposals. It won’t subject Tel Aviv to rent control or agree to fund free “education” from the age of three months (a wildly expensive benefit that even Europe’s most generous welfare states do not offer), but it might, for instance, increase mortgage subsidies to needy families. This proposal, which many ministers and members of the Knesset favor, wouldn’t create a new benefit; it would merely expand an existing one. But it has been tried repeatedly, with predictable results. Contractors increase housing prices by roughly the amount of the subsidy increase and reap windfall profits at the taxpayer’s expense, while needy families still can’t afford to buy.

The second reason to worry is that even sensible measures won’t be financed properly. For instance, the protesters’ demand for lower indirect taxes is eminently proper. Israel’s indirect tax burden totals 17.4 percent of GDP, compared with an OECD average of 10.3 percent. Lowering tariffs enough to make artificially high-priced items competitive, moreover, would presumably boost import volumes, and in turn boost tax revenues. But the protesters specifically want a lower value-added tax, and previous VAT reductions generally haven’t paid for themselves. The retail and manufacturing cartels typically lower prices by only a fraction of the tax reduction, so sales volume doesn’t increase enough to compensate for the lower rate.

Similarly, the government recently agreed to boost the pay of starting policemen—something it had apparently been planning for some time, but that protesters could claim as a success. This, too, is sensible: policing is a core governmental function, and Israel’s understaffed force (2.7 policemen per 1,000 residents, compared with 5 in Europe) is a major barrier to effective policing. Low starting salaries were a serious impediment to recruiting and keeping good people. Still, it must be paid for, and the risk is that the government will finance such measures either by counterproductive tax increases or by increasing the deficit. The latter, a perennial favorite of Israeli parliamentarians, would be particularly dangerous. Israel’s debt-to-GDP ratio, 75 percent in 2010, is already high, and Israel faces much greater diplomatic and security risks than other OECD countries. What’s more, debt servicing is already slated to account for 11 percent of the government’s budget this year, making it the second-largest line item after defense. A higher deficit means even higher debt-servicing costs, which means either higher taxes or lower spending on productive purposes—hardly a recipe for improving the standard of living.

The third danger is that the government will simply fail to seize this opportunity to enact the kind of reforms Israel truly needs, due either to fear of defying the anti-free-market ethos of the protesters or to disagreements within the coalition, many of whose members support big-government solutions. If that happens, not only will Israel have wasted a golden opportunity that may not soon be repeated, but also the next prime minister (who will almost certainly be less pro-market than Netanyahu) may well adopt precisely the kind of tax-and-spend policies that nearly bankrupted Israel in the past.

Part of the problem is that there are elements in the Israeli government that will do nothing to hurt the cartels because the cartels are quite powerful.

But we also have a government that is addicted to spending, and a public that is addicted to government benefits and to cheating on its taxes. I've discussed these issues before. But let me give you another example.

Over the past few years, the government claims to have lowered income taxes. The problem is that they have increased other taxes so that your take-home pay remains the same. For example, one of the biggest benefits employees used to get was use of a car. The amount that was added to your income for use of the car was quite small, and employees benefited from it greatly. Now, the value of the use of a car has been increased beyond all proportion. The use of a car can cost you more in taxes than the actual cost of the car. Now, for those who are low income, it doesn't matter, but then their tax cuts are tiny anyway. But for the middle class, this has made the tax cuts a wash or worse.

Anyway, there's a lot to discuss here, but I'm not sure how many of you are interested in discussing it (the Israelis probably are, but they are still in the minority on this blog). So let's see how much interest this post draws, and based on the interest I'll decide how much more time and space to devote to this issue.

Labels: Binyamin Netanyahu, Israeli economy, Trajtenberg Report

posted by Carl in Jerusalem @ 12:21 PM