Israel’s Other Road Map

Worth A Look, Role of Government, Frontier Centre

Benjamin Netanyahu wants to transform strife-torn, strike-ridden Israel from a welfare state to a free economy. But will he finish the job?

Since leaving office in 1999 after a term as Israel’s prime minister, Benjamin Netanyahu has worked with Israeli high-tech companies, read widely and traveled the world seeking to understand why some economies flourished while others floundered. In his travels he came across the writings of Roger Douglas, a New Zealand politician who transformed his nation’s economy in the 1980s with what boils down to a single transformative idea now known as Rogernomics: Economic reforms should be bundled together so that individuals hurt by some reforms–say, elimination of farm subsidies–are helped by others. Speed is crucial. “Don’t blink or wobble,” Douglas warned.

Netanyahu took the reformist Laborite’s lesson to heart. When he became finance minister in February 2003, Israel stood at the brink of financial catastrophe, coming off three years of shrinking per capita GDP. Unemployment neared 11%. Tourism revenue had declined by half since the beginning of the second Palestinian intifada. The nation of 6.2 million was unable to raise money abroad. Yet despite war, terrorism and labor strikes that have shut down airports and ports, Netanyahu put forth a slew of economic reforms. His goal: to transform Israel from a heavily regulated, bureaucratic tax-and-spend welfare state into a free-market economy.

In the space of 20 months he cut government spending; began privatizing the nation’s ports, sole electricity provider, oil refineries and El Al airline; and reduced the top marginal tax rate from 64% to 49% (a change that will go into effect in January). To get a poorly managed government pension back on track, he raised the retirement age, increased workers’ contributions and replaced its union management with professionals. He also took aim at the nation’s welfare system, which rewarded families handsomely for having more children. “You had Bedouins with 40 children driving around in limousines,” he says.

Result: The economy is growing again. In 2002 GDP shrank 1%. This year economists expect 4% growth. “How many economies made a plus-five change?” Netanyahu says. “Take a look and see how many have made that change that quickly–on a dime.” Netanyahu still has ambitious infrastructure projects in mind–including a new transit system and casinos in the Red Sea resort city Eilat to buttress a comeback in tourism. He also wants to sell off some of the state’s 7,500 square miles of land (93% of the country) to private owners and reform an antiquated and highly concentrated banking industry, which charges customers high fees for things like entering a transaction into an account-holder’s record.

Yet Netanyahu’s plans may now be in jeopardy. In October he threatened to resign from his post as finance minister over a disagreement with Prime Minister Ariel Sharon’s policy on Gaza–a move that could scuttle any hope for economic reform. The Israeli press is abuzz with speculation about what Netanyahu’s move might mean for the near-term future of his party, Likud. It is widely known that Netanyahu wants another shot at the nation’s top job.

In the meantime, Netanyahu is feeling pressure from other sides. The nation’s much-vaunted high-tech sector is more concerned about trains running on time than giving high-profile support for reform. A big terrorist attack or another burst of violence in Israel could spell doom for further hopes of economic revival.

Netanyahu’s sympathizers complain he should be moving faster. Unemployment is not far from its peak. Real wages declined 3.7% since last year, according to Morgan Stanley. Despite tax cuts, economists at the free-market Shalem Center in Jerusalem say a worker earning $30,000 has a marginal tax rate faced by only the highest earners in the U.S. Consumers also pay a 17% value-added tax–even for staples like milk and bread. “There’s still a lot of work to be done,” says Asher Blass, a Shalem economist and senior fellow. “The rhetoric is very good. But the pace is slow.”

Until he threatened to resign, Netanyahu’s biggest obstacle has proven to be the tenacious Israeli labor union Histadrut and its ambitious leader, Amir Peretz. Peretz, who also has his eye on the prime minister’s job, says Israel still has the highest poverty rate among developed nations and the biggest gap (as a multiple of average wage) between the top 10% of earners and the lowest decile. Even as Netanyahu seeks to draw investors and capital to Israel, Peretz is attempting to raise the minimum wage to $5.37 from the current $4 per hour. “I’m not against competition,” Peretz says. “But I’m against the free market that’s become like a jungle. And I’m against competition when this competition produces a slave market.”

Peretz and Netanyahu butted heads from the get-go. In September a wage dispute culminated in a strike that shut down the nation’s ports and government offices. A court order forced Peretz to instruct 400,000 union members to return to work. But a four-hour delay in carrying out the order caused chaos at the airport.

Netanyahu, known as Bibi, took to name-calling, telling the Israeli daily Haaretz that the labor union is turning Israel into “Histadrutstan.” He tells FORBES his experience with the union has given him a corollary to Douglas’ dictum about fast action: It’s best to do as many reforms as possible because no matter what he does, Histadrut will strike. “They have turned us into the world champion of strikes, and that is unacceptable,” he says. But if Netanyahu sticks around–and he neither blinks nor wobbles–even today’s detractors may someday give credit to Bibinomics.