During the past year, one Israeli official after another repeatedly boasted, at home and abroad, that Israel's recent economic growth placed it at the forefront of the OECD countries, a group that includes Canada, the United States, Japan, and the Western European democracies.
These boosters cited statistics to the effect that Israel's gross domestic product (GDP) grew at an average annual rate of more than 6 percent during 1990-1992. They expressed only mild concern that growth for 1993 may slow to 3.5 percent, because both Government and private economic forecasts indicate an acceleration of growth to between 5 and 6 percent in 1994. The Israeli media have played up in bold headlines the high growth predictions for 1994, acting more as cheerleaders than reporters.
How can this high growth be? The last three Scorecards (1990, 1991, 1992) have assigned dismal grades to almost every area of economic policy. Has the Scorecard been blind to Israel's impressive growth? These are good questions. An explanation to this question was published in Issue 49 of the Bank Hapoalim Economic Report on November 1, 1993. Bank Hapoalim is Israel's largest and most respected bank, with assets of $43 billion. The cover page of Issue 49 graphically displays the real percentage change, adjusted for inflation, in both GDP and GDP per capita between 1983 and 1993. For the three highly touted years, 1990-1992, real GDP growth was 5.8, 6.2, and 6.6 percent.
But the correct economic measure of growth is real per capita GDP. If population growth equals or exceeds economic growth, the average resident will not enjoy any rise in living standards. During the three high-growth years, Israel experienced a sharp rise in population due to the arrival of more than 400,000 immigrants from the former Soviet Union. In 1990, 199,516 immigrants settled in Israel, followed by 176,100 in 1991 and 77,057 in 1992. These numbers are in addition to natural population increase, the excess of births over deaths, of more than 70,000 per year (although as many as 20,000 emigrate each year). So what was Israel's per capita growth? The front-page table in the bank's report shows real per capita growth of about 0.5 percent in 1990, 0.8 percent in 1991, and 2.9 percent in 1992, because of a two-thirds decline in immigration in 1992.
The statistics look differently in this light. For the full three years, 1990-1992, per capita annual growth averaged about 1.8 percent. But for the two years, 1990-1991, per capita growth was a minuscule 0.65 percent. For the 10 year period displayed in the bank's report, real per capita annual growth averaged about 1 percent. At that rate, it takes 72 years for real personal income to double -- which means that it will take three more generations before Israelis attain current U.S. living standards. This is a long time to wait.
The first correction to the touted high growth is this: per capita growth has remained at its long-run real average annual increase of about 1 percent. Boastful Government reports of high growth have not changed the long-run trend of slow per capita growth.
But wasn't there positive growth, even with this correction? The Bank Hapoalim Economic Report completely pops the balloon of puffed-up growth on page 2.
To quote from the Report:
On closer examination of the investment data, it becomes clear that the difference between the 1993 growth rate of 3.5% and the 1992 growth rate of 6.6% stems entirely from a 29% reduction in investment in housing. This fall was to be expected after the residential construction that followed the initial years of the immigration wave. When this factor is excluded, there is no significant difference between the growth rates for 1993 and the three preceding years [emphasis added].
In other words, the high GDP growth derived, in large measure, from massive investment in housing. And it is important, in assessing growth in Israel, to keep in mind that housing is priced in dollars. More on this in a moment.
First, some history. Former Minister of Housing Ariel Sharon undertook a massive multi-billion dollar, state-directed housing program during the two years of heavy immigration. His program was described in detail in the 1990 Scorecard. The Government imported thousands of prefabricated houses and mobile homes, and built tens of thousands of apartments, many in the northern and southern regions of the country. The Government granted 100 percent purchase guarantees to contractors to eliminate their risk and paid substantial bonuses for meeting deadlines. Minister Sharon overspent his approved budget, but neither budget constraints, the Prime Minister or the Knesset slowed his bulldozers. He threw every conceivable subsidy into the crash construction program to meet his building targets. In fact, a record 70,300 housing units were completed in 1992, a 65 percent increase over 1991. About 69 percent of them, or 48,300, was built by the public sector. Naturally, any public sector program of this magnitude will result in waste and inefficiency.
But Sharon's program went well beyond the bounds of normal Government mismanagement. The reason is that he arranged for thousands of apartments to be built in the Galilee and Negev, while most of the immigrants wanted to live in or near the big cities of Haifa, Tel Aviv or Jerusalem, where jobs might be available.
This building spree, as the Bank Hapoalim Economic Report states, shows up in Israel's national income accounts as "growth" because the cost of the housing units, even if the apartments sit empty and the mobile homes deteriorate, is counted in GDP. The increased debt associated with the financing of new construction is not subtracted from GDP; it shows up as a liability of the Government.
It may be useful to think about how this enormous expenditure on public housing would be treated from the perspective of a private firm. What does a business do with massive unsold inventory? The business corrects its balance sheet by taking a restructuring charge. It writes down to market price, or writes off completely, the value of apartments that no one will buy. In so doing, the company takes a charge against earnings and profits may turn to loss. If the GDP figure were corrected for the increased liability of the public sector, which will not earn a yield on its so-called "investment in housing," the touted high growth loses some of its lustre.
Let's shift back from this example of how a private firm treats a loss to the treatment found in the Israel State Budget for 1994. The proposed budget for the Ministry of Construction and Housing [pages 162-163 of the 1994 draft budget] states that the ministry has been trying to sell its inventory of government-owned housing units since November 1992, but without much success.
Current estimates of the net difference between the cost of completing construction and development of the 1990-1992 program and the potential revenue from selling the dwelling units rest at NIS 10 billion for the program that was in effect during those years. [emphasis added]
Bank Hapoalim's report evidently took into account this section of the 1994 budget, which reads like a true economic horror story in every respect. The Bank's report also must have concluded that subtracting real economic losses of NIS 10 billion from the country's national income accounts for 1990-1992 dramatically changes the story about "high growth." As a concrete illustration of why these losses should be subtracted from GDP to derived a real measure of growth, Ma'ariv reported on November 21 that the Government had sold 10,500 apartments to the public in 1993 at an average price of $45,000, or at about half the market price of comparable quality units.
Let's switch to U.S. dollars for a moment to see the arithmetic. NIS 10 billion is roughly equal to $3.4 billion, which in turn amounts to about 6 percent of Israel's $58 billion GDP for 1992. Now spread out that $3.4 billion over three years. It amounts to about 2 percent of Israel's GDP for each of the three years of 1990-1992. Do the simple arithmetic and the average annual 6 percent "high growth" contracts to a smaller 4 percent. Adjust this for population increase of about 4 percent and per capita growth completely disappears.
Return to the Government's crash public housing construction program. It is necessary to recall that Israel sought and utilized a U.S. government guarantee of $400 million in housing loans, money that must be repaid. But empty apartments do not generate revenue from rentals or sales. This issue of the Scorecard, for example, cites taxpayer outlays in 1993 of NIS 1.5 billion (about $500 million) to buy 42,000 unsold apartments from contractors.
As if this situation were not bad enough, the Minister of Immigrant Absorption, Yair Tsaban, stated on November 23, 1993: "The Government has no choice but to send a limited number of immigrant families who have housing rights to development towns where there are thousands of empty public housing units." The Jerusalem Post reporter who accompanied Tsur on his tour of Kiryat Gat absorption facilities might have asked him whether the preferences of the immigrants, who have been waiting for housing in the central region of the country for three years, matters. But Israel is a democracy, which means that ministers can order people to live where they don't want to live.
Assume that Bank Hapoalim correctly estimates GDP growth in 1993 at 3.5 percent. Correcting for population increase of about 2.8 percent reduces real per capita GDP growth to a rather paltry 0.7 percent. At this rate, it will take 100 years for real per capita income to double. The second correction to the touted high growth is this: adjusting for losses on housing, per capita growth for 1990-1992 was zero or slightly negative.
A third correction must be made. As noted, housing in Israel is priced in dollars. The choice of dollars stems from the country's experience with high inflation during the past two decades. Housing prices make up one-fourth of the Consumer Price Index, which means that rapid increases in dollar prices of housing translate into high overall shekel rates of inflation. Put another way, Israelis earn shekels but buy apartments in dollars. Budget Director David Brodet explained on November 18 that the sharp 20 percent rise in shekel housing prices would be the main factor in the overall relatively high inflation rate of 11 percent in 1993. So, the rate of exchange between the dollar and the shekel affects the wealth and income of Israelis.
Let's convert shekels into dollars and see how this works. According to the Central Bureau of Statistics, the average exchange rate during December 1991 was one dollar to 2.31 shekels. A year later, the average exchange rate during December 1992 had fallen to one dollar to 2.70 shekels. This amounts to a devaluation of 16.9 percent in 1992.
What does this mean for growth? In 1992, consumer prices, a measure of inflation, rose 9.4 percent in Israel compared with 2.9 percent in the U.S., a difference of 6.5 percentage points. To keep the real exchange rate constant, which preserves the purchasing power of the shekel in terms of dollars, requires a 6.5 percent devaluation of the shekel. But the actual devaluation was a much higher 16.9 percent. Subtract 6.5 percent from 16.9 percent to determine the decline in the purchasing power of the shekel against the dollar -- the real level of devaluation. The result is that the apparent 6.6 percent growth in 1992 in real, inflation-adjusted shekels translates into a 10 percent decline in real, inflation-adjusted dollars in the external purchasing power of Israelis, and in their internal purchasing power of dollar-priced assets.
Put this another way. The large devaluation of 1992 had the effect of increasing the price of imports, tourist travel abroad, and the shekel cost of housing priced in dollars. Rising dollar prices for housing continues to frustrate attempts to reduce Israeli inflation to the much lower levels of its main trading partners. In 1993, the devaluation of the shekel just about kept pace with the difference between the U.S. and Israeli inflation rates. But the effect of the 1992 devaluation was so dramatic that foreign tourists find Israeli prices to be more reasonable than in recent years, while Israeli tourists abroad are confronted with sticker shock.
The third correction to the touted high growth of the past few years is this: per capita income in Israel, expressed in dollars, declined. It's time to add up the score. Adjust growth for increase in population -- strike one. Adjust growth for misspent resources on housing that must be subtracted from the country's national accounts -- strike two. Adjust growth for the large devaluation of the shekel, which has substantially reduced the dollar purchasing power of Israelis -- strike three, and out. Add in estimated 3.5 percent growth in 1993, which is less than 1 percent in per capita terms, and any Government official who boasts of high growth is guilty of misleading advertising .
Ha'aretz reported in its November 22 issue that the Government has selected a new public relations firm, at a cost of $300,000, to refurbish the image of Israel's economy in the United States. But no amount of public relations can overcome reality. Per capita income continues to rise at a snail's pace, which is a far different state of affairs than the claims of 6 percent high growth would imply.
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