ISRAEL AND AUSTERITY: AN OVERVIEW

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP85T01058R000507000001-4
• Release Decision: RIPPUB
• Original Classification: C
• Document Page Count: 9
• Document Creation Date: December 22, 2016
• Document Release Date: January 22, 2010
• Sequence Number: 1
• Publication Date: October 10, 1985
• Content Type: REPORT

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DATE:
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State Dept. review
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VLVC 1LLLN.LIL'LL
SUBJECT: Israel and Austerity: An Overview
NESA M#85-10205
DISTRIBUTION
EXTERNAL
The Honorable Caspar W. Weinberger (Pentagon)
Lt. Col. Fred Hof (ISA)
The Honorable Richard L. Armitage (Pentagon)
Jock Covey (NSC)
George S. Harris (State)
Philip Wilcox (State)
David Mack (State)
Howard Teicher (NSC)
1 - DDI
1 - NIO/NESA
1 - C/PES
1 - DDO/NE
1 - PDB Staff
4 - CPAS/IMD/CB
1 - D/NESA
1 - DD/NESA
1 - C/NESA/PPS
2 - NESA/PPS
1 - NESA/AI
2 - NESA/AI/I
DDI/NESA/AI/I
(10Oct85)
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Central Intelligence Agency
DIRECTORATE OF INTELLIGENCE
10 October 1985
ISRAEL AND AUSTERITY: AN OVERVIEW
Summary
To tackle Israel's massive economic problems,
the National Unity government proposed substantial
budget cuts, devaluation of the shekel, and a
wage-price accord upon entering office in
September 1984. After intense negotiations with
labor, the government announced the first package
deal in November, but it frittered away the
opportunities to implement fully this and
subsequent accords. The unity government has made
a serious effort at economic reform only since its
announcement on 1 July of a new series of
austerity measures. This program calls for cuts
in real government expenditures, along with
reduced public-sector employment and a new
wage-price accord. While public reaction was
sharply critical at first, Israelis now appear to
have accepted the. need for fiscal austerity. To
make the new plan work, the government must
enforce the entire range of restrictive policies
called for in its July program plus additional
measures including major tax and wage indexation
The formation of the National Unity government in
September 1984 was meant in part to assure bipartisan support for
tackling Israel's economic morass. Seven years of Likud rule had
left Israel with soaring triple-digit inflation and widening
external deficits. The new unity government was thought by many
in Israel to possess the political clout to push through a long
This memorandum was prepared by I I the Israel- 25X1
Jordan-Palestinian Branch, Arab-Israeli Division, Office of Near
Eastern and South Asian Analysis. Information as of 10 October
1985 was used in its preparation. Questions and comments should
be directed to Chief, Arab-Israeli Division,
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overdue austerity program. Moreover, Israeli consumers were
The government acted quickly by proposing substantial budget
cuts, shekel devaluation, and higher energy prices. The next
step was to seek a wage-price accord to cool inflationary
expectations and give the government time to develop a more
comprehensive economic program. After weeks of squabbling within
the coalition and the Histadrut labor federation, Prime Minister
Peres personally intervened to secure the first package deal in
psychologically prepared for such a move.
Ineffective Package Plans
The government failed, however, to use the breathing space
provided by this accord--as well as the early provision of US
economic aid--to implement a more lasting stabilization
program. Moreover, it encountered great difficulty in executing
the budget cuts initially agreed upon. The few cuts that
actually occurred were soon negated by revenue shortfalls and
The coalition frittered away the last month of Package
Deal 1 in January seeking minor, politically palatable ways to
correct its deficiencies. Two subsequent package deals and
additional ad hoc measures--tax hikes, higher travel fees, import
restrictions, and the like--were merely cut-and-paste attempts to
close the budget deficit, halt foreign exchange losses, and
rising expenditures on subsidies.
cuts--eliminating most of last year's overspending--by increasing
fees and taxes, and only partly by reducing other expenditures.
One opportunity for action--the 1985/1986 budget commencing
1 April--was also wasted. The $23.3 billion budget agreed to
was, in fact, higher than the 1984 budget. 'This budget aims to
reduce the deficit largely by continuing subsidy
generate renewed public confidence.
With the collapse of the latest package deal this
spring--largely because the government lacked the political will
to enforce all the provisions of the accord--the coalition
approved a n*w plan on 1 July. It calls for reductions in
government spending, additional taxes, reduced public-sector
employment in selected ministries, devaluation of the shekel, and
price increases to correct for subsidy reductions that will be
Reaction to the new austerity program predictably was
sharply critical. The Histadrut argued that the plan would harm
workers and threatened. a national strike as a show of force
against the plan. The threatened one day national strike was
averted after Prime Minister Peres intervened to smooth strained
relations between Finance Minister Modai and labor leaders.
followed by a three-month wage-price freeze.
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Outlook
The Israeli economy is beginning to respond to the
government's latest austerity measures, but so far the private
sector has made most of the sacrifices. The government has
dragged its feet in dismissing public sector employees and has
been unable to hold the line on expenditures, despite projected
cuts. Unemployment is rising, even though the dismissals planned
for the public sector have yet to occur.
Israelis seem to have accepted the need for fiscal austerity
despite its unpleasant impact; recent polls suggest that nearly
two-thirds of the public support the government's program, and
labor actions have virtually ceased since earlier disruptions
that occurred periodically last spring. Even the announcement of
an inflation rate of 27.5 percent in July--representing the
highest monthly increase in Israel's history--resulted in little
more than grumbling. The August inflation of 3.9 percent has
further quieted public concern.
Broad public support for current policies could wane,
however, if workers perceive that they are once again bearing the
brunt of austerity. To deal effectively with triple-digit
inflation, the government must enforce the entire range of
restrictive policies outlined in its July program plus additional
measures, including further reductions in real government
expenditures, tax reforms to boost worker incentives, and
indexation reforms--especially of financial assets--to reverse
the downward trend in labor productivity and investment. The
recent infusion of additional US economic aid gives Israel
breathing space to enact these measures.
In the past, the unity government has lacked the political
courage to move decisively to enforce agreed provisions of the
various austerity plans. We judge that the coalition is more
determined now to implement tougher austerity measures, but will
remain unwilling to move quickly to impose the full range of
reforms. Prime Minister Peres is particularly likely to act with
caution on the economy as he nears the end of his tenure next
fall, when he is obliged by the coalition agreement to turn over
the prime mi*istership to Likud leader Shamir.
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Appendix
Israel: Inflation and Indexation
The National Unity Government's campaign to curb Israel's
triple-digit inflation has focused on reforming the wage
indexation system. Indexation is not the sole problem, however,
and the government must enforce all aspects of its current
austerity program, including reductions in real government
expenditures.
The Inflationary Spiral
Israeli inflation has grown dramatically over the past
decade, climbing from low two-digit levels in the early 1970s to
an annual inflation rate of 445 percent in 1984. The unity
government's stop-gap measures have helped, but inflation still
is running at about 275 percent on an annual basis after the
first nine months of this year.
The growing inflation during the past decade was due in part
to a series of external shocks, especially the large increases in
OPEC oil prices in 1973, 1974 and 1979. The first oil price
shock alone increased Israel's oil import costs by an amount
exceeding 3 percent of its gross national product. The second
oil price hike in 1979 proved even more damaging because it was
accompanied by the return to Egypt of the Sinai oil fields.
Excessive demand, fueled by government spending, has also
been a major factor. Starting in 1977, Likud-led governments
resorted to an expansionary fiscal policy to curry favor with
Israeli consumers, while pursuing such costly projects as the
expansion of settlements on the West Sank and the invasion of
Lebanon. Such moves resulted in large annual budget deficits
financed by either borrowing in the private sector or by printing
money. Furthermore, Likud's exchange rate policies designed to
reduce the trade deficit boosted import prices, adding to the
upward spiral of domestic prices. 25X1
The financial liberalization introduced by the Likud Party
at the end of 1977 added further impetus to inflation because the
lifting of capital controls allowed Israelis to hold both. foreign
currency and foreign bank accounts. PATAM accounts--dollar-
linked shekel accounts--created at this time have been used
extensively since as transaction accounts by Israelis, allowing
for further growth in the money supply. F_ -1 25X1
The Indexation Link
Indexation of wages to the consumer price index has been an
important--but not predominant--factor in the inflationary
process. The initial justification for implementing an
economy-wide system of indexation was founded on traditional,
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egalitarian beliefs in Israeli society. Indexation was promoted
as a mechanism to help ensure social justice. More recently, it
has been viewed as a necessity to protect Israelis from the
ravages of triple-digit inflation. In the process, indexation
has expanded into virtually every aspect of the Israeli
economy.
-- The current wage agreement--temporarily suspended by
wage-price accords--indexes wages at 80 to 90 percent of
the previous month's increase in the consumer price index.
-- Pensions and welfare payments are fully linked to the CPI.
-- Most financial assets--such as long-term savings accounts
or government-issued bonds--are partially or fully linked
to the CPI or some foreign currency.
-- Taxes are fully linked to the CPI and adjusted on a
quarterly basis. 25X1
The Costs of Indexation
Wage indexation--as extensive as it is--would not by itself
completely protect Israeli workers from inflation. With
indexation at less than 100 percent and applied with a one-month
lag, real wages theoretically would fall with no additional
adjustments and thus dampen demand. But indexation coupled with
normal promotions and the high level of success enjoyed by most
labor unions in se-curing additional wage boosts, has contributed
to positive real wage growth. Real wage growth averaged
5.3 percent during the 'Likud years from 1977-1983 and was close
to one percent last year despite a sharp economic slowdown.
Such wage growth has discouraged the serious social
disruption typical of countries with triple-digit inflation.'
Work actions are common, but usually are mounted to press the
government to adopt tougher anti-inflationary policies, not for
higher wages. Because indexation has taken much of the sting out
of inflation, moreover, successive Israeli governments have only
resorted to bandaid measures that have not realistically
addressed other pressing issues, such as reforms in monetary
policy and curbs on government spending.
An additional problem is that high wage growth has not been
matched by labor productivity growth, ensuring that aggregate
demand continues to outstrip supplies. Labor productivity grew
by just 1.6 percent per year between 1977 and 1981 and has
steadily dropped the past three years. Some of the main factors
contributing to this decline include:
-- The hesitancy of employers to lay off workers for fear of
being caught short when demand strengthens.
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-- High marginal tax rates that have reduced workers'
incentives.
-- The use of substantial blocks of work time to juggle
assets and make purchases to hedge against triple-digit
Indexation also has contributed to resource misallocations
with investment a major casualty. With most financial assets
linked, Israelis have been unwilling to risk investing money in
capital goods with uncertain real rates of return. Real
investment fell over 9 percent last year and is projected to drop
10-15 percent this year, contributing to the recent poor
productivity performances.
Recent Indexation Adjustments
Since the first wage-price package deal in November 1984,
the unity government has reached several agreements with the
Histadrut labor federation to revise the cost-of-living-
adjustment (COLA) formula. For a brief period the indexation
formula was reduced by one-third, but more recently the COLA's
have been suspended outright. The government's agreement to
grant supplemental lump-sum wage payments has helped offset these
losses. Nonetheless, real wage growth during the first nine
months of the coalition government was less than it would have
been without the revisions, and the sharp cuts in real wages
since the imposition of the austerity program in July have
lowered wages to the level of about four years ago.
The National Unity Government is continuing its pressure to
lower wages, according to US Embassy sources. The government
recently gained Histadrut's agreement in principle to forego
special wage adjustments--other than those provided for last
July--until 1.April 1936, when the current public sector wage
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%. %JLYL" LL/.L LY 11ALJ
SUBJECT: Israel and Austerity: An Overview
NESA M#85-10205
DISTRIBUTION
EXTERNAL
1 -
The Honorable Caspar W. Weinberger (Pentagon)
1 -
Lt. Col. Fred Hof (ISA)
1 -
The Honorable Richard L. Armitage (Pentagon)
1 -
Jock Covey (NSC)
1 -
George S. Harris (State)
1 -
Philip Wilcox (State)
1 -
David Mack (State)
1 -
Howard Teicher (NSC)
1
-
DDI
1
-
NIO/NESA
1
-
C/PES
1
-
DDO/NE
1
-
PDB Staff
4
-
CPAS/IMD/CB
1
-
D/NESA
1
-
DD/NESA
1
-
C/NESA/PPS
2
-
NESA/PPS
1
-
NESA/AI
2
-
NESA/AI/I
DDI/NESA/AI/I
(10Oct85)
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CONFIDENTIAL
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