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In-Depth Information
average rate of more than 3 percent annually, a pace insuffi cient to keep up with population
growth, while infl ation reached a rate of 450 percent in 1984. The immediate causes of the
problem were the war's huge human and fi nancial costs and the jump in world energy prices.
Defense spending reached 30 percent of GDP in the mid-1970s — more than three times the
U.S. level during the Cold War.
The government exacerbated the crisis by allowing its budget to grow so quickly that rising
taxes could not offset a widening defi cit and growing debt. The Bank of Israel was beholden to
the government to create money as needed to cover the state's overspending. The widespread
use of infl ation indexing — automatically raising wages to keep pace with prices — designed
to protect savers and wage earners from price rises was also exacerbating the problem while
reducing the political pressure to take steps to stop it.
But there were deeper problems. The state-directed economic model was no longer work-
ing. The era of big infrastructure projects that had generated so much growth was over, mak-
ing it increasingly obvious that the government and the Histadrut-owned companies domi-
nating economic life were bloated and ineffi cient.
Unlike the United States (but much like Europe), Israel was reluctant to embrace capitalism
in the 1970s and 1980s, even as the quasi-socialist economic model that had previously served
it so well was obviously failing. The rise of Menahem Begin and the Likud Party to power in
the 1977 elections, ending twenty-nine years of Labor Party rule, should have ushered in a new
era of freer enterprise. The party was hostile to the Histadrut, the kibbutzim, and the other
components of the Labor establishment, but the Likud's primary ideological concern was ce-
menting Israeli rule over the West Bank and the Gaza Strip by constructing settlements.
To the extent that the Likud Party had an economic policy, it was populist, not capitalist.
Its few efforts at liberalization were overwhelmed by the depth of the economic crisis that it
was contending with and by a lack of commitment. In fact, welfare spending and the size of
government grew during the fi rst years of Likud rule. When the Economic Stabilization Plan
was adopted eight years later, it was adopted by a Labor-Likud coalition government.
In July 1985, the government responded to economic failure with an Economic Stabiliza-
tion Plan. The budget defi cit was slashed, the shekel, Israel's unit of currency, was devalued
by 20 percent, cost-of-living allowances were suspended, and price controls were imposed.
The U.S. government pitched in with $1.5 billion in aid. By 1986 infl ation was down to about
20 percent. The government also undertook a long-term program to sell off state-owned com-
panies (privatization), deregulate markets and foreign trade, and reduce state spending. The
Economic Stabilization Plan was more than a policy change: it marked the end of the socialist
era of Israel's economy. While the state's role remained substantial, the principle that private
enterprise and free markets were the key to economic growth and development now came to
the fore.
REFORM AND REBOUND
With GDP growing at an average annual rate of 3.8 percent from 1986 to 1990, renewed eco-
nomic growth took longer to achieve than economic stabilization. The immediate impact of
the Economic Stabilization Plan was to choke off easy credit and reduce the stimulus of gov-
