Accountant-General Nir Gilad, today a key figure at the Finance Ministry, proudly announced a few days ago that the government would meet its deficit target this year. The spanking new budget division manager, Ori Yogev, chimed in, saying the budget was being managed as planned.

Well, hats off to the treasury officials but before we heap laurels on their balding heads, let's take a moment to remember what deficit target they are boasting about meeting.

The target is 3.9% of Israel's gross domestic product, and if the treasury's financial finagling is discounted booking aid money it comes to 4.5%.

A deficit of 4.5% is very high. Now take a moment to remember what the deficit target was a year ago, six months ago, three months ago

When Finance Minister Silvan Shalom took his seat a year and a half ago, the deficit target for 2002 was 1.5% of GDP. By year-end 2001 it had climbed to 2.4%, as 2002 began it was reset at 3.0% and two months later it was boosted to 3.9%.

The last 12 months will probably go down in history as one of the worst in Israel's history, from the perspective of budget management and fiscal policy. A senior treasury official admitted a few fays ago that Silvan Shalom had made every possible mistake. When asked as to the minister's good qualities as a finance minister, the official scratched his scalp and finally said he had no answer at this time.

Although Shalom has managed matters badly, arrogantly and irresponsibly, one must not lay the blame for all Israel's fiscal ills of the last year at his door. He and the entire marketplace are now paying the price of more than ten years of irresponsible fiscal policy.

The root of all evil

To understand the root of the problem, we must go back ten years in time, to the era of Yitzhak Rabin as prime minister. That was when the government passed a law mandating itself to reduce its deficit as a function of GDP, aiming for zero by 1995.

The law became a sad joke within a year of its enactment. Every two or three years the government would convene and postpone Year Zero, or the year of the balanced budget, by three or four years.

It also became apparent that the law had been phrased oddly: it commanded the government to act to achieve its deficit target, but did not command that it actually achieve it.

The idea behind the deficit-reduction law had been, naturally, to reach the deficit targets set by Europe's Maastricht treaty, and then later by the Growth and Stability Pact. A glance at the following table shows what has happened to deficits since then.
































































New Zealand



OECD average



EU average



* The Israeli deficit figures do not include linkage difference.

The average of countries with deficits greater than Israel's in 1993, was 6.8% in 1993, and is today 0.6%.

Israel is the only country in the world where time ground to a halt ten years ago. Almost all the others have acted determinedly to lower their deficits, except for Israel.

There are plenty of excuses for the Israeli economy's failure to grow in the last two years, for the high taxes and the drop in GDP per capita: defense costs, infrastructure, education, high interest rates, it's Nasdaq's fault isn't it. But the truth is starkly evident from the table above, even if the reason isn't: it's the public sector that's gobbling up everything good, and preventing the marketplace from realizing its growth potential.

Until a few years ago, comparing Israel's deficit with that of the developed countries was a theoretical exercise for egghead economists. Israeli governments shrugged and said, "But here it's different" a variation on the theme of the Chosen People: we have a unique economy operating under its own rules, and comparisons aren't relevant.

But two things have changed: the Bank of Israel's policy during the 1990s proved that global economic rules apply here too. High interest rates reduces inflation. The second, more important thing: three years ago the government completed the liberalization of the foreign currency market. It opened the market, completely, to capital movement in both directions.

From that moment, the standards of Maastricht and of the Western world stopped being abstract. They became applicable. They are the standards by which investors examine Israel and decide whether to invest here, or in other developed economies.

This does not refer only to foreign investors who would abandon Israel unless it adopted accepted norms. The liberalization of the market freed Israeli investors to send their money abroad, if they grew worried about how the economy was being managed in Israel. We got a taste of that in the last few months, as money began to seep out of Israel.

If the conclusions of the Rabinovitch panel on tax reform are adopted, then many of the domestic investment vehicles will lose one of their biggest advantages the tax exemption. Investors will have even more reason to compare domestic investments with alternatives available in the United States or Europe.

The third-from-last country in the table belongs to the only major country that, like Israel, lacks abundant natural resources, and also failed to restrain its deficit, which doubled from 1994. The Bank of Israel keeps insisting we aren't a second Argentina. Fine, but soon the central bank will have to answer a different question: Maybe we look a little bit like Japan?