Waking Up in a Fool's Paradise

By Kenneth W. Banta

Faced with triple-digit inflation, the government tries austerity

This is my sixth visit to Israel, and I am amazed at your apparent prosperity. It seems that every flat has a TV, usually color, one and sometimes two cars, and other modern appliances." Few visitors to Israel would dispute that glowing report, which came from an American tourist in a letter to the Jerusalem Post. Highways are flooded with new cars. Shop windows are filled with food processors, freezers and videocassette recorders. At Tel Aviv's Ben Gurion Airport, long queues of vacation-bound Israelis wait to board flights for Europe and the U.S. Despite more than three decades of costly conflict with its Arab neighbors, Israel enjoys a standard of living that ranks near that of many West European nations.

The appearances, however, are deceiving. By most yardsticks, the Israeli economy is in serious trouble. During the month of July alone, prices climbed 6.3%; the inflation rate for the year may reach a record 160%. The rise in prices has been so rapid that a 500-shekel note today is worth less than a 50-shekel note was in 1980. The country's G.N.P is expected to grow only 2% this year, after stagnating in 1982. Foreign debt is, at $20.9 billion, one of the highest per capita in the world, and the trade deficit may exceed $5 billion this year. The U.S. General Accounting Office warned recently that a substantial portion of Washington's $2.5 billion in military and economic aid was being used to help Israel repay past debts. Without increased levels of assistance, Israel could soon owe the U.S. as much in annual repayments as it receives in loans.

The dimensions of the problem have provoked alarm within the government of Prime Minister Menachem Begin. At a Cabinet meeting last month, Energy Minister Yitzhak Modai charged that the situation was "catastrophic." Last week, after four days of wrangling, the Cabinet unveiled a package of austerity measures designed to reduce the $1.6 billion budget deficit. It agreed to cut spending by $526 million, mostly in defense and welfare. It also decided to raise taxes on travel and certain government benefits.

The most heated arguments were over defense, which accounts for 29% of the budget. Finance Minister Yoram Aridor lad proposed cutting $333 million in military spending. But Defense Minister Moshe Arens argued vehemently that such reductions would impair the army's preparedness and require cutbacks in troop numbers. Begin agreed. At one point he chastised Aridor, saying, "It's not worth cutting the defense budget at a time like this." As a compromise the defense budget was reduced by $141 million this year; another $125 million will be sliced off in the next two years.

Most Israelis took the announcement in stride, just as they have ignored the economic crisis all along. Despite the negative indicators, consumers have been on a massive spending spree, snapping up appliances, going on vacations abroad and buying automobiles at a rate almost twice that of last year. The reason for their nonchalance: a combination of official and homespun safeguards that insulates almost every citizen from the roller coaster of the national economy.

Most important is a sophisticated system of indexation that protects Israelis from the ravages of inflation. Four times a year, employers raise all salaries so as to compensate workers almost completely for higher prices. Similarly, social security and other government payments are adjusted regularly to make up for inflation The value of life insurance policies increases steadily to reflect rising prices, and banks fully index savings accounts in addition to paying conventional interest rates.

A further sense of security has come from labor contracts that make it difficult for employers to fire workers, even if they are no longer needed. As a result, unemployment is only 4.9%, although many businesses are saddled with unproductive workers. In addition, consumers are aided by generous government subsidies that hold down the prices of some basic foods. A loaf of bread, for example, costs only 120, and half a pound of margarine 230. Says a senior Foreign Ministry official: "The economy is a problem for the government, not for the people."

With triple-digit inflation the availability of easy credit has given Israelis a strong incentive to live beyond their means. Although the average wage is only $7,200 a year, and income taxes take 50% of that, Israelis do not hesitate to spend more than $10,000 on a basic Japanese compact car. The Israeli answer: borrow now and pay later.

For everyday budget stretching, banks routinely extend consumer loans, and actually encourage wage earners to take out overdrafts of up to $600.

But the system has begun to show signs of strain. Earlier this year, 90% of Israel's 8,500 physicians joined in a hunger strike, claiming that even with indexation their salaries were not keeping up with living costs. This month 150 collective farms announced that the government's refusal to devalue the shekel in proportion to the inflation rate had depressed exports, pushing the farms close to bankruptcy. Says former Tel Aviv University President Haim Ben-Shahar: "Our fool's paradise can't last much longer."

The government's latest austerity measures will only begin to address the problem. Ezra Sadan, Director-General of the Finance Ministry, argues that inflation will not be curbed until the system of indexation is substantially modified.

"Indexation is like a drug," he says. "Once you've got used to it, you have to keep it up." The Begin government bears its share of the blame. Shortly before the 1981 elections, Finance Minister Aridor lowered taxes on a variety of consumer goods, including TVs, cars and refrigerators. The move helped Begin win reelection, but it fueled the spending spree and budget deficit that the government must now deal with. Ultimately, the culprit is Israel's relationship to its neighbors. As long as Israel spends nearly one-third of its budget on defense, it cannot expect to have a trouble-free economy.

-- By Kenneth W. Banta

Reported by Robert Slater/Jerusalem

With reporting by Robert Slater This file is automatically generated by a robot program, so viewer discretion is required.