Dan Singer - Start-up Nation

In retrospect, however, it is clear that Israel’s economic performance occurred in part because of the government’s meddling, and not just in spite of it. During the early stages of development in any primitive economy, there are easily identifiable opportunities for large-scale investment: roads, water systems, factories, ports, electrical grids, and housing construction. Israel’s massive investment in these projects—such as the National Water Carrier, which piped water from the Sea of Galilee in the north to the parched Negev in the south—stimulated high-velocity growth. Rapid housing development on kibbutzim, for example, generated growth in the construction and utilities industries. But it is important not to generalize: many developing countries engaged in large infrastructure projects waste vast amounts of government funds due to corruption and government inefficiencies. Israel was not a perfect exception.

Though infrastructure projects were perhaps the most visible element, even more striking was the deliberate creation of industries, as entrepreneurial projects, from within the government. Shimon Peres and Al Schwimmer, an American who helped smuggle airplanes and weapons to Israel during the War of Independence, together dreamed up the idea of creating an aeronautics industry in Israel. When they pitched the idea within the Israeli government, in the 1950s, reactions ranged from skepticism to ridicule. At the time, staples like milk and eggs were still scarce and thousands of just-arrived refugees were living in tents, so it is not surprising that most of the ministers thought that Israel could neither afford nor be capable of succeeding in such an endeavor.

But Peres had David Ben-Gurion’s ear, and convinced him that Israel could start repairing surplus World War II aircraft. They launched an enterprise that at one point was Israel’s largest employer. Bedek eventually became Israel Aircraft Industries, a global leader in its field.

During this stage of Israel’s development, private entrepreneurs may not have been essential because the largest and most pressing needs of the economy were obvious. But the system broke down as the economy became more complex. According to Israeli economist Yakir Plessner, once the government saturated the economy with big infrastructure spending, only entrepreneurs could be counted on to drive growth; only they could find “the niches of relative advantage.” 15

The transition from central development to a private entrepreneurial economy should have occurred in the mid-1960s. The twenty-year period from 1946 through 1966, when most of the large-scale infrastructure investments had been made, was coming to an end. In 1966, with no more frothy investment targets, Israel experienced for the first time nearly zero economic growth. This should have convinced Israel’s government to open the economy to private enterprise. But instead, needed reforms were staved off by the Six-Day War. Within one week of June 6, 1967, Israel had captured the West Bank, Gaza Strip, Sinai Peninsula, and Golan Heights. Collectively, the territory was equal to more than three times the size of Israel.

Suddenly the Israeli government was once again busy with new large-scale infrastructure projects. And since the IDF needed to establish positions in the new territories, massive spending was necessary for defense installations, border security, and other costly infrastructure. It was another giant economic “stimulus” program. As a result, from 1967 to 1968, investment in construction equipment alone increased by 725 percent. The timing of the war reinforced the worst instincts of Israel’s central planners.

Israel’s “Lost Decade”

Still, Israel’s economy was living on borrowed time. Another war six years later, the Yom Kippur War of 1973, did not yield the same economic boost. Israel suffered heavy casualties (three thousand fatalities and many more wounded) and enormous damage to its infrastructure. Forced to mobilize large numbers of reserves, the IDF pulled most of the labor force out of the economy for up to six months. The effect of such a massive and protracted call-up was jarring, paralyzing companies and even entire industries. Business activity came to a halt.

In any normal economic environment, private incomes among domestic workers would have experienced a corresponding decline. But in Israel they did not. Instead of allowing salaries to fall, the government artificially propped them up through a vehicle that resulted in extremely high levels of public debt. In order to try to offset the ballooning debt, every tax rate—including on capital investment—was raised. Short-term and high-priced debt was used to finance the deficit, which in turn increased interest payments.

All this coincided with a decline in net immigration. New immigrants have always been a key source of Israel’s economic vitality. There had been a net gain of nearly one hundred thousand new Israelis between 1972 and 1973. But the number was down to fourteen thousand in 1974 and almost zero in 1975.

What made recovery especially unlikely—if not impossible—was the government’s monopoly of the capital market. As the Bank of Israel itself described it at the time, “The government’s involvement transcends anything that is known in politically free countries.” The government set the terms and interest rate for every loan and debt instrument for consumer and business credit. Commercial banks and pensions were forced to use most of their deposits to purchase nonnegotiable government bonds or to finance private-sector loans for projects that had been earmarked by the government. 16

This was the condition of Israel’s economy during what is often described by economists as Israel’s “lost decade,” from the mid-1970s through the mid-1980s. Today, Intel’s decision to search for scarce engineers in Israel seems like an obvious move. But the Israel that Intel found in 1974 was nothing like what it is today. While it may no longer have resembled an expanse of sand, swamps, and malaria, visitors during the 1970s might have been excused for thinking they had landed in a third-world country.

Israeli universities and Israel’s engineering talent were by this time fairly advanced, but much of the country’s infrastructure was antiquated. The airport was small, quaint, and shabby. It had a Soviet-style utilitarian feel as one arrived and entered immigration. There was no major road that could pass for a real highway. Television reception was shoddy, but it hardly mattered since there was only a single government-owned station broadcasting in Hebrew, along with a couple of Arabic channels that, with a powerful enough antenna, one could pick up from Jordan or Lebanon.

Not everyone had a telephone at home, and not because they all had cell phones, which didn’t exist yet. The reason was that phone lines were still being slowly rationed out by a government ministry, and it took a long time to get one. Supermarkets, unlike the small food marts common in neighborhoods, were a novelty, and they did not carry many international products. Major international retail chains were nonexistent. If you needed something from abroad, you had to go yourself, or ask a visitor to bring it back for you. High customs duties—many of them protectionist attempts to coddle local producers—made most imports prohibitively expensive.

The cars on the road were a bland bunch—some produced in Israel (these became the butt of jokes, much like locally produced Russian cars did in Russia) and a motley assortment of the cheapest models of mostly Subaru and Citroën, the two companies brave or desperate enough to defy the Arab boycott. The banking system and the government’s financial regulations were as antiquated as the auto industry. It was illegal to change dollars anywhere except at banks, which charged government-set exchange rates. Even holding an overseas bank account was illegal.