TCS Daily

Living in Minus

By Arnold Kling - January 23, 2003 12:00 AM

"One of the criteria I think I have for getting married is that the guy has to be opposed to living in minus."

An Israeli entrepreneur we met when our family visited the country last December explained to us the term "living in minus." In the United States, consumer credit takes the form of outstanding credit card balances. In Israel, it takes the form of overdrawn checking accounts, which Israelis call "living in minus." When you open an account at a bank, the clerk asks, "How much minus do you want?" Our acquaintance was adamant that she did not want to live in minus.

The Israeli government has approached the U.S. with a proposal for aid that includes $8 billion in loan guarantees. One might say that they are asking America for $8 billion in minus.

As an economist, I would recommend against granting the loan guarantees. Like the Israeli entrepreneur, I have an aversion to marrying someone who wants to live in minus.
I should say right away that I am not experienced with international finance, nor am I conversant on Israel's economic data. I am speaking solely from instinct, making macro extrapolations from a few anecdotal observations obtained during a personal visit.

What's Wrong With This Picture?

We had not been to Israel since 1980, and much had changed. To me, the most striking difference had to be the large numbers of Asians and Africans everywhere we went. On one ride in a fifteen-passenger mini-bus from Tel-Aviv to Jerusalem, all of the rest of the passengers were Asians.

The Asians and Africans are pouring into Israel as guest workers. It is difficult to estimate their numbers (as in the U.S., some workers are illegal), but it may be in the hundreds of thousands. An article by Martha Kruger in the Jerusalem Post about the exploitation of migrant workers by employers says,

"The ads broadcast '160,000 illegal foreign workers. 260,000 unemployed. It's not fair. It's not legal, and it doesn't work.' Such statements lead the public to believe that migrant workers are stealing the jobs of Israelis, when most Israelis are refusing to do those jobs for such low pay."

So we have a country that is generating enough jobs to absorb large numbers of guest workers. On the other hand, the domestic unemployment rate is over 10 percent. What's wrong with this picture? Is the economy creating the wrong kinds of jobs for its work force? Or have people lost the desire to work? Either way, my inclination is to diagnose Israeli unemployment as a supply-side problem.

Keynes for the U.S.

As a card-carrying saltwater Keynesian, I believe that sometimes the causes of unemployment can lie with the demand side. Take the United States economy today, for example. As Brad DeLong points out, productivity is going through the roof. From a supply-side perspective, our economic engine is purring like a kitten. As Brad puts it, "The only dark lining inside this silver cloud is that faster productivity growth means faster potential output growth and a widening gap between output and potential."

To get back to full employment and close the gap with potential GDP, I am in favor of every stimulus proposal known to man. I nominate Megan McArdle for Treasury Secretary, on a platform of abolishing the corporate income tax. The Democrats want to cut payroll taxes, too? Fine, let 'em. Money to bail out state and local governments? I'll see ya and raise ya.

I am willing to incur deficits in order to get to full employment. I believe that the United States can afford to live in minus for a while, because I am exuberant about the longer-term outlook for growth, thanks to Moore's Law.

Israeli Eurosclerosis?

Israel would be lucky to have the problems of the United States. However, Israel has sufficient demand, as the phenomenon of guestworkers indicates. There is plenty of work to be done.

Instead, Israel's difficulties resemble those of France or Germany, the exemplars of Eurosclerosis. Their high unemployment rates are due largely to regulations and taxes that undercut the ability of businesses to create jobs and blunt the incentive of individuals to work.

The supply-side barriers in Israel include:

  • wages that are uneconomically high

  • union militance

  • regulations and taxes that stifle businesses

  • benefits and subsidies that skew the incentives of individuals toward remaining unemployed

  • subsidies and regulations that protect inefficient firms

  • a large, burdensome public sector

My guess is that of all these issues, the most important to address is labor costs in the public sector and the unionized sector. Wages probably need to be brought down by 10 percent or more. With lower wages, employers in the sectors where Israelis want to work could afford more hiring, Israel's exports would be more competitive, and the adverse impact on the economy of government and monopolistic private companies would be mitigated. Also, lower wages in the public sector could reduce the cost of government, paving the way for lower tax rates, bringing further supply-side benefits.

Israel, like Europe, props up unprofitable enterprises, particularly in farming. To stay in business, there are Israeli farmers who not only need government subsidies but rely on their ability to employ guest workers for long hours at low pay. If the inefficient farms were allowed to fail, those that remain might be better able to attract capital and create better jobs. More generally, letting unprofitable companies go out of business would free up capital to be used by dynamic, efficient enterprises.

Israel's government engages in many construction projects. This raises the demand for construction workers, in a country whose population is better suited to providing brain power than muscle power. If government spending on construction were reduced and the money returned to the private sector, this would shift the demand in the labor market from guest workers to Israelis.

Whatever the outcome of the impending election, Israel's government is likely to continue to be too weak to tackle these problems. With a "tough love" approach, the United States might attach conditions to aid that would push Israel to take the politically difficult reform measures needed to create a dynamic economy. On the other hand, if aid were granted without conditions, the ability to live in minus likely would be used by the Israeli government to try to prop up its unsustainable structure of government subsidies and overly-aggressive trade unions.

Hope for the Best?

Israel can point out that if peace were achieved, the economy would take a sudden jolt forward. Certainly, Israel can afford to live in minus today if within a few years it will enjoy the surge in tourism and trade that would come from an agreement with the Palestinians and other Arabs.

The prevailing view among the elites in the United States and Israel is that the Oslo peace process was the right script, but Yasser Arafat was the wrong actor. Replace Arafat, the thinking goes, and Oslo can work. To me, this seems to gloss over the more generic difficulties with building democratic institutions in the Arab world and with restraining violent Islamists wherever Muslims and non-Muslims must share a border.

This is not the first instance in American history where we thought that removing a single mendacious, corrupt leader would be sufficient to put a floundering policy back on course. Forty years ago, we felt the same way about the first elected leader in another challenging part of the world, South Vietnam. But the optimism that the best and the brightest had for South Vietnam after Ngo Dinh Diem turned out to be somewhat misplaced.

With peace, the pain of restructuring Israel's economy can be postponed, and perhaps even avoided altogether. However, prudence would suggest that restructuring should take place. As the saying goes, "hope for the best, plan for the worst." If peace emerges soon, then it is true that Israel can afford to live in minus for a few years. However, if peace is still many years away, then Israel needs to reform its economy, or living in minus will prove to be a catastrophe.

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