Israel’s Economic Miracle

(Bloomberg Opinion) -- Many visitors to Israel come for its historic and religious wonders, while others view it through the prism of political conflict. I am currently visiting Israel, and I’d like for you to ponder it from another angle: Israel’s 72-year history is a pretty spectacular example of economic science getting it right.

In the last half century or so, Israel went from being a relatively poor country to one of the 25 richest in the world, as measured by per capita income. Israel has done this largely by pursuing trade, integration into the global economy, liberalization of its economy, and heavy investment in the tech sector and in startups, often with government support. Israel still has some problems with living standards and income inequality, but it is a classic case of neoliberalism — at least in the economic sphere — mostly working out as planned.

It is remarkable how many lessons of neoclassical economics — both micro and macro — are reflected in the history of Israel.

From about 1973 to 1985, Israel had very high rates of inflation at one point reaching over 400%. That was the result of excessively loose monetary policy. Over time, printing money at such a clip took in successively less government revenue, as Israelis adjusted to the inflation and worked around it by holding less cash and denominating their contracts in foreign currencies. The inflation stopped giving macroeconomic benefits, even for government revenue, and Israel moved toward a regime of lower inflation and fiscal strength, to the benefit of the country’s longer-term growth.

This is a classic episode of MMT — “Modern Monetary Theory” — getting it wrong, as argued by Assaf Razin in his recent study of Israeli macroeconomic history. Under MMT, monetary policy can cover government spending, and fiscal policy can regulate price levels. Israel wisely followed more mainstream approaches.

What about the financial crisis of 2008-2009? Well, Israel had decent bank regulation, and so it avoided the worst lending and real estate excesses of Ireland, Iceland, and the U.S. Israel did find that its exports were damaged by the global recession, but the nation responded with a modest fiscal expansion and a very strong countercyclical monetary program, mostly with success (see the Razin paper again). Economist Stanley Fischer was the head of the Israeli central bank from 2005 to 2013, and he is considered one of the foremost practitioners of mainstream macroeconomics.

Economists tend to hold a pretty sympathetic view of immigration, even at fairly high levels. For about a decade during and after the collapse of the Soviet Union, Israel took in large numbers of Soviet Jews, increasing the working-age population by about 15%. Studies have shown that this influx helped the Israeli economy and, after a few years of adjustment, did not hurt the general level of Israeli wages. Yes, there was a greater supply of workers, but there were also more consumers, and more human resources of value. This large-scale movement of labor worked out just fine, and its effects are well-described by neoclassical models.

Even many of the microeconomic developments in Israel fit standard models. As you might expect, given the aridity of the region, Israel has had longstanding issues with water supply. Yet today water is not a huge practical problem in Israel, though it requires constant attention. Under the Israeli water regime, which has strong governmental support, high prices and well-defined property rights encourage conservation and careful use. Remarkably, the Israeli population basically quadrupled from 1964 to 2013, but water consumption barely went up. Israel has become a world leader in dealing with water problems, and in turn the country has become an exporter of sophisticated systems for water management.

One of the most controversial issues in current Israeli politics is the large number of religious Israelis who are paid to study the Torah and receive military exemptions for their study. I am not trying to assess whether, on theological or political grounds, this is good or bad policy. I would only observe that it is a classic example of microeconomics at work. If you reward people for withdrawing from standard labor markets, you will find that many of them withdraw in exactly the predicted manner.

One of the easiest columns for an economic commentator to write is how macroeconomics has failed us, or how microeconomics does not capture the full complexity of human behavior. They are valid points, but these articles often neglect the successful cases of applied economics. They fail to give consideration to examples in which economic reasoning has worked out well, or to compare those cases to the failures.

So the next time you read an attack on neoclassical economics, give these matters a moment’s thought — and consider the case of Israel.

To contact the editor responsible for this story: Michael Newman at mnewman43@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Tyler Cowen is a Bloomberg Opinion columnist. He is a professor of economics at George Mason University and writes for the blog Marginal Revolution. His books include "Big Business: A Love Letter to an American Anti-Hero."

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