Income Matters More Than Gaps

Dr. Michael Sarel, the former chief economist of the Treasury Ministry, had to implement Yair Lapid's amateurish attempts at managing the economy · Then the 0 VAT law came and broke the camel's back: "There were discussions, alternatives were presented, and in the end the Minister chose the worst possible option" · An interview on populism, growth and invisible laws of economics

Amnon Lord and Akiva Bigman

Dr. Michael Sarel served as Chief Economist for the Treasury Ministry until March 2014, when he suddenly announced his resignation over the "0 VAT" plan led by then-Treasury Minister Yair Lapid.

Some described this act as winning the "world championship in throwing your resume in the garbage." Sarel is one of the finest economic minds in the country: he is BA cum laude in computer science and economics from Hebrew University, received his doctorate from Harvard, was an economist in the International Monetary Fund and an advisor in the World Bank, served for five years as the head of the economics and research department in the Treasury Ministry and then served in a similar position in the Harel group. In 2012, he returned to the Treasury to serve as the head of a new research services department.

When Lapid was accused of causing Sarel's resignation, he replied on his facebook page: "Michael Sarel is a worthy person, but it's my job to make decisions." The fact that Lapid called someone on the level of Sarel merely a "worthy person" demonstrates Lapid's misunderstanding of reality.

Today, Sarel develops economic policy proposals as a senior Fellow at the Kohelet Forum. We asked him if it wouldn't have been preferable for him to say despite his disagreements with Lapid. After all, a few months have passed since the 0 VAT dustup, the minister is gone and we're heading to elections.

You could have stayed and even tried to delay or sabotage a plan that caused serious economic damage. We've heard of civil servants doing this before.

"As far as I'm concerned, sabotaging is not an option. It is improper that any civil servant, no matter how senior, sabotage the work of the government. I accept entirely the approach that the responsibility and authority resides in the Minister. He is the authority who dictates policy. Our job is to clarify issues from the professional perspective."

Did you try to convince? What grade would you give Lapid on economic comprehension?

"I wouldn't give personal grades. On the "0 VAT" issue there were in-depth discussions, alternatives were presented, the alternatives were discussed after being presented by me. In the end, the Treasury Minister, after hearing and seeing all the options, chose the worst one. So the decision making process was fine. Only the decision was bad."

In terms of staff work and the decision making process, the State Comptroller can be satisfied. Only the citizens are left with a problem.

"This kind of plan was not meant for economists. It shows an extreme lack of understanding of economics as a profession. The task of the economist is to examine how different plans affect the general social welfare. It's not personal. The laws of economics have been examined over 200, 300 years. They were not invented. They are like natural laws discovered by the economists. The demand curve and the supply curve are not laws invented by an economist. The Treasury Minister didn't understand this basic fact. He started to say, that these laws were invented by people. Such statements show a basic lack of understanding."

What's your opinion on Moshe Kahlon?

"I'm impressed by his public courage."

Is it possible to do to the banks what he did with the cellular market?

"It's not simple. In the cellular market, there are a small number of companies with a high profit margin. From this perspective, bringing in a new player and dealing with cartelization was the right thing to do. It succeeded in bringing down prices. The banks are not the same. There are few banks, but the profits aren't high. If there's a situation of lack of competitiveness which leads to a rise in the cost of banking services and the cost of credit to small businesses – then the question is where do the banks' profits go. They don't go to firms, though they might go to the workers.

There don't seem to be excessive profits in the banks. Maybe it would be better to deal with the employment structure in the banks and the problem of managerial flexibility. In any event, there's less an issue of bringing in new players. In case of brining in a new player, the result might be the collapse of one of the existing banks."

What's your opinion of Naftali Bennet, another economic player on the governmental level?

"I didn't get to work with him. When he spoke of the reforms he intends to do, he said he's a Shiite suicide warrior. In practice, we didn't see dramatic changes. He dealt a lot in statements in the political and defense areas. So he also participated in the populism contest. This is the real problem: we have to take leave of populism."

The populism contest is the primary obstacle to a fundamental improvement in Israel's economic situation. According to Dr. Sarel, since the days of Netanyahu's reforms in 2003-2005 when he served as Treasury Minister, Israel has not had an economic policy which deals with fundamentally changing the situation but only one which deals with the symptoms of the present one.

"Very often, there are very attractive ideas which ostensibly deal with the problems in the economy," he says, "and they have good visibility. On the macro level they seem to solve the problems, but when you properly examine these cures, you understand that the negative results are greater than the positive ones."

We asked Sarel for examples and he came back to "0 VAT". There is no doubt that this economic program of former Treasury Minister Lapid will enter the pantheon of the study of economics and future students may know Lapid's name solely because of this failed idea. "0 VAT was not in Lapid's original program when he took office. It came up in midway," he says. To explain the problem philosophically, Sarel makes use of Frederic Bastiat, who wrote in 1850 on "What is Seen and What is Not Seen."

"What he explains there, is that almost every economic policy has a direct positive effect, alongside which are negative effects which economists can see, and the negative effects are much stronger. Minimum wage too. It looks good, it ostensibly helps the weak, it narrows gaps, and helps first and foremost those with low wages. Those are the visible positive effects."

"But the indirect effects are that a large portion of those who get out of the army will not earn anything, because business owners will prefer to hire less people. The unemployed, especially the young, who enter the work force will have difficulty doing so. This is one of the reasons why the unemployment in France is so high."

"They won't fire in the public sector; there are many wage components in the public sector which are not included in the minimum wage. So raising the minimum wage not only helps those who need it, but also those who, combined with other benefits, earn 11 thousand shekel. The higher costs in the public sector will be paid for by the budget and that means we'll need to cut from somewhere, which means higher taxes. Raising the minimum wage will necessarily come at the cost of other public expenses.”

Didn't they succeed in limiting the application of the minimum wage raise?

"The estimations are that in the agreement with the Histadrut, they did manage to make an exception for the aforementioned 11 thousand shekel people in the public sector. But in the business sector, there are many employers who will employ less or worse: the businesses themselves will not last. Studies on minimum wage show that they do not narrow gaps but they do harm growth."

Articles have come out in which the left argues that there are studies which dispute what you say here.

"The studies done in countries where there is a high minimum wage show that it harms employment. In the US, the minimum wage is lower than other western countries – and there the studies show mixed results regarding employment. Israel has a relatively high minimum wage, and to truly compare results, we need to examine studies in countries similar to ours. Looking back at the effects of the minimum wage which came into effect 10 years ago – unemployment rates did indeed not go up. But that's one isolated point in time, and it's hard to arrive at empirical conclusions based solely on that. Furthermore, these studies were one at a time of significant growth in the economy, which balanced out the negative effects of minimum wage."

What policy do we need for a higher growth rate than 3% – say 4-5%?

"In terms of growth potential – there are external factors which are a negative influence. The world is growing more slowly. All the growth predictions are lower than in the past. The second obstacle is demographic. Israel had positive demography when the number of people of working age was relatively high. The number of working people in the population grew, among other things due to the Russian Aliyah."

"But the trend has since reversed and the percentage of working-age people is in decline. This is due to the aging of the population and the lower rate of Aliyah. There is also a sectorial dynamic which does not support growth. The population growth rate among sectors is not uniform and it is particularly prominent among Haredim and Arabs. Today the workforce is characterized by a low participation rate of these two sectors. This shrinks the growth potential."

"In other words, in general the economy is facing a strong counter-wind. We can increase the productivity of the two aforementioned sectors, but the time frames needed to do so are very large. The capabilities that their education provides them to integrate into the workforce, especially into high-paying jobs, are not high and this affects their quality of life. The change involves a policy which stretches over ten, twenty years. Nevertheless, there are things that can be done in favor of growth but unfortunately the policy steps are moving in the opposite direction."

And all this is happening on Netanyahu's watch as Prime Minister.

"Regarding the Prime Minister's policy: he contributed a lot to growth and an increase in productivity and in general to Israel's financial success in the programs he implemented in 2003-2005. Both in terms of changing incentives and dealing with long-term problems – budgetary pensions, raising the retirement age, cutting benefits, reducing the corporate tax. All these brought about a positive momentum in terms of growth and encouraging productivity. As a result, the business sector led to impressive growth for a decade. The fairly good coping with the 2008 economic crisis also originates in the policy adopted a few years before."

So what's changed since then?

"After 2005, no significant structural reforms were made. There was no attempt to deal with the low productivity in government companies or in reducing the number of people employed by the public sector. There was no improvement in managerial flexibility. There was a lot of dealing with symptoms. Cost of living, for instance. Cost of living is a sign of low productivity in the economy. Dealing with it means dealing with improving productivity. Instead, they deal with the price of a Milki and toilet paper and arrive at price controls. Such an approach reduces the efficiency of the private sector, and takes Israel even further away from the leading countries."

Just recently we've witnessed two regulatory bombshells – in the energy sector and the closed-opening Channel 10.

"Regulation also harms growth. It could be that this entire populist direction comes from the protests of 2011."

One of the names which rise to prominence in the wake of these protests was Prof. Manuel Trajtenberg, presently the Herzog and Livni's choice to be Treasury Minister in a Labour-led coalition. But the more interesting question is whether Netanyahu has had a change of mind on economics.

"It's hard for me to believe that he changed his economic worldview," Sarel said. "There are probably political and coalition-related considerations which create policy constraints, or other considerations which take up most of his time like Iran and Hamas. The amount of attention he's given to economics has changed."

What's your opinion on the intervention of the Antitrust Authority regarding the gas monopoly?

"It's not a field I specialized in. I delved more in depth in the issue of import and export of gas; everything that has to do with the Sheshinski Committee. In retrospect the committee's conclusions were a good move. It's important to maintain the faith of the business sector and not change laws retroactively. On the other hand, you have to change tax laws retroactively in extreme cases when existing policy is unreasonable – and the existing situation was not reasonable. They tried not to change the conditions to a situation where if the investors had known this would be the case form the beginning, they would not have bothered to look for gas."

"They tried to maintain a balance and not cause investors to feel that we're changing the rules of the game. On the other hand, in terms of income to the state – they were unreasonable in the extreme. So the correction was logical and reasonable. Then the question of export came up – what's desirable for the economy and the owner of the stockpiles. There, too, they also went for a reasonable and logical goal. The Zemach Committee recommended allowing 55 percent to be exported. We said that was too high, and that the number should be lower. So they brought it down to 40 percent. In this sense, this was a gesture for the producers to avoid harming the firms. Do the contracts fulfill the demands for a competitive market, and how you can achieve it – I don't want to go into that."

Did the rise in power of the Histadrut and of unions in public monopolies become a burden which increases the economic counter-wind you described? More than that, there's an increasing trend of unionization in private companies.

"In terms of the right of workers to unionize, no-one disputes the right. But it's important to ensure that it's not obligatory. It's important that workers at a particular place reserve the right to freely choose and not to cause pressure. Just like the Histadrut has a right to convince – the employers also have the right to explain the consequences. There are court decisions which prohibit business owners from intervening in the process. But if there is a right to convince others to unionize, there needs to be an equal right for everybody to do that. Witness the recent case of HOT."

"Regarding the consequences of strong unions – the macro-economic consequences are very negative. There's a negative effect on the public sector for excellent workers who could help improve things. On the other hand, there are workers who simply aren't appropriate, some of whom did well in the past but no longer belong. Today, there is no managerial ability to move workers or fire them. This causes a great drop in productivity and also greatly inflates costs at the expense of vital public services. Every unnecessary worker costs the taxpayer in terms of services like education and transport."

"The wage costs of the public sector amount to about 100 billion shekel. The educational system is incapable of getting rid of teaching employees who are no longer appropriate or who don't really teach anymore and it cannot reward excellent teachers – all because of the unions. The result is not the government spends more money but that the results are worse."

In the Treasury Ministry, on the other hand, work is efficient and the motivation of the civil servants and workers there is high, according to Sarel. In other places in the public sector, "bad workers harm motivation."

"Regarding the Electric Company, there are studies that show that the number of workers there is too high. This excess cost will not necessarily by felt in the electric bill but in the company's profit margin, and consequently lowered dividends passed on by the company to the government. In recent years, they didn't even pass on dividends. As a result, government revenue is lower, and when revenue is lower you have to increase taxes. Thus the public finds itself funding these excess workers through excess taxes. What you need to understand at the end of the day is there is no such thing as a free lunch. Every unnecessary expenditure ends up coming from the taxpayer."

Guy Rolnik from The Marker has effectively argued that we've gone back to a time when increased government involvement in the economy is important. He claims a number of economists support this. Do you accept this?

"He argues that capitalism when it works right benefits markets not businessmen, and that the state is not helping the market but businesses. According to him, it isn't classic capitalism but crony capitalism. As an example he brings the economies of Italy, Greece and the United States. This as opposed to Northern Europe which ostensibly does not have ties between business and government. He says that Israel needs to be more like the Scandinavian economies. It's an interesting approach. He talks about the micro level, and argues that in the recent financial crisis the US government protected the banks too much."

So on the one hand, we need to break the business-government link, which removes the government form involvement, yet on the other hand he says the government needs to be a visible and guiding hand.

"A big part of government intervention doesn't show in the macro data. The tax burden in Israel is not very high; it's low compared to Europe. Government expenditure is not very high. There was a significant drop there in the last decade. In spite of the high defense costs. But there is government intervention at the micro level: in regulation and in many processes in the business sector and in individual areas. Mandatory pensions, for instance. This means the government forces employers to set aside pension money for his employees. You have to do it. So even though the tax burden is not very high, the regulatory burden is, so the result is effectively the same."

Isn't that socialism through the back door?

"It's not exactly socialism. After all, it doesn't reduce inequality. In addition, there are regulatory acts which narrow freedom of action. Price controls, for instance. They don't narrow gaps, but they mean less freedom for everyone. The central issue for the next few years is to raise market productivity and subsequently bring Israel closer to leading countries in quality of life. After 2003-2005, we’ve dealt mostly with the short terms and ostensible social justice. Increasing productivity and per-capita income is more important than the gaps issue. There is an improvement regarding inequality in recent years; it's lower than eight years ago. To constantly harp on the gaps issue won't help."

Dr. Sarel, with all his substantial academic credit, insists that contrary to the accepted populist discourse in Israel today, "there is a drop in poverty rates and an impressive process of reducing social gaps. But in terms of income we haven't come close to Switzerland or Canada."

According to Sarel, this wrong-headed discourse stems from the 2011 social protest. In addition, globalization has created comparative measures which didn't bother the public in the past. "Because of the great mobility and the trips abroad, Israelis look more at what they see there and compare it to their situation at home. If the points of comparison were once Petah Tikvah and Tel Aviv, today it's between Petah Tikvah and Berlin. We need to reduce that gap between Tel Aviv and Berlin. It is wrong to focus on gaps among ourselves rather than increase life quality and satisfaction. I'm pessimistic in the sense that policy today doesn't handle problems, but I'm not entirely pessimistic about changing the policy. It depends on the politicians, the economists and the public atmosphere."

English translation by Avi Woolf.

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