Analyses Economic Growth Process - Israel

Economic Policy Setting of Israel

Discuss about the Analyses Economic Growth Process.

The aim of the study is to discuss about the economic growth and development of Israel. This is a strong economic and political power in the Middle East.  The case study of Israeli strategy and the UNESCO resolution highlights the military power of Israel and mentions that the country has turned out to be a strong regional power. Immigration in the country from the central and Eastern Europe has changed the economic structure of the country. Immigration started after the Second World War and the modern economic history of Israel began since then. Israel has been experiencing a positive economic growth rate to become a rising power in Asia (Plessner, 2012). The economy grew at 11% during the period 1950-65. Study reveals that government of Israel has taken numerous policies to boost up the economies.  Major two driving forces of economic growth are immigration and capital inflows. Capital inflows helped in infrastructure development and sectoral growth in both public and private sector.  As growth rate increased, per capita income of the country increased overtime. Rise in per capita income increases saving rate and gross investment in the economy (Ram, 2013). 

The Capital inflows from US, sale of Israel bonds, and unilateral transfer from developed countries had helped capital formation in the economy.  The new economic policy introduced in 1952 has changed the economic, social and political structure of Israel. Due to immigration, there was huge aggregate demand for consumer goods. This report discusses economic policy setting in Israel that has transformed the economy from young economy to modern one. In the later section, overtime change in economic policy setting in this country is discussed.

Social, economic and political structure of Israel started to change since 1948.  Modern Israel started to develop from this period. This study analyses the economic policy setting and factors behind the structural changes occurred in Israel.  Israel has become a growing power in the idle East Asia and in the world.

Horowitz (2014) stated that two important factors such as immigration and capital inflows have attributed to the positive growth of the country. During the end of 1947, the population size of Israel was increased by 630000 due to immigration. Immigration mainly occurred from central and eastern Europe. Capital inflows came in the form of public and private funds.  Large immigration had contributed to the production process of the country. They were in different sectors of the economy and were directly linked with the production process. Immigration increased population size and active labour force the economy (Sachar, 2013). Therefore, labour became a cheaper resource of production. Private organisation plays an important role in the growth of the country. It was easier for the private sector to employ labour at a low wage. Hence, it was possible for the firm to make profit at a lower cost.

Historical growth of GDP and per capita GDP in Israel

Immigration has two faces. Maman & Rosenhek (2012) stated that in one hand, it positively worked for the nations and government. On the other hand, it was a burden the economy in terms of foods, shelter or housing. Pressure on agricultural sector was growing. Therefore, in order to mitigate those economic problems, government took strict austerity program, government finance, price control mechanism and rationing of basic commodities. Government implemented a new economic policy during 1952 (Halevi, n,d). This policy had several dimensions such as devaluation of exchange rate, gradual relaxation of price control mechanism and rationing of commodities. Contractionary monetary policy and constrained fiscal policy was main instrument of Israel government.

Historical growth of GDP and per capita GDP in Israel. Both the figures indicate that new economic policy 1952 had been effective to achieve an economic growth rate from 9.3% from 1952 to more than 12% during 2010. However, the growth rate has been slow after 1972. As immigration had occurred in the economy demand for food and housing increased. Aggregate demand increased substantially. The possible reason behind this is rise in consumer prices rapidly. When consumer prices increases, real money value held by people also decreases. Therefore, nominal interest rate rises. As borrowing cost rises, investment level falls in the economy. Therefore, overall productivity of the economy falls. Wage rate rises because of inflation. Therefore, cost of production rises and aggregate supply falls in the economy. When both aggregate demand and supply falls, economy falls into the recession. This happened in case of Israel.

In the short run, aggregate demand is fluctuating; however, aggregate supply is stringent. Therefore, price of consumer goods increases creating inflation in the economy. Government took austerity measures to control inflation. Austerity measures include increase in tax, cut in government spending, which is effective for reduction in aggregate demand. However, Kleinberger (2014) argued that austerity measures create unemployment in the economy as government spending decreases. Job creation in public sector decreases therefore. Mizrachi & Herzog (2012) commented that increase in tax rate reduces the disposable income of the household, which further has negative impact on country’s saving and investment profile. Therefore, demand and supply both fall in the economy by reducing total GDP and per capacity income. Krampf (2012) argued that if this process continues, the economy might go into recession. Israel had to experience a recession during 1965-67. Figure 4 shows that government expenditure has decreased overtime in Israel.

Positive Effects of Economic Policy Setting in Israel

However, economic policy setting in this country has overall positive effect over the years. The economy has gained government support for innovation in business and other sector of the economy. Both human and physical capital formation have gained priority in socio-economic context. Reform in labour and capital market has facilitated growth of business. Globalisation and privatisation policies remain effective policies for this economy (Barnett, 2012). Investment in research and development, technological up gradation has facilitated industry, agriculture and service sector growth  (Flug & Strawczynski, 2013). This high technology sector has helped to attract foreign investment. 

Israel is a country with a low unemployment rate. Unemployment rate during 2016 was 6.1%. During 2011, the rate was 5.7%. 46% people aged between 25-64 years have tertiary education compared to other OECD nations and OECD average (financeisrael.mof.gov.il, 2012). This development of human capital has increased the scope of service sector within and outside the economy. However, Shindler (2013) stated that with increase in the level of education, frictional unemployment increases in the economy. 

One of the most significant policy implications that have turned Israel economy from young to modern is the economic openness. Due to globalisation and business outsourcing, the largest number of domestic companies has been listed in NASDAQ after US and China. Another strong side of the economy is stable money and capital market. Therefore, Israel was little affected during global financial crisis. In the resilience of the economy index, Israel ranked 1^st during 2012-11. Banking sector has been successful to protect economy from GCF even there have been international cooperation. This success indicates effective money market, capital market policies taken by monetary authority (Roy, 2012).

During 1973-83 Israel economy experienced several economic crisis, Yom Kippur War and as a consequences, government expenditure as well budget deficit extended. In order to reduce the deficit, government took deficit financing through printing new money, which created 445% inflation during 1984 (financeisrael.mof.gov.il, 2012). In order to stabilise the economy, government took stabilisation plan through budget cut, forbidding money printing, stabilisation of price level, setting fixed exchange rate and establishing ‘Arrangement Law’. This stabilisation policy was known as key factor for the development of the economy. This policy was successfully implemented and inflation rate gradually decreased to 20% during 1990s and to 0.5% during 2016. Therefore, the above analysis demonstrates that economic policy setting of Israel has brought remarkable change in the economy, despite facing war several times. However, not every aspect of stabilisation policy had been effective in the economy. Fixed exchange rate regime was introduced to stabilise economy. Currency was allowed to fluctuate within an upper and a lower limit. However, this policy was not fruitful and hence, it ended during 2005. Drezon-Tepler (2012) mentioned that agriculture has been neglected in this economy due to rapid expansion of industrial and service sector. 

Israel got independence during 1948. This economy was under government control since then. Every aspect of the economy such as fiscal, monetary policies, law and order, trade policy, social aspects all were governed by the state. There was less economic freedom. Gradually the economy transited into the free and market economy. As immigration started in to the economy after 1922 from Europe and Russia, policymaker felt the importance of government intervention.  Due to immigration, labour was cheaper in this economy. Therefore, supply of labour has been elastic due to increasing competition. The phase of 1948-65 was the formative phase of the young Israel (Kipnis, 2016, February). Israel has faced war situation several times. Therefore, initially government spending in defence was high in this economy especially after immigration. As an effect, demand for consumer goods was increased so much that inflationary situation was created in the economy. Therefore, government control was inevitable.

Government took decision to devalue Israeli currency. Devaluation makes export cheaper and import costlier. Therefore, export and import both have been grown since 1990s. However, the pattern of trade was changed. Economic based was shifted from agriculture to manufacturing and high tech industry. US have been a major trading partner for Israel for exporting the high tech intensive manufacturing product. Israel mainly imports industrial raw materials, wheat, motor vehicle, and uncut diamonds. As agricultural production has fallen in this economy, Israel imports grain and wheat from other economy as overtime it gained competitive advantage.

Inflation in the country started to rise to reach at a hyper-inflationary stage. During the period 1977-1985, economy faced banking crisis as investors started to withdraw their money from the economy. Therefore, cash flow reduced and Israel faced uncertainty regarding payment of debt. Again, government intervention was necessary. In order to control the situation, cut in government spending was an important decision. A remarkable decision to manage monetary situation is freedom of central bank from political influence (Krampf, 2012). Central bank took more autonomy to set monetary policy. The central bank followed Keynesian spending policy, which opined to cut deficit in good times and letting it go at bad times. The government took import substitution policy to protect domestic industry. This policy was taken to provide opportunity to the new industries like textiles.

New economic policy was taken during 1975. Trade liberalisation and privatisation have been two important drivers of the economy. Liberalisation came up in the form of free trade. A free trade was agreement was signed with European economic union and another with US. Israel has moved from fixed to free exchange rate regime.  Government provided unemployment benefit, pensions, and child allowances. However, as stated by Weitz & Rokach (2013), poverty has risen in the economy with rapid growth of industrial and high tech manufacturing goods. Kaye (2012) mentioned that neo liberalisation policy was implemented in the economy to achieve economic prosperity.

In the view of Hausman & Johnston (2014), Israel is a strong diversified modern economy in the Middle East. It has risen as an economic as well as political power in this region.  Israel has now appeared as an emerging economy from developing economy.  Israel has emerged as the strong regional power compared to other countries like, Egypt, Syria, Jordon and Lebanon. Trade and political relations with these countries have been great impact on Israel economy. One instance can be highlighted here. During 1990s, Palestinian suicide bombing was associated with Arab-Israeli conflict. However, strong economic and political strategy enabled Israel to restrict the conflicts to enter into the economy.  Physical infrastructure of the internal Israel economy remained unaffected from this conflict.

The scope of foreign direct investment has risen in the economy. However, as stated by Elis (2015) the level of foreign investment has decreased 46% from 2013 to 2014. The FDI has dropped from $11.8b to $6.4. This may be a reason for slow growth rate in recent decades.

Israel has become a diversified economy with both high-tech and low-tech production. Two factors attributed for economic growth of the country.  One is the immigration of entrepreneurs and experienced engineers from Germany and the other is increasing demand for industrial products. Before liberalisation period, tradition industries such as textiles, chemical, rubber, metal products and plastics, fertilisers and pesticides played important role in trading.  Until 1970, most of the resources including labour were used in agricultural sector (Flug & Strawczynski, 2013). Due to increasing immigration, the labour market was elastic. However, with the globalisation, the production base of the company shifted from agriculture to industrial base. Gradually education system, medical services, electronic, computer hardware and software business developed in the economy to contribute domestic and export sector.  However, Kaye (2012) mentioned that Gaza war in recent times has pushed Israel economy into contractionary situation due to heavy investment in resolving war conflicts. Increase in government spending increases debt burden on people in future and hence growth rate decelerates.

Conclusion

The assignment has focused on economic evolution of Israel. The economy starts from young stage with a very low growth. However, this country has emerged in a remarkable way by surpassing major economies in the world in terms of real and per capita GDP.  Modern economic history began from 1948. The above study has analysed two factors such as immigration and capital inflows in the economy. Gross National products in the economy grew rapidly during the period of immigration. At the initial stage, wage cost was low, therefore, private and public organisations could employ large labour at very cost. However, economic policies before liberalisation age have not been much effective. Government experienced policy failure in terms of hyperinflation.  Israel economy has faced challenges like hyperinflation, immigration, war conflicts. The report has presented the process of resolving all the challenges through tight policy implementation.

In order to manage demand in the economy as after effect of immigration, government took austerity measure. Spending cut, increase in tax were two policies.  Before 1972s, banking sector faced severe crisis in terms of capital outflow and a hyper-inflationary situation was created in the economy. Government then took decision regarding the autonomy of central bank. Among the other effective economic policies, important were, price control, contractionary and monetary policies and fiscal policies. The stabilisation plan was taken followed by government. Israel economy has experienced a shift in economic importance from agriculture to manufacturing and hi-tech industries. Government has relaxed fixed exchange rate regime. Instead, floating exchange rate has been implemented.  Geopolitical strength of Israel in the Middle East zone has made it to be emerged as 35^th nation in the Work ranking in terms of GDP.

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