at the 15th Caesarea Forum
June 28th, 2007
President of the Israel Democracy Institute, Dr. Arye Carmon, Academic Director of the Caesarea Forum, David Brodet, honored guests, ladies and gentlemen.
In past years, the framework of the discussions at the Caesarea conference has been shaped around the rules of play dictated by globalization. And in the year when the State of Israel has been accepted as a candidate to join the OECD––the organization that brings together the developed democratic countries, with free market economies––the need to maintain the rules of globalization are all the more important.
The Israeli economy has already become part of the global economy. How do we know? It is enough to glance at a few figures that represent the openness of the Israeli economy to the world: Israeli exports (excluding diamonds), for example, in 2006 constituted 38.3 percent of GDP, and imports 37.3 percent. On the financial side, in the capital account in the balance of payments, nonresidents' investment in Israel in 2006 reached 16.1 percent of GDP, a rate similar to that of Israeli investments abroad, which reached 15.9 percent of GDP. And every day we hear more news of Israeli companies and individuals investing abroad, and of foreign investment in Israel.
This reality of successful integration into the world economy places challenges and opportunities before us. The rules of globalization are sufficiently flexible for different countries in the fields of economic policy: Countries as diverse as Sweden, with a large government, and the US or Australia, with smaller governments, succeed in the global economy.
However the rules of globalization limit, in the good sense of the word, the freedom of those countries with free capital movements to exercise variety in their macroeconomic policies. And Israel, as we know, has a free capital movement regime. In recent years Israel has drawn up a macroeconomic framework which can exploit the opportunities that the global economy places before us, and meet the challenges that the global economy sometimes raises. At the center of this framework are budgetary discipline, a monetary policy that maintains price stability and supports financial stability, and economic reforms. This framework has contributed greatly to the firming of economic growth which the country currently enjoys, and can also help us to turn this into sustainable growth.
As economic advisor to the government, I have felt almost no need in the past two years to talk about the government's budget policy, as I was sure that the path we were on was the right one: a path of budget discipline which played, no doubt, a very important part in the economy's success.
But today I have chosen to talk about the budget policy, as I see signs that raise some question marks over the government's ability to continue along this route, and this is most undesirable.
The story I want to describe to you is relatively simple: If the Israeli economy wants to continue thriving, it must continue to stick to its budgetary discipline. The principle objectives of pursuing this discipline are:
- to reduce the size of the government until it falls to the desired size;
- and to limit the deficit and hence reduce the debt-to-GDP ratio, which would allow the government to return gradually to the state in which it can manage an anti-cyclical budget policy, when needed.
I would like to concentrate now on the required budget strategy, and more specifically to the budget for 2008 and later years.
Budget strategy
Here I would like to refer to two topics: first, the size of government in GDP terms, and secondly, the budget deficit and the burden of debt as a proportion of GDP.
- Size of government in GDP terms
In principle, the optimal size of government is the size at which the social marginal benefit from an additional government expenditure of one shekel equals the marginal social costs, mainly the cost of taxes that must be paid by the public in order to finance th