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WEEKLY NEWSLETTER
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Israel
Index
Gross investment reached an exceptionally high level of 30
percent of GNP in the period ending in the early 1970s, but
subsequently dropped to 20 percent of GNP in 1986. While this
figure is substantially lower than that achieved by earlier Israeli
performance, it is internationally an acceptable standard of
investment and private savings.
Nonetheless, concern existed in Israel about the extent of
public-sector debt. Since 1973 the government has incurred a
substantial domestic and foreign debt that has resulted in a
significant reduction in the proportion of private savings
available for investment. From 1970 through 1983, private savings
averaged slightly above 10 percent of GNP. The success of the
Economic Stabilization Program adopted in July 1985 in order to cut
back on government spending led to an increase in private saving,
however; by 1986, private savings stood at 21 percent of GNP.
Unlike the unstable trend in private savings recorded in the
banking sector, investment in housing has taken a consistently high
share of GNP, hitting a 40 percent peak in 1980. This high level of
investment in housing, which many economists argue is not justified
economically, further constrained the rise of gross business
investment. For example, despite the rise of the share in GNP of
gross investment in manufacturing during the 1970s, Israel's 1982-
86 average share of 4 percent clearly is below international norms.
The lack of uniformity in government investment incentives and
in the rate of return on capital within the manufacturing sector
may be responsible for the mix of Israeli investments. Economists
generally agree that inefficiencies have arisen as a result of
excessive substitution of capital for labor, underused capacity,
and inappropriate project selection. Government policy has been
identified as the primary factor causing capital market
inefficiencies by crowding out business investment, creating
excessively high average investment subsidies, and introducing
capital market controls based on inefficient discretionary policy.
The 1967 Law for the Encouragement of Capital Investment
provided for the following incentives to "approved-type"
enterprises: cash grants, unlinked long-term loans at 6.5 percent
interest, and reduced taxes. The Treasury assumed full
responsibility for any discrepancy between the linked rates paid to
savers and the unlinked rates charged to investors. Because
inflation in the mid-1970s reached levels close to 40 percent, the
real interest rate paid on long-term loans was close to -30 percent
per annum, with a total subsidy on long-term loans reaching a high
of 35 percent in 1977. These extremely favorable interest rates and
implied subsidies led to an excessive substitution of capital for
labor.
The investment system has been characterized by the following
factors: private firms generally are not allowed to issue bonds,
the government establishes the real interest paid to savers and the
nominal interest paid by investors, and the economy is plagued by
high and unpredictable rates of inflation. These conditions have
maintained an excess demand for investment. The result has been a
continuous need to ration loans--and an implicit role for
government discretion in project approval. Thus, since the late
1960s, as a result of capital market controls, the government has
been making industrial policy.
Data as of December 1988
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