Safe as Houses
How did the Israeli economy come through the global economic crisis in such good shape, having suffered relatively little damage? This question has emerged as a standard item in every conversation conducted during a visit to the UK and Ireland – and I expect the same to be the case on the other side of the pond. Whether in academic seminars or lectures, or in discussions with analysts in financial institutions, or even in informal conversations with people even vaguely aware of developments in the Israeli economy, the glaring discrepancy between the impact of the crisis/ recession on the world in general and the UK and Ireland in particular, on the one hand, and Israel on the other, up, attracts everyone’s attention and demands explanation.
Explanations are, indeed, not lacking. After all, that is what economists are best at – ex post explanations of what happened and why. One set of explanations, by now nicely packaged by the Bank of Israel and the Treasury into a slick presentation of “how we got it right and why we’re so clever”, puts the emphasis on policy measures taken before and during the crisis that helped the Israeli economy avoid several potential dangers and disasters, and also enabled it to navigate through the storm without capsizing. There is much truth in this analysis – as there must be, because it takes a lot more than mere luck to generate such a superior result.
However, highlighting “what we did right” is only part of the picture. No less important, and quite possibly more so, is “what we didn’t do wrong”. It is more difficult to make people see and appreciate the importance of not doing wrong and stupid things, because what didn’t happen is literally invisible. But it is easier to identify and highlight these “negative” achievements, when others – in fact most others – did do what we didn’t do, and suffered mightily as a result.
There is a quite a list of these “negative” achievements. The Israeli public did not bury itself in debt; Israeli banks did not adopt progressively laxer lending standards, to facilitate throwing money at people patently unable to repay the loans they took; the Israeli financial system never adopted securitization and therefore never generated its own “weapons of financial mass destruction”; and so on. Each of these represents a very valid and hence important point that turned out to be an “achievement”, albeit of a negative nature because it was something that was NOT done – but that can be appreciated by comparing Israel to countries where these things WERE done.
There is, though, a negative achievement that goes back much further and is much more deeper-rooted in the long-term success of the Israeli economy – and conversely, a feature that has long existed in other economies and that has caused huge long-term damage. This is the existence of tax breaks for household mortgages. In the US, UK, Ireland and Australia, to name but a few, government policy has for many decades sought to promote home-ownership and has encouraged this by allowing households to deduct the cost of their mortgage from their taxes. The scope and the details of this incentive vary enormously between countries, but the principle has been long-enshrined. The result has been the systematic skewing of the economy in the direction of investment in bricks and mortar. Americans, Britons, Irish and Australians sank a disproportionately large share of their savings, and came to hold a similarly large share of their wealth, in residential housing – but this was entirely rational behaviour, because the tax system had been rigged to encourage them to do so.
In the 10-15 years prior to 2007, various forces combined to create a property mania – which, by definition, is an irrational phenomenon — in these (and other) countries. The inevitable crash has left Ireland as the worst-hit country. The national obsession with real-estate has left the banking system bankrupt and the entire economy in shambles. To stave off massive cuts in the country’s bloated public sector, the government has effectively sold the country to the EU, but its citizens are nevertheless facing a very bleak future. At the other end of the spectrum is Australia, which actually escaped recession this year and is seemingly far-removed from bankruptcy, bail-out and the other curses of the recent crisis. But the reality is that the Australian economy has been sold to China, to help assuage the emerging giant’s voracious appetite for raw materials. This allows Australia to maintain its rich-country lifestyle, but the cost of the public’s ongoing channeling of its savings into housing – a non-productive asset, par excellence — has helped prevent Australia becoming a technology-driven economy of the likes of Singapore and Taiwan.
Or Israel. The contribution made to the Israeli economy by the absence of a tax-break on residential mortgages is very difficult to quantify, but it is certainly enormous. Every so often, a minister or Prime Minister suggests enacting one, but fortunately nothing has ever come of these initiatives – probably because the Treasury mandarins quietly kill them. That is the ultimate “negative achievement”, because the day any such law passes will mark the beginning of the end of the Israeli economic miracle.