Israel and the World Economy : The Power of Globalization

1. Israel and the World Economy:The Power of Globalization by Assaf Razin May 2018

2. Anti-globalization sentiments are rising, especially in Europe and the United States, with the increasingly integrated global economy blamed for domestic economic distress. In the book, I argue that Israel’s remarkable takeoff offers a counterexample to this view.

4. Features The book demonstrates how Israel did the opposite! It used globalization to its advantage. Israel’s economic experience contains many highly relevant lessons: how to tame inflation, how to absorb immigrants, how to make the transition to high-tech, and to fight inflation and depression forces.

5. Unprecedented Global Episodes (1) the collapse of the Soviet Union, and the massive wave of high- skill immigration to Israel that followed; (2) the Great Moderation in inflation and output- employment fluctuations in the advanced economies, and the convergence of Israel’s inflation to the low world inflation rates;

6. (3) the 2008 global financial crisis (epi-centered in the United States, spreading violently to Europe), and the surprising robust per for mance of the Israeli economy; (4) the rise of the Asian markets, recently opened up to Israel’s exports, which also became an abundant source of foreign direct investments into Israel;

7. (5) the global information technology surge, and its spillovers to the fast- developing high- tech sector in Israel, aided by high skill immigration;

8. Israel among the OECD economies: Real GDP per capita

9. Israel’s Immigration-Assimilation Unique StoryThe Swiss playwright Max Frisch put it theatrically: “We asked for workers. We got people”.

10. Migration is not just “International mobility of labor”! Migration differs from the movement of other factor of production and financial assets (e.g., capital flows) in one fundamental way. As immigrants become part of the society of the host country, help shape its economic policies. The policies, in turn, affect in turn the labor-market types and volumes of immigrants, and skill acquisition by the native born.

11. Immigration has significant fiscal implications While high skilled and therefore high-wage migrants may be net contributors to the fiscal system, low skilled migrants are likely to be net recipients, thereby imposing an indirect tax on the taxpayer of the receiving country.

12. The Economic and Fiscal Consequences of Immigration:The US Experience The New Americans: Economic, Demographic, and Fiscal Effects of National Academies of Sciences Immigration (1997) Economic and Fiscal Consequences of Immigration Francine D. Blau and Christopher Mackie, )Editors; National Academies of Sciences (2016

13. Controlling Migration: A Political Economy Issue Jeff Sachs (2017) says: “If people were told that they could move, no questions asked, probably a billion would shift around the planet within five years, with many coming to Europe and the US. No society would tolerate even a fraction of that flow. Any politician who says, “let’s be generous,” without saying-”we’re not going to let the doors wide open”, will lose.”

14. Israel’s Waves of immigration!

15. Free Migration is Unique to Israel! The (semi-constitutional) Law of Return not only enabled free immigration but also grants these immigrants immediate citizenship, and naturally voting rights.

17. Israel’s immigration waves Serves Economists As a “Natural Experiment” Immigration to both the pre-state Palestine and to the State of Israel came in exogenously determined waves. Immigration in the last wave from the Former Soviet Union (FSU) amounted to about 19 percent of the established population, within less than a decade.

18. Emigration of Jews from the former USSR

19. Labor-Market Characterisics of FSU immigrants [1] Including immigrants

20. Assimilation of First Generation as indicated by the Second Generation

21. Earning Deciles of Children Born to the Bottom-Decile Parents

22. Probability of outranking parents by 5 percentiles (against parents’ quantiles) FSU Total population Arab

23. Immigrants are Like Us: The Voting turnout Voting turnout patterns of Soviet-Jew immigrants to Israel in the 2001 elections, conducted by Arian and Shamir (2002) find no marked difference in the voting turnout rates between these new immigrants and the established population.

24. A FSU-Immigration Style Model The model predicts that: 1. The middle Class gets stronger 2.The domographic change flips the welfare state to be less progressive 3. All income groups become better off, except low-skill immigrants 4. Market based Gini inequality coefficient improves 5. Disposable-income based Gini inequality coefficient worsens The political economy model draws on Richard Metzler (1981)

26. FDI and Information-Technology: The Surge

27. Key Role of Foreign direct investment in the form of Venture Capital Innovation requires scale, and scale require trade. An isolated small economy cannot be a center of innovation. The incentives of entrepreneurs to invest effort and resources in generating valuable services are related to the ability to use the resulting knowledge repeatedly, on a large scale, over time. Foreign direct investment provides critical incentives to be able to use scale economies, so as to leap from the precarious innovation stage at the confined of a small economy to the execution stage, by utilizing the world markets. The globalization of an economy is crucial for its nascent high-tech industry to develop, and flourish.

28. Foreign direct investment

29. Israeli High-Tech Venture Capital Fund Raising (right axis, Million, current US dollars) and Inward Foreign Direct Investments (left axis, Million, current US dollars)

30. Gross domestic spending on R&D, Total, % of GDP, 1981-2014: Israel and OECD average Source: OECD Data.

31. Israel's Labor Productivity led by the IT Sector (annual percentage changes)

32. Israel’s Triumph over Inflation

33. The 1980s Hyperinflation 1. Early acceleration to three-digit levels, lasting 8 years, generated by populist government; 2. Credible stabilization program, based on political backing triggered sharp fall in inflationary expectations, and consequently to sharp inflation reduction to two- digit levels;

35. High Inflation Inflation accelerated starting in the 1970: Source: BOI

36. Macroeconomic populism Dornbusch and Edwards (1989) define populism as policies that are favoured by a substantial part of the voting population, but which ultimately harm the majority of the population.

37. Sugar high, Melting away “In economics, things take longer to happen than you think they will, and then they happen faster than you thought they could.” - Rudi Dornbusch

38. First Stage of Populism In the first phase after their policies are enacted, populists are vindicated. Profligate spending and intrusive government control do expand the economy. The surging government spending and mandated wage hikes tend to produce a temporary “sugar high”.

39. In the second phase: Financial and Fiscal meltdown, followed by recession.

40. Sugar High and Meltdown: Economic Activity During the Inflation Crisis • Economic activity severely impacted by swelling credit frictions Source: ICBS, World Bank

41. Populism Must Rely on Seigniorage Revenue • Failing economic governance made it essential for the government to raise revenue through money expansion. • The fast-expanding government spending and transfer were financed by the printing press. • But, how much seigniorage revenue (the profit made by a government by issuing currency) will the inflation-induced money creation generate?

42. Seigniorage Generated through Inflation Spike Calvo (2016) writes: “An inflation spike is, in the short run, one of the cheapest and most expeditious manners for securing additional fiscal revenue. Moreover, this "carrot" is always there. As noted, though, a problem arises if the government repeatedly reaches out for the carrot. However, even in this case, the evidence presented in Friedman (1971) does not prove that authorities were making an error.”

43. The Irrelevant Steady State Calculations Necessary condition for maximization of seigniorage revenue across steady state is that the inflation rate is equal to one over the semi-elasticity of demand for money. This Laffer point is significantly below the rates in high inflation episodes.

44. Israeli Economists: The Debate Dollarization as a Monetary Reform / דולריזציה כרפורמה מוניטרית ניסן לויתן Economic Quarterly / הרבעון לכלכלה Vol. No. 119 / 1984),

45. Redistribution of income must accompany Any inflation-halting Policy If the government surprise market participants by in the presence of entrenched inflation expectations, the fiscal burden of public sector wage bill and subsidies to basic food must rise. Therefore, the government may hesitate to do so. There must be a full-fledged social agreement between the government, savers (who hold government bonds), public sector wage earners, and recipients of food subsidies..

46. The 1990s-2000s “Great Moderation” and Israel’s Disinflation

48. The “Great Moderation” and Globalization A wave of globalization took place in the 1990s after the collapse of communism and the openness acceleration in China. The 1992 single-market reform in Europe and the formation of the euro zone were watersheds of globalization. The globalization wave has swept emerging markets in Latin America, European transition economies, Emerging markets, including China and India, likewise became significantly more open.

49. The 1990s Steady Decline of the World inflation Global inflation declined from 30 percent to 4 percent between 1993 and 2003.

50. The “Great Moderation” US Trend Deviations of Unemployment and Bond Yield Spread, 1953-2014, standard deviations. The Great Moderation Period Source: FRED, BLS, an extension to Eckstein, Setty and Weiss (2015) Notes: Detrended unemployment rate obtains through HP-filter, in SD. Bond yield spread is defined as the difference between two things: 5-Year Treasury Constant Maturity Rate, and Moody's Seasoned Baa Corporate Bond Yield, HP filtered, in SD.