1. Israel and the World Economy: The Power of Globalizationby
Assaf Razin
November 2017

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.

3. 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;

4. (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;

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

6. Brief Overview
The state of Israel, founded in 1948, benefited immensely from the post-1945 world economic order with globalization at its center. By steadily reforming its financial and commercial institutions, and becoming increasingly globalized in trade, labor market, and finance, Israel became a member of the Organization for Economic Cooperation and Development (OECD) in 2010.

7. Things to be concerned about: (1) The Rising Costs of West Bank Occupation (2) The brain drain of top Israeli talents, assisted greatly by Israel’s advanced higher- education system and helped by the pro- skill bias immigration policies in Europe, Australia, and North America; (3) the rise in income in equality and social polarization.

8. Israel’s Immigration Story

9. A Reminder---Migration is not just a 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, affects its welfare-state policies. The policies, in turn, affect the the types and volumes of immigrants.
The Swiss playwright Max Frisch put it theatrically: “We asked for workers. We got people”.

10. 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.

11. 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

12. Why Controlling Migration?
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.”

13. Israel: land of immigration!

14. 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.

15. Growth Rate of Population
Period
Immigrants as a Percentage of Established Population
Growth Rate of Population
8.2
8.0
6.4
8.4
19.8
21.9
13.2
20.0
2.2
4.0
1.3
3.0
0.9
2.1
0.4
1.8
19.0 -
Source: Ben-Porath (1985) for the years , Central Bureau of Statistics (1992), Bank of Israel (1991b) for the years

16. 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.

17. Israel Immigration and Emigration of Jews from the former USSR

18. Labor-Market Characterisics of FSU immigrants
Immigrants from the FSU
National Average
Share in Total Population (%)
14.5
100
Household Size (numbers of standard persons)
2.32
2.74
Schooling Years Of Head of Household (no.) 14
13.3
Head of household with a bachelor degree (%)
41.1
29.5
gross monthly labor income per standard person (2011 NIS)
4,351
4,139
[1] Including immigrants

19. Academic Degrees of FSU immigrants
Even more striking is the percentage of the head of the household with a bachelor degree: 41.1% among the new immigrants, compared to a national average of just 29.5%.

20. Asimilation as indicated by Intergenerational Mobility: Immigrants vs
Asimilation as indicated by Intergenerational Mobility: Immigrants vs. Established Population

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 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. 𝑚 𝑈
𝑚 𝑆
𝑥 𝑈
𝑥 𝑆
𝐼 𝑈 𝑀
𝐼 𝑈 𝑁
𝐼 𝑆 𝑀
𝐼 𝑆 𝑁 ∗ 𝑤 𝑟 𝑡 𝑏

25. Israel’s Triumph over Inflation

26. 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;

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

28. 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.

29. 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”.

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

31. Israel in the 1980s: Populism
The hyper-inflation crisis started to develop when the opposition “Gahal” (now “Likkud”) party gained power for the first time since independence. The political upheaval in 1977, the so-called “Maapach”, was a game changer for economic policy in Israel.
The newly elected government abruptly switched away from a long- running economic regime, which had been able to maintain fiscal discipline in the presence of strong external shocks (the Yom Kippur War and the first Oil Crisis).
Monetary policy was only moderately accommodative, underpinning a functioning fixed exchange rate regime; shielded from possibilities of capital flights by capital controls.

32. Inflation Generating Regime
Budget deficit explosion.
Relaxation of BOI commitment to peg the exchange rate at a certain level.
Relaxation of Capital and Prudential Controls.

33. Economic Activity During the Inflation Crisis
Economic activity severely impacted by swelling credit frictions
Source: ICBS, World Bank

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

36. 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 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.

37. The Steady Decline of World inflation
Global inflation declined from 30 percent to 4 percent between 1993 and 2003.

38. The “Great Moderation”
US Trend Deviations of Unemployment and Bond Yield Spread, , standard deviations.
The Great Moderation Period
(1) Moody's Seasoned Baa Corporate Bond Yield, (2) 5-Year Treasury Constant Maturity Rate, (3) Unemployment rate 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.
Source: FRED, BLS, Extension to Eckstein, Setty and Weiss (2015)
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.

39. Convergence of Inflation Rates: Israel And the West
Figure 4.1 shows the convergence of Israel inflation rate to US, Germany and OECD rates.
Inflation Rates (Annual GDP Deflator, percentage)
Source: The World Bank

40. Israel’s Financialy Globalizing
Real Interest Rate Adjusted for Real Exchange Rate Changes (US benchmark)
Source: Stats Bureau, FERD, World Bank, Real-exchange-rate adjusted, yields on three-month government bonds for Israel, Canada, Germany and the United Kingdom, and the yields on three-month US government bonds.

41. 2008 Global Depression and Israel’s Resilience

42. Israel avoids the credit bubble by Bank Regulation and Budget Discipline
Domestic Credit to Private Non-Financial Sector (% of GDP)
Source: International Monetary Fund, International Financial Statistics, data files, and World Bank and OECD GDP estimates.
Larry Summers (2014) put forward a conjecture about the longer run implications of the negative real natural rate with occasional liquidity trap

43. Creditor Rights Protection
The Creditor Rights Index (CRI) ranges from 0 to 4, with a higher number associated with better protection for creditors. Israel is among the Creditor rights index = 3 countries, grouped together with Germany and Australia. Italy, and Norway, is among Creditor rights index = 2 countries. Hong Kong belongs to Creditor rights index = 4 countries.

44. Growth during the Global Crisis
Real GDP, Israel and Selected Countries (Jan 2003 = 100)
Source: FRED
Larry Summers (2014) put forward a conjecture about the longer run implications of the negative real natural rate with occasional liquidity trap

45. FDI and Information-Technology: The Surge

46. 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.

47. Foreign direct investment

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

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

50. Israel's Labor Productivity led by the IT Sector (annual percentage changes)
Private Sector: Total
1.5
(1,399)
3.5
(1,559)
1.2
(2,057)
Information Technology Sector
1.1
(71)
10.2
(126)
3.4
1.7
(176)
Information Technology (excluding electronics)
3.1
(35)
11.6
(38)
6.0
3.3
IT Services
-3.6
(26)
5.7
-0.4
(112)

51. What is to be concerned about?

52. Inequality: Market-based Gini coefficient vs
Inequality: Market-based Gini coefficient vs. Disposable-Income Gini Coefficient

54. Redistribution in Post Soviet-Jew Immigration Wave

55. A rise in income inequality between 1990 and 2003, which is a combination of declining market income inequality, which is more than offset by and a marked fall in redistribution. The influx of high skilled immigrants help explain the conflicting trends.

56. Disposable income inequality
Disposable income inequality in Israel, which was roughly stable until the beginning of the 1990s, took a sharp rising trend thereafter, even though no such change occurs with respect to the market-triggered inequality. Interestingly, the upward shift in disposable income inequality occurs following the start of the immigration from the FSU. In this paper we provide a political economy explanation of how the immigration can cause such a shift in disposable income inequality.

57. Minorities

58. Israel has an unusually high fertility rate among the developed economies. High fertility among the ultra Orthodox Jews (about 8 percent of the Jewish population) come with low skill and absenteeing from the labor force.

59. Israeli Arabs
In the academic year, there were 46,519 BA and BS students in “Universities” in Israel (Tel Aviv University, Hebrew University, Bar-Ilan, Ben Gurion, the Technion, the Weizman Institute and the University of Haifa.) Only 2,950 or 6.3% of Twenty-five years later, the picture is very different. Overall, the undergraduate student population at top Universities increased by 52% from to when it reached 70,785 students. The Arab student population increased by 296% during the same time period. The percent of Arab students studying for either BA or BS degrees in the top Universities increased to 16.5% (11,672 out of 70,785) in the academic year. the students were Israeli Arabs.

60. Israeli Arabs in Technical Academic Disciplines
There has been a large percentage increase in Israeli Arab students in Engineering and other technical disciplines in Universities. During the 15-year period from to , Arab students in engineering (which includes all sub-disciplines plus architecture) increased by 86%, while non- Arab students in engineering increased by 22 percent. In the case of Mathematics and Science, Arab undergraduate students increased by 114%, while non-Arab undergraduate students decreased by 14%.

61. Israeli Arabs in Engineering Colleges
In the case of Engineering Colleges, the total number of students studying engineering increased from 14,649 in to 19,552 in (The delineated data do not go back further than that.) Of the engineering students in colleges, 5.1% or 747 were Arabs in , while in , 1,401 or 8.6% of the engineering students in colleges were Arabs.

62. Last Word
Globalization— the integration of markets in goods, ser vices, and capital whose pace accelerated in the 1990s with the fall of communism, the consolidation of the Eu ro pean single market, and growing openness of China and India— is currently under attack in Eu rope and the United States. The disintegration of the former Communist Bloc allowed full integration of central Eu rope into the world economy. The fall of the Berlin wall brought up the unification of Germany. In the 2000s both Rus sia and China became members of the WTO. Israel’s successful globalization- based economic path is consistent with the enthusiasm with which policymakers around the world pushed forward the globalization wave.

63. Thank You!

64. Seigniorage and Fiscal Revenues
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?
From a long-running economic regime, which had been able to maintain fiscal discipline in the presence of strong external shocks (the Yom Kippur War and the first Oil Crisis).
Monetary policy was moderately accommodative, underpinned by a fixed exchange rate regime; shielded from capital flights by capital controls.
Notwithstanding the oil price shock, inflation was low double digit.
To a new populistic government, embarking uncontrolled path of fiscal expansion accommodated by monetary expansion
the new government lifted capital controls without safe guards; that is, no prudent financial and banking regulatory measures existed. Intensive shifts in demand and supply for foreign exchange followed almost instantly. The fluctuations called for the Bank of Israel required to intervene in the foreign exchange market on a day-to-day basis to smooth out these fluctuations; although there was no longer BOI commitment to peg the exchange rate at a certain level. A massive wave of capital flight caused over a few years a fast depletion of the stock of international reserves, which weakened the ability of BOI to intervene in the foreign exchange market. The exchange rate was at a free fall.

65. Seigniorage though 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.”

66. Friedman Steady State Caculations
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.

67. German hyper-inflation
Cukierman (1998a) brings evidence for a significant share of revenue attributable to seigniorage in the 1920s’ German hyperinflation. Inflation spikes can be a significant source for government revenue. He demonstrates that seigniorage, in the case of last century's twenties-German hyper-inflation is monotonically increasing in inflation as well as in the rate of high powered money growth throughout the entire hyperinflation.

68. Budget Deficit and Balance of Payment Crisis: First Generation Model
Because of the steadily worsening fiscal imbalances, the central bank’s domestic assets grow steadily: .
Because of perfect capital mobility, the domestic interest rate is determined
through the interest rate parity, as follows:

69. International Reserves and Exchange Rate
Exchange rate regime switches with Speculative Attack:

70. Expectations and Stabilization: Time Inconsistency

71. Stabilization: Effects of Expectations

72. Effects of Expectations: Time Inconsistency

73. The Stabilization: Politics
Following almost 8 years of the hyperinflation economic chaos, the Israeli voters brought about some major political rebalancing towards the political center.
The newly established Unity Government (“Likkud” plus “Avoda”) implemented successfully key stabilization measures; all of them required political consensus.

74. Inflation conquest Involves Redistribution
To overcome this difficulty 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. To fix the inflated outlays on debt service, wage bill, and subsidies, some major redistribution of income must accompany the inflation-halting step.

75. Features of Stabilization
A new legislation (“Khok Hahesderim”) allowed the government to exercise tighter control over its spending and taxation.
A new law forbade the Central Bank to monetize the budget deficit (“Khok Iee Hadpassa”), and ended the accommodating monetary policy.
A Tri-Party agreement between the government, the Federation of Labor (“Histadrut”) and the association of private-sector employers stabilized the wage-price dynamics and enabled a sharp nominal devaluation that ended in a competitiveness-boosting real devaluation.

76. No-Printing Clause
This is why the 1985 Israel inflation stabilization package included the non-printing item, preventing the Bank of Israel to purchase from the treasury directly government treasuries: “Chok Iee Haadpasa”.
Sargent (2009) argues that high inflation can be stopped quickly, if inflationary expectations are consistent with a credible stabilization program. His argument is that inflationary expectations are quick to adjust when the economic regime credibly shifts.

77. Policy Credibility
Persson, Torsten, and Guido Tabelini (1990) point out that incentives to surprise the private sector by deviating from preannounce policy rule arise if conflicts exist between private individuals and policy makers. Having a broad based coalition reduces these conflicts and policy credibility is enhanced. Israel’s expectations-changing episode is akin to Volcker-policy effect on inflationary expectations in the US, see Sargent (1999).

78. Quick Adjustment of Inflationary Expectations
Cukierman (1988b) reports that expect for a brief period, when the public feared that the government will not be able to prevent the initial large one-shot (policy-induced) price shock from spreading, inflationary expectations started to decline sharply and steadily within months after the implementation of the 1985 stabilization policy. Six months later there was no significant difference between actual and expected inflation.