The Role of Economic Advisers in Israel's Economic Policy

I realize how unusual it is for outside advisers to be given as active a role in the formulation of policy as we eventually had. (Fischer 1995, 3)

Over the period 1953–1956, Lerner served as a resident economic advisor to the State of Israel. For most of this period, Lerner was a member of the Economic Advisory Service (EAS). He also served in 1956 as an advisor to the Finance Ministry. This chapter utilizes the Lerner Papers and the EAS papers in Israel State Archives to document Lerner’s activities and influence in these roles. Lerner analyzed export subsidies, the proposed legislation to establish the Bank of Israel, and the cost of living allowance (CLA system). He also played the unconventional role of critical public intellectual. He contributed to “the economic independence debate” and even launched a campaign to abolish the CLA. He continued his attacks on it after returning to the USA, albeit changing his views in 1974, after the oil price shock and its impact on the Israeli system of wage linkage. We conclude by conjecturing that Lerner’s views emanated from his observations of the operations of the National War Labor Board (1942–1947) and the problem of Federal Reserve independence (1942–1951).

This chapter documents Richard Kahn’s role as an unofficial advisor to the Israeli government, using archival and published sources. In 1957, Kahn predicted that the EEC customs union would harm Israel’s trade and that the EEC would reject Israel’s application for Associate Membership. He proposed a major reform of the COLA that would significantly reduce real wage protection and move Israel closer to the Swedish wage system. In 1962, he took a neutral position regarding the sustainability of Israel’s international imbalances. He also criticized Israeli policymakers for overestimating the potential benefits of an Israel-EEC commercial agreement and argued that the EEC would make reducing Israel’s trade deficit more difficult, even if the UK did not join. Ultimately, Israeli policymakers ignored Kahn’s advice: they continued to push for EEC Associate Membership and failed to adopt his proposal for COLA reform. In that sense, Kahn was unsuccessful as an advisor, but he was probably successful in the more limited sense of helping government officials attain greater clarity on economic issues.

In May 1977, a political sea change took place in Israel, when the Likud Bloc replaced the Labor Party that had ruled since 1948. The government invited Friedman to serve as an unofficial economic policy adviser. Friedman visited Israel in July 1977 and proposed a broad package of free market-oriented reforms. This chapter documents Friedman’s views, activities, and influence using a wide range of primary sources. He advocated gradual disinflation, floating the currency, phasing out exchange controls, reducing government expenditures and taxes, privatizing state lands, and abolishing subsidies and directed credit. However, before his visit, Friedman was reported as calling for “a free labor market and a certain amount of unemployment.” This led to opposition attacks; consequently, the government distanced themselves from his views. In October 1977, the government announced an “economic revolution.” It liberalized exchange controls, reduced subsidies and tariffs, and essentially floated the currency. Friedman was not informed of this in advance. Still, he lauded the government for its “courage and wisdom” and predicted a “reduction of inflationary pressures.” But the government again distanced itself from his views. The “revolution” did not succeed; inflation accelerated. Still, parts of his agenda were ultimately implemented by later Israeli governments.

In this chapter we provide an overview of the politico-historic setting and concern with foreign exchange reserves and government finance in Israel that set the tone for the inflationary spiral over the period 1980–1985. We deal with the long run economic background leading up to the crisis of 1984–1985 and 1985 stabilization plan that is starting in 1970 with a return to a “double-digit” inflation that characterized the years 1948–1954, accelerated by OPEC 1 and 2, and hyperinflation. We then focus on the crisis of 1984–1985 and the 1985 stabilization program itself and on the outcome of the stabilization program designed, in the main, by Stein and Fischer, its ostensible success, and the input of Stein and Fischer regarding 1992 US loan guarantees. Throughout the chapter, the emphasis will be on the views of Stein and Fischer and assessments, contemporary and retrospective, of the 1985 stabilization program and its outcome.