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Israel
Changes in Investment Patterns
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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