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Reforms during wartime: the Israeli lesson for Ukraine

Case Ukraine economist on the Israeli stabilization plan of 1985

The war in Donbass is a poor justification for a lack of reforms. What’s more, reforms are a necessary condition for Ukraine’s victory in this war. And there is certainly nothing unusual or impossible in carrying out reforms in this situation. Israel’s experience confirms all this. All that is needed is the desire to carry them out.

Today Israel is one of the most developed countries in the world, Yulia Shibalkina writes for LIGA.Business. Despite the permanent military conflict that the country is involved in, Israelis enjoy a high standard of living and comfortable conditions for doing business.

However, few people remember that in the late 1970s – early 1980s Israel was very similar to Ukraine today: a war, terrible inflation, a budget deficit in the double figures, state debt exceeding 200% of GDP, meager gold and currency reserves, the threat of default, a “pocket” National Bank, corruption, an inflated state machine, unreliable support from the USA… You will agree there are a lot of things in common…

Before 1977, the center left dominated in Israel’s politics, but their inability to establish peace and stabilize the economy cost them victory at elections. The center right, despite enormous expectations, did not manage to turn the situation around after two terms in power. As a result, at the elections in 1984, votes were almost split equally. It was decided that for the first two years, the Prime Minister would be the Shimon Peres from the center left, and in the following two years Yitzhak Shamir from the center right.

When he became Prime Minister, Simon Peres, as was suitable for a member of the center left, refused to reduce state expenses significantly, hoping to solve the problems of the budget deficit and inflation with gentle methods and the support of the USA. With a lack of political will from the Prime Minister, it was hopeless to expect that ministers would be able to drag the country out of the crisis. In practice, each one of them did everything they could to protect the budget of their own ministry.

Meanwhile, the situation in the country was becoming catastrophic. And after nine months in power, Shimon Peres’ embarked on decisive actions. Along with Finance Minister Yitzhak Modai, he assembled a small team of economists which included both officials and independent experts, and began to develop a stabilization plan.

The plan was ready in three weeks (it included many ideas that had been developed beforehand, but which had previously been ignored). The Finance Minister Yitzhak Modai and Michael Bruno made a particular contribution to the plan. Peres argued with members of government for almost 24 hours, but in the end he was able to get the plan past the Cabinet of Ministers, although the ministers resisted with all their might.

Yitzhak Modai, who was 59 years at the time, was renowned as a person of brilliant intellect, but authoritarian character. Before he became the finance minister in 1984, he had already headed four different ministers. Modai was a graduate of the London School of Economics, where he studied law and economics.

Michael Bruno was a 53-year-old economist of the Jewish University in Jerusalem (a famous Israeli university). He defended a doctoral dissertation on Israel’s economy at Stanford University under the supervision of Nobel laureate Kenneth Arrow.

The Israeli stabilization plan of 1985 included a number of harsh fiscal and monetary measures which were coordinated among one another.

On the fiscal side, the main aim of the plan was to reduce the budget deficit, which was supposed to stop the growth of the state debt and expenses on servicing it. Israel succeeded in doing this: the budget for 1985 was almost balanced, although in previous years the deficit had been in double figures. Taxes were increased and expenditure was reduced. The main source of economizing funds was reducing subsidies to enterprises.

There were also mass cutbacks to civil servants, officials of bodies of local self-administration and various employees in the budget sphere. Given the redundancy payments, the cutbacks did not have much effect on the size of the deficit in that year. But these steps showed the Israelis and the entire world that the government was prepared for reforms and changes.

The authors of the Israeli stabilization plan were very worried that the success would prove to be short-lived. The state bodies which had their budgets cut and the enterprises which had subsidies taken away from them lobbied their interest very actively. Fortunately, the Israeli government withstood their attacks.

Strict observance of the plan made it possible to stabilize the situation in just a few months and create conditions for further market reforms, which is what made Israel the way it is today.

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