Risk to the Israeli economy
The proposed ‘reform’ of the judicial system
The Israeli government is currently engaged in preparing a broad and ambitious “reform” of its judicial system. This article arises from our deep concern with regard to the economic ramifications and the risks inherent in the proposed reforms. We should emphasize that we do not deal with the legal aspects of the plan, in as much as we are not legal experts.
Nor will we relate to the political and partisan aspects of the public debate since we are not active in or identified with any party or political body. Our position is purely professional and is based on our many years of experience in tackling challenges to the Israeli economy, along with our significant experience and intimate knowledge of how international financial bodies and institutions operate.
In the modern world, economic growth and prosperity require stability, a legal system that guarantees among other things property rights, compliance with budget legislation, respect for the central bank law (the Bank of Israel Law), enforcement of regulations promoting competition, and clear and stable rules of the game that enable and facilitate the development of a longterm planning horizon.
This creates a favorable environment for economic development and especially for innovation and excellence. Israel has garnered striking achievements; the Israeli economy has become a desirable destination for foreign investments, with these investments making a major contribution to economic growth and to raising our standard of living.
This development has been accompanied by an impressive improvement in the country’s credit rating, as measured by the three leading international rating agencies: Moody’s, Standard and Poor’s (S&P) and Fitch. We must not jeopardize these accomplishments.
In recent years, the performance of the Israeli economy has been especially impressive, due in part to an unprecedented volume of foreign investments in the Israeli hi-tech industry.
However, the economic environment has changed and the global slowdown and decline in available capital are already leaving their mark on the Israeli economy.
A debilitation of the judicial system, which might reduce foreign investors’ interest in Israel and lead to higher borrowing costs for the Israeli government, as a result of a cut in the country’s credit rating could deliver a serious blow to Israel’s economy and its citizens.
In this context, we should pay close attention to the statement by a representative of S&P that appeared recently in the Israeli press: “A consistent tendency to weaken key and essential institutions or the system of checks and balances is liable to increase the risk of a reduction of Israel’s credit rating.” With this in mind, we must not endanger Israel’s credit rating.
A key factor that determines where Israel stands in the global economy is the strength of its professionalism and independence of its judicial system. Safeguarding the separation of powers (between the legislative, executive and judicial branches) is the ironclad principle on which democracy rests.
The balance in the relations among these three is extremely sensitive; the mere hint of suspicion as to the government’s commitment to abide by this principle could undermine the image of Israel, which is crucial for the community of investors in Israel and abroad. Today, the world over, we are living in a period of geopolitical and geo-economic uncertainty.
It is precisely in such a sensitive time that it will be all too easy to damage the country’s economic image and very hard to restore it. An extensive and exceedingly rapid change in the judicial system and in
the role and authority of legal advisers without in-depth deliberations that produce broad consensus is fraught with danger. Despite the fact that there is broad agreement as to the need for some improvements in the judicial system, the overall package of measures that has been proposed comes with major risks for the very character of Israel’s democratic regime and for its international image.
THE ISRAELI economy operates in a very competitive world; everything we do is being closely examined, sometimes with very little patience and very little tolerance. In this competitive scene, any blow to the Israeli economy as the result of the adoption of hasty and misguided measures is liable to be costly and hard to repair. A sober strategy of risk management leads to an unequivocal conclusion: Given
the Israeli economy’s significant dependence on international financial markets and accepted standards and norms, we must not risk the Israeli economy’s standing in the global capital markets.
The reaction of investors and rating agencies to the planned changes, which would curtail or weaken judicial oversight of actions by the government and legislature (Knesset) and weaken the system of checks and balances among the branches of government, is likely to be sharp and swift.
Economic literature consistently maintains that independent courts and effective judicial restraint of the executive branch have a positive influence on economic growth. This occurs through several channels, including by ensuring stability in policy framework regardless of changes in the government, protecting the rule of law and reducing
the uncertainty that may result from arbitrary government decisions and actions.
A weakening of judicial review is liable to make it possible for a government to adopt measures that deal a blow to the economy. These include damage to property rights, fanning investors’ fears of arbitrary and unanticipated decisions and changes in the rules of the game when there is no effective judicial review and oversight.
We have already seen recent examples of this dire impact in countries where judicial review was curtailed and the system of checks and balances between the branches of government undermined in a way that left the government all-powerful. In Turkey, where beginning in 2015, judicial review was severely curtailed and the central bank deprived of its independence, the decline in foreign investment was much sharper than in other countries during the same period and its credit rating plummeted.
In Hungary, where the assault on the judicial system began in 2009, the country’s credit rating was lowered for several years and is still lower than it was before the process began and the impact on foreign investment was much sharper than that in other countries during the years after the global economic crisis. In Poland, where the weakening of the judiciary began in 2016, there was a (temporary) drop in foreign investment in contrast to the (small) increase on average in OECD countries.
In all three countries, the international rating agencies cited the curtailment of judicial review, thus weakening the system of checks and balances, as a factor with a negative influence on the credit rating. It is important to note that with regard to Hungary and Poland, which are members of the EU, the latter’s institutions limit their ability to undermine the democratic system and the independence of various institutions. Since Israel is not a member of the EU, it does not have such institutional protection.
Israel’s situation is still very far from countries like Hungary and Poland, and its economic situation is immeasurably more favorable than that of Turkey. Nevertheless, it is important to understand that there is a link between processes that on the surface do not seem to be related, such as the capacity for judicial review of government actions and investors’ confidence in a stable economy.
The steps being proposed to weaken the process of judicial review and oversight increase the risk of harsh and painful repercussions. Israel should avoid taking such a risk.
Prof. Jacob Frenkel served as governor of the Bank of Israel from 1991-2000, is a laureate of the Israel Prize in Economics, and is chairman of the Frenkel-Zuckerman Institute for Global Economics at Tel Aviv University.
Prof. Karnit Flug served as governor of the Bank of Israel from 2013-2018 and is vice president of the Israel Democracy Institute.
This article is an adaptation of a previous essay published in Hebrew.