The election and the economy

The February 10 general election was extremely inconclusive. The 2 leading parties, Kadima and Likud, won a practically equal number of seats in the new Knesset, with each one's share less than 25% of the total 120 Knesset seats. There is no certainty as to which of the leaders of these parties will be asked first to try and form a coalition (both claimed victory immediately after the election), there is consensus that each leader will have a formidable task in forming a coalition, and there is a general feeling that even if a coalition is formed eventually, it will not last long. How will all this affect the economy?

First things first: the 2009 State Budget. Knesset approval of this budget (generally by 31 December of the previous year) was postponed until after the election and it will now be further delayed until after a new government is formed, when there will be a new Minister of Finance in place.

Based on what we know at present, the party leader asked to form a government will not be invited to try and do so (by the President of Israel) much before the end of February. He (Binyamin Netanyahu, the leader of the Likud party) or she (Zippi Livni, leader of the Kadima party) then has up to 42 days to create a coalition – which brings us to mid-April. If he/she fails, the other party leader then gets a chance and another 42 days – which could bring us to the end of May. It will then take time to formulate the budget (there is a budget proposal on the table, but presumably a new government will want/need to make – possibly significant - changes to it), which will then need to be approved by the Knesset. All this could take us up to mid-2009.

Is there a problem with this? If the approval of any budget proposal is delayed, the government is allowed to spend each month during the delay period 1/12 of the total budget expenditure of the previous year, so there is a de facto budget. But the new budget is supposed to reflect the government's economic policy for the current year, so a delay in approving the new budget means a delay in implementing necessary economic policy. This creates uncertainty, particularly unwanted when the underlying economic situation is bad and in itself a source of great uncertainty, as it certainly is at present.

This brings us to the declared economic policy of each of the two party leaders vying to head the new government, both recognizing the fact that the Israeli economy is clearly on its way to recession or is already in recession. One major proof of this is a steep decline in tax revenues that began in early 2008 and is forecast to continue in 2009. About one thing there is complete consensus regarding the 2009 budget – the budget deficit is going to be much higher this year, as a direct result of the decline in tax revenues: it was already higher in 2008 (2.1% of GDP) than in 2007, when the budget was balanced.

Back to declared economic policy: in its election campaign, the Likud announced that if it came to power, it intended to reduce tax rates to help the economy exit the recession. This planned policy is strongly opposed by both the Ministry of Finance and the Bank of Israel – if the 2009 budget deficit is already going to be much higher at existing tax rates, they argue, lowering tax rates will only make the deficit situation worse. It is not clear at all how the Kadima party intends to extract the economy from its current plight.

Given the severity of its current economic situation and the deep uncertainty it has created, Israel would have benefited greatly from a clear-cut result in the recent election: this would have enabled a new government to take office quickly and get on with solving current economic problems. The actual election outcome casts significant doubt on the ability of any government to find a suitable solution to the economic malaise. Since the election, politicians from many parties have stated that what is needed is a radical change in the electoral system. But even if this were feasible (there has been talk about this need for a very long time, without any results), the economy cannot afford to wait until the change takes place.