00:00:00
This is Israel, a small Middle Eastern
00:00:02
country on the Mediterranean Sea that is
00:00:04
home to 9.4 million people and a
00:00:07
surprisingly robust economy. We say
00:00:09
surprisingly because the economy of
00:00:11
Israel doesn't have a lot of things
00:00:12
going for it, and it has a lot going
00:00:14
against it. It's impossible to look at
00:00:16
the economy of Israel without
00:00:17
acknowledging the historically hostile
00:00:19
relationship has had with its neighbors.
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And while I'm not nearly knowledgeable
00:00:22
or brave enough to talk about the
00:00:23
geopolitical intricacies of this region,
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economies tend to do a lot better when
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they work well with surrounding
00:00:29
countries, which is an advantage Israel
00:00:31
does not have. Purely through the lens
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of economics, this is a real challenge
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because they don't have direct trading
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partners across their borders. They have
00:00:39
to spend a larger portion of their
00:00:40
national budget on defense and their
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only real access to global trade is over
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the ocean. And although that's typically
00:00:45
the best option anyway, it's nice to
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have alternatives, especially for
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commodities like oil that can be
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transported through
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pipelines. Speaking of which, the
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country also doesn't have much in the
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way of natural resources, arable
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farmland, or a population big enough to
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use for lowcost
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manufacturing. In 2009, Israel was
00:01:03
spending more than 5% of its GDP on
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energy imports, which not only made it
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vulnerable to the countries supplying
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this energy, many of whom really didn't
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like them, but it also meant that
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economic growth and competitive industry
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would be a challenge when so much
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capital was flowing overseas just to
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keep the lights on, literally. Despite
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all of these challenges, though, Israel
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is still one of the wealthiest and most
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advanced economies in the world with
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output figures more than 10 times that
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of their direct neighbors and higher
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even than places like Canada, Germany,
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France, and the UK. What's even more
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impressive is that less than four
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decades ago, Israel's economy was in a
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very similar situation to ones that
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countries like Turkey, Pakistan,
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Lebanon, and Sri Lanka find themselves
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in today. Political unrest, stalling
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economic growth, high inflation, and a
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general lack of confidence in the
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economy makes these problems extremely
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difficult to fix. But Israel did fix
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them. So they are a very useful case
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study for a lot of economists around the
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world today. So how did Israel come back
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from complete economic failure? What is
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leading their economic development to
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make them one of the richest countries
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in the world now? Is it possible to
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replicate the success in other countries
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facing similar challenges today? And
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finally, could this story of economic
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success be starting to come to an end?
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Once we have done all of that, we can
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put Israel on the economics explained
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national leaderboard of Israel as it
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exists today really got started in the
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mid 1980s. During this time, the country
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was struggling with an annual inflation
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rate of over
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350%. Which meant that the Israeli
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shekele was basically useless for
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economic
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applications. Most people in the country
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resorted to using foreign currencies
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like US dollars, which came with its own
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problems. On a macroeconomic level,
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using the currency of a foreign country
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means that the government has less
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control over almost everything. Raising
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taxes in US dollars would have been
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admitting that their own currency was
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worthless. But if they raise taxes in
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shekels, they would have been left with
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something with a quarter of the
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purchasing power that it had a year
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before, and they'd be forced to make up
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the difference with more money creation,
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which would lead to more inflation and
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the need for more money printing.
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Typically, the role of a central bank is
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to stop this feedback loop by
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controlling the money supply and
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increasing interest rates to preserve
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the value of their currency.
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Unfortunately, this only works when a
00:03:16
central bank is allowed to act
00:03:17
independently of the government. In the
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last 2 years, Turkey, formerly Turkey,
00:03:22
has had problems with severe inflation
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well beyond even the elevated level that
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most countries around the world are
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experiencing. The central bank has at
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least tried to slow this down by raising
00:03:31
interest rates, but the Turkish
00:03:33
government has repeatedly forced them to
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lower rates instead with the idea that
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if businesses need to pay less interest
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on their loans, they can grow faster and
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provide more employment, countering the
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problem of
00:03:43
inflation. This theory is not completely
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wrong. If economic output can increase
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faster than the supply of money, then
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there will be more new goods and
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services than dollars or leas or
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shekels. So each unit of currency can
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buy more of these goods and services
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which is deflation. A little bit of
00:03:59
inflation is also a good thing because
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it encourages people to either spend
00:04:02
their money or invest it so it maintains
00:04:04
its value. Unfortunately, what
00:04:07
governments in these situations don't
00:04:08
realize is that high inflation itself
00:04:10
can stifle economic growth because it
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scares off foreign investors and just
00:04:13
makes industry harder. Some business
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contracts are made over many years. And
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when a business wants to hire an
00:04:18
employee, the first thing they'll want
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to know is how much they're going to get
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paid for their work.
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If the value of a currency is falling so
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rapidly and unpredictably, it makes
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formal long-term arrangements like this
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impossible because a great deal now
00:04:31
might be a terrible deal in the future
00:04:32
if the country's currency is only buying
00:04:34
a fifth of what it was when the deal was
00:04:36
made. Realistically, inflation beyond
00:04:38
about 5% does more harm than good. So,
00:04:41
Israel's 370% rate of inflation in 1984
00:04:45
was a real problem that most of its
00:04:47
citizens avoided by just not using their
00:04:49
own currency.
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Stability and confidence is one of the
00:04:52
most important things in economics and
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nobody within or outside of Israel had
00:04:56
any confidence in the currency's
00:04:58
stability and by extension the economy
00:05:00
as a whole. Changing this was the first
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and most difficult step the government
00:05:04
had to take to start turning the country
00:05:06
around. In 1985, Israel introduced a new
00:05:09
currency to replace the shekele that had
00:05:11
effectively become worthless with the
00:05:13
unimaginatively named new Israeli
00:05:15
shekele. Just introducing a new currency
00:05:18
doesn't fix the problem of sustained
00:05:20
inflation by itself. The government had
00:05:22
to get people to actually use it instead
00:05:24
of doing business in the much more
00:05:25
widely recognized and stable US dollar.
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To get people to use their new currency,
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they had to give them confidence that it
00:05:31
wouldn't have the same problems as the
00:05:32
old currency. It's worth noting that the
00:05:35
old shekele was only technically around
00:05:37
for 5 years between 1980 and 1985 after
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it replaced new Israeli shekele.
00:05:44
Although that replacement was done at a
00:05:45
rate of 1 one, it wasn't so much a new
00:05:47
currency as it was a rebranding to a
00:05:50
Hebrew name. Either way, the new shekele
00:05:52
was supposed to be a new start, and it
00:05:54
was rolled out in parallel with the
00:05:56
Israeli government's economic
00:05:57
stabilization plan. To turn its economy
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around, Israel rolled out a five-point
00:06:01
plan that was simple in theory. The
00:06:04
government first cut its excessive
00:06:06
expenditure. Government spending is a
00:06:08
major inflationary pressure. If the
00:06:10
government is putting money into the
00:06:11
economy through welfare payments,
00:06:12
government jobs or big infrastructure
00:06:14
projects, that is going to increase
00:06:16
consumer demand because more people will
00:06:18
have more money. By cutting the
00:06:20
spending, people that used to receive
00:06:21
income from these sources won't anymore.
00:06:23
And the businesses that used to receive
00:06:25
income from them will also find it
00:06:26
harder to make money. If a currency
00:06:29
becomes a scarcer resource, it will, all
00:06:31
other things be equal, also become more
00:06:33
valuable. As countries around the world
00:06:36
today struggle with their own inflation
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problems, a lot of attention has been
00:06:39
paid to monetary policy from central
00:06:40
banks. And many people don't realize
00:06:42
that government spending and taxation is
00:06:44
just as important because it adds and
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subtracts from the money supply, which
00:06:47
is a major component of
00:06:50
inflation. They also made the Bank of
00:06:52
Israel, the central bank in the country,
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completely independent of the
00:06:55
government, like it is in most advanced
00:06:57
economies around the world. Central
00:06:59
banks and governments normally have
00:07:00
aligned roles of general economic
00:07:02
prosperity. But letting the banks act
00:07:04
independently means that they can step
00:07:06
in and raise interest rates and stop
00:07:07
money creation even if the country's
00:07:09
leader is trying to get them to do the
00:07:11
opposite. Like the example from Turkey
00:07:12
we explored earlier. After cutting
00:07:15
expenses and giving independence to the
00:07:17
central bank, Israel's government also
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let the shekele fall in value in
00:07:20
international exchange markets and then
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temporarily fix the rate at the new low
00:07:24
price. A devaluation in domestic
00:07:26
currency was an interesting move because
00:07:28
it actually heightens inflation. If a
00:07:31
country is dependent on imports, which
00:07:33
Israel definitely is, having to spend
00:07:35
more local currency for the same amount
00:07:36
of stuff is the definition of inflation.
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But the government's first challenge at
00:07:40
this time was not to control inflation.
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It was to get people to use their
00:07:44
currency. If people could trade in the
00:07:47
US dollars they were using for a
00:07:48
reasonable amount of new currency, they
00:07:50
would be more likely to adopt it, which
00:07:52
was a worthwhile trade-off, even if it
00:07:53
did come at the expense of heightened
00:07:55
inflation for the first 5 years. By the
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end of the 1980s, inflation had returned
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to a reasonable level, and most of the
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trade within the country was once again
00:08:03
been done in their own currency. The
00:08:06
stabilization plan had worked, and even
00:08:08
today, a lot of countries could take the
00:08:09
same steps to pull their way out of
00:08:11
similar problems. But for Israel, this
00:08:13
now meant that it could fully realize
00:08:15
its potential. In 1987, after inflation
00:08:18
had stabilized, Israel had a GDP per
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capita of
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$9,000, which was just less than half of
00:08:23
the USA at the same time. This wasn't
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bad by any means, but in the following 3
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and 1/2 decades, the country would close
00:08:30
the gap
00:08:31
significantly. Their first breakthrough
00:08:33
was the discovery of offshore natural
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gas. Up until that point, the country
00:08:37
had been very dependent on energy
00:08:39
imports, and this made them
00:08:40
self-sufficient. But it wasn't enough
00:08:42
for them to become a fossil fuel state
00:08:44
that just becomes economically dependent
00:08:46
on exporting its natural resources.
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Israel also benefits from tourism. The
00:08:51
country is home to a lot of religiously
00:08:52
significant destinations for a lot of
00:08:54
different faiths. The country normally
00:08:55
welcomes over 4 million tourists each
00:08:57
year with the exception of recent years
00:08:59
due to co. That's almost one tourist
00:09:02
arriving for every two residents which
00:09:03
introduces a lot of foreign income into
00:09:05
the country and creates a lot of jobs.
00:09:07
For a country with less than 10 million
00:09:09
inhabitants, that tourism industry alone
00:09:11
would normally be a significant portion
00:09:12
of total economic output. But in Israel,
00:09:15
it only amounts to 2% of their total
00:09:17
GDP. Israel's real resource is its very
00:09:20
clever population. Today, Israel spends
00:09:23
twice as much on research and
00:09:24
development than even very technical
00:09:26
nations like the United States. This has
00:09:28
allowed the country to build out
00:09:29
worldleading industries that add a lot
00:09:31
of economic value within its borders.
00:09:34
Israel is one of the world's largest
00:09:35
producers of advanced semiconductors.
00:09:37
Its need for a strong military has also
00:09:38
made it a worldleading weapon system
00:09:40
manufacturer. And one of its biggest
00:09:42
imports is uncut diamonds that it then
00:09:44
shapes into jewelry that is sold at a
00:09:45
significant markup. Last week, we looked
00:09:48
at the economy of South Korea and found
00:09:49
that their global companies were the
00:09:51
driving force of their success and they
00:09:52
added value to the economy even beyond
00:09:54
the nation's borders. The story is very
00:09:57
similar in Israel. It's just that their
00:09:59
companies are less household names
00:10:00
because they operate in less
00:10:01
consumerfocused industries. Not too many
00:10:04
people are buying missile defense
00:10:06
systems. The companies are also smaller
00:10:08
but more plentiful which is actually a
00:10:10
good thing. Just Samsung's revenue
00:10:13
accounted for 20% of South Korea's GDP
00:10:16
which does lead to some economic
00:10:17
instabilities when so much of an economy
00:10:19
is dependent on the performance of one
00:10:21
company. Israel also attracts a lot of
00:10:24
international companies from Europe and
00:10:25
North America that have set up high-tech
00:10:27
manufacturing facilities and research
00:10:29
centers in the country to gain access to
00:10:31
its small but very well educated
00:10:33
workforce. The amount of innovation that
00:10:35
takes place in Israel has earned the
00:10:37
region around Tel Aviv the nickname
00:10:38
Silicon Wii which is the Arabic term for
00:10:41
valley and a reference to its innovation
00:10:43
which is on par with Silicon Valley the
00:10:45
tech innovation capital of the world.
00:10:47
Unfortunately, for other countries
00:10:48
looking to replicate Israel's success,
00:10:50
it's not as easy as just becoming a
00:10:52
global center for innovation and
00:10:53
technology. Israel was only able to grow
00:10:56
these industries through a program that
00:10:58
it rolled out once its economy was back
00:10:59
on track that encouraged innovation by
00:11:01
having the government directly invest in
00:11:03
promising industries. This was not a new
00:11:06
idea by itself. The reason Taiwan is the
00:11:08
global center of chip manufacturing is
00:11:10
because their government directly
00:11:11
invested and supported companies like
00:11:13
TSMC. But Israel arguably did the same
00:11:16
thing better. Government investment into
00:11:19
for-profit institutions is always
00:11:20
difficult because there is so much room
00:11:22
for corruption to just end up with
00:11:23
government funds being given to people
00:11:25
that pay the right bribes. Israel is not
00:11:28
immune from corruption. And during the
00:11:30
period of economic recovery, the
00:11:31
government was trying to get the people
00:11:32
to just trust their own currency. So
00:11:34
trusting them to responsibly invest in
00:11:36
private industry was a bit of a stretch.
00:11:39
The solution they ended up with was a
00:11:40
hybrid approach where private investors
00:11:42
were encouraged to fund businesses in
00:11:44
Israel with their own money and in
00:11:45
return they would get generous tax
00:11:47
concessions and zero interest rate loans
00:11:49
from the government to make their money
00:11:50
go further. This meant that investors
00:11:53
were still risking their own money so
00:11:54
they wouldn't use it irresponsibly. But
00:11:56
it also made Israel a very attractive
00:11:58
place to invest and start a business.
00:12:00
The best part was that since these loans
00:12:02
got paid back, the Israeli government
00:12:04
effectively built out its advanced
00:12:05
industries for no cost to them
00:12:07
whatsoever. In the 1990s, the government
00:12:10
expanded this strategy to leverage the
00:12:12
technical expertise they got from almost
00:12:14
a million former Soviet scientists,
00:12:15
engineers, and doctors who moved to
00:12:17
Israel after the collapse of the Union.
00:12:19
We have already spoken about the
00:12:21
benefits of skilled migration just last
00:12:22
month. So I don't want to repeat too
00:12:24
much here, but just looking at the
00:12:26
population charts of Israel, you can
00:12:27
actually see this inflow of some of the
00:12:29
most skilled workers in the world. The
00:12:31
state of Israel did not have a lot of
00:12:33
advantages, and it has overcome a lot of
00:12:35
challenges in its short 75 year history
00:12:37
as a country. And again, this is
00:12:39
ignoring all of the geopolitical issues
00:12:41
that I couldn't even hope to scratch the
00:12:43
surface of in a single video. The fact
00:12:45
that despite these challenges, it has
00:12:47
been able to become one of the most
00:12:48
prosperous economies in the world is a
00:12:50
fantastic sign that even countries
00:12:52
facing severe challenges today have a
00:12:54
hope of making a better future for their
00:12:55
people with some good economic
00:12:58
management. Okay, now it's time to put
00:13:00
Israel on the economics explained
00:13:02
national leaderboard. Starting with
00:13:04
size, Israel has a GDP of $488 billion,
00:13:07
which makes it the 29th largest economy
00:13:09
in the world, falling just behind
00:13:10
Ireland and Norway. It gets a 7 out of
00:13:13
10. While being far from a trillion
00:13:15
dollar economy, its output is only
00:13:17
spread out over $9.5 million people. So
00:13:19
GDP per capita is an impressive $52,000,
00:13:22
which puts it ahead of countries like
00:13:24
Canada, Germany, Japan, and even Hong
00:13:26
Kong. It is the 15th most productive
00:13:28
country in the world, but it's still a
00:13:30
fair way behind countries like the USA,
00:13:32
and extreme outliers like Luxembourg. So
00:13:35
it gets an 8 out of 10. Stability and
00:13:37
confidence is a difficult one to place
00:13:39
because of the affforementioned
00:13:40
geopolitical issues that will inevitably
00:13:42
be on anybody's minds when they are
00:13:44
doing business with Israel. In the past
00:13:46
three decades especially, the country
00:13:48
has been able to reshape that image and
00:13:50
people have a lot more confidence
00:13:51
investing into it. But for now, it gets
00:13:53
a 6 out of 10, which to be clear is not
00:13:55
bad at all. Growth has been very strong
00:13:58
thanks to everything we've explored in
00:14:00
this video. It has an average annualized
00:14:02
growth rate of just under 7% which is in
00:14:04
line with some of the fastest growing
00:14:05
economies in the world. In just the past
00:14:08
decade, the country has almost doubled
00:14:10
its output, giving it a score of 9 out
00:14:12
of 10. Finally, industry. This is where
00:14:15
Israel really shines. It has fully
00:14:18
leveraged its population to create a
00:14:19
diverse selection of highly value
00:14:21
adding, worldleading, and globally
00:14:23
important industries, doing everything
00:14:24
from cutting and trading diamonds to
00:14:26
producing state-of-the-art computer
00:14:27
chips. Its economy is however still
00:14:30
relatively small compared to the true
00:14:31
industrial superpowers. So it gets an 8
00:14:34
out of 10. Altogether that gives Israel
00:14:37
a very respectable average score of 7.6
00:14:39
out of 10, putting it up here on the
00:14:41
leaderboard. Check out the video linked
00:14:43
on screen next or if you'd prefer to
00:14:45
listen to these videos. We make all of
00:14:46
them available as well as full
00:14:48
interviews with worldclass economists up
00:14:49
on our Spotify page. Thanks for
00:14:51
watching, mate. Bye.
