The Crony System That Makes Israelis Poorer

Last summer’s peaceful mass demonstrations in Israel protested economic hardships resulting from excessive government interference in the economy.

The protests were ignited by Izhak Elrov, a young religious father who started a Facebook page calling for the boycott of one consumer item, cottage cheese, which was selling in Israel for double what it cost abroad. Mr. Elrov protested that price-gouging by Israeli monopolies had inflated the price of most consumer goods and services by 100% to 300% over average European and American prices. One hundred thousand Israelis “liked” his page. Hundreds picketed supermarkets.

Mr. Elrov’s one-issue boycott eventually was taken over by populist groups demanding cheap housing and free preschool education, then it was seized upon by well-funded leftist political groups pushing an “Occupy Wall Street” anticapitalist agenda and trying to unseat Benjamin Netanyahu’s pro-market government. By summer’s end, the protests had fizzled, with many Israelis disenchanted by these hidden agendas.

But the core truth of Mr. Elrov’s lament remained. Even before the cottage-cheese boycott, the prime minister had appointed a commission to deal with Israel’s extraordinary concentration of political and economic power. The latter had become the center of public furor after an April 2010 Bank of Israel report affirmed that “some 20 family business groups, structured as pyramids, control some 25% of firms listed for trading, about half of the market share.” The report also noted that a mere handful of business groups received over 60% of Israel’s available credit, which they invested in highly leveraged and speculative real-estate ventures.

Clearly, such concentration creates great risk for Israeli financial markets. It also denies small and medium-size businesses access to credit, blocking Israel’s engines of growth. Two major regions, the southern Negev and the northern Galilee, with mostly small businesses, have suffered a permanent credit crunch. Living on average monthly salaries of $2,400, according to official figures, and having to pay for most consumer goods and services at prices similar to those in New York City, most Israeli families have difficulty making ends meet.

Unfortunately, political necessity dictated that the commission Mr. Netanyahu charged to investigate these problems was composed partly of regulators who had failed in the past to tackle excessive concentration. One result is that its final recommendations, released last month, did not call for banning all pyramid-structured holding companies. The commission called for a separation of ownership between financial and nonfinancial firms. But it fixed too high a threshold—an annual turnover of $1.6 billion dollars—for the separation. Still, even these limited recommendations could improve Israeli credit allocation and competitiveness.

Following last summer’s protests, Mr. Netanyahu appointed another commission, this one to deal with issues of preschool education, cheaper housing and lower consumer prices. As a result, “free” elementary school education was extended to children ages 3 to 6.

Mr. Netanyahu’s government recently appointed a legal group to draft legislation based on the recommendations of “the anti-concentration” commission. But that group is composed mostly of the same regulators who are halfhearted about reform. And if the recommendations get to legislators, they will face a tough battle in the parliament, where the tycoons and their powerful lobbyists will fight them.

Strong vested interests blocking progress are not unique to Israel. Everywhere, powerful elites manage to erect entry barriers that cut competition, reduce efficiency and lower productivity. Generally impoverished Islamic countries are extreme examples of the ravages caused by such entrenched elites.

Mr. Netanyahu, Israel’s first prime minister to understand economics, realized that economic viability is essential to Israel’s survival and initiated bold reforms. He faces resistance from his bureaucracy and some coalition partners serving the tycoons and their lobbyists. Despite this and great challenges such as Iran and the prospect of new elections, Mr. Netanyahu could still convene a special session of parliament before the fall elections and pass the reforms he deems essential.