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December 8, 2013 4:20 pm

Analysis: Israel’s Economic Dominance of the Middle East; Foreign Currency Reserves Dwarf Neighbors

avatar by Joshua Levitt

Bank of Israel, Jerusalem. Photo: Ester Inbar.

The Bank of Israel said on Friday that foreign currency reserves hit a record $80.59 billion at end-November, after breaking the $80 billion threshold, for the first time, in October. In 2004, Israel held only $25 billion.

As Israel’s dollars-in-the-bank have grown to dwarf the reserves held by many of its neighbors, economists said the windfall from its natural gas deposits will help Israel fight above its weight-class, and compete directly against the oil-rich nations of the Middle East in the coming years.

“Israel’s ability to put spare cash in the bank for emergencies very much signifies that the Israeli economy is growing, especially compared to its Arab neighbors,” said Professor Joseph Pelzman, the Institute for International Economic Policy the Elliott School, George Washington University Professor of Economics, International Affairs and Law, in Washington, D.C., and a permanent visiting professor at Ben Gurion University of the Negev, in Be’er-Sheva.

“What I found fascinating is that the world hasn’t really understood how marvelous the Israeli economy has become and, obviously will expand much faster, as its natural gas makes Israel a participant in the global energy business — and this because of the anti-Israel sentiments on many international levels that have worked to preclude Israel from being recognized,” Professor Pelzman said.

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Professor Pelzman’s latest book, Economics of the Middle East and North Africa, was published in September, 2012. “What was so remarkable,” he said, “is that my book is the very first economic study to compare Israel with its actual Arab neighbors in the Middle East, and the Jewish state really shines. Until now, in every single study by economists at the university, institutes, and especially at global institutions, including the United Nations or the World Bank, Israel is usually put up against European countries, even though it would be one of the smallest states, but, more importantly isn’t even in that region — Israel is in the Middle East.”

Israel’s $80.6 billion in the vault was particularly favorable compared to its more populous neighbors.

In Cairo, the Bank of Egypt said the country’s foreign currency reserves stood at $18.6 billion at the end of October. The figure does not include any of the recent pledges from Saudi Arabia, the United Arab Emirates and Kuwait of $12 billion dollars in aid following the July 3 military coup that ousted Egypt’s Islamist President Mohammed Morsi.

Meanwhile, in Damascus, before the start of its civil war three years ago, the International Monetary Fund estimated Syria’s reserves  — a state secret — at about $18 billion. But by April, 2013, Reuters reported that those reserves had dipped below $4 billion. At the time, Syrian central bank governor Adeeb Mayaleh told Reuters that Iran had already granted a $1 billion credit line to Syria, and that Damascus was close to an agreement with Russia and Iran to obtain fresh funds before it completely ran out of money, financing the civil war against the Free Syrian Army.

Israel’s neighbors to the North and East, Lebanon and Jordan, have $51 billion and $12 billion of foreign reserves in the bank, respectively.

But, as has been the case since the first American and British firms began exporting oil from the Middle East before World War II, energy exporters Saudi Arabia, with $700 billion, Libya, with $130 billion (same as net energy-importer Turkey), and Algeria, with $121 billion have the most foreign currency reserves in the region.

Meanwhile, Iraq’s foreign currency accounts, with $80 billion, now stand at the same level as Israel, boosted by Iraqi oil pumping.

In Tehran, the Central Bank of Iran has an estimated $69 billion, despite a decade of  global economic sanctions against the Ayatollah’s regime. With last month’s U.S.-brokered agreement in Geneva, the Iranians are expected to add $7 billion to that total, all money held in frozen international bank accounts. If the Islamic Republic sticks with the international community, and follows through with its new commitments, Iran could be able to return openly to the energy markets, where oil-starved countries, including India, which was once one of Iran’s major buyers, with $5 billion worth of crude per year, could help make the country very wealthy, again.

Israel’s growth, until now, has largely been due to very high investment in research in development.

In order to sustain its competitive high-tech edge, Israel dedicates 4.5% of its GDP to research and development, the highest proportion in the world, ahead of the Organization for Economic Co-operation and Development (OECD) (2.3%), Sweden (3.8%), Finland (3.5%), South Korea (3.4%), Japan (3.3%), the U.S. (2.8%), Germany (2.7%) and Canada (1.7%), noted former Israeli Ambassador Yoram Ettinger, in a recent Op-Ed published by The Algemeiner.

But with the discovery of vast fields of underwater natural gas reserves, economists hope to see the prudent policies of the past continued, allowing Israel to avoid a terrible outcome of its natural resources windfall, called “Dutch disease,” a term coined in 1977 by The Economist magazine to describe the decline of the manufacturing sector in the Netherlands after the discovery of a large natural gas field in 1959.

Off the coast of Haifa, the Tamar field, Israel’s first major hydrocarbon discovery, is believed to hold over 10 trillion cubic feet of natural gas. On the international market, at $5 per thousand cubic feet, Tamar’s gas would be worth $50 billion.

In 2010, U.S. developer Noble Energy signed an agreement with Israel’s Delek group to develop the field. Meanwhile, other major fields, including Leviathan, an even larger natural gas reserve, is expected to begin supplying energy after 2016.

Israeli Energy Minister Silvan Shalom said that by not importing from the open market, Israeli natural gas is already saving the country’s economy $300 million a month, a figure that could reach as high as $1 billion as more electricity generation switches to gas fuel and the economy grows.

“It means it will bring a huge improvement to the Israeli economy because the gas will be much cheaper. We will cut the tariff for electricity. We will cut the tariff for water that is produced by electricity, and all the products that are produced in Israel will be much cheaper,” Shalom told Bloomberg in November.

In 2018, Israel will transfer the government’s share of the resource profits into the Israeli Sovereign Wealth Fund. Economists hope that Israel maintains is prudent economic policies, using the cash for growth, rather than wasteful spending.

“The danger of ‘Dutch disease’ comes if all this resource money is spent in non-productive ways — importing luxury goods from abroad or ‘white elephant’ public projects that don’t increase productivity,” said Professor Pelzman.

He said the Bank of Israel, under Professor Stanley Fischer, the prior central bank chairman, who was followed in the role this year by Dr. Karnit Flug, who had been Acting Governor of the Bank of Israel since Fischer stepped down at end-June, was very successful.

“Under Fischer, Israel had the best macro policy, a lot of advantages, with no recession or  price reductions, with a monetary policy that didn’t rely on quantitative easing [lowering interest rates] as the Americans did. As a result, Israel didn’t have the hollowing out problem, like in Japan or the U.S., with the outsourcing of both low-labor skill manufacturing jobs and hi-tech jobs overseas. Because of Fischer’s policies, Israel continued to invest in high technology and added-value jobs, which is how Israel competes at the highest levels, with or without these added natural resources.”

“Obviously, Israel could get inflation if all this new money suddenly entered the economy or was put into unnecessary construction projects or unneeded infrastructure, but as long as the path is followed to focus on hi-tech exports, education, science and applying all those lessons to the tough spots in the economy, Israel will emerge much stronger,” he said.

“Beyond all the numerical comparisons, what Economics of the Middle East and North Africa showed was the impact of policy choices in how the world compares Israel to its regional rivals. What the Israeli miracle shows is how a state can maintain its identity – in this case, Jewish – while embracing the best of what is available from around the modern world,” Professor Pelzman said.

“In the case of the Arab countries, the question is, how did the inventors of ‘algebra’ totally lose their relevance in the global market of ideas, and thus their position among the world economies?  And the answer is that in their zeal for self-preservation from any Christian influences, Muslim countries totally closed themselves off to the world’s ideas, and never thought about the consequences,” he said. “What we’ve done in this comparative study is try to understand their policy choices, as it relates to economic strength, and by comparing that point-by-point to Israel, yes, the Arab countries certainly do not come off well.”

In January, Professor Pelzman’s graduate-level economics class, with the same title as his new book, will begin at George Washington University’s Elliot School of International Affairs, and is expected to attract many Arab students from GW’s Institute of Middle East Studies (IMUS). What he’s waiting for is the response from the Kuwaiti government, major financial backers of IMUS, which haven’t caught wind of the new course, or any of its controversial conclusions, including all the ways Israel’s economy is superior to its Arab neighbors.

“This is going to really tick them off,” Professor Pelzman said.

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