Nouriel Roubini’s warning to Israel: ‘You’re playing with fire doing things this radical’

The Israeli shekel, stock shares, and bonds will be hit hard if the judicial overhaul that the Knesset has begun to legislate is completed, according to Prof. Nouriel Roubini – preventing the economy from achieving its potential rate of growth and eventually to an outright recession as foreign investment plummets and high-tech companies move abroad.

Roubini is an American Jewish economist who is a professor emeritus at New York University and achieved lasting fame for predicting the financial crisis of 2008 four years earlier. He is intimately familiar with the situation in Israel, and has family in the country – some of whom have traditionally voted for Likud.

‘If these changes continue, you cannot rule out an outright recession in Israel at this point.’

He says it’s important for him to make clear to Likud voters that the judicial legislation that Prime Minister Benjamin Netanyahu is advancing will come at a cost to the economic welfare of 80 percent of all Israelis – not to mention the cost to democracy.

Moreover, it will undermine Israel’s ability to cope with the Iranian nuclear threat, which is far more important than any overhaul of the justice system, he says.

Markets don’t wait

Last week, the international credit rating agency Fitch published a report that neither lowered Israel’s credit rating nor downgraded its outlook to negative. The report noted the political risks, but did not adjust Israel’s sovereign rating or its outlook in response. How do you explain that? The shekel has fallen 5-7 percent, which isn’t as steep a drop as your scenario suggests.

“It’s not a lot. But you know, there’s a famous saying about people who are in too much debt and say everything is fine, until they suddenly go bankrupt. So there are nonlinearities in the behavior.

“Traditionally, rating agencies lag behind the markets into changing the ratings of a country when there is a deterioration of economic and macro fundamentals. And for now, those economic and macro fundamentals have not yet deteriorated as much and the economy is doing fine, there is still macroeconomic stability, there is still the independence of a central bank, fiscal policy has not yet become loose.

“The impact of those changes, then, on potential growth and impact on capital flight, either by domestic firms abroad, or foreign investment to Israel, is still [just] potential.

‘My fear is that this particular coalition in Israel doesn’t care as much about economic growth. Some of them might even think, ‘Who cares if these liberal, secular tech leaders go abroad?’’

“But one thing that you have to be aware of is that before any rating agencies take action, the market can move very, very fast. The markets price out the credit risk of a country every day. They’re not waiting for rating agencies to make a decision that often occurs after the markets react. You’re playing with fire when you’re doing things that are this radical, and the markets will punish you well before rating agencies are going to take any action.

“If these types of judicial changes are enacted, it will lead to capital flight, then you have downward pressure on the currency, rising inflation, and you have a rising increase of the country’s sovereign debt. And the only way to deal with it is increasing interest rates.

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“You’re going to have not only a slowdown abroad – because there’s already a slowdown of growth, as the Bank of Israel was tightening monetary policy – but you could actually have an outright economic contraction. … This is something that if these changes continue, you cannot rule out an outright recession in Israel at this point.”

Based on the experiences of other countries that have undertaken similar changes and knowing the situation in Israel, do you see the reaction of the markets, the protests and international pressure stopping the changes from being legislated?

‘In situations where the rule of law is compromised, wherever the authoritarian leader of the country is entrenched in power, like in Turkey, the economy was hurt, and the policy wasn’t changed.’

“It depends, you know. In traditional democracies, market discipline works. So in the United Kingdom, when the market discipline became severe, the prime minister resigned in a matter of literally weeks, and that market discipline put the right price around doing economic and political changes.

“But in situations where the rule of law is compromised, wherever the authoritarian leader of the country is entrenched in power, like in Turkey, the economy was hurt, and the policy wasn’t changed.

“My fear is that this particular coalition in Israel doesn’t care as much about economic growth. Some of them might even think, ‘Who cares if these liberal, secular tech leaders go abroad?’ They want to protect their own political and religious base.

“The problem is, in Israel, the revenue, and the economic growth that comes from the tech sector, from the dynamic parts of the economy, is the engine of the fiscal resources that are then transferred to those who are left behind. … Then you don’t have the fiscal resources, even for making those kinds of budget payments.

‘When the pressures on the currency become excessive, it’s typical for countries to impose capital controls. But those capital controls actually make things worse.’

“They don’t seem to care about the fact that even from a security point of view, there has been turmoil … As you know, the Israeli economy has been resilient … and therefore Israel has done well, even when the neighborhood became more dangerous, more violent.

“But the core of it is having a strong part of the economy that is resilient, that also supports the financing of transfer payments, the financing of budget spending, of the security spending, and so on.

“And by the way, a lot of the tech sector creates apps that are beneficial not only for civilian purposes, but also for security purposes. So you know, you’re undermining indirectly, even the security of the country … So it’s a sector of the economy that is core to the success and the security of Israel.”

Do you see a scenario in which restrictions are placed on capital movements and moving money abroad? Should an Israeli be concerned about this possibility and perhaps want to take money out of the country now?

“Eventually, when the pressures on the currency become excessive, it’s typical for countries to impose capital controls. But those capital controls actually make things worse, because, first of all, Israel requires inflows of capital, especially foreign direct investment and portfolio investment in the economy.

“You can restrict outflows, but you cannot force people to put the money in. And once you impose those capital controls, when there is this policy uncertainty, the foreign money stops. You cannot prevent that.

‘I don’t know if Jews should go and lobby the White House. I’m sure that there is dialogue occurring between Israel and the United States.’

“Second, I don’t think you can prevent Israeli firms from setting up operations somewhere else, if they decide to do so. Those are types of restrictions, thought that most countries would not impose under any circumstance, unless they become really desperate.

“And if you impose those restrictions, some of these firms are going to either shut down, or they’re going to reduce the amount of investment they do in the country.

“You cannot prevent people from moving out of your country. … And you can accelerate a brain drain that will be very dangerous for the country, even with capital controls.”

Undermining what defines democracy

You keep up to date with what is happening in Israel. As a Jew who lived in the United States – with family in Israel and a deep knowledge of Turkey and Iran – what are your feelings about the judicial legislation?

“Well, you know, I’m Jewish, I’m a great friend of Israel, my parents are retired, my sister lives there. Thirty-one cousins, and probably more than 20 of them live in Israel. You know, actually, when I was three years old, I was in Israel for a year and a half.

“After high school, I spent a year in a mechina program at Hebrew University in 1976-77. … I go there at least four or five times a year, I have many friends and many colleagues there. … In Israel, there are different political views, and it’s a democracy.

“But there are certain things that really threaten the future of a democratic Israel and will have severe economic consequences. We’re already seeing a weakening of the value of the shekel , the beginning of capital flight.

“When I was last there in January, I spoke with a number of tech CEOs. And they told me, ‘if things really get bad, it doesn’t take very much for us to just shut down and leave.’

“There’s not much physical capital, it’s all human capital. You can shut the operation tomorrow, move to Cyprus or anywhere else in the world. Many of them, like programmers, already work all over the world. So these things become economically and socially, politically, dangerous.

“I think one of the strengths, of course, of Israel is being ‘the startup nation.’ The share of employment in the tech sector is relatively small, but it accounts for at least around a half of exports, and is one of the foundations of the service industry and the rest of the economy. And unfortunately, all this great success is under threat right now.

“And it’s not just the judicial changes, as you will know better than I do. They want to interfere with academia, with the media, with broadcasting, with the statistics bureau.

“It’s what happens when you have a regime that slowly controls the executive branch, then the legislative, then the judiciary, then tries to control the media, and other institutions that define democracy.

“In Israel, there is no constitution, and so the Supreme Court serves as an alternative to a constitution. There are always different political positions, but this coalition is undercutting everything that defines the meaning of democracy – and not just on the judicial level.”

A very dangerous game

Do you think it is still possible to stop the changes, like if Jews in the U.S. lobby President Joe Biden to pressure Netanyahu into abandoning at least part of the legislation?

“I don’t know if Jews should go and lobby the White House. I’m sure that there is dialogue occurring between Israel and the United States.

“If Iran becomes a nuclear state, that’s a threat and existential threat to Israel that goes well beyond everything else. And you know, Iran has enriched uranium to 84%, it might be even closer to 90. And once you’re at 90, it is only a matter of time before you can build a few bombs.

“And once you build three bombs, then regime change becomes impossible. See what happened with Pakistan. See what happens with North Korea. And we’re maybe only a few months away from that.

“Israel needs to think about the real threat that it has to face. I don’t think Israel can handle them on its own. Again, everyone news friends, and I don’t think the Israeli government understands how much the issue of the judicial overhaul could harm efforts to deal with the real dangers. This is a very dangerous game.”