BusinessWeek: January 24, 2000

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 International -- European Business: Israel

A Fiscal Reformer's Last Hurrah (int'l edition)
Bank czar Frenkel quits, but his policies will live on

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A Fiscal Reformer's Last Hurrah (int'l edition)

CHART: Frenkel's Good Fight

Jacob A. Frenkel: The Man Who Opened Israel's Economy (int'l edition)


For Jacob A. Frenkel, it was a high-profile departure. Just before Frenkel stepped down as governor of the Bank of Israel on Jan. 9, Israeli Prime Minister Ehud Barak ducked out of his talks with Syria to nominate a successor. Then Frenkel made news of his own. Three days after he left the central bank, the 56-year-old economist joined Merrill Lynch & Co. in New York, where he will help Chairman and CEO David H. Komansky plot global strategy.

As central bank governor since 1991, Frenkel was a key force in opening--and disciplining--an economy that for decades had suffered from chronic inflation, a bloated state sector, and a dearth of competitive industries. Now, for the first time in years, Israel is showing signs of life--and with no inflationary pressures. Moreover, Barak's choice for Frenkel's successor demonstrates a strong commitment to his free-market policies: Barak has proposed David Klein, Frenkel's tough-minded adviser on monetary policy. "This is a fundamental strategic choice about economic stability," Frenkel says of Barak's decision.

Klein's appointment--which is likely to win Cabinet approval on Jan. 16--will mark a hard-won victory for Frenkel. Through much of the late-1990s, he was widely blamed for exacerbating Israel's slowdown. Yet with inflation as his target, he kept interest rates high and the shekel richly valued. He also proved a consummate political operator. Working under five prime ministers and seven finance ministers, he pushed for deregulation and privatization.

As he arrives at Merrill, where he will develop business in Europe and Latin America, Frenkel admits Israel has more reforms in front of it. Its pension funds, for example, are still not free to invest substantially in local capital markets--an issue on which Klein is expected to move forcefully. And while the economy may now be back on track, Israel still needs roughly $3 billion in U.S. aid a year--a sum likely to rise after any peace deal with Syria.

BUSINESS GRIPES. While Frenkel won major battles during his tenure as governor, he wasn't universally popular in the business community. Industries such as food and textiles were hit by steep rates and market opening. "Frenkel's policies of the last three years have cost Israel at least $10 billion," complains Dan Propper, a top exec and former head of the Israel Manufacturers Assn.

But the discipline Frenkel introduced may now be paying off. Inflation is below 2% and steady. The recovery in Europe and Asia, the peace talks, high-tech exports, and rising consumption could double growth this year, to 4%. And the long-term picture looks a lot brighter, too. Ptahyiya Bar-Shavit, an economist at Bank Hapoalim, says the nation "now has the potential to grow at a rate of 6% on a sustained basis."

Apart from the numbers, the Israeli economy is starting to assume a new look. The state sector, which formerly accounted for a third of gross domestic product, now speaks for less than half that. State banks such as Hapoalim and Bank Leumi are being sold off, and financial markets have been thrown open to foreign competition. By May, 1998, Frenkel was able to remove all but the vestiges of exchange controls.

While tight money has hurt old-line industries, it has had little impact on software companies, chipmakers, and other high-tech operations, which are dollar-based and tend to borrow little. In effect, Frenkel has helped push the economy more toward U.S.-style, technology-driven growth. Foreign direct and portfolio investment--once a mere trickle--hit a record $5 billion last year. Some $1 billion of that was from venture-capital funds--a 65% rise from 1998.

Global powerhouses such as Intel, Cisco Systems, and Computer Associates International are also paying hefty prices for Israeli high-tech companies. In November, Intel snapped up DSP Communications Inc., an Israeli chipmaker, for a cool $1.5 billion. Far from resisting foreign takeovers of star companies, Israelis welcome them. "Enormous global distribution channels are suddenly being opened up for our local products," notes Eran Goren, CEO of Nessuah Zannex Ltd., a prominent investment bank.

STRONG HAND. This is not the Israel Frenkel saw when he took command of monetary policy. Then-Prime Minister Yitzhak Shamir--facing pressure to cut a deal with Arab neighbors as the Persian Gulf War ended--needed a strong hand on economic policy. On top of raging inflation, public spending was rising as the country absorbed waves of immigrants from the collapsed Soviet Union. Frenkel launched an innovative plan that initially devalued the shekel to ward off speculative attacks. In 1992, inflation went into single digits for the first time in three decades.

Shamir chose wisely when he recruited Frenkel, a free-marketer committed to bringing Israel into the global economy. After earning a doctorate at the University of Chicago under monetarist luminaries Milton Friedman and Harry G. Johnson, Frenkel rose to the post of research director at the International Monetary Fund. Then he astonished colleagues by answering Shamir's call and returning to his native Israel. And it wasn't for the money: "My first paycheck as governor was a small fraction of my last IMF paycheck," Frenkel recalls. Indeed, as he left the central bank, Frenkel was taking home $3,250 a month--a fraction of what he'll make at Merrill Lynch.

Frenkel will be a tough act for Klein to follow. He is probably the most influential central banker in Israeli history. And he may just have taught the nation's politicians the fundamentals of free-market economics. "I accomplished what I set out to do," says Frenkel. And he did it his way, too.

By John Rossant in Paris, with Neal Sandler in Jerusalem

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Jacob A. Frenkel: The Man Who Opened Israel's Economy (int'l edition)

Jacob A. Frenkel--Jake to his friends--is no stranger to career changes. A University of Chicago economist with 15 books to his credit, Frenkel left academe in 1987 to become head of research at the International Monetary Fund. Now, following his nine-year tenure at the Bank of Israel, Frenkel is moving to the private sector as chairman of Merrill Lynch's Sovereign Advisory Group and Global Financial Institutions Group. From New York, he spoke with European Regional Editor John Rossant:

On Mideast peace:

It is our historic destiny [to have] a more peaceful region, where everybody stands to gain from the peace process. Even if there are some detours along the way, this thing is now irreversible. A few years ago, I wouldn't have made that forecast. Our comparative advantage in Israel is knowledge creation and high tech, and human capital will continue to spearhead our growth. We will have flourishing high-tech and tourist industries, and we will probably end up being a natural financial center for the entire region.

On reform of the IMF:

The world economy and the global financial system have changed dramatically in the past few years, and we recognize the central role of financial markets in determining the fate of nations. These new realities have to be reflected in multilateral relationships. And I think the IMF people themselves are the first to recognize the changes and modifications that are needed.

[U.S. Treasury Secretary Lawrence H.] Summers' proposals to reform the IMF have to be seriously considered. But I actually think the IMF has received greater criticism than it has deserved recently. Yes, a lot of improvements are needed, but one has to recognize the fact that the Asian crisis and much that was threatening the world financial system is behind us.

On the New Economy:

In Israel, as in the U.S., we are not anymore in a trade-off between growth, inflation, and unemployment. One of the aspects of open markets and fast communication is that "long term" and "short term" have no meaning anymore, since the markets immediately reward good policies and penalize bad ones. It means politicians can be more courageous and not worry about the short-term political costs of policies.

On doing business in the Arab world as an Israeli:

That question was raised in 1987 when [then IMF chief] Jacques de la Rosiere hired me, and we crossed the bridge without any difficulty. In fact, I was the one who developed the IMF's approach to Islamic banking, and I have good relations even with Iranians. It's a nonissue.

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