Adviser and Activist: Lerner on the Israeli Economy, 1953 and Afterward

Abstract

Over the period 1953–1956, Lerner served as a resident economic advisor to the State of Israel. For most of this period, Lerner was a member of the Economic Advisory Service (EAS). He also served in 1956 as an advisor to the Finance Ministry. This chapter utilizes the Lerner Papers and the EAS papers in Israel State Archives to document Lerner’s activities and influence in these roles. Lerner analyzed export subsidies, the proposed legislation to establish the Bank of Israel, and the cost of living allowance (CLA system). He also played the unconventional role of critical public intellectual. He contributed to “the economic independence debate” and even launched a campaign to abolish the CLA. He continued his attacks on it after returning to the USA, albeit changing his views in 1974, after the oil price shock and its impact on the Israeli system of wage linkage. We conclude by conjecturing that Lerner’s views emanated from his observations of the operations of the National War Labor Board (1942–1947) and the problem of Federal Reserve independence (1942–1951).

Appendix

3.1.1 Lerner’s First Open Letter: 8 January 1956

Reproduced with the permission of the Jerusalem Post; published January 10, 1956 under the title “Wage Rise Will Mean Disastrous Inflation: PROF. LERNER APPEALS TO PUBLIC.” Emphasis (via bold type) in original.

Editor, The Jerusalem Post

Sir—

There is great danger that the Israel economy will rush into a ruinous inflation on the wave of a general increase in money wages. The surprising thing is that such a panic action could come about after weeks of intense deliberation. It is as if, at the end of a theatre performance, a thorough discussion by the audience of the dangers of panic were followed by unsuccessful negotiations in which each person insisted on being the first to go out, and it was solemnly decided to solve the deadlock by crying “Fire!”

In the discussion on wages that has been raging, all serious participants have recognized:

• (1) that a general increase in wages by itself would lead to increased prices and inflation and would not give anything real to the workers.

• (2) that accompanying measures that could result in increasing real wages (by increasing the total product or increasing the share of it going to labor) would be at least as effective without an increase in the money wage.

• (3) that in any inflation such measures are ineffective and the total national product and the share going to wages are both reduced, so that the worker must suffer a reduction in his real wage.

From this, it follows that anyone who cared for the real conditions of the workers should be against a general wage increase. Yet there is now the great danger that we will have a “compromise” general wage increase which will bring ruin to all.

That this should be the policy of Communists is understandable. They can say to themselves (in accordance with Lenin’s strategy of disrupting capitalist societies by debauching their currency), “We will pretend to be friends of the workers and ask for higher wages for them. When this results in inflation and in lower real wages, we will turn their anger against the Government, and over the ruins of the Israel economy we will march forward to the social revolution.”

While the important protagonists of a general wage increase in Israel are not Bolshevik-Leninists but Zionists, the reason for their position no less distressing. One half of the Mapai Centre is for the wage increase because they are afraid of demagoguery from the left, or because they are afraid of admitting that promises made before the elections were unwise and irresponsible, or because they are afraid that others will not be able to understand that a general wage increase brings harm and not benefits to workers and the State.

The two left-wing parties support a general wage increase in part because they have not got out of the habits of an irresponsible opposition (for whom claims that cannot be met are better than claims that can be met—revolution is superior to reform) and in part because they, too, are afraid that their supporters would not understand the difference between the money wage and the real wage (even though they have for years been telling them how past increases in money wages have been negated by increases in prices).

It is this fear and cowardice on the part of leaders who hide behind their followers, that is putting the Israel economy in dire danger. It is therefore possible for the situation to be saved if such followers as are not as ignorant or as intimidated as these leaders think would make themselves heard before it is too late.

I know that in writing this letter to the Israel public, through the press, I am departing from the proper role of a foreign expert. I should write memoranda to the office where I am employed, shrug my shoulders, collect my exorbitant (by Israel standards) salary and go back to America. But I have a more than professional interest in Israel, and I am writing this letter, in my personal capacity, because of my belief that the Israel public can understand the issues and is not really pushing towards the abyss of inflation, in the way that some leaders claim.

I believe the public recognizes that wage increases lead to price increases—it has had plenty of experience of this. The Israel worker does not want a wage increase that turns to dust in his hands and in a general agreement not to push, where he would not be left behind, he would be willing to cooperate.

I do not believe that it is the public that resents high officials or doctors getting more pay than a semi-skilled laborer or would be outraged if the Government kept the solemn promise of salary increases to doctors and other higher grade professionals (that were found necessary for justice and efficiency after long and careful study) even in the absence of a general wage increase. It is only some doctrinaire leaders who are so addicted to what the Russians called “bourgeois equalitarianism.”

I am therefore appealing to serious men in all parties to let their leaders know that courageous leadership to save the country from inflation would have support.

Pick up a pen or a telephone and tell your trade union secretary or your party leader, and tell the minister of finance, too,

• 1. that in order to prevent inflation you would be willing to cooperate in postponing wage increases in general, although you could not stay behind if wages are being raised all over.

• 2. that you do not want to black-mail the Government into breaking its solemn promise to the professionals, especially since the black-mail would take the form of demanding a general wage increase that would bring inflation on everybody.

If enough of you do this today, the inflation may yet be stopped.

Yours, etc.

Prof. Abba P. Lerner

Jerusalem, January 8.

This letter has also been sent to other newspapers.

3.1.2 Lerner’s Second Open Letter: August 1956

From Lerner Papers, Library of Congress, Box 13, Folder 2, 30–33.

Letter to Israel by Abba P. Lerner August 1956

After working for three years as an economic adviser to the Government of Israel and before returning to my University in America, I feel I can do a service by saying a few last words to the Israel equivalent of Mr. John Q. Public.

During my stay I have seen a great deal of progress not only in economic conditions (although some of these may be questioned as sacrificing future economic security to present comfort) but in the spread of understanding of the difficult steps that will have to be undertaken if the economy is to reach economic independence—i.e. if it is to be protected from the destruction that otherwise would accompany the fall in foreign aid that is expected in a few years’ time.

The spread of this understanding is of the utmost importance because without it the government and the other centers of power in a democracy are unable to do what needs to be done. And this is why I think it is useful for me to speak to the public even though it is not what I am paid to do and even though there are some people who would prefer me to be silent.

The minister of finance, the prime minister, and some of the other men in charge of economic policy are aware of what needs to be done and are fully prepared to sponsor the policies necessary for economic health even in the face of irresponsible demagogic opposition. The existence of a labor government makes it more possible for even unpleasant medicines to be applied because the public would less easily be persuaded by the demagogues that such a government is motivated by hatred of the working man and woman. But without the support of the public, the necessary medicine cannot be applied. A successful democracy needs good citizens even more than it needs good ministers.

The focal point of almost every economic problem is the Cost of Living Allowance System (CLA). The economist sees that it prevents the achievement of the relationship between costs and prices in Israel and costs and prices abroad which must be achieved if Israel is to reach the harbor of economic independence, and that it induces instead inevitable, repeated and fruitless devaluations. The man in the street sees that it leads to inflation, with its injustices and damage to the efficiency of the economy. And the worker is increasingly aware that it is a swindle because it cannot keep its promise of keeping wages ahead of prices. He has been learning from experience that every time the CLA raises wages in order to catch up with prices, it only pushes the prices up again. Prices may still be held down by subsidies out of money needed for defense or development,—but in that case it is the subsidies and not the CLA that should be praised (or blamed).

Although this understanding of the harmfulness of the CLA is more and more widely felt, there is still a strong defense for it for several reasons:

• 1. It is properly felt that if there is a runaway price inflation, to which wages must, of course, be adjusted, the CLA method is more orderly and may be less disturbing than a less systematic readjustment. But this does not apply where the inflation is being overcome, as in recent years, when the CLA can only work against the stabilization.

• 2. It is correctly seen that the inflationary effect of the CLA may be absorbed by increased productivity and by increased use of foreign aid to subsidize consumption—as has happened in recent years. But this cannot happen if there is a wage increase, such as that of 1956, and there is no corresponding sudden increase in productivity, or in funds available for subsidies, to provide the real increase in consumption. The CLA cannot then succeed in keeping wages ahead of prices (except for a possible short interval during which the country is being impoverished by capital consumption in the form of the eating up of goods that are sold for less than their replacement costs). This means that the increase in wages will not be a genuine increase in real wages, and that the attempt by the CLA to keep wages ahead of prices will only cause inflation. From this inflation the workers will lose much more than they can gain from any possible temporary enjoyment of capital consumption.

• 3. Trade Union leaders, perhaps thinking of periods of rapid inflation, have the indestructible habit of considering the CLA ”the greatest achievement of organized labor” even when everybody else, including the workers themselves, can see that this is not true when some progress towards stability is being achieved.

In spite of these protestations in favor of the CLA even many trade union leaders are conceding that something must be done about it. Compromises are being put forward for saving it from abolition by watering it down. Thus, it is being proposed that CLA increases should take place only every 6 months instead of every 3 months, and only when prices are increased by 5% instead of by 1–1/5% (3 points on a base of about 250 points).

Such compromises do nothing significant to correct the evil. The 10–12% general wage increase will certainly raise costs and prices by more than 5%. The 6 months rule would mean theoretically that the secondary repercussions would be only half as fast as on the 3 months rule. But much more important than the mechanical operation of the CLA according to the rules of the game is the psychological effect of a system that promises that rising prices will not be permitted to reduce real wages or to negate wage increases. The psychological effect is that any failure of these promises to be fulfilled—whether because of time lags, or because of suspected distortion of the index or because of anything else—is seen as some form of cheating. It is then felt to be proper to engage in “counter-cheating” by upgrading, by phony allowances, by fictitious (“automatic”) efficiency premiums, etc., in attempts to maintain real wages or real wage increases.

In 1951 the “New Economic Policy” included a CLA system that was calculated to reduce real wages in a mechanical way by giving CLA on only a part of the basic wage, as prices were raised by devaluation and decontrol. Nevertheless real wages continually and gradually increased because of the “counter-cheating.”

It was possible for this “counter-cheating” to be successful between 1951 and 1955 because of increased productivity and because of increased (hidden) subsidies to consumption, but at present there is no source available to enable the increased basic wages to keep ahead of prices. There was no sudden increase in productivity of 10–12% in June 1956 and the defense situation means that subsidies to consumption are more likely to be reduced than to be increased. Consequently, the attempt by CLA and “counter-cheating” to keep wages ahead of prices can now lead only to a continuing and accelerated inflationary race between wages and prices.

It is the glimpsing of this that is responsible for the current concern about CLA. But a full recognition of the situation must involve also a recognition that compromises like the 6 months rule or the 5% rule completely fail to solve the problem. Only the complete abolition of the CLA can remove the implicit promise to keep wages 10–12% ahead of prices. Only a completely free system of fixing wages annually would permit the realities to be recognized. Wages could then be set at levels compatible with the ability of the economy to provide the goods that the wages are to buy. The CLA, in any form, in conjunction with the 1956 wage increase, constitutes a promise that the workers will be able to buy more than the economy is able to provide and this promise can only be a false promise. The resulting inflation is only the inevitable result of workers trying to obtain that which has been promised them but which does not exist.

The contention that a 10–12% increase in wages, in real terms, could come out of profits cannot be treated seriously without considering whether this means out of profit consumed or out of profits reinvested. To claim that it could come out of reduced consumption by capitalists is simply dishonest, while to increase wages, and thereby consumption, out of the invested profits would constitute disastrous economic sabotage.

It is possible for real wages to be increased, and therefore for the promise of increased real wages to be kept, if there is increased efficiency and increased production. But the test of whether such suggestions are anything other than empty talk is whether men displaced by increased efficiency can be dismissed so that costs can be cut and the labor saved (as well as materials, machines, etc. saved) can be used elsewhere to produce the increased real wages. Without the efficiency dismissals, all talk about increasing efficiency as an alternative policy is dishonest and indecent. With them it can be hoped that increased efficiency will produce what the CLA can only promise.

I have been convinced that the men and women of Israel are able to understand all that I have said, that there is wide agreement with it, and that the great majority could be made to accept the policy. Some labor leaders are lagging and will continue to lag behind the public. But that is only because they cannot forget their share in the credit for the “famous victory” of the CLA as an alleviation of runaway inflation or because they tend to act as if they were representing a particular group of workers against exploitation by the economy at large. All others are realizing more and more that unless there is an increase in real output of consumption goods all promises of general increase in real wages are bound to be false promises.

Nevertheless, it is not possible for the minister of finance and the other leaders with genuine social responsibility, to do what needs to be done if the citizen does not show his support. Some months ago, I published a letter suggesting that those who agreed with my view that the 1956 wage increase was a bad thing and a fake promise should make themselves heard. Well only about 100 made themselves heard and the wage increase took place. Judged by the sample of those who spoke to me about it, there must have been at least 10,000 who would have written letters if they had realized that it was not somebody else who was meant; and very many times that number are in agreement, but do not write letters. Of every 100 people who expressed earnest agreement with me, and were asked if they had written a letter, about 99 said, “Who, me?”

Democracy does not work if everyone depends on someone else and in Israel the power of the individual in expressing and forming public opinion is a basic infant industry that has to be developed. I am therefore asking every reader who agrees with my analysis and who has an earnest interest in the welfare and security of Israel to recognize that it is not someone else but he himself who must act. I am asking him to explain the issue to the people he meets in a national campaign of economic education and to begin by sending a letter to four of his acquaintances, and to the minister of finance, containing the 6 points of the following sample chain letter.

Abba P. Lerner

Dear Moshe:

• 1. I’m worried about the dangers of inflation and economic collapse and I think it is up to citizens like you and me to show those leaders who have the courage for social responsibility that we are prepared to support necessary measures even if they appear to be temporarily painful.

• 2. It is clear to me that the Cost of Living Allowance cannot keep wages ahead of prices and can only help to cause inflation and destruction.

• 3. I am for giving up the CLA for annual determination of total wage rates; and for permitting efficiency dismissals as a means for achieving the increased productivity which alone can provide both economic security and higher income levels.

• 4. It is understood, of course, that I would not give up my CLA unless everyone else gives it up too, and that the wage stabilization and efficiency dismissals would not be misused for increasing profits, but that, on the contrary, that profits would be reduced in relation to wages by effective measures for fighting cartels and increasing competition.

• 5. I am sending this letter to three other acquaintances and to the minister of finance for whose information I mention my occupation.

• 6. If you think I am right, it is your duty to do the same, namely, to explain the matter to your friends and to begin by sending a letter containing these 6 points (including this one) within three days, to four acquaintances of yours and to the minister of finance, so as to keep the chain going until appropriate action is induced.

Yours for responsible citizenship,

Name______________________

Address____________________

Occupation_________________