Speech

Stanley Fischer
First Deputy Managing Director
International Monetary Fund
Prepared for delivery in a session commemorating Herb Stein, at the American Economic Association meetings
New Orleans
January 6, 2001

1. Introduction

Herb Stein once said that if you are organizing a conference or a professional gathering somewhere pleasant like New Orleans, it is a good idea to invite an economist to address it. This reassures the Internal Revenue Service that attendance cannot be for the purpose of pleasure and thereby makes it a deductible expense.

But it is certainly a pleasure for me to take part in this session to remember and pay tribute to Herb Stein's life and work, for I not only respected and learned much from Herb, but we and our families also became friends.

Over the years Herb made important contributions in several professional capacities: at the Committee on Economic Development, on President Nixon's Council of Economic Advisers, as an academic at the University of Virginia, and as a senior fellow at the American Enterprise Institute, in which capacity he worked on the Israeli economy. To many he was best known in his later years as an entertaining and thought-provoking columnist in newspapers and magazines. For several years he wrote frequently in the Wall Street Journal and Slate.

I have been asked to talk about the work Herb and I did as consultants on the Israeli economy to the State Department, in particular to Secretary of State Shultz, from 1983, through the stabilization program in 1985, and later.

2. Israel

Herb's first real involvement with Israel came during his time as Chairman of the Council of Economic Advisers in 1972, when President Nixon asked Herb to represent him at Israel's Independence Day celebrations. He met with various dignitaries, gave a talk at the Bank of Israel (I happened to be there at the time, and saw and heard Herb for the first time), and he and his wife Mildred toured the country.

The highlight of their visit was a meeting with Golda Meir, then prime minister. Herb subsequently described sitting across the desk from her while she chain-smoked and told the story of her and the country's struggle. She did so in a matter-of-fact - and therefore all the more moving - fashion that soon had tears running down Herb's and Mildred's cheeks. A few years ago, Herb described the trip as one of the high points of his time in the Nixon White House. He said it had increased his pride in Israel and in being a Jew.

Ten years later Herb had the chance to be useful to Israel in more concrete fashion. By mid-1983 the country was suffering from what he described as "an economic crisis and an economic problem". The crisis was triple-digit inflation and falling foreign exchange reserves. The problem was weak economic growth.

George Shultz invited four economists to advise him on Israel's problems, including Herb and myself. The others were Abe Siegel, then Dean of the Sloan School at MIT and an old friend of Shultz's, and our chairman today, Paul McCracken, former chairman of the CEA. Abe Siegel and Paul McCracken dropped out at a relatively early stage, but Herb and I remained closely involved for years.

The solution to Israel's inflationary crisis was in principle straightforward: a sharp cut in the budget deficit, devaluation and a tighter monetary policy, and an end to the indexation of wages along with other measures that would reduce inflationary momentum and thus the unemployment costs of the stabilization. But because such a program promised pain before gain, the government was reluctant to grasp seriously the nettle of disinflation, and there was a series of failed half-hearted stabilization attempts, starting as early as 1979.

Although the election of a coalition government in the summer of 1984 made decisive action more likely, the economic crisis worsened into the fall, with inflation soon exceeding 400 per cent per annum. In October Prime Minister Shimon Peres came to Washington asking for financial help and promising tougher economic measures, including budget cuts and a possible freeze in wages and prices. Shultz said that he doubted that the freeze would work and that more action was necessary to dampen domestic demand, devalue the shekel, and reduce public sector employment. Peres insisted that the program could not be seen solely as an austerity package. It had to offer Israelis what he called "a ray of hope".

President Reagan announced on the following day that the US stood ready to provide support if Israel's reserves neared depletion, but the administration insisted on waiting for a more convincing economic program before handing over any money. To that end, Peres and Shultz agreed to establish a Joint US-Israeli Economic Development Group (the JEDG) to meet regularly, comprising government officials and some non-government economists. The idea of including non-government economists, almost certainly George Shultz's, was that there were people in Israel, professional economists, who knew what needed to be done, but who were not succeeding in influencing their government's policy. The JEDG would help provide a forum for them, and in turn help the Israeli government think its way through the issues. Herb and I were the non-government advisers on the US side.

In the wake of the Prime Minister's visit, the pace of exchanges between Jerusalem and Washington picked up, though little in the way of concrete plans emanated from Jerusalem. Herb and I were sent to Jerusalem in March 1985, to see if we could firm up what needed to be done. We spent several days talking to government officials, the Secretary-General of the Histadrut, private businessmen, and academic economists, and a good deal of time in discussions with Emanuel Sharon, Director-General of the Israeli Treasury, who was doing everything he could to move the Israeli government to take the necessary measures.

At the end of the visit, Herb pulled out of his pocket a 10 point stabilization plan that he had jotted down on a sheet of yellow paper. The ten points were the essential elements of a stabilization program, even though they were incomplete, for instance in not sufficiently emphasizing the need for fiscal consolidation. The idea was for Sharon to take the plan up privately with the prime minister and the finance minister.

No sooner had we returned to the US than the list was leaked and published in the Israeli newspapers, under the title "Herb's 10 Points". The fact that they then appeared in the newspapers under that heading conveyed an unfortunate impression that they were being imposed on the Israelis, which contributed to an initially hostile press reaction. Another interpretation was provided by an Israeli academic friend who told me at the time: "Reading them in English, one has a clear sense they were written by someone whose native tongue is not English" - implying that they had been written by Emanuel Sharon. While the ten points are not Herb's finest prose, they were certainly written by him.

But, as it turned out, the leak ended up being helpful. The points were widely discussed, their shortcomings - particularly in underemphasizing the need for fiscal balance - identified, and the increased public understanding probably strengthened the government's willingness to act.

The American side never had any illusion that it could impose an economic program on Israel: the Secretary of State knew that - to use today's language -the program could succeed only if it was owned by the Israelis. Our task was thus one of persuasion, not imposition. To that end a full official delegation, headed by Undersecretary Allan Wallis visited Israel at the beginning of June, 1985. The economy had deteriorated since March, making it more likely that a stabilization plan would be undertaken. It was during the June visit that Prime Minister Peres appointed a small team, including Michael Bruno and Eytan Berglas from the outside, with Emanuel Sharon the key inside figure, to develop a stabilization program.

The team worked intensively, together and with the Prime Minister, and on July 1, after an all-night cabinet meeting, the historical stabilization program was adopted. It was a heterodox program, orthodox in the massive (about 8 percent of GDP) cut in the budget deficit, brought about mainly through a cut in subsidies, the fixing of the exchange rate, and the tightening of monetary policy, but decidedly not orthodox in freezing prices and originally wages. The heterodox elements played an important part in bringing inflation down almost immediately, after the initial price shock associated with the devaluation, and were certainly critical to the political acceptability of a very tough program.

I am sure that neither George Shultz nor Herb liked the heterodox parts of the program; they had both been in the Nixon administration when it imposed wage-price controls, and they thought that had been a mistake. But as long as the fundamentals, particularly the budget deficit, were taken care of, they were willing to go along - the very tough budget correction made everything else in the program possible. Based on his pragmatic appraisal of the overall program, the Secretary of State authorized the release of the $1.5bn two-year aid package that Mr Peres had requested.

By the standards of such programs, the stabilization was a great success. The monthly inflation rate dropped from 30 per cent in June to less than 4 per cent in August and was less than 2 per cent a month during 1986. The shekel also stabilized on the foreign exchanges. Fortunately, the rise in unemployment - from 5.9 per cent in 1984 to 7.1 per cent in 1986 - was small enough to be seen as a price worth paying.

I have of course wondered about the lessons the IMF should draw from the success of the Israeli stabilization. One obvious lesson is that a program is more likely to succeed if it is owned by the country implementing it. But ownership is a complex issue, and even in this case, it took a long time to develop, and must have been promoted by the prospect of receiving a grant of $1.5 billion if the program was implemented.

Another lesson is about conditionality. The Israeli program was implemented without formal conditionality. Perhaps there is a lesson in the fact that it succeeded despite the absence of IMF-type conditionality? But the lesson is ambiguous, as a story I want to tell - with the permission of George Shultz - illustrates. Shultz did not like the idea of conditionality. All along his idea had been that the Israeli government would set out a program with their own "markers", actions that they would set as their own conditions so that both sides could monitor the program. Neither Herb nor I thought that this generous approach would work, and so we asked if we could impose conditions on the aid. Shultz said no. After we had pressed hard, he reluctantly made a small concession to us: he said "you can tell the Israelis that I will be very disappointed if they receive the aid without carrying out the program."

It would be nice if IMF programs operated this way. When I asked George Shultz if he would mind my telling this story, he replied that it would be fine to tell the story, but that the word "disappointed" carried a lot of weight under the circumstances. He must have meant that the U.S.-Israeli relationship is multi-dimensional, and that his goodwill was needed across the board. Besides, there was an extraordinary degree of trust between the Israelis and George Shultz.

To return to the Israeli program: the crisis was dealt with successfully. But dealing with what Herb had identified as "the problem" - weak economic growth - was less easy. The US had long advocated a broadly based strategy of liberalizing policies to boost growth. These included reductions in government spending, tax cuts, privatization, deregulation, the dismantling of monopolies, the removal of subsidies, and the freeing of capital and credit markets. But political resistance to measures of this sort was initially even greater than the political resistance to the measures needed for stabilization.

It would have been easy to have blamed this resistance on the socialist ideology of Israel's founders and on the institutions and attitudes they fostered. But as was typical of Herb, his explanation was more pragmatic. As he wrote in 1990:

"The Israelis are slower than they should be to move toward free markets for the same reason that Ronald Reagan tolerated controls on the importation of automobiles, steel, sugar and many other things; spent tens of billions of dollars subsidizing agriculture; and made no move to stop spending hundreds of billions of dollars in support of old people who are not poor. It is not because politicians are socialists that they do such things, but because they are politicians."

Herb's involvement in the Israeli stabilization gave him great satisfaction. No doubt he derived satisfaction from both his diplomatic success in the always difficult role of adviser to a foreign government and his professional success in having given the right advice. More than that, he said "I felt I had done something for my people".

3. Herb's qualities

Working with Herb, I learned much more than about the Israeli economy, the operations of the United States government, and how to stabilize an economy. I was fortunate to spend time together with this gifted and gentle man, a man with strong convictions and a soft voice, a remarkably graceful and witty writer, a modest man who nonetheless knew how to make things happen, a man whose sense of perspective - often expressed with a shrug - and whose wit could illuminate and leaven the most difficult of situations.

There is no better way to convey a sense of who Herb was than to quote from his writings:

Herb was proud to think of himself as a Republican and as a market economist, but he was rightly wary of simplistic political or economic posturing. Introducing a book of his own essays, Herb once wrote: "There is a certain continuity, the absence of conservative convictions and also of liberal ones. I don't vote the straight ticket."² He was accurately described as "a liberal's conservative and a conservative's liberal" - a combination that did not endear him to all his colleagues.

Along the same lines, he wrote: "I am hesitant about the derivation of policy decisions in particular cases from general ideologies or attitudes. The principle that seems to me to require the least qualification is that the government should not intervene in the heart of the market - in the determination of relative prices and the allocation of labor and capital among various industries. But beyond that, the policy issues are more difficult and require more case-by-case discrimination."

Herb was a man of great loyalty, as well as wit. One evening in Jerusalem, after listening to a story of his, I said "You still seem very fond of Richard Nixon". He replied: "Well, it's hard to quarrel with the wisdom of a man who appointed you to a high position."

He said once that he disliked being asked to serve on committees that were going to draft statements because "I know there is going to be something that I cannot go along with". Similarly: "People ask me to sign petitions with which I am basically sympathetic, but there is always a sentence I cannot sign".

Herb's intellectual honesty - and the difficulty this created for people who feel a need to divide the world neatly into "them and us" - was illustrated by his attitude to taxation and government spending. One of the reasons that Herb felt comfortable as a Republican was his long-standing belief that the US should spend more on defense. Others fretted about the budgetary and economic cost, but Herb's view was the US was a rich country and that the costs of a strong defense were much less than the costs of an inadequate one.

Needless to say, this view endeared him to conservative thinkers. But not so what he regarded as the logical consequences of that view. Having accepted the case for spending more on defense, Herb could not bring himself to argue that government spending is per se a bad thing. And neither, therefore, could he accept the argument that tax cuts are inherently desirable in order to deliver politicians from the temptation to spend the money that taxes raise.

Herb also had little sympathy with the case for tax cuts that was advanced by President Reagan and his supporters in the early 1980s. "When some journalists and economists won the hearts and minds of the Republican party with the notion that reducing tax rates would increase the revenue, I was affronted by the flimsiness of the evidence" and then, in a typical Herb aside, he added "and even more by the fact that graybeards like me were displaced on such flimsy evidence."

Let me close by giving you a few examples of both original Herbisms and favorites that he picked up from others.

First, a saying from Henry Simons, one of the four pillars of the original Chicago School. In Economic Policy for a Free Society, Simons said: "Surely there is something unlovely, to modern as against medieval minds, about marked inequality [of income or power]". What delighted Herb was the use of the word "unlovely" which captured for him the fact that feelings on this subject were matters of taste and emotion rather than efficiency or justice.

Second, one of Herb's own: "If something cannot go on forever, it will stop". This was a rejoinder to those arguing for urgent measures to address the widening US current account deficit in the 1980s, and a reminder that knowing if and when to act is never easy. As a corollary to the above statement, Herb often observed: "Economists are very good at saying that something cannot go on forever, but not so good at saying when it will stop."

Third, despairing at the kneejerk reactions of many economic and politicial pundits, Herb recalled the description of Ernesto IV from Stendhal's The Charterhouse of Parma: "If a plank creaks in the floor, he snatches up his pistols and imagines that there is a liberal hiding under his bed".

Fourth, Edward Denison's cautionary reminder - with reference to economic growth - that "the difference between 2 percent and 3 percent is not 1 percent, but 50 percent". The implication being that what appears a small increase in the growth rate is more significant than it looks. Herb was a great admirer of Denison's and in writing about Denison, was also writing about himself. As Herb wrote in the Wall Street Journal following Denison's death in 1992:

"When I ask myself why Denison was so exceptional, I think first of his unusually high intelligence. But there was something more, and more rare, than that. It was a moral quality of responsibility. He accepted his responsibility to do his work as thoroughly, comprehensively and honestly as possible, with no short cuts, no unnecessary displays of virtuosity, no acceptance of unexamined data, no fear of saying that he did not know, and no contamination by pride, ideology or politics... I suppose he was a registered Democrat, but that affiliation no more affected his economics than did his being a Chicago White Sox fan."

Finally, a piece of wisdom I learned from Herb over dinner one night in 1984: Herb asked what was happening in the Israeli economy. I replied with a lengthy, and no doubt learned, analysis of the state of the economy, the role of the budget deficit, of indexation, of monetary policy, and the balance of policy views among the various participants - in short, a very good exam answer. When it was over, Herb asked me: "Well, but what do we want them to do?" That is the essential question that a policy adviser has to answer - and that is one of the many things I learned from Herb Stein.