A Fiscal Reformer's Last Hurrah

Bank czar Frenkel quits, but his policies will live on

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.

Before it's here, it's on the Bloomberg Terminal.