Settlement Halt Seen Hurting Economy : Israel: Central bank governor says less construction means slower growth, but he praises the government’s policy.

The new Israeli government’s widely hailed decision to halt construction of settlements in the occupied West Bank and Gaza Strip will come at the cost of slower economic growth for the country next year, the governor of the Bank of Israel said Wednesday.

But Jacob A. Frenkel argued that the sharp cutback in housing, particularly in government funds for the controversial settlements, was an essential move in restructuring the Israeli economy, shifting resources out of ideologically motivated but unproductive expenditures into job-creating investments.

More than 40,000 of the houses built under the former ultranationalist government remain unsold, and the government will probably lose more than $400 million, even if it succeeds in selling them at a discount.

‘What’s the good of building houses where people don’t want to live?” Frenkel asked. “What we need is productive investment, generated both domestically and from abroad.”

The building boom, undertaken to move Israelis into West Bank settlements and to house Russian immigrants, constituted nearly half of Israel’s 6% growth in 1991 and 1992--growth about which even Frenkel boasts.

“Everyone wants to grow faster, but even in the West you don’t see these numbers--6% in real terms several years in a row,” Frenkel said at a news briefing here Wednesday. “But housing was the engine for growth . . . and we should by design and strategy change the structure of the economy and reorient industry away from such transitory activities.”

Frenkel, a former economics professor at the University of Chicago and a onetime official of the International Monetary Fund, praised the Labor-led government for helping to reshape the Israeli economy.

“Don’t underestimate the degree of determination required to introduce fundamental changes in the structure of the (government) budget,” Frenkel said.

He noted that the Cabinet of Prime Minister Yitzhak Rabin has been willing to make tough decisions required for future growth.

Besides the cutback in housing, he pointed to the decision to begin the widespread selloff of state enterprises in a push to develop the private sector, which now accounts for perhaps only a third of Israeli production.

“The government simply must reduce its involvement in the economic system,” he said. “While many public enterprises are run very efficiently, in private-enterprise style, we clearly should get out.”

The third major economic decision the Rabin Cabinet made, Frenkel said, was to hold the government’s budget deficit to 3.2% of the gross national product, the total value of all the country’s goods and services, after periods in which it ranged as high as 8%.

Also on the new economic agenda here are tax reductions to encourage investment, broader export incentives, greater reliance on the private sector for job creation, opening of the country to foreign capital and gradual weaning of the country from U.S. aid.

“It is a little too early to start talking about the achievements of the new government,” Frenkel said. “Looking for something that is measurable is a temptation to find shortcuts.”

But combined efforts by the government and the Bank of Israel to curb inflation have brought the annual rate down from 18% a year ago to an estimated 9% this year, and the drive to reduce it further will continue, Frenkel said, noting, “It takes a long time to get this disease out of the system--though only a short time to catch it.”

Arguing against calls by political leaders for increased government spending to create jobs and to ease the 11% unemployment, especially among Russian immigrants, Frenkel said the private sector should be encouraged through lower taxes and investment incentives to expand.

Exports, he noted, are up 14% this year.

In Frenkel’s view, the greatest economic challenge Israel faces is the absorption of the 400,000 recent immigrants from the former Soviet Union--and the 1 million or more likely to follow in the next few years if, as Frenkel put it, Israel develops “an attractive economic environment” for them.

With unemployment among immigrants running 40% and their arriving at two to three times the speed that jobs are created for them, Israel must develop a long-term program if it hopes to use the talents, education and experience of the immigrants, Frenkel said.

“The human capital that comes with these people is unique,” he said. “The real test is not how many jobs we create but the quality of those jobs--how many of them are in the private sector, how much investment there is to use their skills. Israel has had various phases of mass immigration, and each has been associated with a quantum jump in economic growth.”

But the immediate outlook, Frenkel acknowledged, is for slower growth as the government restructures the economy in a series of basic policy changes.

Even with a renewed investment in the country’s infrastructure, a priority replacing the development of settlements, growth next year could drop below 5% as a result of cutbacks, according to Israeli economists, and such a slowdown could make economic reform even more difficult.

“The housing cutbacks don’t just ripple lightly across the economy--they are like huge ocean swells, buffeting everything,” one private economic newsletter commented this month.