"Nobel Laureate Aumann says that Judaism subscribes to a market philosophy and contains important lessons for solving today's economic woes"

Nobel Laureate Economist Professor Robert (Yisrael) Aumann clarified for the first time last week how he sees the link between Economics, Judaism and the current economic downturn. In the inaugural lecture of the Center for the Study of Judaism and Economics at the Jerusalem Institute for Market Studies, Professor Aumann reminded us that Economics is based on incentives, and only when people and firms have the right incentives to work and produce can the economy grow and prosper. He argues that many examples illustrate how the Torah and the Talmud acknowledge the importance of economic incentives within a competitive market economy.

As one example of fundamental market-oriented principles inherent in Judaism, Professor Aumman cites the support in the Talmud for unfettered price competition. He notes that the Talmud precedes Adam Smith's groundbreaking ideas on price competition by hundreds of years. In the Talmud, there is absolutely no room for price fixing; only support for ensuring the use of honest weights and measures. In a competitive market economy, the firm selling at the highest price will either go out of business or be forced to decrease its price in order to survive. This simple point is often overlooked by policy makers in Israel. The Israeli government routinely acts in contrast to this principle and fosters the existence of monopolies that over charge us for their products and services. For example, few Israelis can forget the outrageous fees paid to Bezeq for international phone calls in the 1990's. However, once the market was opened to competition, calling family and friends or doing business abroad quickly became 70% cheaper. Economic growth could be restored by quickly introducing and deepening the competitive environment in Israeli markets, especially in energy and shipping markets.

As another example of Economics in Judaism, Professor Aumann discussed the concept of the Pruzbul. The Pruzbul allowed creditors to collect repayment of loans past the Sh'mitah year (Sabbatical year). Until Hillel instituted the Pruzbul, creditors were forbidden to collect loans after the seventh year. One effect of this prohibition was that very few individuals offered loans in the years preceding the seventh year. The lack of liquidity, or credit crunch, had devastating effects on the economy. Hillel realized that in order to assure a sound credit market and a continuous flow of loans to firms, the Pruzbul had to be instituted. Politicians in Israel should follow the example of Hillel and ensure that small and medium sized businesses have easy access to loans to finance their operations. Unfortunately, according to a report by the Milken Institute, the current situation is that 1 percent of Israel's largest companies receive 71 percent of available credit. This severe credit crunch hampers economic growth since expansion of small and medium business are often the main engine of job creation and increasing societal wealth.

Professor Aumann also talked about the many discussions of the moral hazard problem in the Torah and Talmud, and how moral hazard is currently at the heart of the faulty proposals currently being offered to solve the current financial crisis. The term moral hazard is used by economists to describe the fact that when an individual, a firm or an institution is "insured", there is an incentive to act less carefully and take harmful risks. For example, an individual with insurance against valuables kept in the home may be less vigilant about locking doors or investing in a good alarm system. As Nobel Prize Professor Gary Becker writes on his blog: If individuals are not held accountable for decisions and actions that harm themselves or others, they have less incentive to act responsibly in the first place since they will escape some or all of the bad consequences of their actions". This point relates directly to what is happening today as failing banks and other companies ask for government guarantees to stave off bankruptcy. This type of "insurance" against bad business decisions in the past will lead to even more bad investments and trouble in the future.