Typically, for most goods and services, an increase in price results in enhanced supply. This result is based on reasonable behavioral assumptions regarding suppliers--it is assumed that suppliers desire to maximize their profits, and that the profitability of adding additional supply is enhanced when prices are higher. 3 When a good's supply demonstrates little or no response to price, the good is termed a "fixed factor." The defining attribute of a fixed factor is that its supply will not respond to price incentives. Land is generally regarded as closely approximating a fixed factor. Ultimately, land is limited to the supply established on the third day of Creation. While it is possible to reclaim land from the sea, such projects have proven prohibitively expensive in all but the most crowded and wealthy countries, such as Japan, Hong Kong, and the Netherlands. Hence, in most countries, an increase in the price of land is not likely to result in an increase in the quantity of land.

While the total supply of land may be fixed, the supply of real estate services (i.e., housing, office space, etc.) is much more flexible and responsive to price. Developers are able to vary the supply of real estate services by altering the allocation or intensity of land use. For example, farm land can be shifted to residential applications, while scattered single family homes can be replaced by high-rise apartments. Hence, under normal market conditions, it is wrong to view the supply of real estate services as fixed. Rather, it is reasonable to assume that higher prices for real estate services will increase the quantity of real estate services supplied.

Israel's real estate market, however, is not normal. The government completely dominates all segments of Israel's real estate market. Access to resources required to alter land use intensity-- building materials, construction labor, and financial credit--are controlled by the government. Furthermore, the government determines, for the most part, which land will be developed, when land will be developed, and the degree of land use intensity in any development. These government decisions are not governed by traditional business considerations, such as earning profits or avoiding bankruptcy. To repeat, in principle, the supply of real estate services is not completely fixed in any physical sense. But in the case of Israel, real estate services can be approximated as a fixed factor since supply decisions are not dictated by prices. The supply of real estate services in Israel is determined by bureaucratic fiat, not by market forces.

While all advanced nations regulate real estate markets via land-use zoning rules, Israel's real estate market intervention goes far beyond zoning. The Israeli government (I) regulates the markets for construction inputs such as cement and labor; (ii) regulates the allocation of credit to private contractors and developers; (iii) owns and manages a significant proportion of the housing rental stock; and (iv) owns a number of real estate development companies that often compete head to head with private contractors.

A. The Israel Lands Authority

All of the above market interventions pale in importance when compared to the Israeli government's central mechanism for land market intervention--the Israel Lands Authority (ILA). The ILA administers all land owned by the government or by the Jewish National Fund (JNF). The area under ILA control comes to 94 percent of Israel's land. While the ILA was actually established in 1960, its origins lie in the strategic and ideological imperatives that have dominated government policy (actually, the Zionist Organization and Jewish Agency's policy) prior to Israel's independence.
The most important imperative was the need to lay claim to as much land as possible in order to secure the frontiers of the emerging state. Purchase of land by public institutions, in particular the JNF, was the preferred method of expanding the area under Jewish control. It was feared that private investors, motivated by profit considerations, might resell land to Arab purchasers.
An additional imperative was ideological, and stemmed from the socialist orientation of the mainstream Zionist leadership. The leadership was ideologically opposed to private land ownership. Plessner sums up the attitude of the Zionist leadership towards private land ownership as follows:

First, private ownership leads to the unjustified enrichment of the few; second, it causes hunger for land among the working people; third, it brings with it land speculation, which causes real estate prices to rise; and fourth, it leads to over urbanization, defeating the struggle to return Jews to the land. 4

As a result of these considerations, the Zionist leadership chose to combat private land ownership wherever possible. Following the War of Independence, the new Israeli government found itself in possession of vast tracts of land that had previously been either unclaimed, controlled by the Palestine Mandate authorities, or under Arab ownership. Instead of transferring this land to the private sector, the government, consistent with its strategic and ideological outlook, chose to retain control of all the additional land, effectively ending any possibility for private investors to expand their land holdings in Israel beyond the 6 percent already held by the private sector prior to independence.

Until 1960, public land holdings were controlled by three entities. The Jewish National Fund continued to manage real estate that it had purchased. Lands that had belonged to the Mandate authorities came directly under state supervision. Land that belonged to Arabs who had fled during the 1948 war was supervised by the Development Authority. The establishment of the ILA was intended to improve government planning and administration in the land sector, while eliminating duplication of effort.

The ILA is generally forbidden to sell land to the private sector. Rather, the ILA awards leases to those chosen to develop or use given parcels of land. The lease confers upon its purchaser partial control of the parcel. For example, if a farmer chooses to transfer his lease to a housing development firm, he may do so (assuming that zoning laws permit it) only with the approval of the ILA. The farmer and the ILA then share the proceeds of the transfer. The ILA continues, following transfer of the lease, to retain ownership of the parcel, and continues to control decisions regarding the land's future development as well as additional transfers of the lease.

Rivlin explains this point clearly.

The ILA, through its executive council, decides who is to get land, what price they will pay for it, and the conditions under which they can use it. The ILA therefore influences decisions regarding housing, office buildings, factories, farms, hotels, and other buildings on over 90 percent of the land in Israel. These enormous powers are not wielded within a clear, published legal framework. 5

Like all government organizations, the ILA and other Israeli government entities involved in the real estate market, are immune to market forces. They need not maximize profitability nor answer the complaints of irate shareholders. For example, the land lease prices the ILA charges often have no relationship to market value or economic realities. Recently, the ILA demanded that Israeli appliance manufacturer Amcor pay $330,000 per dunam for industrial real estate in Givat Zeev. When Amcor complained that the price was several times the true market value of the land, the ILA's only response was that Amcor "has the right to appeal the decision, but not by exploiting the media." 6 At the same time, the ILA does not seem averse, effectively, to giving land away, occasionally offering plots at steep discounts to market prices or assessed value to favored recipients. As a result:

These steps are creating anomalies over space and time. Land in one place is made cheaper than land elsewhere. Land bought in one period will be made cheaper than land bought during another, all because of official decisions rather than market forces. 7

While the ILA is formally committed to Zionist objectives such as employment creation and population dispersal, it is characterized by the same three motivations that describe the objectives of all government authorities or parastatal companies: (i) "rent seeking," or a desire to exploit public resources in order to favor your friends and allies, or to obtain bribes and kickbacks; (ii) "empire building," or a desire to assure that your organization is as big and important as possible; and (iii) "effort minimization," a desire to do as little work as possible.

Rivlin notes that "the (ILA's) allocative process, whereby politico-bureaucratic decisions prevail, meant that those not favored for any reason did not get land." 8 Indeed, there has long been evidence that rent seeking plays an important role in ILA decision making.

A recent article in Ha'aretz suggests that the ILA remains a center of political favoritism. The article points out that "politicians are able to interfere (in ILA decisions) in order to determine how much is given to associates, potential supporters, or pressure groups, all through discounts (on land sales) and changes in zoning." The article also notes that "due to the ILA's impossible bureaucracy, an entire branch of ‘Authority Graduates’ has developed, lawyers and political players, who are able to obtain large amounts of land at a quarter of its true value, as they enjoy connections in the right places." 9 There is no evidence that the ILA considers market prices or the impact of those prices on its profitability as considerations in determining its policies.

B. Russian Immigration and Israel's Real Estate Supply Response

A magnificent demonstration of the irrelevance of prices as a determinant of the supply of real estate services in Israel is provided by the government's response to the current wave of Russian immigration, which began in 1988. During the immigration wave, housing prices rose sharply, reflecting the ever growing demand for real estate services driven by rapid growth of both population and output. Housing starts increased from 21,950 in 1988 to 83,350 in 1991.

One could conclude that higher housing demand had resulted in a sharp increase in the quantity of housing services supplied. This, however, is incorrect. Private contractors, although powerfully motivated by price incentives, were barely able to raise supply, increasing the number of private housing starts from 18,920 in 1988 to 22,540 in 1991.

It was the Israeli government, which had correctly identified the need for expanding the supply of real estate services to meet the needs of its new citizens, which accounted for nearly all the increase in supply. In 1988, government firms initiated 3,030 housing starts. In 1991, when the immigration wave was reaching its zenith, government firms initiated 60,810 housing starts. 10

The Israeli government accounted for almost all the marginal increase in building activity. The government chose to conduct most of its construction in peripheral areas far from sources of employment. This decision was consistent with a long standing objective of the Israeli government --to disperse the population in order to strengthen Israeli claims to remote regions. Demand for housing, embodied in prices, was not a criteria in determining the location of these new homes. Thousands of these apartments still stand empty today, five years later, since there is little demand for housing in regions where employment opportunities are non-existent.

This example demonstrates the irrelevance of prices as a determinant of real estate supply in Israel. Had private real estate suppliers been able to respond to price incentives, the increased demand for real estate services in central areas close to employment opportunities that resulted in sharp price increases in those areas would have stimulated increased real estate development in those central areas. Instead, the government choked off the ability of the private sector to respond to price incentives, and dictated a perverse supply response whose consequence was furious construction activity in peripheral areas where prices were not increasing rapidly, if at all.

C. Conclusion

As we have seen, government entities control the real estate market in Israel. These government entities, of which the most important is the Israel Land Authority, are entirely immune to market forces, and do not respond to price incentives. Critical decisions--when, where, and what to build--are made by bureaucratic fiat. As a result, it is reasonable to consider the supply of real estate services in Israel as a fixed factor. Although the supply can be physically altered, it is not altered by changes in the price of real estate services.

Part III