Israel Makes a Free-Market Move

Dan Porges | Peter Arnold | Getty Images

There's a great old joke about the lone Jewish survivor of a shipwreck who finds himself alone on a desert island.

Ten years later he is finally rescued by the U.S. Navy and the sailors are all astounded by what they see: all by himself, the castaway has built an entire small village dominated by schools, hospitals and houses of worship.

The shocked rescuers ask the man what on Earth possessed him to build so many facilities when he was the only human being on the island.

The old Jew responds: "Well I had some spare time, so I figured I'd do a little volunteer charity work."

What makes that old joke funny is that Jewish communities all over the world have a hyperactive "charity and relief organization" gene, if there is such a thing. After codifying the idea of mandatory charity in the Hebrew Bible, Jews have spent much of the last 4,000 years outdoing themselves, (and often trying to outdo each other), by establishing community schools, hospitals, food pantries, etc.

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And it's that 4,000-year-old tradition that makes what's going on right now in Israel so remarkable.

To put it simply: the most charitable people in the history of the world have come to the realization that the welfare state doesn't work … and they're actually doing something about it.

Earlier this year, Prime Minister Benjamin Netanyahu's Likud Party won re-election. But a new party called Yesh Atid, led by former Israeli TV news anchor Yair Lapid, came in a strong second and forced Netanyahu to bring it into a new coalition government. Yesh Atid's major platform planks called for more economic equality, but not in the way the Occupy Wall Street crowd thinks of that term.

Instead, Lapid and his top lieutenants pointed out what everyone in Israel has known for decades: the fastest growing segment of the Israeli population is the ultra-orthodox "Haredim," who generally do not seek outside employment and have a total exemption from military service that every other Israeli must perform.

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Even as Israel's economy continues to grow and the nation becomes an even bigger player in the tech and pharma sectors, this demographic drag takes a real and psychological toll on the country. This will also be a big challenge for Jacob Frenkel as he is expected to retake the reigns of Israel's central bank.

While Lapid is Yesh Atid's political leader, its heart and soul is a young ultra-orthodox rabbi named Dov Lipman. Lipman provides the religious bona fides when he insists that his fellow Haredim in Israel should participate in the economy by taking even menial jobs if necessary. As a result, welfare payments to the ultra-religious community were recently reduced by the equivalent of several thousand dollars per year.

And the military service exemption is also gone, although all the details have not been worked out on just how to induct thousands of young men into the Israel Defense Forces who may not have the rudimentary skills to serve with any fighting units.

These are hard details to work out, but the message is crystal clear. The Israeli people see that welfare too often encourages those who are on it to find ways to stay on it. And true compassion does not mean endless handouts.

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A funny side story to all of this is that while most Jewish-American voters would probably angrily reject a Republican candidate promising to drastically reduce welfare programs for the unemployed in the United States, that same number of Jewish voters probably would wholeheartedly approve cutting welfare payments to their much more religious counterparts in Israel.

In other words, watch how fast Keynesians like Paul Krugman change their tunes when they find out that the poor people on welfare we're talking about aren't ethnic minorities in America, but super-religious Jews in Israel.

But the real reason to smile is that the once hopelessly socialist state of Israel has once again made a free-market move that will help its economy long term.

This is reminiscent of what it did more than a decade ago when pension payments were reformed by Netanyahu, who was then serving as finance minister. That policy has helped Israel avoid falling into a Greece-like scenario and so will this latest welfare reform move, as long as the new coalition holds.

Indeed, ultra-religious parties in Israel are already revolting against the plan, smearing Rabbi Lipman on a daily basis, and threatening violent protests to reverse the nation's course.

No matter what happens on the political battlefield, a huge victory for sound economic theory and policy has already been won. If a majority of Jews living in the once socialist-dominated Israel can come to realize that welfare is a failing policy, perhaps the rest of the Western world will figure this out too.

At the end of the Passover Seder, Jews around the world end the telling of the story of Exodus by chanting three times: "Next Year in Jerusalem." As soon as Israel solidly steps back from falling off the cliff of the crumbling welfare state, perhaps every Jew and non-Jew worldwide will add a new chant: "Free market capitalism is the best path to prosperity!"

—By CNBC's Jake Novak.