Bank of Israel Chief Laments Two Israeli Economies

Karnit Flug says thriving tech sector is pulling ahead of other sectors, leaving the rest of the country behind

Bank of Israel Governor Karnit Flug.
Bank of Israel Governor Karnit Flug. Olivier Fitoussi

Bank of Israel Governor Karnit Flug told a conference on Monday that the country really had two economies – a high-tech locomotive pulling “old and decrepit cars” – and that the situation was creating unacceptable income gaps.

“Reducing the gap between two parts of the economy is a necessary step in reducing [income] gaps and forging a single society. The path to get there does not pass through slowing the locomotive, but through inclusive growth – such that will lead to an increase in efficiency in 'the other economy,'" Flug told the Eli Hurvitz Conference on Economy and Society.

Wage gaps in Israel are the highest in the world’s advanced economies, school performance is too highly correlated with family background and the skills of the labor force on average are poor.

“To have a single economy does not mean that the entire economy only produces high-tech,” she said. “A single economy is one in which all industries make use of advanced technologies with high productivity and innovation, which leads to the most important thing of all, which is an adequate wage to their employees.”

The “Startup Nation” economy numbers about 5,000 startup companies that Flug characterized as having “remarkable innovation and dynamism.” They are complemented by top-flight universities and strong cooperation between academia and business.

The result is that 9% of the workforce is employed in high-tech, double the median for countries belonging to the OECD, she noted. Israel also leads in venture capital investment and the added value of information technology industries to gross domestic product.

But as the 9% figure shows, the sector is narrowly based, Flug said. “A large majority of employees in high-tech live and work in the center of the country [where] they reach 15% of total employed. The share of high-tech jobs in Tel Aviv and in the center has remained stable at about 60% over the past 20 years,” she said.

Moreover, salaries in high-tech are approximately double the average nationwide. The other 90% who work in other sectors of the economy are paid much less, especially if they work in the hospitality and food and administration and support sectors, where pay is unusually low.

“Labor productivity in Israel is low by international standards, and we are not closing that gap,” Flug said. “Productivity is particularly low in domestic industries that are not exposed to international competition.”

Even Israel’s high levels of research and development reflect the dichotomy, she said, because R&D spending is concentrated in the high-tech sector; in other industries spending on innovative products and services is low.

Flug said the way to merge Israel’s two economies was through better schooling and enhancing competition in domestic markets. She said the Law for Encouragement of Capital Investments should be amended to encourage investment in business serving the domestic market.