Five Significant Reasons to Start Worrying About Israel’s Economy

With small and medium businesses struggling to stay afloat, a dogged high cost of living and a whopper deficit, Israel's post-pandemic horizons remain bleak

Nati Toker
Nati Tucker
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A man uses an ATM in Tel Aviv, July 2020.
A man uses an ATM in Tel Aviv, July 2020.Credit: Eyal Toueg
Nati Toker
Nati Tucker

Israel and its leaders have been receiving praise from around the world over how it has handled the coronavirus pandemic. But there are quite a few reasons to worry about the state of Israel’s economy and the country’s capacity to recover after the crisis passes. Here Here are five.

1) GDP per capita isn’t picking up

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The single most important statistic reflecting Israel’s relative stability in the face of the financial crisis is the GDP (gross domestic product), which declined less than the OECD (Organization for Economic Cooperation and Development) average. According to the Finance Ministry’s chief economist’s bureau, the 2020 GDP was 3.3% less than in 2019, compared to the average 5.5% drop for OECD nations. Israel’s GDP declined less than the average due to the high-tech sector’s relative stability and because tourism plays a minor role in the country’s revenues.

But a more accurate measure of the impact on Israel is GDP per capita. Given that Israel’s population is expanding at 1.9% a year, the GDP per capita has actually declined by 5.2%.

This statistic still leaves Israel in a relatively good place, although not as good as the GDP figure alone. In other OECD nations, GDP per capita declined by less – by 4.2% in the United States, 4% in Finland and 3.45% in Poland. The concern is that the pandemic will halt Israel’s efforts to increase its GDP per capita. Israel is now 23rd out of the 37 OECD member nations in terms of GDP per capita as measured by purchasing power – $39,000 per person as of 2017. Dr. Lev Drucker, head of macroeconomics at the Finance Ministry’s chief economist’s bureau, forecasts that GDP per capita will increase slightly to $36,000 next year, leaving Israel 24th out of the 37 member nations.

The low GDP per capita in Israel relative to the OECD average is directly related to the high cost of living in Israel. A look at the GDP per capita in nominal figures – not adjusted for purchasing power – would rank Israel 20th, between Italy and France. But it’s commonly accepted that GDP per capita should be measured based on what people can actually buy with their money, and thus the figure is adjusted for purchasing power parity. This is where Israel loses ground.

Reducing the cost of living in Israel is directly tied to the reforms that the government should approve as part of the state budget. But Israel hasn’t approved a state budget in three years, and repeated rounds of elections have stalled reforms aimed at increasing competition.

2) Deficit will weigh on the government

In all developed nations, governments took unprecedented steps to spur the economy. Israel also engaged in similar policies with aid plans equal to about 15% of GDP, but as of the end of 2020, Israel’s deficit was higher than the OECD average.

According to the Finance Ministry’s review, the deficit equaled 11.7% of the GDP in 2020, after taking into account that government revenues declined less than expected. Even though the deficit was lower than expected, it was still higher than the OECD average of 9.6% of GDP.

One of the reasons for this is Israel’s deficit prior to the crisis. Even before the pandemic, Israel was forecast to have a deficit equal to 3.8% of GDP for 2020 due to the government’s actions during an election season. Israel’s steadily diminishing debt in the decade prior reduced Israel’s debt-to-GDP ratio – the main measure of the government’s capacity to pay back debt – to 73.1%, a relatively low figure compared to other developed nations.

Israeli Prime Minister Benjamin Netanyahu, right, with current Finance Minister Yisrael Katz, during the weekly cabinet meeting at his Jerusalem office, Sunday, May 12, 2019.Credit: Gali Tibbon / AP

But even Israel’s policy leaders understand that sooner or later, they’ll need to prepare for the next crisis. This means Israel will need to keep working on cutting its debt and deficit, which is likely to weigh on the government’s operations over the next few years.

3) High unemployment won’t disappear

The average unemployment rate in 2020 was 15.4%, relatively high compared to the OECD average, but the Finance Ministry believes that international comparisons are inaccurate when it comes to unemployment. This is because Israel distorted its statistics by financing unemployment pay through June 2021, while other countries used other tools, such as flexible unemployment pay that enabled workers to work part-time and also receive a partial income from a government stipend.

Therefore the Finance Ministry recommends examining the change in total number of work hours in Israel relative to Europe. According to data from the second quarter of 2020, work hours dropped 16.9% in Israel compared to an average of only 14.4% in Europe. This drives the Finance Ministry to conclude that companies improved their output by laying off weaker workers, and that there is significant hidden unemployment that will become fully visible. Will these workers, who likely don’t have significant skills, find new jobs?

4) Small and medium-sized businesses hit

In the first three quarters of 2020, private consumption dropped 10.1% versus the 6.7% OECD average. This was primarily due to the harsh lockdowns, which included strict limits on businesses.

The Finance Ministry found that the sharpest drop in consumption was in the various sectors of the service industry – everything from performances to haircuts. Services are responsible for 19% of Israel’s GDP, and consumption of services dropped 25.8% in 2020. There was also a 22.5% decline in car purchases, an item responsible for 2% of GDP.

Demonstration against lack of financial compensation during pandemic, in Tel Aviv.Credit: Tomer Appelbaum

However, other aspects of private consumption increased 5.1% last year. In other words, there wasn’t a drop in demand for businesses that remained open. The services industry is generally made up of small and mid-sized businesses, which will be hard-pressed to make it through the crisis. The most recent International Monetary Fund report warns that the country will see a wave of bankruptcies when the government stops paying financial aid in June 2021.

5) Permanent uncertainty

That IMF report listed Israel’s deep-seated problems: inequality, poverty, and a severe lack of skills among part of the workforce. It also noted the complicated political situation and its implications for the economy.

Over the next few months, political uncertainty will continue as the country goes on without a functioning government or official budget. That report forecast significant short-term uncertainty.

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