Central Bank Calls for Spending Surge to Boost Flagging Israeli Productivity Growth

Report urges gov’t to undertake wide-ranging program to make up for years of under-investment, calls for end to industrial subsidies

Bank of Israel governor Amir Yaron speaks at a press conference in Jerusalem, March 31, 2019.
Emil Salman

The Bank of Israel on Sunday issued a road map for how to boost Israel’s low level of labor productivity, in a bid to raise the issue from a largely academic debate into a declared policy of the government.

The 51-page report contained some familiar policy prescriptions, calling for more investment in education and infrastructure and reducing bureaucracy and improving the regulatory environment. But it also made some unusual ones, such as the government’s abandoning its long-standing policy of weighing business incentives like tax breaks to industry and exports.

The report also proposed aligning school vacation days with business holidays to reduce the time and cost of childcare for parents. In that framework, the report proposed ending classes on Fridays, when most parents aren’t working, and eliminating vacation days like the week before the Passover holiday, when most parents are at work.

>> Read more: In Israel, industry is a thing of the past | Analysis

Labor productivity is the measure of how much output is produced per labor hour. A higher rate means that an economy can produce more goods and service per person, which should translate into high pay over time. Growth in labor productivity depends on investment in machinery, new technology and human capital.

The Bank of Israel said the country’s labor productivity gap with the Organization for Economic Cooperation and Development was about 24% and had not narrowed in decades, despite the rise of the high-tech industry and the growth of higher education.

“Closing the productivity gap with the advanced countries should raise wages and is the key to a continuous rise in living standards in Israel,” the report said. It estimated that if all its recommendations were put into effect, Israel’s GDP per capita would be 20% higher in the long term, enough to bring Israel at or close to the OECD average.

“The disparity in Israel’s labor productivity gap is largely due to low basic skills of the workforce in Israel, and lagging levels of infrastructure and business investment. In addition, improvement in the areas of regulation and bureaucracy is required,” the report said.

Raising productivity to that degree will come at a steep cost, the Bank of Israel admitted, but said that was because the government had ignored the growing problem for too many years. “Even today, public spending in Israel on growth-supporting areas is significantly lower than is necessary to close (and even maintain) productivity gaps, partly because of the rapid population growth,” it said.

The report put the price tag at about 45 billion shekels ($12.7 billion at current exchange rates) annually, or about 3.3% of gross domestic product. Most of those costs would go to extra spending on schools and infrastructure.

It said the government could cover the cost by eliminating spending in areas that don’t contribute to higher productivity and/or by raising taxes.

Although higher taxes generally weigh down on economic growth, the central bank’s economist said higher productivity would more than compensate for the loss. For instance, it sited research that a three percentage point increase in the tax burden relative to GDP would lower growth by 0.15-0.3 point, but if the extra tax revenues were used to fund the Bank of Israel’s program they would add 0.5 point to growth.

In spite of Israel’s reputation as a center for high-tech and innovation, its workforce suffers from poor skills and young people perform poorly in international exams of student performance. Thus, most of the report was devoted to human capital issues as against more spending on machinery and equipment in factories or on public transportation and other infrastructure.

One way to close the gap in spending per student between Israel and the OECD average, the education budget would have to grow by 13 billion shekels in 2018 terms. It said that extra spending should go to improving teaching.

Apart from education, the central bank took aim at the Law for Encouraging Capital Investment and other government programs that provide incentives for industry in Israel’s periphery. The state grants about 5 billion shekels in tax breaks under the law every year and provides hundreds of millions more in grants.

But Bank of Israel economists expressed doubt that these programs helped boost Israeli productivity. The exception is big multinational companies – most notably in Israel’s case the semiconductor giant Intel – which bring technology and management innovations to Israel.

It recommended gradually reducing the incentives, without backtracking on existing commitments, expect in the case of businesses that bring unique innovation to Israel.

The Manufacturers Association, which represents Israel’s biggest industrialists, rejected the report out of hand.

“Productivity and wages in industry are 40% above the average for the economy, among other reasons due to the incentives for investing in research and development,” it said in a statement on Sunday.