Flug: Raising Productivity Must Be Government's Top Priority

Presenting Bank of Israel’s annual report, governor issues strongest signal so far she is weighing quantitative easing.

Emil Salman

Bank of Israel Governor Karnit Flug on Tuesday put increasing labor productivity at the top of a long list of challenges the new government must address, even as she stressed the economy on the whole is in good shape.

“The elections are over. The government needs to contend with Israel’s fundamental socioeconomic problems by way of a list of priorities it establishes,” Flug told a press conference to mark publication of the central bank’s 2014 annual report.

“The Bank of Israel believes that the most critical challenge the new government faces is raising the growth rate of labor productivity and increasing the earning power of workers,” she said.

Israelis productivity rate – a measure of how efficiently a worker adds value to the company with his or her labor – is relatively low for a developed economy, and the gap between Israel’s rate and those of the most productive countries has been widening, she warned.

Flug also addressed the chief question before her, namely how the Bank of Israel will ensure that the shekel doesn’t appreciate in an era of negative interest rates. The central bank has said it is studying steps such as quantitative easing, but on Tuesday Flug offered her most forceful comments yet on the issue.

“We are not eager to use them, because of course unconventional policy tools have adverse effects, but if conditions arise such that there is a need to use them, we will not hesitate to do so,” she said.

The Bank of Israel last week lowered its benchmark interest rate to a record low 0.1%, but has since held the rate steady even as many European central banks have cut their rate to below zero and the European Central Bank itself launched a QE program.

Flug weighed in on several other key issues:

The gas cartel: In her first public comments, Flug expressed concern about the delays being created by Antitrust Commissioner David Gilo’s decision to rescind a consent decree allowing Texas-based Noble Energy and Israel’s Delek Group to retain control over nearly all domestic gas production. “The issue of competition is certainly worrisome,” she said. “But I think there needs to be an overall view here, and if as a result of certain decisions there will is a significant delay in the development of the reserves, I think that damage will also be big and a balance needs to be found.”

Infrastructure: Flug said the government had not been spending enough on infrastructure and that higher investment was needed, especially in public transportation and development of a pipeline to ship natural gas throughout Israel, in order to raise Israel’s labor productivity. She cited figures from the International Monetary Fund showing that every percentage point increase in infrastructure spending, relative to gross domestic product, added 0.4 percentage points to economic growth in the short term, and 1.5 points after four years.

Value-added tax: One item in the coalition agreement that Prime Minister Benjamin Netanyahu is now negotiating with prospective partners calls for eliminating VAT on food subject to price controls. Yesterday, however, Flug said the Bank of Israel opposed any kind of differential VAT policy, as well as government price controls.

Government spending: Flug said Israel’s spending on welfare, education and health is low compared to most other developed economies. While income inequality has seen some reduction, it remains high, as does Israel’s poverty rate. One way poverty can be reduced is by expanding the negative income tax program the government has started, but Flug said the next finance minister would have to increase government revenues.

Fiscal policy: Flug reiterated the central bank’s view that Israel must continue to lower its public debt while engaging in a balanced fiscal policy, which means increasing the government’s tax take to enable higher spending on infrastructure and social welfare. “There is certainly room to increase [tax] revenue by reducing the number of unjustified exemptions,” she said. 

Nathan Sussman, head of research at central bank, told the news conference that Israel had grown faster in recent years than the world’s other developed economies, thanks to the bank’s expansive monetary policy and a financial sector that didn’t suffer the traumas that hit Europe and America.

But growth lags behind Israel’s potential growth rate, and is slower than in the past, Sussman said. Moreover, growth has been led by the services sector, which is labor intensive, requires less capital and suffers low rates of productivity.