In the Money

Israeli Government Finally Getting Serious About Boosting Productivity

New program will condition grants to industry on efficiency and innovation, not just creating new jobs.

The Taub Center for Social Policy Studies issued an important message Sunday in advance of the High Holy Days: It turns out that Israeli productivity – already ranked 23rd among the 34 developed countries of the OECD – is in rapid decline. The latest update of official government figures, after being crunched by the Taub Center’s economists, shows Israel has sunk to 26th place in developed-world productivity, putting it behind Greece and Portugal.

It's hard to imagine less joyful economic tidings for the new year. Low productivity has a clear and painful cost: a lower standard of living. A country producing and earning less due to low labor productivity is a country that is necessarily less wealthy and less advanced, and one that will simply offer its citizens less.

Since labor productivity only measures output by the working population, it is no comfort that, in fact, Israel is in an even worse situation than the numbers show. Not only are Israeli workers inefficient, but the number of Israelis actually working is also low relative to the population due to the low labor force participation rate by Haredi men and Arab women.

There is still some good news, however, with the new year ahead. True, our labor productivity situation is shocking – in industry alone the average Israeli worker lags behind his U.S. counterpart by 40%, ranging from 57% in traditional industries to 17% in high-tech - but at least we've woken up to the problem. For many years the government devoted itself to the question of Haredi unemployment, without at all addressing the tough labor productivity problems among those who do work. But in the last few years the problem of low productivity has finally penetrated the consciousness of decision makers.

It began in 2007 with the Makov Committee report, which examined low productivity in traditional industry, and continued with studies performed over the past two years by Applied Materials and the Zvi Eckstein committee on the emerging backwardness, too, in the high-tech industry. Today it has reached the stage of critical decisions to be made in the framework of the Law for Encouraging Capital Investment.

Beginnings of a new approach

In recent weeks the Economy Ministry's Investment Center, headed by Nahum Itzkovich, has completed plans for changing the criteria for grants handed out to industrial plants under the capital investment law. The new criteria will take effect at the beginning of next year and herald the beginning of a new approach. For the first time, conditions for the grants offered by the government to traditional industry (as opposed to high-tech, which receives assistance from the Economy Ministry’s Office of the Chief Scientist) will be based on innovation and productivity.

The grants option is the less discussed track of the investment law (more attention is usually focused on the tax exemption option). Since the grants are money that actually comes out of the state budget and is transferred into the hands of industrialists, it’s smaller in scope. In 2013 and 2014, it amounts to just NIS 350 million to NIS 450 million a year, respectively. But its importance can't be understated: There is nothing like receiving money directly from the government to get the blood flowing.

The government receives applications for some NIS 2 billion in grants annually (reflecting total investment by the applicants of some NIS 10 billion) against a budget of around NIS 400 million. With demand far outstripping supply, the government has a lot of room to set the criteria.

The basic conditions are that the grants go only to industrial plants located at a distance from the center of the country, and that export at least 25% of their output. (Non-exporting companies can also request a grant, but only if it serves them to begin exporting at the required rate). Applications meeting these criteria total about NIS 1 billion a year, which is still nearly triple the supply. The Investment Center therefore ranks the applicants, a process that until now was based mainly on the number of additional workers the plant would take on, which was calculated according to the investment. In this way the grants were meant to encourage employment in the far reaches of the country.

But starting in 2014 there will be a change. The rankings will still weigh job creation but also take two new factors into consideration - innovation and productivity, which will be given a substantial, 30% weight in the score. Companies that can prove they're improving both will be given priority.

But there’s a contradiction here

However, the new criteria raise two problems. First, there is a clear contradiction between improving productivity and generating jobs. Obviously the more people employed with the same amount of capital spending means unit productivity declines, and vice versa. On this count, the government still hasn't decided in which world it stands - one that encourages innovation and productivity with the knowledge that this means fewer workers producing more, or one that encourages more employment, even at the price of lower productivity. The government for now is glossing over this issue and including both criteria despite the inherent clash between them.

The second problem is that God is in the details. Things get extremely complicated when trying to measure innovation and productivity. After all, exactly how is innovation measured? The government chose eight measures, including research and development investment as a percentage of turnover, the number of patents in use, purchase of new technology, new product lines, sharing of knowledge with companies around the world, compliance with advanced production standards, and continual improvement in labor productivity. However, it still acknowledges that these are merely indications whose concrete value is very hard to estimate.

The new policy is still in its infancy and fraught with problems, but it could prove a milestone. Just as the government's Yozma venture capital fund sparked Israel's startup industry in the early 1990s, making grants conditional on old-line businesses innovating and raising productivity could mark the beginning of a managerial-cultural change in Israeli industry.

Israel must improve its labor productivity if it wants to remain an advanced and competitive economy. Therefore, focusing managerial attention in the industrial sector on the issue of productivity is absolutely critical. Now it just remains to be seen if the government dares to deal with the main focal point of low productivity - namely the public sector itself.

AP