Treasury: High Defense Costs, Poor Training of ultra-Orthodox Slacken Israeli Productivity

Report warns that government may not be able to solve all barriers to boosting key economic indicator.

Olivier Fitoussi

The Finance Ministry’s chief economist on Sunday blamed Israel’s high defense costs and low levels of training and education among Israeli Arabs and Haredim for the country’s dangerously low rate of labor productivity .

But, it warned, that the solutions would not always be easy to come by and that some policies that were otherwise good for the economy at the same time impinged on productivity. Nevertheless, the government had to act where it can, the report said.

“This issue is of critical macro-economic importance because labor productivity affects directly and in a significant way the standard of living,” the treasury said.

Israeli workers produced $36.70 of value-added per hour in 2013, 24% less than the average for countries belonging to the Organization for Economic Cooperation and Development. Among 34 OECD countries, Israel ranks 24.

In the 1990s Israeli labor productivity was about 70% of the level in the United States; by 2012, it had fallen to under 60%, the treasury said. Israel’s rate is about one third the level of productivity leaders Luxembourg and Germany, and is only slightly ahead of countries like Greece and Portugal.

Nevertheless, Israel is not in a position to rectify all the barriers to higher productivity, the report said, pointing to the increase in defense spending at the expense of the civilian budgets.

Although it has been in decline over the last decade, Israel’s defense budget remains high as a percentage of gross domestic product, compared to other Western countries. After years of decline, it grew to 6.4% of GDP last year from 5.6% in 2013. 

“If the government were to decide to move funding from defense, it would help productivity, but that figure will be difficult to change given the geopolitical situation today,” the report said, estimating excessive defense spending costs $3.10 of lost productivity per worker per hour, every year — or nearly 10 percent of worker productivity.

Israel’s high-tech sector is internationally competitive thanks in part to the high level of education in Israel. But the government’s efforts since 2003 to push more people into the labor market — women, by reducing child allowances — means there are more employees with less training and experience, particularly Haredi men and Israeli Arabs, who are filling low-paying, low-productivity jobs.

It estimated low education and training levels in the Haredi and Arab sectors reduced Israeli productivity by $2 an hour.

The back-to-work campaign has worked, increasing the percentage of Israelis of working age who hold jobs amid record low unemployment. Now, the treasury said, the government has to address the productivity problem it has created with more and better training programs, the report said.

The report also cited Israel’s large black economy, whose output doesn’t get included in GDP figures, and technical issues such as the underreporting of intellectual property in national accounts.

Israel’s young population, relative to most OECD countries, means its workers have less experience and shave some $2.60 off the average productivity figure. The treasury said that there was little policymakers could do to change this, apart from waiting for the inevitable aging of the population.

Still, the treasury said, Israeli companies underinvest in machinery and equipment, which reduces labor productivity by about $5 a hour. Israel should be able to close the gap with the OECD by more private and public sector spending, it said.