In the Money

Israel’s Economy: Should We Be Saying Goodbye to Growth?

Israel needs a big improvement in labor productivity or GDP growth slow

Visitors standing in front of a stock market ticker screen at the Tel Aviv Stock Exchange (TASE).
Bloomberg

Israelis have come to expect a thriving economy as business as usual. For the last decade, gross domestic product has expanded at a rate of 3% to 3.5% annually, wages are rising, unemployment is at its lowest in decades and the standard of living is rising. Even the economy’s weak point, the high level of poverty, is showing some improvement.

But assuming that the good times are here to stay would be dangerous. Prof. Manuel Trajtenberg, who once headed the National Economic Council, has said that the year 2018 looks disturbingly similar to the year 1972. Back then, Israelis were euphoric, but a year later things would look very different.

To get a more sober picture of what is happening in 2018, we would do well to look at why the economy has performed so well over the last 15 years. A revolution in the labor force turned Israel from a country where the percentage of the working-age population actually holding a job was relatively low to among the highest of countries belonging to the Organization for Economic Cooperation and Development.

Moreover, the improvement came in the weakest segments of the population – Ultra-Orthodox and Arab women, ultra-Orthodox men and older people.

Normally, a big rise in the labor force participation rate would lead to higher unemployment as the number of people actively seeking work grows faster than the number of new jobs available. In Israel, that hasn’t happened and the jobless rate has fallen. It’s nothing less than an employment miracle.

Large number of people flowing into the labor force should have also depressed wage growth, and for many years it did just that. But more recently, wages have been rising across all income deciles, not just for the wealthiest. Still, that leaves big gaps.

Israel’s success in raising the employment rate has been so impressive that eight years after a government committee looking into the issue published its recommendations, they are already irrelevant. So, another one – the 2030 Employment Committee headed by Prof. Zvi Eckstein – was charged with setting new goals.

Among its goals was to set higher targets for employment of Haredi men and Arab women, the only two groups that have not met the previous committee’s targets. Another important goal the panel has is to improve the quality of jobs, especially for those at the bottom end of the wage ladder.

But there’s a problem: Even if Israel can boost its participation rate from 78% to 81% as the 2030 committee is aiming for (and that’s an ambitious goal that would put Israel at the very top of global rankings), our ability to squeeze the kind of economic growth we’ve become used to will be much diminished. The employment engine can’t be revved up much more.

Eckstein, who heads Aaron Institute for Economic Policy at the Herzilya Interdisciplinary Center, said even if the 2030 committee’s goals are attained, economic growth will wane. He estimates that three quarter of the growth Israel has enjoyed over the last decade is due to the employment miracle and only a quarter from increased labor productivity.

That means if growth averaged 3.5% annually over the last decade, 2.6 percentage points of that was from the addition of more workers and only 0.9 points from all workers producing more.

Even if the 2030 panel’s targets are met, added employment will contribute 1.6% to annual growth. If productivity gains remain at the same level they have been, economic growth will be just 2.3% a year.

Why is Israeli productivity so low? The answer lies in a poor educational system, yawning socio-economic gaps, poor infrastructure, excessive regulation and inefficient government services.

The 2030 committee focused on an important component, namely job training, by proposing reforms to Israel’s technical colleges. The Aaron Institute adds to that a call to boost infrastructure spending by 20 billion shekels ($5.6 billion) annually. The Bank of Israel points to the need for better schools, especially better teachers.

These are all major undertakings. The odds aren’t good that we will succeed at all of them, but for the future of Israel we should be making the effort.