The Israeli Finance Ministry announced a revolution this month. Not a revolution that will be, but one that has already happened – but only now they have bothered to identify it and give it a name. It is the “technology revolution,” which Israel has been going through since 1991.
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During its 67 years of existence, the Israeli economy has gone through three eras, each followed by a revolution. The first was that of the first two decades after the establishment of the state, an era when the foundations of the economy were created. During the 1950s and 1960s the economy grew at an annual pace of almost 10%, faster than China today. This was the result of huge investment in construction and industry, which allowed Israel to catch up in many ways to developed nations.
The second era was one of economic crisis, the years 1973 to 1990, which started with the Yom Kippur War and has earned the name the “lost decade.” Economic growth plunged to an average of just 3.5% a year, while productivity growth dropped from 5% to only 1.2%.
This low point in Israeli economic history ended with the mass immigration from the former Soviet Union. A new study from two economists in the Finance Ministry, Lev Drucker and Assaf Regev, noted that the years since 1990 have not only been characterized by much better economic numbers (with the annual growth rate averaging around 4%), the type of growth has changed. If before 1990 it had been based on huge capital investment directed at a poor country with underdeveloped infrastructure, since then, investment has been less of a factor.
The first influence was research and development, where Israel has spent heavily since 1990, enabling technology to become the main engine of growth. The second factor was government policy and the policy of reducing defense expenditures. That freed up resources for investment in growth-inducing areas like education and infrastructure, while sending a message to the business world that the risk premium Israel suffered from being in the Middle East was no longer so significant. As a result, investors were willing to take greater risks. The third factor that pushed growth up since the early 1990s is its relatively rapid population growth, which has meant a fast-growing labor force.
What is weighing down the Israeli economy more than anything else now is its low productivity. Israeli workers may work long hours, but they produce relatively little added value for all their labors. This is one key area where the revolution of the 1990s did not bring with it any positive news. In fact, the gap between productivity in Israel and the United States has been widening. That stands in sharp contrast to Israel’s first two decades, when the gap in per capita GDP compared to the U.S. steadily narrowed.
Lagging behind in per capital GDP means Israel is lagging in its standard of living. The rapid rise in Israel’s population may be adding to overall economic growth, but shrinking productivity means Israelis aren’t benefitting from it.
Figures from 2013 show that productivity per worker in Israel was 24% lower than the average for developed nations. Compared with the U.S., per capita productivity was almost 50% less.
Losing to America
In the 1990s our productivity was still equal to 63% of that of the Americans. In other words, within 15 years the productivity of an Israeli worker deteriorated by some 10% versus an American worker – and that happened during a period when Israel was undergoing a technological revolution, reinventing itself as the startup nation. Israelis, it turns out, are great at technology but not so great at working. And no, that is not because we don’t work very hard here.
An analysis by Regev from the chief economist’s office in the Finance Ministry shows that while the productivity per hour in Israel is 24% below the average for the developed world, the productivity per worker is only 13% lower. That’s because Israelis work a lot of hours, which compensates for how little added value they produce for each hour on the job. But working long hours isn’t as smart as working smarter to begin with – producing the same amount of added value in fewer hours.
Why are we such poor workers? Regev’s analysis shows this has a great number of causes. Defense expenditures, even though they are lower than in the past, damage productivity by diverting resources from investment in education and infrastructure. Israel’s lingering security risk deters investment, and because young people serve in the army their key job-training years are delayed. Altogether, these reduce productivity by 14%.
Another element is the poor education levels of Haredim and Arab Israelis, which in turn reduces their productivity considerably and contributes another 6% decline in the nationwide productivity figure. The weight of low Haredi and Arab productivity has grown over the last decade, but there is a positive side to this otherwise unfortunate development: As more Haredim and Arabs enter the labor market, it has meant an increase in the number of poorly trained and educated workers, the kind that suffer low productivity. In fact, this may be one of the major reasons for the deterioration of Israelis’ productivity in comparison to that in the U.S.
But these new workers have also made an enormous contribution to economic growth and per capita GDP growth, so the change is still a fundamentally positive one.
Finally, the one factor that damages Israeli productivity more than anything else is the low level of investment, which is among the lowest in developed countries. Our capital investment is 26% lower than the average for developed nations; only Poland, Turkey, New Zealand and Mexico invest less than we do. This factor alone has reduced our productivity by 14%.
Sectorial labor productivity and the overall productivity of Israelis are lower than the average level in the OECD in every one of the industries examined, writes Regev. This means it is not the structure of the industries that is responsible for Israel’s relatively low productivity, but the low levels of efficiency across all industries, including finance, real estate, business services and agriculture.
It is not only the Finance Ministry’s chief economist who thinks this way. The governor of the Bank of Israel, Karnit Flug, also thinks so. On Monday she devoted an entire speech to the problem and blamed it for the fact that our standard of living is well behind most of the developed world. Our economic policies may enable us to fully exploit our short-term economic growth potential, but refusing to change them will push us backwards in the end, she warned.
The historical lesson is that Israel finessed the move to high technology in the 1990s, but has failed since then to make the same revolution in efficiency and labor productivity. After two and a half decades of reaping the fruits of high tech, the time has come for a revolution of management, efficiency, competitiveness and high productivity.