Analysis

Things in Israel Are Expensive, So Why Are We Still Spending Like Crazy?

Israelis complain about the cost of living, all while taking vacations abroad, buying cars and dining out at restaurants

A coffee shop on Tel Aviv's Rothschild Boulevard, July 20, 2019.
Tomer Appelbaum

There is an internal contradiction between Israelis’ two most common complaints in recent years. They gripe about the high cost of living and about how crowded everything is – the traffic on the roads and the lines at restaurants and the airport. But if prices are so high, how are people managing to live it up?

Economic theory dictates that high prices should curb demand. Despite the high cost of living and the people’s complaint about high prices for almost everything, in recent years growth in the Israeli economy has been driven by high household consumption. People are complaining but they are also spending.

There are several reasons for this. Low interest rates have reduced the cost of buying on credit. Meanwhile, the cost of housing has doubled over the past decade, giving those who own a home a sense of wealth that whets their appetite for consumption. And then, of course, Israel’s low jobless rate and raising salaries also play a central part in the growth of consumer spending, because more people are earning a living.

Some have even argued that the rise in housing prices has increased private consumption for another reason: Young people who can’t buy a home due to the cost are convinced that under the current circumstances, they might as well spend their spare cash rather than save it. If they can’t afford an apartment, at least they can dine out, shop and take vacations.

The one area of the economy where the contradiction between the high living costs and stiff demand is particularly apparent is the car market. Cars and gasoline are both expensive in Israel, mainly due to taxes imposed on them. The high prices should have lowered the use of private cars and encouraged Israelis to use public transportation, killing two birds with one stone. But there are solid reasons for Israelis’ preference for their own cars.

Cars are readily accessible thanks to the recent expansion of the automobile leasing market, and for those who want to buy one, cheap credit is available. In addition, there is a dearth of efficient public transportation in many areas.

According to the Central Bureau of Statistics, private consumption jumped 7% in the first quarter of this year. The figure reflects an annual increase of 5.1% in private spending. As in prior years, the increase has been affected in a big way by the automobile market, where spending is up 63%.

Every two years, the Finance Ministry adjusts taxes on cars as a matter of environmental policy; sometimes there is a surge in car purchases in anticipation of higher green taxes. This fluctuation in car sales has a major impact on consumer spending figures.

Even without changes in the green tax, however, automobile purchases have been a major component in the growth of private consumption in recent years due to the cheap car loans available from banks and other lenders. As a result, in 2017 the Bank of Israel’s Supervisor of Banks Hedva Ber warned the commercial banks over the credit risks involved in their car loan business. That did curb credit for car purchases to some degree.

The growth in consumer credit in general has been halted in recent years. At the end of the first quarter of 2019, it was 198 billion shekels ($55.9 billion), similar to the level a year earlier. That’s evidence that the growth in consumer spending is not the result of households buying on credit to a larger extent. Consumer credit per household had crept up from 38% of Israel GDP in 2007 to 42% in 2017.

Strong shekel and strong consumer

It’s doubtful that the cost of living will be a major issue in the run-up to the Knesset election in September, although a few candidates, including Democratic Israel’s Ehud Barak and Hayamin Hehadash’s Naftali Bennett, have made noise about lowering prices.

The common wisdom is that everything in Israel is expensive, and that’s generally true. Housing, cars, gasoline, hotels, parking and natural gas are in fact expensive. Prices in Israel are 20% to 25% higher than the average for Organization for Economic Cooperation and Development countries, which Israel is a part of. When Israelis travel abroad, they can see the difference.

In the first half of this year, Israelis have racked up 3.8 million trips abroad, a figure 7.4% higher than the first half of last year and a 58% jump in four years. The Open Skies aviation liberalization agreement that Israel signed with the European Union has lowered fares and expanded the number of flights from Israel, and the shekel has strengthened against the greenback, the euro and the British pound, boosting Israelis’ purchasing power abroad. These trips have made it obvious to Israelis what is cheaper abroad and what they might purchase while they are overseas.

But actually, they don’t need go overseas to get a good deal. Similar prices are also available to Israelis who shop on foreign e-commerce websites (something that Israelis have done in much larger numbers in recent years). They can also take advantage of the strong shekel in the process.

The U.S. dollar is trading at about 3.54 shekels, compared to 3.78 at the end of 2018. The British pound is at 4.40 shekels. It was trading at 4.83 at the beginning of the year. And the euro is down to 3.95 shekels, compared to 4.32 at the end of 2018.

A strong shekel should also lower the cost of imported products sold in Israel, but many sectors of the Israeli economy are marked by a distinct lack of competition, which means that some importers are able to pocket the savings from the rise in the shekel rather than passing it along to the consumer.

Saving less?

One of the main reasons for increased spending among Israeli consumers is undoubtedly the rate of participation in the workforce, which is on the upswing – as are salaries. For poor Israelis, almost all of the increase in their disposable income has gone to consumer spending.

The unemployment rate has been steadily dropping. In April 2019, it was at a low 3.2% (among those of prime working age, 25 to 64) compared to 5.7% in mid-2013. During that same period, the rate of workplace participation steadily rose from 74% to 77.7%.

There is major significance in the consistency of the increase, because it has given people a sense of job security, which in turn affects spending. Even more importantly, it’s happening as wages have been rising, particularly over the past two years.

Now we should look at these major trends together: low interest and cheap credit, high housing prices that give homeowners a sense of wealth while sending the message to those who don’t own homes that “there’s no way I can buy an apartment, so why not spend my money?” When you add high rates of employment and growing salaries, you get very strong consumer spending that in turn is growing the economy.

Officials at Israel’s central bank see a strong link between wages and increased consumer spending, but in analyzing the numbers, they try to eliminate the impact of the volatile automobile market. They focus instead on non-durable items (excluding cars and heavy appliances). What they then find is that spending growth is linked to wage growth.

That may seem self-evident, but from the standpoint of the Bank of Israel it’s an important finding that shows that Israel isn’t experiencing an unsustainable bubble in consumer spending. In other words, the growth in consumer spending is based on real wage increases and not just a feeling among homeowners that they’re rich – or the result of households overextending their credit.

The Bank of Israel’s conclusion, however, is that if the link between rising salaries and rising consumer spending remains strong, consumer spending will not continue to increase substantially because the job market is close to its full potential.

There is possible concern that low interest rates are also causing us to save less and devote a larger portion of our incomes to consumer spending. After all, banks are not paying significant interest on our savings. That’s causing some of us to divert our funds to investments in housing and capital markets. Some may also be going to increased spending on consumer goods, but the data don’t bare that out in a significant manner.

Lack of pressure

All of this makes one wonder how the cost of living in Israel can be brought down as long as consumer demand is high. In practice, Israelis are voting with their feet, vacationing abroad, buying cars and going out to eat. That takes substantial pressure off the government to do something about the high cost of living.

It’s reminiscent of the story of the college students who staged a protest about the cost of tuition and threatened a strike, but also complained that it was impossible to find a place to park around campus. How do you complain about tuition when campus parking lots are chock full with students’ private cars?