As Growth of Israel's Labor Force Sputters, Government Warns of Long-term Economic Fallout

A dangerous cocktail of retiring baby boomers, aging immigrants from the former Soviet Union and shifting demographics is brewing, which bodes ill for Israel's economic future and for the state budget.

The Israeli labor force growth is shrinking and as a result the economy's long-term growth is in danger, according to the Central Bureau of Statistics's recently updated long-term demographic forecast for the Finance Ministry. The crisis in the labor force and multi-year growth has already begun, the CBS says, and is forecasted to reach a troubling crescendo in 2019.

This is one of the most worrisome demographic forecasts ever issued for Israel, principally because parts of the forecast already aren't really forecast – they already being realized now.

The CBS forecast for Israel until the year 2059 examined the population growth rate in general and with a particular focus on the working age population of 25-64 year olds. It predicted that Israel's population growth would stabilize at a rate lower than present. Already instead of an annual growth rate of 1.9 percent for the entire population that Israel experienced at the beginning of the previous decade, the population growth rate has dropped to 1.6 percent per year. An already present implication of this is a slowing of Israel's long-term pace of growth.

The most prominent forecast findings are related to the growth of Israel's working-age population that reflect Israel's potential work force. According to CBS figures, the working-age population is expected to undergo, and in practice is already experiencing, a growth crisis.

At the beginning of the previous decade (between 2000 and 2004) the growth rate of the working age population was 2.6 percent. By 2009 this age group's annual growth rate had dropped to 2 percent and in recent years, from 2010 until 2014, it is expected to drop to 1.3 percent. Based on the CBS's forecast the working age population's growth rate will continue to drop until 2019. Afterward this age group's annual growth rate is expected to stabilize at 1.1 percent. This latter growth rate is less than half of that in the early 2000s.

A retirement tsunami

The crisis in the growth rate of Israel's working-age population, which has taken hold within less than two decades, has its roots in Israel's burgeoning number of retirees.

A massive wave of retirees is washing over the country, comprised of Israeli baby boomers (born in 1947 or later) and the crush of immigrants that came to Israel from the former Soviet Union in the 1990s (the average age of the immigrants at the time was 40).

As a result, the coming decades will host a tsunami of pension retirees, one that is much larger than the number of young adults who will reach the age of 25 and join the working-age population.

The problem is that there isn't a one-off change, but rather a permanent shift in the growth rate in Israel's working-age population. But the situation is much more serious than just that. The population of 25- to 64-year-olds is just an indicator of the economy's potential work force, in other words the total number of people in this age group who can work. The problem is that sizable sectors of the population in Israel, such as Arab women and Haredi men, have working-age people who choose not to work. The result is that the share of the working-age population that actually works is significantly lower than its potential.

For the first time, the breakdown of data in the CBS's forecast allows for the analysis of different growth rates of Israel's Arab and Jewish populations, as well as a comparison of the differing growth rates between the Jewish population (as broken down by Haredi Jews and secular Jews). It appears that the annual growth rate of the Arab populations is already (from 2010 up to 2014) 2.8 percent, which represents a slowing in that population's annual growth. The Haredi population is growing at 4.2 percent per year within the same time frame, compared to a 0.6 percent annual growth rate among the secular Jewish population. At the general population equilibrium growth rate forecasted for 2019, the rate of growth will be 3 percent per year for the Arab population, 4.3 percent per year for the Haredi population and just 0.2 percent per year (almost nothing) for the secular Jewish population.

Consequently, not only is the growth rate for Israel's entire population slowing down, but the growth rate of the principal population group that works and maintains a high level of productivity is falling to practically zero.

Party like it's 2059

Nevertheless, according to the CBS forecast, the general working-age population's annual growth rate is expected to improve slightly by 2059, as will the growth rate for the secular subset of that population.

Israel's population growth rate will apparently stabilize at 1.3 percent per year, while the secular population's annual growth rate is expected to vary between 0.2 and 0.9 percent.

In light of this, it is clear that what Israel experienced until the beginning of this decade will no longer be true. The annual growth rate of 3.5 percent that Israelis grew accustomed to over the years is a dream that has dissipated. Israel is heading toward an era of much lower fixed growth. Its growth potential is expected to shrink by as much as one third and to fall to 2.5 percent per year. All of this isn't some prophecy of the future. It's happening already.

This has some far-reaching implications for state budget planning: The assumption that the economy will continue to grow an average of 3.5 percent per year and that the growth of revenue from tax receipts will match no longer has a basis in fact. Even if this assumption may hold for the 2013-2014 budgets, it apparently won't for the budget that follows it.

The general level of expenditure in the budget is also determined using a formula based on the average growth rate over the past decade. This rule is now becoming problematic as the average growth rate in the previous decade isn't relevant to the growth forecasted for the current decade. As a result, the rate of government expenditure in proportion to forecasted GDP will increase rather than decrease.

Based on the CBS analysis, the principal increase in government expenditure will occur in the category of welfare spending, apparently at the expense of defense spending and servicing interest payments on government debt.

The implication is that Israel's budget deficit and national debt, which are supposed to decline (relative to GDP) until the end of the decade, apparently will not decrease. Likewise, Israel will need to implement drastic steps in order to prevent a budget crisis beyond 2013-2014, such as sharply increasing taxes or implementing heavy budget cuts. In other words, Israel will need to abandon the government spending formula it has set, since it can no longer afford to fund that level of expenditure.

In order to prevent an ongoing budget crisis, the Finance Ministry is planning a whole slew of reforms to increase Israeli productivity and competitiveness, principally increasing the rate of workforce participation among Haredim and Israeli Arabs. Only long-reaching reforms stand a chance of putting the brakes on the almost inevitable decline in Israel's rate of economic growth.

Alon Ron