Good afternoon,
I am very happy to be here today. The Eli Hurvitz Conference on Economy and Society deals this year as well on issues of policies that impact, and will continue to impact, on the directions in which Israel’s economy will develop in the coming years. In my remarks I would like to examine where the labor market is headed, and what policies we can adopt in order to bring workers, and the economy as a whole, to a better place. However, before I touch on that central issue, I will try to outline an up-to-date picture of the macroeconomic environment.
Israel’s economy has been operating in recent years in a global economic environment that has become complex and challenging, and we also have domestic challenges. Last month, I participated in the IMF and World Bank annual meeting, which took place in Washington, DC. The general atmosphere was somewhat gloomy, though definitely not at a crisis level. During the conference a new term, mediocrity, was used to refer to what is expected for the global economy—the low productivity, and the importance, while at the same time the political difficulty, in advancing reforms that can change that. Also discussed, in addition to reforms, was the need to invest in infrastructures that will also work to improve productivity. The assessment is that the potential growth in most countries, both advanced economies and emerging economies, is markedly lower today than it was before the crisis.
As for the short term—the 2015 global growth forecast was again revised slightly lower, to 3.8 percent, and world trade volume, which is an important variable for the Israeli economy, is expected, according to the most recent forecast, to expand by 5 percent. This is the central scenario, though the uncertainty around that scenario was strongly emphasized, and the risks clearly tend toward the downside.
Against the background of moderate growth which is affected by developments in the global economy, and in light of the near-zero inflation rate, the Bank of Israel’s Monetary Committee adopted monetary policy that contributed to reducing the negative impact on our activity of a deterioration in the global economy. We acted by interest rate reductions to a very low level, as well as by foreign exchange market intervention. The low interest rate acts to encourage activity through various transmission mechanisms, and recently it acted primarily by creating shekel depreciation, which was also supported by the strengthening of the dollar worldwide. The depreciation is expected to improve the tradable sector’s ability to compete, and thus support an economic growth process.
The Bank of Israel is committed to meeting the inflation target and to supporting economic activity, as its objectives are defined by law. The standard tool of monetary policy—I refer, of course, to the interest rate—is nearly exhausted, and as we announced, we are examining the need to use various tools in order to achieve the policy objectives, while we are closely following developments in the inflation environment, activity, the global economy, and the exchange rate.
We are of course aware of the risks as well. For example, the very low short- and long-term interest rates worldwide, and the Bank of Israel interest rate which is influenced by those rates, have an impact on the mortgage and housing market. In order to reduce the risks in the mortgage market in such a low interest rate environment, the Supervisor of Banks took the step of increasing capital requirements in order to increase the buffer for absorbing shocks should they occur, and this followed a series of measures adopted since 2010 that were intended to reduce the risk characteristics of mortgages.
Fiscal policy, which over the past decade has acted to reduce the debt to GDP ratio, is also relatively expansionary: the deficit this year and next year will be greater than 3 percent, government expenditure is expected to grow, in real terms, by 3.9 percent in 2015, after an increase of 3.4 percent in 2014, and most tax rates will remain at their current level. While the expansionary fiscal policy acts to encourage activity, it also incorporates an increase in government debt and an increasing burden of interest payments, which increase the burden on citizens in the coming years. In order to return to sustainable deficit levels, as the government committed to do in 2016 and onward, which will ensure the convergence with a path of reduced share of debt in GDP, a substantial fiscal effort will be needed in coming years.
Besides the issue of the business cycle, and dealing with it, which I discussed, the main challenge that we face in the longer term is to bring the economy to sustained and inclusive growth—that is, growth whose benefits are divided among the entire population—and to increase the economy’s resilience to shocks over time. In order to create a persistent and stable process of inclusive growth, we need to advance a series of structural reforms. Naturally, such reforms are likely to encounter opposition from groups that are liable to be negatively impacted by them in the short term. However, they are the key to increased productivity and efficiency, and they will contribute to the economy’s ability to develop and to be more resilient to shocks over time. The various sessions in this conference will deal with some of the required reforms.
In light of the forecast for relatively moderate growth of the global economy in the coming years, and in view of the demographic developments that are expected to slow the increase in the labor force, our potential growth will be considerably dependent on our ability to invest in growth drivers, to advance reforms, and to implement them. These reforms will need to focus on encouraging innovation and creating a supportive business environment (by the way, Israel’s ranking on the Doing Business survey of the business environment declined this year as well) by reducing bureaucracy and adopting smart regulation. We will need to determinedly advance a list of structural reforms, such as in the electricity market, ports, and in all areas related to increasing the efficiency of public services. In addition, we will also need to wisely utilize the natural resources we recently discovered by, for example, rapidly connecting energy-intensive industries to the natural gas pipeline.
At this point I just want to parenthetically refer to the Sheshinski Committee, which regulated the government’s receipts from natural resources in a manner that balances ensuring the public a fair share over time in the natural resources and taxation which leaves a suitable return, and reduces uncertainty for entrepreneurs and the producers of those natural resources. The committee proposes a comprehensive taxation framework for natural resources in Israel that will be with us in the future as well. I attach great importance to the implementation of the recommendations and call on the government to adopt them as soon as possible.
The list of reforms would be incomplete without the reforms necessary in the labor market. The ramifications of the processes in the labor market on the economy’s inclusive growth potential are extensive, and it is therefore important to focus on the challenges posed to us by this market and on the policy tools needed in order to deal with those challenges.
In the labor market, there are temporary cyclical processes and structural, that is, longer term, processes. The distinction between the cyclical and structural processes is not simple, but it is very important both for setting monetary policy which responds to the cyclical situation, and for formulating labor market policy that is intended to impact on the structural processes in that market. The distinction can become even more complicated when the business cycle stretches out, in which case phenomena which are essentially cyclical can become structural. (An example is the phenomenon called hysteresis, in which people who are unemployed for a long time lose relevant skills and find it harder to return to employment even after the labor market recovers.)
Incidentally, in the US as well, the Federal Reserve is involved in an attempt to make a distinction between structural and cyclical phenomena in the labor market. There, the structural phenomena are reflected in a decline in the participation rate as a result of the retirement of the baby boomer generation. In Israel, however, we have seen over the past decade a trend of rapid increase in the participation rate and employment rate in all population groups, excluding a temporary halt during the global crisis, while at the same time observing only a slight increase in salaries, and many employees are earning low wages. The unemployment rate also increased temporarily around the time of the crisis, but returned to a consistent decline since then. In the past year, the unemployment rate has stabilized, and even increased slightly in recent months, though it remains low in historical terms.
A similar trend of increased employment rates cuts across all population groups (ultra-Orthodox Jews, Arabs, and for the rest of the population – both men and women) though it is stronger among women, and contributed greatly to reducing the gap between employment rates of men and women. It should be noted that these trends are also reflected in a consistent increase in the share of households with two wage-earners, and have the effect of reducing inequality in household income.
The continued increase of the participation and employment rates, and the continued decline in unemployment, reflect structural processes. Some of those processes can be attributed to policy, and others to demographics and technology:
(1) One of the main processes that occurred derived from the reduction in income assurance allowances and child allowances in 2002–03, which encouraged populations with relatively low earning capacity to enter the work force. Naturally, such a measure creates a long term process. At first, households that relied on those allowances experienced a negative impact on income and standard of living but as labor force participation became entrenched, and employment experience—and with it, human capital—increased, their income increased as well.
(2) Another structural process is the increase in the rate of educated workers, which was in line with the increase in the share of industries that rely on educated workers, and it improved the matching between worker characteristics and workplaces’ needs. This process contributed to an increase in employment, and also increased the ability to retain workers during slowdowns in demand, in order not to lost valuable human capital.
(3) Alongside these processes, there was an increase in the efficiency of the search processes, by employees and employers, which contributed to a decline in frictional unemployment.
(4) The increase in wage flexibility and the move to facility-level agreements also led to salary responding to the business cycle and aligning itself with demand, and allowed layoffs to be avoided during temporary slowdowns in demand.
(5) The reduction in income tax reduced labor costs and increased net salary, thereby providing an incentive for employment, both for employers and for employees.
(6) Negative income tax—the earned income tax credit—provides an additional incentive for those with low earning capacity to enter the workforce.
Alongside the welcome increase in labor force participation and employment, we are seeing only a moderate increase in real gross wages, by about 0.7 percent per year, on average, since 2003. This is contrast to a more rapid increase that occurred in per capita GDP during that same time. The gap between the very moderate increase in salaries and the more rapid increase in per capita GDP can be illustrated with a simple example: Assume that the economy contains only one household, with two parents and two children. Assume that only one of the parents works, and earns NIS 100,000 per year. Divided among the 4 members of the family, the GDP per capita is NIS 25,000. Assume that due to the steps I mentioned above, the second parent enters the labor market at an identical salary of NIS 100,000 per year—the household income doubled and per capita GDP increased two-fold, but the salary in the economy remained unchanged.
Nonetheless, we still need to answer the question of why the real wage increased at such a low rate? Part of the answer lies in the composition of employees. We have seen:
(1) An accelerated increase into the labor market of workers without experience, and thus at a low salary.
(2) Related to that, an increase in the rate of part-time jobs and a concurrent decline in work-hours per employee.
(3) Income tax reductions that led to an increase in net salary and moderated the pressures for an increase in gross wages.
(4) A decline in the share of labor in GDP as part of a global phenomenon deriving from, among other things, technological changes, a low rate of investment that leads to a slow increase in capital per worker, and a decline in the share of collective wage agreements.
In connection with the technological changes, it is worth mentioning fascinating research by David Autor that was presented in the Jackson Hole symposium this past August, referring to the effect of automation and computerization on demand for different types of workers. Autor shows how the computer is in effect a substitute factor of production for some occupations—primarily those with intermediate skill levels—and a complementary factor in other occupations—those on the high end and that are based on, for example, creativity and ability to react to a changing environment, and those on the lower end of the skills ranking, primarily manual labor. We can derive from this that computerization has a different effect on the demand and salary for workers at different skill levels.
So what challenges does the labor market pose to us in the coming years?
· Absorbing populations whose employment rates and earning levels are low into the core of the labor market—based on forecast demographic trends, the share of two population groups—ultra-Orthodox Jews and Arabs—in the overall population will increase significantly. It is thus very important that the positive trends in recent years, of an increase in employment rates among those populations, continue, as their employment rates and earning capacity remain relatively low.
· The wage challenge—reducing wage gaps through an increase in the salary of low wage earners. Low labor productivity in some industries is reflected in a high percentage of employees earning a low salary, which is seen in, for example, the median wage—the salary which half of all employees earn below—is around NIS 6,000 per month (as of 2012), much lower than the average salary of about NIS 9,000 per month. This obviously also has ramifications on inequality.
· The challenge of aligning skills and schooling to the changing labor market—both because of the technological processes that I already mentioned, and because of processes related to international trade and the need to maintain and improve our ability to compete and our comparative advantage in human capital intensive industries.
What is required on the policy side?
Three groups of policy tools will assist Israel’s economy in meeting the challenges I noted:
1. A marked expansion of active labor policy. This policy includes providing up-to-date training and basic skills, placement services, mentoring services, incentives to recruit and employ weaker population groups, and subsidies of services that support employment. The result of an active labor policy in Israel, in GDP terms, is about one-third of the average in OECD countries, and it would be advantageous to adopt the OECD recommendation of markedly expanding this policy in Israel. The importance of a lifetime’s training and studying, which refreshes and adjusts itself to technological changes affecting the labor market, is especially great in the dynamic labor market.
2. The second area is aligning the education systems and professional training with the needs of a changing labor market and the needs of various population groups. A recently published OECD report found that the investment in this area in Israel is especially low, and is critical in order to deal with the needs of the labor market and with demographic trends. There is room to markedly expand professional technological education. However, one of the risks that should be taken into account, and avoided, is tracking—the delineation of youths’ professional path during school ages, on the basis of their belonging to a specific socioeconomic level, rather than based on the skills and interests that may be developed at an older age. Research conducted by economists in the Bank of Israel’s Research Department indicates that in the past, the labor market achievements of graduates of professional education were significantly lower than the achievements of academic-track graduates who are similar in cognitive skills and social-background characteristics. Another point that should be taken into account is that in a modern labor market that is dynamic and variable, a professional education, beginning in the school stage, is likely to become outdated by the end of a youth’s military service. For these reasons, general scientific technological content should be provided in the high school stage, which will enable youth to choose between professional and academic tracks at a later stage, and to concentrate professional education primarily in providing focused training after military service.
3. The third policy area is focusing tailored policy tools on weaker populations with low skills and earning capacity.
o The earned income tax credit—“negative income tax”— should be expanded. It is a policy tool that, in contrast to allowances, contributes to reducing the incidence of poverty among workers, while increasing the incentive to work. The grant in Israel is markedly lower than similar programs around the world.
o We need to closely examine, taking into account the different industries, the benefit to the economy of foreign workers, in terms of the negative impact of competition with domestic low-skilled workers, the drawing downward of wages, and the reduced incentive to bring in advanced technologies.
o We need to strengthen the mechanisms of enforcing labor laws, and focus them on weaker populations.
o To establish additional vocational centers that will encourage those who receive income assurance allowances to join the employment market and at the same time will allow the application of an effective employment test on recipients of the allowances.
I note that the Alalouf Committee recommendations, in particular those by the employment team, offer concrete solutions to the specific needs of various populations in the areas of training, assistance, incentives, etc. There is room to consider whether the minimum wage can be increased at this time, taking into account the level of productivity and the potential effect on employment.
In conclusion, I will return to macro: we know that one of the main factors for the relatively low level of per capita GDP in Israel, compared with other advanced economies (despite the relative improvement that occurred in recent years) is the relatively low labor productivity. Therefore, focused handling of the challenges posed to us by the labor market, alongside the implementation of reforms and focused investments that will be discussed tomorrow at the session on that topic, can contribute to a marked increase in per capita GDP and in the standard of living.
Thank you.