An excerpt from the upcoming "Recent Economic Developments" that will soon be published: The development of wages in Israel over the past two decades
An excerpt from the upcoming "Recent Economic Developments (138)" that will soon be published: The development of wages in Israel over the past two decades.
Graphs & Data
v The wage per employee job and output per worker increased at a similar rate in Israel from the mid-1990s through 2013.
v Real wages were marked by considerable fluctuations in the beginning of the past decade, so the assessment of the rate at which wage per employee job increased in the past two decades is sensitive to the years chosen to compare.
v Wages in Israel increased at a faster rate than wages in OECD countries at the end of the 1990s and in 2000–01, and in the following years the gap closed. On average, wages in Israel and in the OECD increased at a similar rate in the past 20 years.
v Wages in Israel are relatively low because average productivity per hour of work in Israel is relatively low compared with the corresponding figure in other OECD countries.
v As for the labor share in GDP, Israel is not all that different from other OECD members, both in terms of its level and in terms of its decline over the past 15 years.
1. The trend of wages over time
Labor wage is the main source of income for households in Israel—representing more than 70 percent of their income, on average—so its level and its development over time serve as a main socioeconomic indicator. Periods of time in which the wage is increasing slowly are possibly marked by a standstill in the standard of living for the considerable portion of the population for whom the wage is the main source of income. Such periods are also sometimes marked by a decline in the labor share in GDP—an indicator of the distribution of income between capital and labor—and thus also to widening income gaps.
An examination of how the average real wage per employee job has developed in Israel in recent decades finds that the level today is similar to its level at the beginning of the previous decade. This finding features prominently in the public discussion on trends in the Israeli economy, and at times it is attributed to structural changes that have reduced workers’ negotiating power. However, the data presented below indicate that in the past decade it is difficult to identify a significant, unexplained, moderation in wages.
The path of wages from the beginning of the previous decade indicates that the answer to the question “how much did wages increase?” is markedly affected by the point chosen to compare against. Figure 1 indicates that alongside a long-term trend of increase, real wages develop with considerable fluctuation between particular years, so that the measurement of the change during this period is very dependent on the base year. To illustrate, from 2001 until 2013 wages declined, although since 2003 they have been on an increasing trend, which is similar to the longer term trend. The rapid increase in wages in the second half of the 1990s, and in particular the sharp increase in 2000–01, stands out. This development began with the comprehensive wage agreements signed in the public sector, continued as a result of the strong response by business sector wages and an unexpected decline in the rate of inflation, and reached a peak in 2001, a year in which there was a sharp turnaround in growth and in the rate of increase in prices. That is, though wages have in fact essentially remained in place since the beginning of the previous decade, but this standstill came after very rapid growth in the preceding years.
In order to examine the development of wages in a more precise manner—that is, beyond the effects of business cycles or other short-term noises—two points in time with similar output gaps should be chosen. Based on accepted estimates, the output gap in 1996 was similar to the gap in 2013. From 1996, the real wage increased at an average rate of 0.8 percent per year, similar to wages’ average rate of increase over the past five years.
For an increase in wages to be sustainable, it must be accompanied by an increase in labor productivity; otherwise, the worthwhileness of employment will decline over time and the economy’s competitiveness will be negatively impacted. Therefore, it is accepted to examine the development of wages based on the extent of their increase relative to an accepted measure of productivity—output per worker, which is the ratio between business sector product to the number of employees in the business sector. Output per employee increased from 1990 at an extremely stable pace, of about 1.0 percent per year (Figure A-1), and there is a stationary ratio between that and the average wage per employee job—that is, the ratio does not have a long-term trend (Figure 2). The figure also indicates that wages increased at an extraordinary rate, more than output per employee, from 1998–2001, and by 2003 returned rapidly to the long-term average. Since then, the ratio between wage and productivity has been extremely stable, revolving around the long-term average.
2. International comparison
Examining the development of wages in Israel compared with advanced economies (an average of the 19 members of the OECD for which there are comparable data), presents a picture similar to the one obtained from a historical comparison of domestic data: wages in Israel increased rapidly from the end of the 1990s until 2001, and then converged to the trend line of other countries (Figure 3). Over the entire period, wages in Israel increased at a similar rate to that in other countries.
The data highlight the difference between Israel and other countries from the perspective of the response of wages to the global financial crisis: in Israel, wages declined, while in other countries they continued to increase in 2008 and only then did they stabilize. Wages in Israel are marked by high flexibility relative to other countries, and it appears that this flexibility contributed to the response of domestic employment being shorter and more moderate.
Compared with the other OECD countries, the level of wages in Israel is in line with labor productivity: in 2012, average productivity per labor hour in Israel was around 73.4 percent of the OECD average, and the average wage per hour was around 74.7 percent of the average (based on purchasing power parity).
a Australia, Austria, Belgium, Canada, Denmark, Finland, France, Hungary, Italy, Japan, South Korea, Luxembourg, the Netherlands, Norway, Slovenia, Spain, Sweden, Switzerland, the US, and the UK.
b The variable represented is equal to the product of (1) the ratio between total wage payments in the economy and the number of employees, and (2) the ratio between the average number of hours worked by a full-time employee and the average number of hours worked by all employees. This serves as an estimate of the average wage for an employee in a full-time position. The data in Israel are calculated based on annual Income Surveys.
Israel is in the middle of the distribution of OECD countries both in terms of the labor share in GDP, and when examining the decline in this share in the past five years.
3. Other domestic factors impacting on wages
The trends presented above refer to gross wages. However, over recent decades, the average net wage increased by more than the gross wage, due to income tax rate reductions. Since 1996, net wage per employee job increased at an annual rate of 1.2 percent, while gross wage increased by 0.8 percent; since 2001, net wage increased by 0.7 percent per year, while gross wage declined by 0.2 percent, and since 2003, net wage increased by 1.7 percent while gross wage increased by 0.7 percent. That is, the reduction of tax on salary allowed an increase in employees’ wages and the moderating of their wage pressures, without increasing employees’ salary expenses. Brender and Politzer (2014) found that the tax reductions implemented since 1992 were divided between employees and employers at a ratio of about 60 to 40, respectively. This calculation of course refers to average salary, and there are notable differences between employees in the extent that they were affected by the change in taxation, especially based on their level of income.
In addition to tax reductions, there have been two processes in the economy recently that increased the return on labor and the cost of labor, but are not directly reflected in the real wage per employee job, as it is measured here:
1. Income grant (earned income tax credit, or negative income tax): Including this grant in the calculation of average salary per employee job would increase the salary in 2012 by 0.2–0.3 percent.
2. Required pension allowance: Since 2008, every employee and employer in Israel is required to set aside funds for a pension. The share of employees who set aside funds for a pension increased from about 60 percent in 2007 to more than 80 percent in 2012. As the cost to the employer is at least 12.5 percent of gross wage, including this component in calculations would have increased the cost of labor measured in the economy by about 1.5 percent on average.
Yet at the same time, employees who join the public sector today save in defined contribution funds, instead of defined benefit plans, and this change reduced the effective net wage for some employees, particularly in the past decade, but is not reflected in the measurement.
This survey examines how the average real wage per employee job in Israel developed in the past two decades. It indicates that over the medium term, as well as in recent years, it is very much correlated with the development of output per employee. In the medium term, the wage is also impacted by other short-term factors, so that the assessment of the manner in which wage changes over time is a function of the years chosen to compare. This is especially true when major changes occur in a short period of time, like in the end of the 1990s and beginning of the previous decade. The survey also indicates that wages in Israel increased over time at a similar rate to most OECD member countries, and that the ratio between average wage per hour and output per hour of work is similar to the average ratio in those countries.
 A broad discussion of the development of wages during those years, with a distinction between the private sector and public services, may be found in Mazar, Y., “The development of wages in the public sector and the links between it and salary in the private sector”, Bank of Israel Survey (forthcoming).
 In the short term, the average wage is affected by wage agreements in the public sector, changes in the minimum wage, inflation surprises, the business cycle (via the effect on demand), and supply shocks such as the large-scale immigration from the former Soviet Union in the early 1990s.
 The output gap is the difference between actual GDP and potential GDP (the GDP under full employment). A discussion of the calculation of the output gap appears in: Menashe Y. & Y. Yakhin (2005), "Mind the Gap: Structural and Nonstructural Approaches to Estimating Israel Output Gap", ISER No 2.
 Output per worker includes self-employed workers, while wages are calculated for employee jobs. Nonetheless, since the share of self-employed workers in the economy’s employment did not change markedly over the course of the period, their exclusion does not bias the trend calculation.
 The annual rate of change ranges from 0.9–1.1 percent, based on the time period chosen.
 A basic statistical test confirms, with a confidence level of 5 percent, that from 1980 through 2012 this ratio was stationary.
 An expanded discussion appears in Bank of Israel Annual Reports for those years, particularly in the chapter dealing with the labor market. It was also found that the flexibility of the share of wages in GDP, relative to the output gap in Israel, is relatively high compared with the other OECD countries and with their average. See “Israel’s Cyclically Adjusted Deficit” in Recent Economic Developments #132, September–December 2011 (Bank of Israel).
 The comparison with the OECD does not include Turkey, Chile, Iceland or Mexico.
 A detailed discussion of the issue can be found in a box published in Chapter 6 of the 2010 Bank of Israel Annual Report. The current discussion ignores the effect of tax reductions on government services, indirect tax rates, and individuals’ expenses derived from them.
 Brender, A., and E. Politzer (2014), "The Effect of Legislated Tax Changes on Tax Revenues in Israel", Bank of Italy, Public Economic Workshop.
 In contrast, GDP is divided this way: 66 percent return on labor, 34 percent return on capital.
 An expanded discussion appears in Box 6.1 of the 2010 Bank of Israel Annual Report.
 A discussion of the mandatory pension’s effects on wages, labor cost, and employee welfare appears in Brender, A. (2011) “The effects of mandatory pensions on return to labor”, Economic Quarterly #58 (1/2), pages 90–119 (in Hebrew); and in Brender, A. (2010) “The effect of retirement savings schemes on the distribution of income in Israel”, Bank of Israel Survey #84, pages 87–123 (in Hebrew).