Four recommended pillars of strategic government action to accelerate economic growth and a fiscal framework for financing them
The economic program in this document is being presented more than three years after the approval of the last budget and about two years after the Bank of Israel submitted a special report to the government on the level of labor productivity in Israel as a primary cause of the gap in the standard of living between Israel and other developed countries, which included recommendations to improve the situation.
During the COVID-19 crisis, public attention and economic policy were primarily focused on responding to the pandemic and its effects. The recovery of the economy now calls for the government to focus on achieving rapid growth and preventing any long-lasting damage from the crisis. However, at the same time, it is important to deal with the challenges to the economy that extend beyond the COVID-19 horizon. The crisis did not change the strategic issues that the Israeli economy must deal with, but it did highlight aspects of their importance and urgency. The formulation of a plan to deal with these fundamental problems, as presented in this document, is crucial in view of the time that will pass between initiating the processes and their coming to fruition, and because setting out a well-reasoned plan for the long term may help the economy exit the current crisis.
In this document, we highlight four policy pillars that correspond to the core strategic issues. These policies will contribute to long-term growth by creating conditions for increased productivity in the real economy, to the development of financial markets, and to the narrowing of gaps in economic earnings and worker skills. The pillars presented in the document set out the optimal directions for policy in the short and long terms and describe the changes that have occurred in the various domains during the past two years and in particular during the COVID-19 crisis. The fruits of some of the proposed policies, such as regarding issues related to transportation and the development of human capital, will be seen only in the medium and long terms. However, unless these processes are initiated immediately the problems will be exacerbated and will remain unresolved even in the long term.
Some of the issues described in this document have already been dealt with to some extent by the relevant government bodies, and in a few cases considerable public effort has already been invested. In these cases, the document highlights the importance of the directions for action, since experience shows that the distance between deciding on the policy directions and measures and their full implementation can be significant. Following the description of the policy pillars, a long-term fiscal framework is presented, which will be necessary to achieve economic stability and the success of the economic program.
The four pillars upon which this document is based focus on the following areas:
1. Development of human capital: Human capital constitutes a critical component in the growth of modern economies. It is accumulated primarily in the education system, and the quality of education is therefore of major strategic importance. This document presents a series of recommendations for improving the quality of the education system’s output at all levels: from improving the educational component in early childhood daycare frameworks and particularly among weak populations, to the quality of the general education system and its teachers, with particular focus on increasing the extent to which this will help narrow gaps resulting from a pupil’s socioeconomic background, and finally, to occupational education and vocational training for the adult population. The recommendations stress the need for additional resources to be invested in children from a weak socioeconomic background, in view of the prime importance of the education system in this case and due to Israel’s particularly large lag in achievement among children from a weak socioeconomic background relative to other developed countries. The effect of this lag on macroeconomic performance is already significant, and is expected to grow in the coming decades.
2. Investment in physical and technological capital and infrastructure: The physical and technological capital used by businesses, and the quality of the transportation, housing, communication, and energy infrastructures, have a direct effect on labor productivity and GDP growth, and therefore also on quality of life. The recommendations in this document relate to how to encourage investment in capital and the adoption of technologies that can boost productivity in the entire business sector. These include increasing the investment in public transit, communication, and energy infrastructures; improving the business environment; and developing human capital, as mentioned above. The document suggests ways to advance in all of these channels while taking into consideration the modifications that need to be made, such as the regulation of demand for energy in view of the international targets for maintaining environmental quality, shortening the time needed to complete public transit projects in the large cities and the removal of barriers to expansion of some of the communication infrastructures. The recommendations also call for increasing the supply of housing in the high-demand areas by facilitating urban renewal and improving the incentives for local authorities to absorb new residents.
3. Development of the financial system: The removal of barriers to the development of the financial system and introduction of various credit products will increase the efficiency of the credit market and the public’s access to sources of credit. This analysis emphasizes the gap between Israel and the other developed countries in the quantity of credit provided to the business sector from nonbank sources. The recommendations relate to the development of new markets and the elimination of barriers and distortions in order to develop the financial system. This will in turn increase the variety of financing possibilities available to savers and investors, increase the efficiency of the allocation and pricing of credit, and facilitate a more efficient allocation of risk among the financial institutions.
4. Improving the regulation and use of technology to streamline government activity: Efficient, precise, and transparent regulation is beneficial for business activity. It reduces the direct costs of complying with excess requirements and the cost of bureaucracy (in time and money) both for businesses and for the government itself. This kind of regulation also reduces the uncertainty and risk in business activity. The integration of technology, such as advanced data systems, within government activity improves the execution of processes within the government and its interface with individuals and firms; improves service to the public; and enables the efficient management of the data possessed by the government in support of decision-making and innovation. Moreover, the use of technology in managing the government’s information and data and its interface with the public supports the government’s ability to manage regulation more efficiently. The recommendations appearing in this document highlight the necessary policy directions and emphasize the need to accelerate and broaden processes that have already begun in the public sector to improve existing regulation and to wisely implement new regulation, while taking into account its economic consequences and its benefit in reducing risk. This report recommends a switch from “regulation at the gate”—i.e. obtaining permits prior to the entry of goods or the initiation of a new business activity—to a model that relies on declaring compliance with regulations and greater supervision in the markets. The recommendations in the report also relate to the need to encourage and integrate advanced digitization in the management of data and information and in government services.
The main benefit of the recommendations in this document will be achieved in the long term. However, their implementation involves significant fiscal cost in the medium term. In order to implement the recommendations, an institutional-economic framework is needed that can exist outside of short-term constraints, and that supports the government’s long-term targets, such as those being proposed in this economic program. This framework must include effective fiscal rules that take into account the volatility of the macroeconomic environment and of tax revenues; a rational work process for the State budget; and the reactivation of the Numerator rules.
As a first step in adopting this economic program, and in view of the growth in public debt during the COVID-19 crisis, the government must set a long-term target for the debt-to-GDP ratio. The target should take into account both the importance of the markets’ confidence in the government’s fiscal responsibility and the need to carry out large-scale investments. The major increase in the debt-to-GDP ratio during the crisis again underlined the importance of dealing with the large structural budget deficit that existed prior to the crisis. Even before the necessary investments, the stabilization of the debt-to-GDP ratio will require a permanent reduction of about 1.2 percent of GDP in the primary structural deficit, and a reduction in the debt-to-GDP ratio to the precrisis level will require even greater fiscal effort. The economy-wide return from the proposed programs is higher than the budget cost. Nonetheless, financing them by debt alone will bring about a continual and divergent rise in the debt-to-GDP ratio and of the interest payment burden, since a significant part of the benefits to the public will not be manifested in an automatic rise in tax revenues. Therefore, the cost of the program must be financed by a mix of debt, taxes, and a reallocation, or a more moderate rate of increase, in some types of public expenditure, which will bring about a convergence of the debt-to-GDP ratio to the target to be set by the government while not endangering the stability of the economy.