This is my fifth address to the annual conference of the Israel Economic Association. Looking over my previous addresses, I saw that there was a common denominator: All of them had noted some satisfaction with the current macroeconomic situation, alongside the diagnosis that policy was not doing enough to ensure positive trends in the future as well. The diagnosis regarding the economy’s weaknesses over the long term is clear, and thus the policy required to support inclusive growth over time is also quite clear. Nonetheless, the policies adopted by the governments in recent years have tended to focus on achieving short term results, at times even at the cost of long term harm, and they do not place sufficient emphasis on future-oriented policy. Apparently these things are related: it is precisely when the economy is in a good state that it is the right time to adopt reforms and to deal with fundamental weaknesses, but apparently the good situation just doesn’t create a sense of urgency. Quite a bit has been written on a crisis essentially being an opportunity,
but do we really have to wait for a crisis in order to deal with the fundamental problems of the Israeli economy?


So at the price of repeating some messages that are similar to those I have already noted here in previous conferences, I will refer this time as well to the macroeconomic situation, and this time as well the macroeconomic picture is positive (happily even more so than in previous years); and I will again refer to several of the issues that are critical to attend to if the government wants to promote its declared goal of sustainable growth and reduction of poverty.


The macroeconomic picture


The economy continues to grow at a pace of 3.5–4 percent per year; in contrast to previous years, in which growth was based on private consumption, growth is currently more balanced, with exports and investments also contributing to growth.


The growth is reflected in continued demand for workers, and the economy is in an environment of full employment with a tight labor market; unemployment is low among all sectors and schooling levels; wages are increasing among all population groups; and the human resources constraint is reported by most companies as the one that limits their expansion. The Beveridge curve can be used to assess whether the labor market trends reflect a cyclical change or a structural one. We are at the upper lefthand side of the curve, meaning in a prolonged cyclical improvement, but the curve is also shifting toward the origin of the axes, so that there is a decline in structural unemployment. This is apparently a result of the improvement in effectiveness of the job search processes and an increase in the attractiveness of the labor market (among other things because of toughened criteria for unemployment benefits and the reduction in allowances at the beginning of the previous decade.


The low inflation rate is not a result of weakness in demand, and it is on a trend of increase. Macroeconomic policy continues to support economic activity: the Bank of Israel interest rate continues to be low, and to act to return the inflation rate to the target range, and to support economic activity; fiscal policy is also expansionary as reflected in the relatively high level of cyclical adjusted deficit in international comparison.


Looking over the long term:


The policy adopted in 2002–03, in which subsistence allowances were reduced and the criteria for receiving unemployment benefits became stricter, increased participation in the labor force, including for population groups whose employment rates were low, particularly Arab women and ultra-Orthodox men. However, the employment rates among those population groups are still particularly low, and the increase in the employment rate among ultra-Orthodox males halted in recent years.


The increase in employment rates in low-income households is reflected in an increase in the number of employed persons per household in the lowest income quintile, from 1.2 at the beginning of the 2000s to approximately 1.6 wage-earners in 2016. Likewise, the increase in the employment rates among the lowest quintile is seen in the marked increase in the share of labor income out of total income of households in the lowest quintile, from approximately 35 percent at the beginning of the 2000s to 61 percent in 2016. However, alongside the decrease in allowances, this increase mainly reflects an increase in the labor input, while the gaps in hourly wages between workers in the lowest quintile and the highest quintile remained especially high, and markedly higher than in any other OECD country.


Indices of net income inequality and of poverty increased in the years following the cuts in transfer payments, and began to decline starting from 2010, with the increase in labor income that derived from the increase in the labor input among the low-income population. It should be noted that the decline in poverty rates occurred despite an increase in the level of the poverty line itself, which reflects the relatively sharp increase in median income in recent years. Even after the decline, the poverty level in Israel is the highest of all OECD countries. Poverty is highest among the Arab and ultra-Orthodox populations, and in contrast to the situation in the past, there are even families with two wage-earners are poor.


A marked share of those who joined the labor force are low-skilled workers, and as a result their earning capacity is low as well. As a result, there has been a marked increase in the rates of poverty among families with two wage earners: among the Arab population, 15 percent of the families with two wage earners are below the poverty line, and among the ultra-Orthodox the share is much higher—27 percent! With that, it is important to note that in some of these families the wage earners work part time, and the size of the family also requires a higher income in order to get out of poverty.


The high share of workers at low wages reflects to a large extent the level of productivity, meaning GDP per work hour, of a large part of the workers being relatively low.


While GDP per capita has increased since the beginning of the millennium at a rate similar to the OECD average, and the labor force participation rate increased at an even slightly higher rate, GDP per work hour increased at a moderate pace that does not reduce the gap of about one-quarter between us and the OECD average. A by-industry examination of the GDP per work hour gap between Israel and the OECD average points to a large gap in nearly all industries, except for industries that are export oriented, meaning they are directly exposed to global competition.


Looking forward, the challenge to productivity growth is even expected to strengthen in view of the slowdown becoming apparent in the growth of world trade which is a headwind to growth from abroad, and in view of the domestic factors that are expected to moderate the growth, headed by the exhaustion of the contribution of the increase in the number of years of schooling and demographic trends.


Numerous studies point to three groups of factors in the productivity gaps between us and the countries with higher levels of productivity: inferior quality of human capital, inferior quality of physical infrastructure, and a business environment that is not at all friendly. The skills gap between us and the OECD average in the areas of literacy, numeracy, and functioning in a digital environment is notable in all schooling groups, and is notable among the population groups as well. On PISA tests as well, which point to future gaps in skills, the achievements of Israeli students are relatively low compared to the OECD average, and Israeli is notably poor in terms of the gaps in educational achievements. The weakness in these skills among a large part of the population is expected to weigh on future integration into employment, particularly when processes such as digitalization, automation of workplaces, and use of artificial intelligence decrease, and will decrease even more in the future, the demand for workers in routine jobs, and in manual labor, while demand for workers in analytical jobs relying on a high cognitive level and creativity is increasing and is expected to continue to increase.[1]


Against this background, it is clear that only inclusive and sustainable growth, which depends on an extended increase in productivity, will lead to a prolonged increase in the standard of living and to reducing gaps and poverty. Such growth requires:


  • An improvement in human capital:

o   While the increase in number of years of schooling, as noted, is nearing its exhaustion, the quality of education must be improved and basic skills provided to all parts of the population

o   The education system should work to provide talents and skills such as independent learning, problem solving, creativity, and critical thinking

o   In view of the especially low achievements of children from weak backgrounds, and the low expenditure per student in PPP terms in international comparison, there is room for a budget supplement that will focus on affirmative action without adversely impacting on the other children

o   Add additional teaching hours together with providing an incentive for high-quality teachers to teach in the (geographic and social) periphery is an effective way to improve the achievements of children from weak backgrounds.

  • Professional training, including in technological areas
  • Active labor market policy and aligning policy tools to each population group in order to continue the integration of various populations in the labor market
  • Removing barriers to growth and to productivity

o   Long term planning and removing barriers to investment in infrastructures (chief among them public transportation in metropolises)

o   Improving regulation and reducing bureaucracy

o   Promoting competition where needed

o   Promoting reforms (ports, electricity, the natural gas industry, energy)


However, even in conditions of prolonged growth, reducing poverty requires dealing with populations whose ability to integrate into employment and whose earning capacity is limited. This can be done via:

  • Encouraging employment among populations whose employability is limited, by providing appropriate incentives, and in particular, reducing the tax inherent in benefits to disabled people, and increasing the retirement age.

  •         Senior citizens:

o   Adjusting the retirement age to the increase in life expectancy, particularly increasing the retirement age for women

o   In the long term—the Mandatory Pension Law acts to reduce poverty among the elderly; in the short term, an increase in income support for low-income senior citizens

  •         Working-age people with low work/earning capacity

o   Increase the work grant

o   Improve training and placement services

o   Improve the unemployment benefits to allow appropriate work search processes

o   Increase income support alongside an improvement in employment capability tests


And in conclusion, we should take advantage of the Israeli economy’s good situation in order to require handling the long term challenges, which will contribute to growth that is more balanced, that is sustainable and inclusive. In view of the global and domestic trends that will weigh on growth in the coming years, there is a clearer need for policy to encourage productivity and reduce the moderating effects of such processes.


In 2015, the government adopted, slightly after it was set up, strategic goals for a range of areas, including cultivating and optimally utilizing the human capital, including: 21st century skills, improved efficiency and mobility between the training and schooling systems, increasing the integration into employment in the economy, among other things, by imparting basic skills, and removing barriers to employment. The test will be in translating the goals into a work plan and in implementing it in a manner that will promote the achieving of the goals that were set.


The long term is already here! The sooner we adopt a strategic plan focused on these issues, and implement it, we will be able to deal with the challenges and fully utilize the economy’s potential.

[1] Frey and Osborne, (2017). “The Future of Employment: How Susceptible are Jobs to Computerization, Technological Forecasting and Social Change”.