Remarks by the Governor at the CEPR conference held at the Tel-Aviv University
The theme of this conference—"Growth and Inequality: Long-Term Effect of Short-Term Policies"—couldn’t be more relevant for Israel, when looking back at what we have achieved, and when looking forward to how Israel’s economy can move over the next decades toward a path of sustainable and inclusive growth, and the policies that support that path. In my remarks, I will comment on the route we have taken over the last 15 to 20 years, how policies have affected this route, and the main building blocks of the policies that will support a future sustainable and inclusive growth path.
Per capita income in Israel has grown roughly in line with the OECD average (see slide number 2). It is 17% lower than this average. Productivity, or output per hour, has grown at a slightly slower pace than the OECD average, and thus Israel has not closed the productivity gap, which is currently 26% (slide 3). Where we have made somewhat better progress is in labor force participation, where the rate has increased somewhat faster than the OECD average, to a level that is similar to the average (slide 4). This increase has occurred across all population groups, and was most pronounced among Haredi women (slide 5). It occurred in response to a sharp decline in welfare transfers, which substantially changed the relative attractiveness of employment vis-a-vis relying on welfare payments. However, progress in this respect has halted in the last few years for Haredi men, and reflects insufficient policy incentives in this regard.
The increased employment was particularly notable at the lowest income quintile, where the number of employees per household rose from about 1.1 to 1.5 over the past 15 years (slide 6). This means the share of families with two wage-earners has grown substantially.
However, the large gaps in hourly wage among various population groups have not narrowed over the years (slide 7). Hourly wage inequality, which predominantly reflects skills gaps, has also been high relative to other countries, and has not been closed. (I will discuss that later on.) Nevertheless, the increased rates of employment among the bottom quintile are reflected in a substantial increase in the share of their total income coming from labor income, instead of from transfers (slide 8). However, even after this increase, their labor income reaches 61% of total income, compared with 86% in the rest of the population.
The developments in disposable income over the last 15 years reflect a combination of increased employment—and thus, labor income—in the lower quintiles, and diminished redistribution via transfers and direct taxes (slide 9).
• Reducing (progressive) income taxes and welfare payments provided an incentive for increased labor force participation, but also reduced the contribution of income redistribution to lowering net income inequality (slide 10).
• This policy resulted in a reduction of market income inequality, due to an increase in the number of wage-earners per household in the lowest quintile.
• However, until 2010, net income inequality rose due to the reduced redistribution policy.
• In recent years, with no further changes in the redistribution policy, the continued decline in market income inequality also translated into a decline in disposable income inequality (slide 11).
Looking ahead, Israel faces headwinds to its future growth (slide 13). These place a substantial burden on policy makers who would like to ensure continued growth, even at the rates we have experienced over the last two decades. These headwinds result from the external environment as well as from internal developments:
Externally, world trade is forecast to grow at a much slower pace in the coming years than in the pre-GFC era.
Domestically, demographic trends, as well as the exhaustion of the increase in the share of university/college graduates in the population, will have a dampening effect on productivity growth in the future. This means that policy will have to do more to offset these trends if we are to sustain the recent (modest) growth rate of productivity.
As we have seen earlier, looking back over the past 20 years, Israel has not been closing the productivity gap. Many studies point to various factors behind the poor productivity performance. These factors can be grouped into three main areas: deficiencies in human capital, in the quality of infrastructure, and over-burdening and inefficient regulation (slide 14).
Let me expand on the deficiencies in human capital, as they not only affect potential growth, but are also an important factor behind the wide wage dispersion, and this is where a major contribution can be made toward sustainable inclusive growth. Basic skill levels in the areas of numeracy, literacy, and functioning in digital environments are lower in Israel than the OECD average for all education levels, and there are large gaps across population groups (slides 15-16).
These results suggest that increasing productivity through improving the level of human capital in all parts of society and at all education levels could be the main driver of inclusive growth. However, in addition to supporting productivity growth, there is a need to improve the quality of infrastructure—particularly, public transportation; to streamline bureaucracy and excessive regulation; and to enhance competition in some sectors, including utilities and public sector services, in order to ensure long-term growth that will benefit all parts of society (slide 17).