Yaron Amir: Bank of Israel's recommendations for increasing the
standard of living while maintaining fiscal discipline
Remarks by Mr Yaron Amir, Governor of the Bank of Israel, at the Calcalist conference, Tel Aviv,
2 September 2019.
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Good morning.
I greatly appreciate the opportunity to speak here today. This is a very important time, with the
election campaign drawing to a close, while millions of children are returning to school to further
their education and obtain the tools necessary to lead the country into the future. I would
therefore like to take the opportunity to discussion issues that involve each one of us as
individuals, and all of us, particularly the Bank of Israel, at the societal level: the future of our
children and further generations, and the standard of living that we want to improve for their
benefit, and also of course for our benefit as a country.
A few days ago, the Bank of Israel Research Department published a document that dealt
entirely with the measures necessary to increase the standard of living in Israel. At the Bank of
Israel, we asked ourselves how to do this, and the answer is that the focus must be on improving
worker productivity in Israel. This is the "roadmap" that we created. These recommendations
illustrate the Bank of Israel's commitment to deal with the most pressing macroeconomic issues
for the economy as part of my job as economic advisor to the government, and based on a
professional in-depth analysis. I will expand on this in a few moments.
But before that, I would like to briefly discuss the vision that I and the Bank have in dealing with,
and guiding policymakers in dealing with, the issue even now. The informed decisions made by
policymakers in our country from its founding until today established and strengthened the Israeli
economy, its stability, and its power, and led us to a situation in which we are now ready to begin
taking the necessary steps to prepare the economy for the coming decades. Israel must, and
can, implement these recommendations. Implementing the Bank of Israel's recommendations
will help take Israel into the future with a higher standard of living. I say this with complete
certainty.
This obviously requires considerable investment. The cost of the measures that appear in the
report, when fully implemented a few years from now, is not low-close to 3 percent of GDP,
which is about NIS 44 billion per year in current GDP terms. The cost is high due to the large
gaps that have developed in various areas over recent decades. However, the investment will be
very well worth it. Our assessment of the additional GDP in the long-term from implementing the
recommendations is much higher-about 20 percent of GDP per year. Or, to put it more simply,
about NIS 270 billion shekels more, in current GDP terms, for our children and future
generations.
I emphasize that the implementation of this program will not come at the expense of the need to
deal decisively with fiscal issues and the growing deficit. I have previously enumerated the
measures that the government and the Knesset will have to take in order to deal with the fiscal
necessities: reducing inefficient expenditures to start, cancelling tax exemptions, and apparently
also raising tax rates. This does not contradict the need or the possibilities of starting to
implement the recommendations right now. First and foremost, the stage of planning and
building the tools to implement the reforms, which is an essential part of adopting the
recommendations, will take time, and its cost is relatively negligible. In addition, there are many
recommendations that can be implemented even today, since they deal with diverting existing
sources, and with administrative processes.
I will now briefly discuss the main points of the recommendations and the background of the
report. Output per work hour in Israel, what we economists define as "labor productivity", is 24
percent lower than the OECD average, and this gap has not declined in recent decades. This
gap has large implications for the standard of living in Israel. The low level of productivity
compared with other advanced economies is reflected in lower wages and standard of living in
Israel than in other western countries. We found that the labor productivity gap to Israel's
disadvantage is mainly due to a number of factors: the relatively low quality of education and
teaching in Israel; the lag in the level of infrastructure and the quantity of business capital; and
public sector regulations and bureaucracy.
In the field of education: In recent years, there is a greater recognition that despite the fact that
Israel is the Startup Nation that gave us the flash drive, WAZE, Mobileye, and a wealth of complex
cyber solutions, most Israeli workers lack the ability to solve more basic problems. In addition to
our marked lag in average skills, Israel also feature a high level of inequality in scholastic
achievements, with large differences in basic labor skills among workers, large wage gaps, and
large differences in productivity levels between the various industries. While the strong workers
in Israel are similar in output and skills to the strong workers in other countries, the weaker
workers in Israel are far weaker than their peers abroad.
So how can we strengthen the "weaker" workers and raise the output per worker in Israel?
There is a direct-and causal-connection between a labor force's quality of education and
productivity, with an emphasis on the importance of basic cognitive skills that enable a change in
profession during one's lifetime. Eric Hanushek of Stanford University shows this in a series of
studies he conducted in recent years.
It is important to state that the gaps in the quality of education in Israel exist in almost all age
groups and education groups, and are not the purview of a certain segment of Israeli society.
Therefore, the treatment of the problem must encompass all levels of education, and begin in
preschool. In his research, Nobel prize winner James Heckman found how important the
preschool starting point is for economic success during life, particularly for children from lower
socioeconomic backgrounds. It is therefore important that daycare centers for children from
weaker backgrounds begin the educational process at very young ages. At the same time, it is
important that subsidies for the cost of daycare for weaker population groups be adjusted to
increase the incentives to work for both parents. Such steps lead to a double benefit. They can
materially contribute to future growth, and can contribute to reducing gaps and increase equality
of opportunity.
As economists, we avoid dealing with pedagogical issues. We focus on incentives that will help
improvement in an area, and recommend adjusting the payment structure for teachers to the
urgent needs of the system: improvement payment for those with training in subjects where
there is a lag in achievements and a lack of teachers (mathematics, sciences, and English), and
improving salaries for teachers to teach in schools that cater to students with weaker
backgrounds. This is all on condition that there are continuous evaluations of the success of the
teachers and of the schools in creating scholastic, educational, and social improvements.
In addition to the investment required at young ages, there are also measures that are necessary
for the older population. In Israel, too little is invested in developing human capital at older ages
through professional training programs. The increasing flexibility of the labor market, and the
extension of a person's working life as life expectancy and the effective retirement age increase
require significant reforms in this area, both in improving the output of technological colleges, and
in adapting the content of the courses. The reform that the government recently adopted in the
technological colleges is an important step in the right direction, and the recommendations that
appear in this field in the draft report of the 2030 Committee appointed by the government point to
additional important measures that will help Israel to better deal with the issue of professional
training.
In the field of business capital: The high level of variance in the Israeli economy is also
reflected in the extent of innovation and the volume of investment in physical capital in different
industries. In this area, the situation is good in exporting industries, particularly in software
industries, but it requires improvement in the rest of the economy, compared to parallel areas in
other countries. Why is this happening? First, it is reasonable to assume that some of it is a
natural result of market forces. Israel developed a relative advantage in the field of high-tech,
which makes successful investments and attracts select software and hardware people.
However, the government's involvement encourages these successful areas of activity directly
and almost exclusively, thereby raising the costs of human and physical means of production for
the other industries, which employ most of the workers in the economy. Over time, the
productivity of export companies will have difficulty continuing to grow, as companies that provide
them with raw materials and services remain so far behind.
Therefore, a gradual change is required that will make support of the principle industries based
on incentivizing the various areas of activity and industries by economic criteria that will lead the
economy to higher returns on investment and government support-among exports, which can
continue to benefit from it, and among domestic manufacturers. It is important to focus on
running programs that support the removal of market failures that delay production and the
implementation of unique knowledge, innovation, and management methods that can spill over to
other companies. Such a policy, alongside the effect of streamlining and the reduction of
regulation, which I will discuss later, may contribute significantly to increased stock of capital in
exporting industries and in domestic industries as one.
In the field of infrastructure: The rate of investment in transport infrastructure in Israel has
been similar in recent years to the average rate of investment in OECD countries, but is far from
what is necessary to reduce the gap in transit efficiency compared with the leading countries.
This is due both to the accumulated gap and to the rapid population increase in Israel. Improving
the transport system, particularly public transit, will shorten the time wasted in traffic. An
example that I heard, and which illustrates the issue well is that a plumber in Gush Dan manages
to get to half the amount of homes that a plumber who works in areas without large traffic jams
can service. This is a situation that, obviously, creates lower output for that plumber, and raises
the cost of his service to the consumer.
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Regulation and the business environment: Israel is ranked 29 out of the 34 OECD countries
in terms of the regulatory ease of doing business. Despite the government's recognition of the
importance of the issue, actual improvement is confused and very slow. It is therefore important
to accelerate the process of adopting regulations from other advanced economies, unless there
are significant reasons to avoid this in individual cases. This will help to both ease the regulatory
burden and to increase international competition in the economy. In addition, in order to
streamline bureaucratic processes, we suggest setting targets in public sector wage
agreements for the adoption of digital processes in government services to the business sector.
The current fiscal situation is weighing down on the ability to finance the required investment. The
government's structural deficit has increased in recent years to more than 3.5 percent of GDP,
and without a significant correction, it is expected to continue growing in 2021 and onward. The
implementation of this program will not come at the expense of the need to deal with fiscal
issues and the growing deficit. On the contrary: the required investments make it necessary to
rapidly and decisively deal with the existing deficit.
Since the large expenses due to the programs presented are expected only in a few years' time,
after the initial steps have been implemented and the plans for advancing infrastructure are fully
prepared, it is important that the government prepare for early implementation in terms of the
fiscal frameworks that will allow those investments that have the capability of significantly
improving the standard of living in Israel. Such preparation is important, first and foremost to
ensure the continued stability of the economy, but also to ensure greater ability of sources for
financing the required investments. This means the early convergence of the deficit, which will
ensure at least the stabilization of the public debt to GDP ratio, and maintaining this level in the
coming years alongside the gradual implementation of the growth-supporting measures
proposed in this program.
I would like to emphasize that we do not intend to recommend financing the investments-even
though their expected return will be high-through deficit spending and the accumulation of public
debt to be repaid in the future. In general, there is some logic to this argument, but the question
is what level of deficit is sustainable. The current deficit level is, in our assessment, too high to
allow for further increase, due to the short-term marcoeconomic risks it entails. In addition,
deficit financing creates risks to the quality of project selection and of a loss of control over
costs. When public projects are financed without effective short-term budgetary restrictions that
show the public and decision makers in real time what the cost of the sources required for the
investment is, the risk of inefficient allocation of investments and excessive costs increases.
In conclusion, these recommendations illustrate the material possibilities that we are presenting
to policy makers to increase the standard of living in Israel. I believe that their strength is in their
interconnectedness and in their being sufficiently detailed in terms of the cost of realizing each
item in the report. Their concurrent implementation will maximize the chances of success of the
project. The report is available for viewing, and was already presented to the various government
ministries as it was being formulated.
Thank you.