Increasing the Standard of Living in Israel by Increasing Labor Productivity


The Bank of Israel Research Department published a comprehensive report today, analyzing the problem of low labor productivity in the Israeli economy, and presenting operative recommendations for dealing with the problem in the coming years. The analyses and recommendations in the report are based on discussions of the "Productivity Committee" led by the Director General of the Ministry of Finance, consultations with a variety of officials in the public and business sectors and in academia, and academic studies carried out in Israel and abroad, at the Bank of Israel, and by government ministries. Various sections of the report were discussed before its publication with relevant people at various government ministries, who contributed many insights to the final version. However, the recommendations in the report reflect only the Bank of Israel's position, and are not binding on the entities with which we consulted.

 

GDP per work hour (labor productivity) in Israel is 24 percent lower than the OECD average. This gap has not narrowed in recent decades, and the report aims to bring together the core measures required to close the gap, with the objective of providing the government with a comprehensive picture of the scope of the problem and the ways to deal with it. Closing the productivity gap between Israel and the other advanced economies is expected to lead to an increase in wages, and is the key to a continued increase in the standard of living in Israel. The labor productivity gap is largely due to the low cognitive skills of the labor force in Israel, and lags in the level of infrastructure and in business capital. In addition, improvement in the areas of regulation and bureaucracy are required. A significant part of the report is devoted to recommendations in these areas.

 

The main recommendations:

 

  • Education: The results of international tests show that the quality of education of students and adults in Israel is low. In addition, there is significant inequality in scholastic achievements between various population groups in Israel. These findings are worrisome since there is a direct causal connection between the quality of education of the labor force and productivity.


Early childhood education frameworks currently serve the purpose of day care so that parents can go out to work. The educational component of such frameworks must be strengthened, and access and financing must be increased for households from weaker economic backgrounds, as part of the educational continuum of the student. This must be accompanied by meticulous care not to harm the incentives of the parents to work.

 

In the school frameworks, increasing the quality of teaching staff is the most efficient way in cost-benefit terms to improve achievements in the school system, relative to alternatives such as reducing class size and adding teaching hours. Therefore, concerted action must be taken to change the structure of payment and working conditions of teachers, so that they will be improved particularly for new teachers, especially those with training in subjects where there is a lack (mathematics, sciences, and English).  This must emphasize schools that cater to students from weak backgrounds. Improving productivity and increasing the attractiveness of the teaching profession also require investment in improving the teachers' physical work environment, particularly in view of their longer presence in the schools as part of the reforms carried out in the education system in the past decade.

 

In view of the growing need for professional change during a person's career, we recommend taking action in accordance with research findings that emphasize the importance of general studies at the high school level, including technological studies, over specific professional training and qualification. In parallel, we recommend that professional training be strengthened and concentrated in the post-secondary level, both as part of adult courses supervised by the Ministry of Labor and Welfare and as part of the technological colleges, based on the principles of the recently-approved reform.

 

Promoting studies that are relevant for the labor market among adults in the ultra-Orthodox sector is critical since their share of the population is expected to grow significantly, and since it is very difficult to correct lacks in skills at a later age that were not obtained at school ages.

 

The recommended addition of resources to the education system should be subject to improved personal and organizational evaluation processes, so that the additional resources will be channeled to the highest quality staff at places where the resources will have the greatest benefit. If the required resources can be obtained for offered programs by identifying and reducing activities in the education system that have little benefit instead of increasing the overall budget, it will be easier to promote programs within the budget limitations of the economy.

 

  • Stock of business capital: The rate of investment in physical capital and innovation, as well as the quality of human capital, are particularly low in industries geared toward the local market. At the same time, the government's policy tools for supporting various industries are focused on manufacturing and software services. Subsidizing physical capital and research and development for export industries raises prices for the other industries, thereby distorting their allocation and the allocation of human capital. We recommend gradually cancelling the sweeping preferences in taxation, capital grants, and innovation grants to exporting companies and on the basis of industrial preference. In parallel, we propose expanding programs that support the removal of market failures that delay the creation and implementation of unique knowledge and management methods that should trickle down to other companies and contribute to improvements in the economy, as well as the advancement of new mechanisms in this area. The annual cost of the measures recommended in the report for increasing the business sector's stock of physical capital is not high, since it involves a change in priorities that includes the cancellation of an existing benefit for some industries, and directing the freed-up resources to efficient processes. This policy, alongside the effect of streamlining and reducing regulation that will be discussed below, should contribute significantly to an increase in the stock of capital and an increase in the level of GDP per worker in the long term.

  • Physical infrastructure: The rate of investment in transport infrastructure in Israel has been similar in recent years to the average level of investment in OECD countries, but is far from what is required to reduce the gap in the level of transport infrastructure, particularly public transit. We therefore recommend increasing the volume of investment in public transit infrastructure, taking into account the high growth rate of the population that requires a high rate of investment in infrastructure over time relative to other countries in order to achieve and maintain infrastructure quality at a level that is comparative to other advanced countries. It is recommended to give preference to investment in the use of underground public transit in the center of the Tel Aviv metropolitan area, and public transit with designated lanes in less crowded areas. In order to make the use of existing transport infrastructure more efficient, it is preferable to impose a congestion tax while rapidly expanding public transit alternatives and giving preference to noncommercial shared transit.


  • Re​gulation and the business environment: Israel is ranked 29th out of 34 OECD member countries in terms of the regulatory ease of doing business. We recommend setting targets in wage agreements for the adoption of digital processes in government services to the business sector, and to adopt a digital signature process that will save the need to physically go to government offices. In addition, legislation must be amended to enable a shortening of the process to establish, expand, and manage businesses on the one hand, and to retroactively declare and supervise them on the other, while ensuring that the mechanisms for these processes are budgeted at a level that will enable effective enforcement and proper service. Finally, the process by which the ramifications of any new regulations must be tested should be expanded, and a methodical assessment of each regulation's cost to the economy, existing or new, must be added. Accelerating the process of adopting regulation from other advanced economies, unless there are material reasons to avoid doing so in individual cases, will help to both ease the regulatory burden and increase international competition in the economy.

 

We believe that most of the measures in the area of regulation and bureaucracy can be implemented through a change in managing work and in labor relations in government ministries, without significant budgetary cost.

 

Reducing the gaps that have developed in workers' skills and in the stock of public capital will require a gradual but significant expansion of public resources allocated to growth-supporting expenditures. The cost of the measures proposed in the report, when they reach full implementation a number of years from now, is high. It is estimated at approximately 3 percent of GDP per year, but the addition to GDP in the long term is much higher—about 20 percent. The high cost indicates the depth of the gaps that have developed over the past decades, and the fact that even now, public expenditure in Israel on growth-supporting items is lower than required to close (or even maintain) the productivity gaps. Since the government's current structural deficit is high (despite the low level of growth-supporting expenditure) and is expected to grow significantly from 2021 onward, it is important that the government prepare now in terms of the fiscal frameworks to ensure the stability of fiscal policy and the availability of sources to finance the investments. This means the convergence of the deficit to ensure at least a stabilization of the public debt to GDP ratio, and maintaining that level in the coming years, alongside the implementation of the growth-supporting steps proposed in the report.


 

 

 

 

 

Classification

Estimated budgetary cost, as a percentage of GDP

Estimated benefit to labor productivity in the long term, as a percentage of GDP

Timeframe to initial results in labor productivity

Measures in the area of human capital

Budgetary, change in priorities, administration and regulation

1 percent[1]

Total of 6.6 percent.

About 1.8 percent as a result of increased years of schooling for ultra-Orthodox and Arabs, 2.8 percent as a result of improved quality of education, and 2 percent due to the contribution of the improvement in human capital to increased investment in physical capital.

Medium- to very long-term

Measures in the area of physical capital

Budgetary and change in priorities

0.05 percent

About 4 percent in total.

Thanks to the removal of distortions in the support of investment in physical capital and innovation, and improved regulatory environment.

Medium: About 10 years

Measures in the area of infrastructure capital

 

2 percent[2]

Total of 7.5 percent.

4.8 percent thanks to improved transport infrastructure, and 2.7 percent thanks to improved communications infrastructure

Medium- to long-term: About 10 to 20 years

Measures in the area of total productivity

Budgetary, regulation and administration

0.2 percent

Total of 2.1 percent.

The decisive majority thanks to improvements in bureaucracy and regulation. Contribution of 0.1 percent through synchronizing vacation times.

Short- to long-term

Total of all measures

 

About 3.3 percent

About 20.2 percent

 

 

 



[1] Such an addition, in accordance with the programs detailed in the report, will lead to per student expenditure in Israel that is roughly equal to the average in OECD countries.

[2] The cost required to converge the infrastructure capital in Israel with the OECD median within 20 years, where investment preference is according to the recommendations in the report. Some of the costs can be financed through betterment taxes on individuals' property that will be affected by development, and the sale of state-owned land that will be bettered due to the investment. Within the investment, about one percent of GDP is required to prevent further deterioration relative to the GDP average.