Remarks by the Director of the Bank of Israel Research Department, Prof. Nathan Sussman, at the press conference marking the publication of the Bank of Israel Annual Report


As the Governor showed, the state of the economy is good and growth is solid.  In order to complete the picture presented by the Governor, I will detail some of the macroeconomic analyses presented in the report this year.  I will then relate to a few other issues from among the wide variety of issues covered in the report this year.

 

The relatively rapid growth this year was led, as in recent years, by private consumption.  However, we saw positive developments in exports and investments this year as well, which were connected to similar changes in the global economy, and these may portend to a gradual emergence from the long financial and economic low in which the global economy has been since 2008.

 

The faster growth of the Israeli economy in the past year, compared with growth in the OECD, is a result of the faster growth of private consumption thanks to the financial strength of the economy, the support of accommodative monetary and fiscal policy, and in the past year or two, the decline in relative prices, which I will discuss later.  In contrast, the economy dealt with slower growth of exports, which was affected by the appreciation of the shekel.

 

Exports performed more weakly than in other advanced economies, mainly as a result of goods exports that are more sensitive to appreciation, since they are exposed to stronger competition in international markets.  Israel’s services exports—mainly high-tech services, in which Israel has a relative advantage—enjoyed greater market strength, and therefore increased at a higher rate than other advanced economies, despite the appreciation.

 

Some of the appreciation we have seen in recent years is a result of the current account surplus—the gap between exports and imports—in Israel’s balance of payments.  As such, it is considered as deriving from positive basic forces in the Israeli economy.  In the Annual Report this year, we examined the development of the current account from a different point of view—by looking at the surplus of savings over investment in the Israeli economy.  We found that while the rate of savings in the Israeli economy is similar to that in other advanced economies, the rate of investment is lower, to the point that it does not make it possible to close the gap in the standard of living between Israel and the wealthiest countries.  In particular, we found that the rate of government investment in infrastructure and buildings is low, partly as a result—as the Governor showed earlier—of the desire to limit public expenditure in the economy and of the fact that the government dealt with the budgetary crisis it faced in recent years through cuts that negatively impacted infrastructure investments.  Thus, a problem of a short-term character became a long-term problem.

 

As such, the basic surplus in the current account is partly the result of policy that acted to shrink the size of government in the economy—a policy that resulted in, among other things, reducing investment in infrastructure, leading to a negative impact on productivity and long-term growth potential.  Indirectly, since the current account surplus was not a result of high productivity and growth, it led to appreciation and a negative impact on exports—a high productivity growth engine.

 

One of the phenomena that has been of particular benefit to the Israeli economy in recent years has been the improvement in its terms of trade, which is mainly a result of the decline in the prices of products that Israel imports, but is also a result of the increase in prices of the products that it exports.  We can saw that the economy’s profitability increased—it is purchasing at low prices and selling at high prices.  This positive development leads to two results: First, the economy’s income increases and consumers can consume more.  Second, the prices of some consumer goods decline, so that workers enjoy an increase in their real income, while firms are not required to increase their wages.  This maintains firms’ profitability even in a tight labor market with low unemployment.  However, this phenomenon is generally temporary.  Some of the decline in import prices is also a result of the appreciation, which is obviously beneficial for consumers in the short term, but may impair imports and growth in the long term.

 

One of the issues that is also connected with the developments in the terms of trade is the relatively moderate rate of increase in nominal wages.  In the chapter dealing with labor market issues, we examined this phenomenon, the main explanation for which is the slightly higher level of inflation.  In recent years, we have seen that total wages as a share of GDP is stable—and even increasing—such that there is no erosion in workers’ income relative to GDP.  This follows some decline in workers’ share of GDP, a decline which was more significant in 2002–3 and in 2009.  We cannot explain this significant decline through factors that explain the development of wages over time—such as productivity, inflation expectations and the unemployment rate.  The analysis shows that workers’ share of GDP eroded during the economic crisis, when workers agreed to reduced salary in exchange for job security.  Another explanation for the relative erosion of workers’ income as a share of GDP is derived from reduced taxes on employment, chiefly income tax—which makes it possible to increase workers’ net income in Israel relative to their peers in the OECD without increasing gross wages or wages as a share of GDP.

 

Support for private consumption as a growth engine has come in recent years from both the strong labor market and the increasing access to credit.  The banking system in Israel expanded in recent years, mainly in the areas of credit to households—housing and nonhousing credit—and has increased at an even higher rate in the past two years.  However, the expansion of credit was congruent with the increase in income, such that the credit taken by households relative to GDP remained stable and low compared to reference countries.

 

In view of the low interest rates, the question arises regarding the proper mix of assets to be held in the pension savings portfolio.  From the standpoint of the pension saver, the farther the investment horizon, the more desirable it is to invest in more risk assets that generate a higher yield.  The average investment portfolio of the Israeli pension funds is more conservative by international comparison, and the percentage of shares and other assets with a higher risk is low.  In parallel, exposure to foreign markets is also relatively small.  Due to the size of the stock market in Israel relative to the volume of pension savings, increasing the rate of investment in shares involves an increase in the rate of investment abroad.  The incentives for investment managers—short-term comparisons of yields and the possibility of moving savings, which are intended to increase competition between the entities managing pension money—may have created a preference for achieving yields in the short term, a strategy that is not beneficial for long-term savers.

 

The government is acting to increase the supply of dwellings in order to lower their prices, by increasing the number of planned homes, permits and marketing.  Contractors’ have been able to follow suit due to an increase in labor inputs by foreign workers, which provides some response to the short-term problem, but involves low productivity in the industry and delays its long-term technological development.

 

The “Buyer’s Price” program put in place this year acted to lower home prices for lottery winners.  The largest declines in prices relative to prices in the open market were in localities where demand for housing is high, so that land is a larger part of the dwelling price in those localities.  The benefit was made possible due to a discount on the land and competition between developers in those localities.

 

This year, we chose to focus the chapter on welfare issues on the issue of internal migration—between localities in Israel—of population groups characterized by high poverty rates and low employment.  We found that in the new ultra-Orthodox cities, the employment rates of ultra-Orthodox men are low, and migration to these cities is not for employment considerations, but an attempt to cope with housing costs.  It is therefore very important to create work places in these cities, as well as an efficient public transport system to employment centers, and to carefully consider the benefit of establishing additional cities of this type, particularly if they are distant from employment centers.

 

In contrast, we found that the rate of employment among Arab women living in Jewish cities is significantly higher than that of Arab women living in Arab or mixed urban areas.  Their migration to such localities is apparently motivated by employment considerations and allows their integration into the labor market. However, migration is very low, and it is therefore important to invest additional public resources in strengthening the Arab localities and their residents.

 

In summation, we can see that the tradeoff between the attempt to achieve short-term results and the results expected in the longer term is a common thread in many of the issues on the policy agenda that are dealt with in the report. These include, for instance, the use of lower public investment as a means to reduce short-term public expenditure vs the long-term implications for public infrastructure and growth; increasing short-term yields in the pension savings portfolio vs. the long-term yield that is of real importance in such savings; increasing the number of non-Israeli workers in the construction industry in order to increase its short-term production capacity vs. the long-term negative impact on productivity in the industry and the wages of its workers; and establishing new ultra-Orthodox cities as a relatively quick solution to the housing shortage in the sector vs. the difficulty in providing quality jobs in these cities over time.

 

Increasing the prominence of long-term considerations will contribute to increased growth and the long-term well-being of Israel’s citizens.