Remarks by Bank of Israel Governor Dr. Karnit Flug at the TheMarker Conference on Economy and Society in Beer Sheva
• We must take advantage of the good state of the economy to deal with fundamental problems of the Israeli economy and society, in order to achieve growth that will reach all segments of society.
· We must take advantage of the good state of the economy to deal with fundamental problems of the Israeli economy and society, in order to achieve growth that will reach all segments of society.
· Dealing with some of the problems requires a diversion and increase of budgets, but there are also changes and reforms that can be made without significant budgetary cost.
· Regulations and bureaucracy in Israel make it difficult to do business, and sometimes to bring in new competitors. Israel is ranked low in international comparisons of the bureaucratic and regulatory burden, and our position is declining.
· Strategic action on the part of the government and the advancing of structural reforms will make a significant contribution to growth and can be expected to bear fruit within 3 years (without any additional budget being necessary!). We must act to remove barriers to competition, such as regulations and standards: reducing the bureaucracy and improving communication among government offices and between them and the citizenry, cleansing and streamlining existing regulations, and more.
· The sooner we adopt and implement a strategic plan, the sooner we will be able to deal with the challenges and maximize the potential of the Israeli economy.
The Israeli economy is in good macroeconomic shape, mainly given the relatively weak global economic environment. Growth figures for the third quarter, published last week, backed our assessment that growth will continue at a strong pace. The labor market is strong, which is reflected, among other things, in rapid growth in employment and a continued decline in the unemployment rate to historically low levels, and in a continued increase in wages. Inflation has, for a long time, been below the target range, but if the prices of commodities and oil do not renew their decline, inflation is expected to return to within the target range within a year, supported by the increase in wages.
Against the background of the relatively good macroeconomic situation, it is appropriate to focus on the economy’s long-term challenges, which will help the economy persist in inclusive and sustainable growth. The economy is faced with challenges in a wide variety of areas. The Bank of Israel spends a lot of time analyzing and presenting them, and I have spoken about many of them at various opportunities. Dealing with these challenges requires reforms in a variety of areas. Some of the reforms come with a high budgetary cost (such as upgrading human capital at all levels of education and professional training, upgrading physical infrastructure, etc.), but it is also very important to advance reforms that do not involve significant budgetary cost. In view of the fact that the budget for 2017–18 is in the process of being approved, I chose to focus today on the necessary reforms that do not come with a significant budgetary cost.
On many occasions I have presented our uninspiring placement in the World Bank’s Doing Business index, which examines the business environment in various countries, and there has been no improvement. In various areas examined by the index, such as the process of opening a business, obtaining building permits, international trade processes, and registration of assets, Israel suffers from confusing and long bureaucratic processes. Another index, that of the OECD, which examines the bureaucratic limitations on international trade, also points to Israel’s relative weakness. An updated index by the OECD of regulatory rigidity in the product market, which is composed of a series of sub-indices such as the complexity of regulatory processes or protection from competition by existing companies, also paints a sad picture—Israel is ranked second-to-last, ahead of only Turkey. Indices of the rigidity of regulation in the retail industries and in the professional services industries also show that we are far below the international standard.
Why is all this important?
Because it turns out, to quote OECD economists, that “product market reforms comprise essentially reductions in regulatory barriers to competition which can lead to lower mark-ups and export prices, lower input prices (and production costs) for downstream industries, and higher productivity through efficiency gains and improved product quality and variety through higher investment in innovation.” In other words, reforms to improve the quality and efficiency of regulation can help the economy maximize its potential growth even without increasing the quality or quantity of the available means of production, thereby contributing to growth in the short term. Moreover, such reforms can increase the incentive to invest, since they make the business environment more friendly and provide it with more certainty, thereby leading to an increase in long-term growth potential.
In the OECD’s assessment, the significant contribution to growth made by such reforms can be felt in the range of two-three years after implementation. According to an OECD examination, we in Israel implement reforms at a similar pace to other countries. In other words, in this area as well, the pace with which we are improving is not one that would allow us to close the gaps with other advanced economies.
In order to try an illustrate the significance of the regulatory burden, I would like to tell a story that was related to me, and which I was granted permission to retell minus identifying details:
A kibbutz in the south had a low technology factory. The factory operated in a 6000 square meter building built in the 1970s and 1980s. In recent years, the factory could not compete with imported goods from China, and it was decided to close the plant. Another contributing factor was the fact that a closure order had been issued against the building, which was old, due to the lack of fire safety systems. At the end of 2013, the kibbutz decided to rent the building to another industrial company. The tenant, of course, asked for a business license to operate lawfully in its new premises.
What does the kibbutz need to do in order to obtain the business license for the tenant? The following are the requirements:
A fire sprinkler system had to be installed in the entire building, at a cost of NIS 700,000. The system required a feed from a huge 1000 cubic meter water cistern, which was disconnected from the Mekorot pipeline, at a cost of NIS 450,000. (The kibbutz’s existing 450 cubic meter reservoir did not meet the requirements of the standard.) next to the cistern, two pressure pumps had to be installed. Why two? In order to be prepared for a situation where a fire would break out precisely at the time that one of the pumps would be inoperable. Each pump had to have an independent backup generator in case there was a power outage during a fire. The two pumps cost NIS 500,000 combined. And that’s not the end. The huge cistern, weighing 1500 tons, had to be placed on a concrete platform of the proper size and strength. However, such a platform required a building permit, and as we know, in order to obtain a building permit, approvals from the Israel Antiquities Authority, the Ministry of Environmental Protection, and the Ministry of Health (since we are talking about a water cistern, and even though the water was not for drinking, a sanitary plan had to be prepared) were required.
To complete the fire extinguishing system, a fire detection and warning system was required (separate from the system that operates the sprinklers, which would activate the alarm and call the fire department) at a cost of NIS 120,000. Firefighting stations (NIS 150,000), with separate water fees from that of the sprinkler system (NIS 30,000), and smoke ventilation openings (about NIS 100,000) were also required.
Now to protection. While the factory is not in the area surrounding the Gaza Strip, it is in the south, and needs to be protected against income missiles and rockets. The Home Front Command requirement is to build a central protected area, including a gas filtration system, with an area of 100 square meters, at a cost of… NIS 2 million. Obviously, these areas also require… building permits.
A separate set of standards also sets out safety requirements. The cost is relatively low, but it require a safety plan and an integration plan with all of the other systems. Without such plans, there is no business license.
In the end —
As work began last summer to building the platform for the water cistern, an injunction was issued to stop the work due to the lack of a building permit, which the kibbutz has been trying to obtain since 2014, but has been unsuccessful since it is included in the permit for the protected areas, for which they have not yet reached agreement with the Home Front Command. The sprinklers have been installed, but they are not connected to the water because there is no cistern, because there is no platform, because it can’t be built because the Ministry of Health requires a sanitary plan.
There is a building, there is a factor, but the licenses are still far off. More than NIS 3 million for the license to operate an existing building, with an area of 6000 square meters.
The bottom line is that the kibbutz and the factor are employing a kind of dedicated “regulation clerk” whose job it is to obtain all of these approvals through architects, engineers, consultants, and mainly “middlemen” who move things forward and obtain leniencies without which there is no chance of obtaining the hoped-for approval. End of story (for now).
Each of the regulators does its work reliably. Each regulator sees only its own point of view (and apparently does not tend to take chances in the area of its responsibility), and no one sees or internalizes the price paid by the developers or the economy for the delay in building the factory, assuming that the license is actually granted in the end, before someone gives up.
Let’s get back to the discussion at the economy-wide level. What do we need to do?
In order to deal with the challenges, a focused strategic plan is required, and must include:
v The continued implementation of reforms to cleanse government regulation, for instance through a one-stop shop that would have the authorities and relevant resources in business licensing regulation, adjusted to the OECD best practice.
v Continued efforts to implement reforms and remove barriers that delay exposure to foreign competition, such as uniform standards with the advanced economies and more lenient import regulations.
v Investment and reforms in “network industries” such as public transit, trains, energy, ports, communications, and postal services.
v Transferring information online between government offices, particularly concerning statutory approvals.
The long term is already here!
The sooner we adopt a focused strategic plan in these areas, the sooner we will be able to deal with the challenges and maximize the potential of the economy.