Remarks by the Governor at the Bank of Israel Research Department’s Inequality and Government Intervention Conference, held in Jerusalem
Holding this conference at this time is particularly important, as its timing, which was set a while ago, could not have been better, as it comes to discuss issues of government intervention and inequality in Israeli society. It is very important that the economic research in all areas related to these issues is professional and high-quality, using the most advanced research methods, so that policy makers will have the best information necessary to make informed decisions.
In my remarks today, I will naturally deal with inequality in Israel’s economy. Inequality in Israel has a range of aspects: the economic aspect, meaning the earning capacity, the skills aspect, as they are reflected in school achievements and in labor market skills, and the opportunities aspect.
First, let us look at inequality in Israel compared with other countries, as reflected in the Gini index for disposable income in OECD countries. We can see that inequality in Israel is high, but not exceptional. With that, it should be noted that the incidence of poverty is high. We note that the poverty line increases with economic growth, even when looking at it relative to GDP per capita. Nonetheless, the incidence of poverty in recent years has been on a downward trend. In any case, although the issue of poverty is important and overlaps with the issue of inequality, I will focus in the rest of the address on inequality and its various aspects.
When looking at the development over time of the inequality index in Israel, it can be seen that for approximately a decade there has been a process of a decline in disposable income inequality, after inequality had actually increased in the decade before that.
The decline in disposable income inequality is driven by a contraction of economic income inequality in Israel. The average number of wage earners per household increased, but the most notable increase is among the lowest income quintile. The increase in participation rates in all population subgroups and sectors—a combination of policy that encourages employment, together with cultural processes, alongside an increase in the minimum wage and a prolonged decline in the unemployment level—support a process of reducing economic income inequality and reducing disposable income.
Skills are fundamental talents required in the modern workplace, as the OECD defined and examined them in an international survey among adults (the PIAAC survey). The survey includes examinations of numeracy, literacy and problem solving in a technology-rich environment. It can be seen that the main factor that impacts on indiviuals’ wage is their work talents, meaning precisely those skills. There is a strong statistical link between the grade on the skills test conducted by the OECD and the wage of those taking the test.
The average level of achievements on the skills test in Israel is low—in the average for the overall population, as well as when limiting the analysis to exclude the two population groups generally identified as having lower skills in the subjects examined—the ultra-Orthodox and Arab populations. This is an important point as at times it appears that assisting and advancing these population groups will solve the skills problem in the Israeli economy. But it is not so—this is a problem that relates to all groups in the population and requires an overall policy and steps, even with specific reference to those groups. As such, it is no wonder that the return to required skills out of wages in Israel is among the highest in the comparison countries, as there is a shortage in this resource.
The variance in the skills test grades in Israel is the highest among the countries included in the survey whether on average, or excluding Arab society, or excluding both ultra-Orthodox and Arabs. That is, the gaps in skills in Israel stand out in an international comparison. As noted, these gaps place policy makers at a starting point that is not easy when trying to reduce inequality.
We emphasize that the gaps in skills do not reflect a particularly high ability of the stronger population but rather the weakness of the population with the lowest skills. This can be seen when comparing the results of the tests in Israel with the OECD average, by decile.
The low level of skills among adults in Israel stands in contrast to the high level of formal education—in number of years of study and in the high level of schooling, which is third in the world, following only Japan and Canada.
The level of skills in Israel is low for all levels of schooling compared with other countries, although the gaps contract as schooling levels rise. As such, we have here a type of riddle—how can it be that there is a large number of people studying in higher education but the level of labor market skills is low?
The reason may be that gaps in skills vis-à-vis abroad open at a relatively early stage, at elementary education already. The performance of middle-school students in Israel is very low compared to other advanced economies.
Equality of opportunities
The high inequality in abilities among adults in Israel may reflect gaps in talent, and the gaps cannot be dealt with via social policy of supporting population groups from lower socioeconomic backgrounds.
On way or another, it is very important to make equality of opportunities possible. Beyond the social justice ramifications, equality of opportunities has the ability to contribute to growth, as it improves efficiency. Equality of opportunities at an early age can also reduce the gaps in skills that we see among adults.
As such, it is interesting to ask, to what extent is the equality of opportunities in Israel similar to that in other countries? The various findings dealing with this question are not clear cut.
One index for examining the level of inequality in opportunity is the share of students from weaker socioeconomic backgrounds who succeed in reaching the top quartile in terms of achievements on the PISA tests. In Israel, the share of youth (aged 15) from a lower socioeconomic background who succeed on the PISA tests is significantly lower than the OECD average. This may be an indication that youth from lower socioeconomic backgrounds have not received equal opportunities. The gap on PISA grades between the 95th percentile and the 5th percentile is highest in Israel.
Alongside these findings, it should be noted that precisely the gap in average grade on the PISA science tests between the upper socioeconomic quartile and the lowest quartile is not significantly larger than the OECD average.
Another figure that we can look at to examine equality of opportunities in Israel is the extent of intergenerational mobility. The intergenerational mobility figure is perhaps the best expression of equality of opportunities, but the limitations of the data as well as the long period of time until results are received—we need to wait a complete generation until receiving an answer of whether intergenerational mobility can be identified—markedly adversely impact the relevance of this figure to current policy.
An international comparison of intergenerational mobility is also not simple, primarily due to data limitations, as we require wage data for the parents’ generation as well as for the children’s generation. Low-quality wage data (such as wage data that do not reflect permanent wages) could indicate higher mobility than what occurs in actuality, the test of the subsequent generation when it is still young (and its wage still does not reflect permanent wages) can also point to a higher level of mobility than what actually exists. Therefore, the comparative data on intergenerational mobility received in various research should be viewed with the requisite caution.
Looking at the comparison between Israel and other countries, with all the caution required in analyzing such work, points to intergenerational mobility in Israel that is similar to other countries, and when taking into account the starting point of inequality in abilities that exists in the population, we can even say that the situation in Israel looks good. Another indicator is the probability that an individual whose parents are in the bottom quintile of the income distribution will belong, in adulthood, to the highest quintile. That is, making these comparisons is complicated and we can see that among five countries, the data in Israel is not different than the other four.
Inequality in Israel is indeed high but not exceptional; a marked share of the inequality reflects differences in labor skills, which presents a long term challenge to policy, which should deal with that from an overall view as well as provide a response to population groups, with their special features, for whom it is relevant.
Nonetheless, despite the high inequality, the evidence to date points to intergenerational mobility that is similar to that in other advanced economies, which is certainly an encouraging sign.
There is some evidence of weakness in equality of opportunity in Israel, and it is important that we give that our attention—for proper social reasons and for the contribution to economic growth of an economy with equal opportunities.
I would like to thank Prof. Giovanni Violante who is an honored guest at the Conference. Prof. Violante is among the world’s leaders in the area of creating databases that help in understanding the development of income, consumption, and the labor market. These works contribute to deeper knowledge and ability to carry out informed analysis in many areas, including inequality. It is important to enhance and promote the research in these areas at the Bank of Israel and in Israel in general.