Growing wage gaps and the fight against inflation: Macro-economic trends

The Israeli economy has largely remained resilient and has recovered from the COVID-19 pandemic, though not all of its components have done so fully. Despite recent downturns in demand for workers in the high tech field, their market share continues to grow, and wage disparities between employees in the industry and those in other industries continue to widen. Part of this inequality stems from a lack of private and public capital in Israel, and the resultant low productivity prevalent among non-high-tech workers. The government’s intention to legislate far-reaching judicial reforms has created considerable economic uncertainly which, among other consequences, has manifested itself during the first months of 2023 in a devaluation of the Israeli shekel. While neither Moody’s nor Fitch has changed Israel’s credit ranking, both agencies have expressed concerns regarding the planned legislation as well as the absence of broad consensus and its impact on the country’s economy.

Labor productivity

In the first quarter of 2023, GDP per capita was almost identical to its predicted level had the economy continued to grow after the fourth quarter 2019 at its multi-year average rate. In contrast, private consumption lagged behind by about NIS 1,000 per capita in the first quarter of 2023 relative to the 2.1% growth level that the multi-year average would have predicted during this period.

GDP per work hour in Israel is significantly lower than in other high-income countries of similar size and economic structure, like the Netherlands, Austria, and Denmark, although this figure has grown in the past few years from $30 an hour in the 1990s to about $50 per hour in 2021. Low labor productivity is caused by low quality human capital, stiff regulation, and low levels of private capital per employee and public capital per capita – two components that have remained relatively unchanged in the past 40 years. Bringing Israel’s level of infrastructure up to that in other high-income countries would likely contribute to narrowing labor productivity disparities.

The cost of living

As in other high-income countries, Israel is also dealing with the challenges of inflation. Similar to developments in the US and the Euro Area, the consumer price index began to rise in Israel at the beginning of 2021 in parallel with a slowdown in economic activity due to COVID, and continued to rise in 2022 as a result of the Russia-Ukraine war. In Israel, beyond the price pressures present worldwide, inflation has also been affected by the weakening of the Israeli shekel — a result of the increased uncertainty unleashed by the internal political tensions. The rise in prices in Israel was more moderate than in the US and the Euro Area and this continues to be the case even as there are signs of a slowdown in price rises, especially in the US. In particular, for food prices (a large portion of which are non-tradable goods) and even more so for energy prices (which are tradable goods), increases in Israel in 2022 were much lower than those in the US and the Euro Area. The Bank of Israel has been increasing interest rates in an attempt to curb the inflationary spiral, and the market has reacted accordingly. The inflation in Israel is expected to return to the upper bound of its target, and fall to 2.9% within a year.

It is important to note that until 2021, prices in Israel hardly rose over the preceding decade. Nevertheless, as a result of the strengthening of the Israel shekel in those years, in 2021, the cost of living in Israel was about 50% higher than in Europe and about 26% higher than in the United States. Since Israel is a small economy and not part of any economic union, the number of producers is small and competition is limited. These factors in conjunction with low labor productivity and regulation barriers that limit local competition and import competition, contribute heavily to the high cost of living in the country.

This bulletin article is based on the Macro-Economic Trends chapter from our new “Picture of the Nation 2023” booklet.