Happy birthday to Israel! The country’s economy at 71

In the short term, it appears that the past few years have been economically robust for Israel in many respects: the employment rate is the highest it has been in years, unemployment has reached a historic low, wages have risen, and GDP growth is similar to recent years.

Israel experienced higher GDP growth than in other OECD countries – 3.3% in Israel, compared to an average of 2.9% in the OECD in 2018. However, because the Israeli population is also growing faster than in the OECD, Israel’s GDP per capita growth rate (1.4%) remains lower than the OECD average (2.2%).

When looking at productivity (how much the country produces per hour of work), Israel falls well below the OECD average, as well as below the US and the G7 countries, and is not managing to close the gap.

In fact, Israel has experienced a slowdown in productivity growth since the early 1970s, and even the rapid growth experienced by Israel’s high tech sector from the 1990s onward has not altered the slowdown.

While this trend is concerning, the lack of productivity growth in the past decade may actually be due, at least in part, to more Israelis entering the labor market. Growth in the economy can be attributed to several factors including human and physical capital, the number of work hours, and productivity.

For over a decade, increasing work hours as more people enter the labor market has been the main source of Israel’s per capita GDP growth. However, the fact that most of the workers joining the labor force during this period were low-skilled workers also had a dampening effect on productivity growth.

Despite this, there was some improvement in the quality of employment during this period due to an increase in workers’ experience and education levels.

Looking ahead, as the already-high employment rate continues to rise (leaving little room for it to keep growing) and the share of Israelis who are of prime working-age falls, the potential for future growth based on increased labor input will decline, and the country will need to look to other potential sources of growth.

The sizable increase in real wages in the past few years is not attributable to improved productivity, as explained above, but rather can be traced to a relative decline in consumer prices. The rise in real wages and the accompanying growth in consumption have occurred not only among high-income Israelis, but among the lowest-income Israelis as well.

Consumer prices have decreased in a number of categories in recent years, yet, despite this, price levels and the cost of living in Israel remain high. The steepest price decrease among consumption categories since 2015 occurred in communications, with substantial price reductions for food, transportation, and recreation/culture as well. At the same time, housing prices rose. It is likely that the decline in prices stems, at least in part, from measures taken by the government to try to lower the cost of living.

In addition to the challenges Israel faces in searching for new sources of long-term economic growth and keeping the cost of living in check, the country will need to address its fiscal system, which is subject to growing pressure.

Israel succeeded in reducing its debt significantly over the last two decades – from 90% of GDP to 60% – by adhering to spending limits and following a plan to lower the deficit to 1.5% of GDP by 2024. However, according to the most recent numbers, the annual deficit reached 3.8% of Israel’s GDP during the past twelve months – much higher than the 2.9% deficit ceiling set for 2018, and already on track to surpass the deficit limit for 2019.

This is exacerbated by the “hidden budget deficit” that has been created through common deviations from the spending and deficit rules by enacting long-term programs with long-term funding implications under “temporary directives” or by transferring governmental activities to off-budgetary frameworks that are not technically bound to the budget spending limits.

Given these trends, the government deficit is set to rise well above its limits in the coming years unless government spending is significantly cut and/or taxes are raised.

In summary, there are several indications that Israel’s economy is doing quite well right now, and that it will continue to be strong in the near future, but several larger challenges must be addressed for these trends to continue in the long-run.