Why Does the Start-Up Nation Still Have Low Productivity?

Executive Summary

The Israeli economy is characterized by low productivity, and thus a low standard of living, despite its being a world-class leader in the high-tech field. Why the paradox?

A new study by Taub Center Researcher Gilad Brand shows that the problem lies in the exceptionally large gap in the Israeli labor market between the size of the high-tech and other export-intensive sectors, which are characterized by high wages and rapid growth, and the rest of the market with its low salaries and slow growth. According to the research, the success of the thriving sectors in Israel, unlike in other developed countries, has had little impact on the rest of the economy. Among other things, this is because of low labor mobility which has resulted in the development of two separate economies. In light of these findings, it appears that government support of the high-tech industry has limited impact on the rest of the market and, therefore, other forms of intervention should also be considered.

One market – two economies

According to Brand, the central reason for differential growth between the sectors is that Israel has especially large disparities between the exporting sector (which is primarily made up of high-tech and advanced technologies) and the local sector.

• Israel’s export sector is highly concentrated and largely rests on high-tech and advanced technologies: 56% of those employed in the export sector work in high-tech and advanced technologies – almost double the OECD average, and the highest share of all the countries examined.
• Achievements of high-tech workers on the survey of adult skills (PIAAC) are higher than the OECD average, though the achievements of the rest of the workforce are lower than in 20 of 25 other OECD countries.

Does investment in high-tech have an impact on the rest of the labor market?

Economic literature shows that the benefit the export industry gets from international exposure and competition should trickle down to the rest of the market through labor mobility: higher wages and demand for workers in exporting industries should lead workers to move from local to export industries. As a result, this should incentivize local industries to improve efficiency in order to remain profitable, which in turn would improve productivity and wages. While success in the export sector has indeed trickled down to the rest of the economy in other developed countries, this has not taken place in Israel.

• There is indeed high demand for more workers in high-tech and advanced technologies. For example, among clerks and office workers there are about 3 job searchers for each available position, as opposed to 1.5 workers for every available job for practical engineers and technicians in science and engineering.
• There is low worker mobility from local to export industries because the jobs available in export industries require highly trained and skilled labor.

As a result of low mobility, the efficiency, productivity, and wages in the local sector are not increasing, despite the success of high-tech in Israel.

Improving Israel’s labor productivity

The concentration of high-tech products in the export sector is the result not just of Israel’s relative advantages in the field, but also of government incentives given to this sector over the years. Brand finds that, in light of the conditions described above, additional investment in high-tech on its own is unlikely to improve productivity in other sectors. On the other hand, direct investment in local, non-trade sectors could be risky because they have much more limited GDP growth potential than the tradable industries. In addition, improving productivity in the local sector could improve efficiency at the expense of low-skilled workers, who might be pushed out of a job by advanced technologies.

• Despite the sharp growth in workers in the service and trade sector, its share in the GDP has remained almost identical over the past four decades (45-50%). A growing percentage of workers divide a share of the GDP that is not growing.
• Israel has import restrictions that diminish the volume of trade – Israel imports only 28% of its GDP – less than the majority of OECD countries.
• The volume of imports to Israel has decreased by 1.3% over the past decade, and it is the only country in the OECD whose imports declined during this period. It should be noted that the volume of a country’s imports largely determines the volume of exports in a country, through the exchange-rate mechanism.
• There has been a decline in employed persons in most sectors in the Israel’s export industries.

Overall productivity in Israel would be improved if workers move from the local sector into the export sector where, as stated above, demand for workers is high. Yet Brand notes that “in order to bridge the skills gap between workers in the two sectors, we should think about vocational training that will enable employment mobility and broaden accessibility to employment in the export sector.” Removing trade restrictions and changing government investment policy to allow greater competition in imports and exports could also help to improve productivity by allowing more Israeli companies to benefit from the advantages of exposure to international markets.