OECD Economic Surveys: Israel 2018
Assessment and recommendations
Abstract
The statistical data for Israel are supplied by and under the responsibility of the relevant Israeli authorities. The use of such data by the OECD is without prejudice to the status of the Golan Heights, East Jerusalem and Israeli settlements in theWest Bank under the terms of international law.
Israel’s economy continues to perform well both in terms of macroeconomic and fiscal outcomes (Figure 1). Growth has averaged 3.3% since 2000, higher than in many OECD countries, although this was partly driven by strong population growth, which accounted for half of this impressive increase. The external surplus is comfortable, and the public debt-to-GDP ratio, already well below the OECD average, is still falling. This success is largely attributable to a long history of effective macroeconomic policy settings and bold structural reforms, including the successful absorption of the wave of immigrants from the Former Soviet Union, the promotion of venture capital financing for the nascent high-tech sector and the liberalisation of higher education, all dating back to the 1990s, as well as improvements in work incentives in the early 2000s. These good results are expected to continue, thanks to the persistently dynamic high-tech sector and the forthcoming development of new gas fields. Against this backdrop, Israelis remain on average more satisfied with their lives than residents of most other OECD countries, even though well-being results are mixed in several respects, including the environment (Figure 2, Panel A). They enjoy remarkable health and labour market outcomes, with historically low overall and long-term unemployment rates. Employment growth has been the main factor reducing the gap in average living standards with the most advanced countries these last 15 years, although this driver has weakened in the past few years (Panel B).
Figure 1. Israel’s economy is performing strongly
1. Estimate for 2017.
Source: OECD, Economic Outlook Database; OECD (2018), Economic Policy Reforms: Going for Growth (forthcoming).
Figure 2. Well-being outcomes are mixed
1. Each index dimension is measured by one to four indicators from the OECD Better Life Index (BLI) set. Normalised indicators are averaged with equal weights. Indicators are normalised to range between 10 (best) and 0 according to the following formula: (indicator value - minimum value) / (maximum value - minimum value) x 10. The OECD aggregate is weighted by population. Please note that the OECD does not officially rank countries in terms of their BLI performance.
2. Source: Population-weighted average for the top 17 OECD countries.
Source: OECD (2018), Economic Policy Reforms: Going for Growth (forthcoming); OECD (2017), OECD Better Life Index, www.oecdbetterlifeindex.org.
Israeli society is, however, marked by a lack of social cohesion and significant disparities, which penalise parts of the population and threaten the longer-term sustainability of these good results. Inequalities have declined slightly since 2007, thanks to higher employment rates among Israeli-Arabs and the Haredim (MoF, 2017a), but poverty remains widespread, particularly among these disadvantaged groups, for whom the rate reaches around 50% (Figure 3). Better social and labour-market integration of these groups, which will represent half the population by mid-century, is crucial. Haredi and Israeli-Arabs’ average skills and remuneration levels are low, their families large and social transfers limited (Box 1). In addition, overall productivity growth remains slow, and the cost of living is currently somewhat higher than the OECD average despite GDP per capita being more than 15% lower (OECD, 2017a). High house prices make home ownership difficult for the middle class and young households, and living space per person is modest, given large average family size. Moreover, public transport deficiencies are detrimental to work-life balance and cause urban congestion and poor air quality.
Box 1. Disparities in Israeli society
Israeli society is marked by significant disparities between different communities. Most Haredim and Israeli-Arabs live separately from the rest of the population. They have different school systems, live mostly in different cities and do not serve in the army. This contributes to different outcomes in the labour market, education and earnings. Given their tendency to have very large families, the Haredi demographic share is projected to nearly triple in the coming decades to almost 30%. This will have serious economic implications, since Haredi men have a cultural preference to engage in full-time religious studies rather than participate in the labour market and avoid core subjects in their school careers. Furthermore, Haredi women can work only part-time because of their family responsibilities. The majority of Israeli-Arab women also do not participate in the labour market due to cultural preferences. The result is that most Haredi and Arab families have only one breadwinner, resulting in significant problems of poverty, notably among children.
Source: National Insurance Institute (2016), Poverty and Social Gaps Report, 2015; OECD, PISA Database; Central Bureau of Statistics.
Figure 3. Inequality and poverty remain high
2016 or latest year available
1. Defined as the S90/S10 disposable income share ratio, i.e. the share of all disposable income received by the top decile divided by the share of the bottom decile.
2. Poverty rate relative to threshold of 50% of median disposable income.
Source: OECD (2017), Income Distribution Database, www.oecd.org/els/soc/income-distribution-database.htm; National Insurance Institute (2017), Poverty and Social Gaps Report, 2016, Table 7.
To a large extent, these difficulties reflect persistent weaknesses in three key areas: product markets, education and infrastructure (Flug, 2017a and b). As highlighted in the 2016 Survey, product market regulations are far from best practice. The lack of competition and high non-tariff barriers in many sectors, notably electricity and the entire food chain, push up prices and contribute to duality in productivity between open and sheltered sectors, resulting in wage and income disparities. Much room exists to improve the business environment and lower regulatory burdens and bureaucracy. Haredi and Israeli-Arabs lack the skills needed for well-paid jobs. These deficiencies limit the effectiveness of their employment gains for lowering poverty and perpetuate the strong disparities in formal education between these groups and the rest of the population (Figure 4, Panel A). Contrary to other groups, for the Haredim this situation largely reflects an explicit choice of studying religious rather than secular subjects and of separating themselves from the rest of the society. Moreover, even Haredi men who do work often do not consider their jobs to be a career path but merely a means of relieving tight income constraints. Already 44% of people under 14 are currently from Arab or Haredi families, and the Haredi share is growing rapidly (Panel B). The country’s large infrastructure deficit also contributes to economic and social imbalances. Inadequate public transport accentuates the housing shortage by lowering the attractiveness of more affordable neighbourhoods and reduces access and employment opportunities for disadvantaged groups from peripheral zones. It is also the cause of considerable road congestion and worsens air quality.
Figure 4. Education outcomes are poor for disadvantaged groups, whose share is growing
1. Haredi boys did not participate in the PISA test, as they do not study the required material. Results are thus overestimated.
Source: OECD, PISA Database; Shoresh (2017), Shoresh Handbook 2017: Education and its impact in Israel; CBS, www.cbs.gov.il/reader/newhodaot/tables_template_eng.html?hodaa=201701138.
With this background, the main messages of this Survey are:
The current favourable economic situation provides an opportunity to prepare for the challenges of the future by tackling Israel’s structural weaknesses to ensure the continued increase in living standards and in the quality of life for all Israelis, including in terms of housing.
Enhanced training and education of Israeli-Arabs and Haredim, better infrastructure and further product market reforms have complementary roles to play in making growth stronger, more inclusive and more sustainable by boosting productivity.
Increasing the supply and quality of human capital and infrastructure requires both structural reforms and additional financial resources, which can be funded while maintaining prudent fiscal policy.
Maintaining solid increases in living standards and well-being in the longer term will be challenging
The Israeli economy continues to expand
Growth has slowed somewhat but remained robust at 3.3% in 2017. Domestic demand, supported by accommodative fiscal and monetary policies, has been the driver of activity, which was also boosted by a probably unsustainable increase in stockbuilding. Strong employment gains, low inflation and minimum wage increases are fuelling consumer spending. At the same time unemployment has declined to around 4%, i.e. at or close to full employment, and labour shortages are spreading to all sectors in the economy, while, in previous years, they were above all prevalent in the high-tech sectors and for high-skilled workers (Box 2). On the other hand, goods exports have been relatively weak due to still moderate world trade growth and worsening price competitiveness from shekel appreciation. However, led by the high-tech sector, services exports have been much more buoyant and now represent 42% of the total (against less than 30% in 1995), and the external surplus remains sizeable because of the large export share of low-price-elasticity high-tech products (Figure 5). Despite the substantial real exchange rate increase since 2005, market share losses have been limited compared to other advanced economies (Figure 6). This overall robust performance has further improved Israel’s financial stability, as reflected in its recent sovereign rating upgrade (Barkat, 2017a).
Box 2. The high-tech sector: share and development in the Israeli economy
The high-tech sector in Israel combines the industrial sectors in the electronics, pharmaceuticals and aircraft sectors alongside services – software and research and development. Along with veteran companies in the industry (such as Intel, Teva and Check Point), start-ups have been added in recent decades, financed by venture capital funds as well as research and development centres of multinational companies.This sector has grown rapidly and has contributed significantly to the development of the economy since the mid-90s (CBS, 2017a). Employment in the high-tech industry increased from 7% of total employment in 1995 to 9% in 2014, or 12% of employment in the business sector, which is more than double the OECD-country median. This sector, whose share in GDP increased from 6.5% to 11.4% during this period, experienced stronger growth in services than goods. High-tech services accounted for two-thirds of the value added produced in the high-tech sector in 2014. These developments have also benefited aggregate exports, half of which are high-tech goods and services.
High-tech development has been based on the remarkable performance of the country in the field of innovation (OECD, 2016a). It has been supported by high R&D spending (at 4.1% of GDP in 2014, R&D expenditure is the second highest in the OECD); universities providing high-quality human capital in science and technology fields; good collaboration between academia and industry; a well-developed venture capital industry (Israel has the largest share of early-stage and seed venture capital funding in GDP among OECD countries); and favourable taxation for high-tech firms. In addition to these factors, the challenges Israel faces were also an impetus for innovation and creativity (Flug 2017b). Highly dynamic entrepreneurship in ICT, in particular in the cyber security industry, has emerged partially as a response to security threats. The development of new technologies to respond to water scarcity challenges has also made Israel a world leader in water-related innovation.
However, the vigour of the high-tech sector has weakened, and it has no longer been the engine of growth since 2010. Since then, high-tech industry expansion has been about half that of the rest of the economy. Production in this sector, which exceeded 13% of GDP in 2009, fell by 1.7 percentage points and its share in exports stopped increasing. The most significant challenge facing the sector is the lack of supply of skilled labour (MoF, 2016). Its employment share in the economy, although still higher than that of other countries, has declined by more than 1 percentage point since 2009. Moreover, investment in R&D and the dynamism of innovation are benefiting only a limited number of sectors and are not spreading to the entire economy. The result is that SMEs and entrepreneurs operating in traditional sectors are largely detached from the high-tech economy, their productivity is low compared with SMEs in other OECD countries, and only 15% of Israeli SMEs are involved in exporting.
Figure 5. Exports of goods by market and commodity are fairly diversified
Share of total exports, 2016
Source: OECD, International Trade Commodity Statistics Database.
Figure 6. Competitiveness has been hit by exchange rate appreciation
1. Measured the Israeli’s unit labour costs in dollar terms relative to the weighted average of these costs for its competitors in export and domestic markets. An increase of the index indicates a deterioration of the competitive position.
2. Of goods and services.
3. Change between 2005 and 2017 Q3.
Source: OECD, Economic Outlook Database.
Growth is expected to be around 3½ per cent in 2018 and 2019 (Table 1). The still very low interest rates, expansionary fiscal measures, including corporate tax cuts and higher social spending and investment, coupled with the launch of the Leviathan and Karish gas fields, will support activity (Box 3). An improved external environment should underpin exports and keep the economy at full employment. Against this backdrop, solid wage increases and stronger import price growth are expected to push inflation back up to around 1.5% by end-2018.
Table 1. Macroeconomic indicators and projections
1. Contributions to changes in real GDP, actual amount in the first column.
2. As a percentage of potential GDP.
3. As a percentage of the labour force.
4. As a percentage of GDP.
Source: OECD (2017), Economic Outlook No.102, November, updated.
Box 3. The economic impact of the natural gas discoveries
Israel’s natural gas sector has recently taken off, with major offshore reserves discovered in its exclusive economic area in 2009-10. These reserves, which include the two big fields of Tamar (305 billion m3) and Leviathan (580 billion m3) and other smaller fields, are enough to supply the country for probably more than 50 years. Tamar is currently the only deposit exploited. It meets over 95% of the country’s current demand of 8 billion m3, and its development and production as from 2013 is estimated to have increased GDP by 1.1% mainly due to the over 60% decline in energy imports. Moreover, replacing imported coal and oil by gas in power generation has cut pollution, and related royalty revenues, even though still modest less than 0.1% of GDP, have been positive for the budget.
Because of limited domestic gas demand, Leviathan’s operation, due to start in late 2019, will have a small initial positive impact (0.3%) on GDP, while its longer-term effect will depend on export opportunities. Contracts have already been signed with Jordan and in February 2018 with Egypt, and discussions are ongoing with Turkey and EU countries. In addition to royalties and corporate taxes, the gas industry will be liable for a special levy of 20-50% on profits over normal returns on investment, whose proceeds will be placed in a forthcoming dedicated sovereign fund to share with future generations. It could represent 10% of GDP in 2040 and will be invested in foreign currencies to reduce the risks of Dutch disease. This risk is currently being handled by a central bank foreign-currency purchase mechanism.
Growth would, however, be lower if the shekel were to appreciate further or if the geopolitical situation or the external climate were to deteriorate. Conversely, the economy could be stronger, and even overheat, if demand, supported by a better-than-expected global environment, is more robust and the central bank is slow to withdraw stimulus or the government follows through with mooted tax cuts. Capacity and labour-market pressures could intensify without affecting price inflation much if supply factors continue to push it down, as in recent years (see below). The economy may also face several other shocks whose impact would be difficult to assess (Table 2).
Table 2. Possible extreme shocks affecting the Israel economy
Still, the Israeli economy is enjoying its 15th consecutive year of growth and remains resilient. The country’s macro-financial vulnerabilities appear low, despite the deterioration in price competitiveness since 2007 (Figure 7). The financial situation remains solid, thanks to profitable and well-capitalised banks, with few non-performing loans (Figure 8) and high liquidity (BoI, 2017a; IMF, 2017). However, risks associated with the large financial-sector exposure to the real estate market, where prices have more than doubled since 2007, have intensified.
Figure 7. Evolution of macro-financial vulnerabilities
Index scale of -1 to 1 from lowest to greatest potential vulnerability, where 0 refers to long-term average, calculated for the period since 2000ref refid="fn-0011" format="note"/>
1. Each aggregate macro-financial vulnerability dimension is calculated by aggregating (simple average) normalised individual indicators from the OECD Resilience database. Financial dimension includes: capital ratio (regulatory capital), shadow banking (% of GDP), return on assets and loan-to-deposit ratio. Non-financial dimension includes: total private credit, housing loans, household credit and corporate credit. Asset market dimension includes: real house prices, price-to-income ratio, price-to-rent ratio and real stock prices. Fiscal dimension includes: government budget balance (% of GDP), government gross debt (% of GDP), real bond yield minus potential growth rate (r-g). External dimension includes: current account balance (% of GDP), external debt (% of GDP), real effective exchange rate (REER) and export performance.
Source: Calculations based on OECD (2017), OECD Resilience Database, December.
Figure 8. Capital ratio and non-performing loans
Q3 2017 or latest data available
1. Regulatory capital to risk-weighted assets.
Source: IMF, Financial Soundness Indicators Database.
Pursuing appropriate monetary-policy settings
Monetary policymakers are facing unusual challenges in maintaining price stability. At 0.1% year-on-year, inflation is well below the 1-3% target range; prices declined for three straight years before turning up in the first half of 2017 (Figure 9), despite flourishing economic activity, recent employment and minimum-wage hikes and a job-vacancy rate at its highest level on record (Figure 10). Wages have picked up over the past two years, as firms have managed to maintain their margins thanks to significant improvements in the terms of trade since 2014. Nevertheless, zero inflation is rather hard to fully explain, but the most important additional mechanisms are the lower import prices from shekel appreciation and lower commodity prices, as well as favourable temporary product-market supply shocks: government reforms (see below) and measures to lower the cost of living through public tariff cuts, VAT reductions, and stronger competition from the expansion of e-commerce (Figure 11), encouraged by higher exemption thresholds from customs duties and VAT on these purchases. Furthermore, deflation has tended to be self-perpetuating through expectations mechanisms (BoI, 2017b).
Figure 9. Inflation developments according to the CPI
1. CPI excluding energy and food products.
2. CPI excluding energy, vegetables and fruit, and administrative charges.
Source: OECD, Economic Outlook Database; Bank of Israel.
Figure 10. The labour market continues to tighten
1. Unemployment rate with non-accelerating inflation rate.
2. Three-month moving average of the year-on-year percentage change.
3. Deflated by the consumer price index.
Source: OECD, Economic Outlook and Labour Force Statistics Databases; Bank of Israel; Central Bureau of Statistics.
Figure 11. Packages sent to Israel from abroad are rising rapidlyref refid="fn-0018" format="note"/>
1. Figures for 2016 are incomplete.
Source: Israel Post.
In this context, the Bank of Israel (BoI) is rightly maintaining a very accommodative policy, keeping its official rate at the historically low level of 0.1% since March 2015. The authorities also intervene in the foreign exchange market to limit fluctuations and excessive appreciation that would result from the extraordinarily accommodative monetary policy settings by the world’s major central banks. These interventions come on top of a currency purchase programme to offset the exchange-rate pressure (or “Dutch disease”) from expanded natural gas production (see Box 3 above). The result of persistent intervention is that the BoI has foreign-currency reserves of USD 118 billion (34.5% of GDP), one of the OECD’s highest GDP shares. Since November 2015 the BoI has also provided forward policy guidance to influence investor expectations: this accommodative policy is thus expected to be maintained as long as necessary to entrench inflation within the 1-3% target range (BoI, 2018). Although shorter-term inflation expectations are below 1%, they are well anchored to the target beyond this horizon, indicating monetary policy credibility (Figure 12).
Figure 12. Inflation expectations are low in the short term but within the target range thereafter
Source: Bank of Israel.
Nevertheless, the risks of maintaining an accommodative monetary policy too long should not be neglected, as the favourable effects from the terms-of-trade gains could reverse quite rapidly. Low inflation does not seem related to weak demand, and tightening too late would increase the risks of overheating and rising wage pressures, which, with increased competition, would harm business profitability and investment. It would also raise the financial vulnerabilities from the housing-market tensions, which remain significant and partly result from the low interest-rate environment.
Preserving financial stability while strengthening sectoral efficiency
Israel’s financial system remains robust. However, as highlighted in the 2016 Survey, the oligopolistic banking sector continues to incur high operating costs. In response, the authorities have adopted several measures to boost competition (Table 3). These include the separation of the credit card companies from the two main banks and the creation of a central credit register accessible to all financial entities. Under the BoI’s pressure, banks have also launched plans to reduce their operating costs, develop online banking and lower their fees (BoI, 2017c).
Table 3. Past recommendations on improving the stability and efficiency of the financial system
Macro-prudential policies have been tightened since 2009, reducing the risks associated with the real estate market. The financial system’s resilience in the event of a sharp fall in housing prices and severe recession has thus been enhanced. According to 2015-16 stress tests, systemic stability would not be threatened despite substantial losses (BoI, 2016a). The household-debt ratio would also probably remain relatively low as the lower income deciles account for a relatively small share of household credit: the ratio of total debt to annual income ratio is 0.6 on average and exceeds 1 only for households in the lowest decile (for which it is close to 3). However, only 3.5% of total loans have been issued to households in that decile (BoI, 2016b). The BoI’s macro-prudential measures have also raised mortgage rates since spring 2015 (Figure 13), which, together with higher taxation on real estate investments, has reduced housing-credit demand, eased housing-market tensions and stabilised banks’ exposure (Figure 14).
Figure 13. Market interest rates have stabilised, but mortgage rates have risen somewhat
1. Average of the rates on unindexed mortgages, from 5-10 years and from 10-15 years.
Source: OECD, Economic Outlook Database; Bank of Israel.
Figure 14. Banks’ exposure to the housing sector is high, but housing credit has slowed
1. End-June data for 2017.
Source: Bank of Israel.
Although the tighter macro-prudential policies have helped to lower risks in the housing market, a severe housing-market correction remains possible, and developments should be monitored very carefully. Further improving stability is thus desirable to fully benefit from ongoing efficiency-enhancing financial reforms such as the planned monitoring of the measures spurring competition on the credit market (see Table 3 above). Hence, further steps are needed and are being considered: a deposit insurance system, a bank resolution framework and a financial stability committee enhancing co-ordination between the BoI, the Ministry of Finance and the Securities Authority would all further strengthen financial stability.
Continuing catch-up faces longer-term challenges
Over the longer term demographic trends imply a large increase in the population (from 8.5 million in 2015 to 18.5 million in 2060), even with modest immigration, and a substantial change in population composition. Given the high fertility of Haredi women, which is assumed to remain largely unchanged, the share of that community in the total population would triple in the next 45 to 50 years, with the total share of Israeli-Arabs and Haredim rising from one-third to one-half over this period (CBS, 2017b). Despite recent improvements, these groups have poorer labour-market outcomes and much lower productivity than non-Haredi Jews, and labour force participation remains particularly weak among Haredi men and Israeli-Arab women. Moreover, even though Israel currently has the OECD’s youngest population due to its high birth rates, the share of over-65s will nevertheless increase from 10% now to 17% in 2059.
These demographic changes mean that per capita GDP growth will probably slow in coming decades. Empirical research suggests that, if the recent rate of convergence in terms of labour market outcomes of Haredim and Israeli-Arabs with the rest of the population is maintained, productivity gains will weaken considerably relative to their already slow trend and the average employment rate will fall somewhat (Geva, 2015). In such a business-as-usual scenario, the convergence in living standards with the OECD average will cease and even reverse, with the per capita GDP gap rising from 15% in 2015 to around 20% by 2059 (Figure 15). Without reforms the number of working poor will rise (see below).
Figure 15. The gap in GDP per capita with the OECD average could shrink further with ambitious reformsref refid="fn-0021" format="note"/>
1. The business-as-usual scenario consists of the updated projections for the Economic Outlook No. 102 until 2019, with an extrapolation of real growth per capita based on Geva (2015), at an average annual rate of 1.5%. This scenario assumes that the convergence of employment rate and productivity level of Haredim and Israeli-Arabs with the rest of the population continues at the same pace as in the last decade. The no-reform scenario is also based on Geva (2015) and assumes no convergence of Haredim and Israeli-Arabs, with an annual average real growth of per capita GDP of 1.2%. The structural reform scenario differs from the previous scenarios by assuming gains from structural reforms entailing higher real GDP per capita growth by 0.6 percentage points during the period 2019-29. At the same time, the productivity of Haredim and Israeli-Arabs compared to non-Haredi Jews will increase from 60% currently to 80% and the employment rate of Haredim and Israeli-Arabs will be close to the level of non-Haredi Jews in 2059.
Source: OECD (2017), Economic Outlook 102 Database; A. Geva (2015), Demographic Changes and their Implications for Fiscal Aggregates in the Years of 2015-2059, www.mof.gov.il/ChiefEcon/EconomyAndResearch/ArticlesSet/Article_20150518.pdf.
However, launching ambitious reforms in product markets, infrastructure and education would substantially boost growth performance and living standards. According to OECD estimates, promoting a more business-friendly environment, represented by the OECD average, could enhance efficiency and increase per capita GDP by almost 6% over a 10-year period (OECD, 2016b). Better infrastructure and educational outcomes supported by ambitious reforms (see below) also have an essential role to play in improving labour-market and productivity outcomes in disadvantaged communities. For instance, further improving the Haredim and Israeli-Arabs’ (youth in particular) integration into society through better education and training leading to a lower productivity gap with non-Haredi Jews from around 40% currently to, say, 20% in 2059 would raise average annual per capita GDP growth by 0.2 percentage point. These reforms would shrink existing income disparities within Israeli society and the shortfall in living standards vis-à-vis the OECD average to 10% in 2059 (see Figure 15 above). By contrast, if the authorities fail in their enhanced integration efforts and these groups keep their current employment and productivity gaps, average Israeli incomes would fall to close to 30% below the OECD average in 2059, almost double the current gap.
Preserving prudent fiscal policy while addressing spending needs
Israel has succeeded in reducing its government debt from 90% of GDP in 2002 to 62% in 2016, thanks to the normal deficit-growth dynamics due in part to a prudent budgetary framework, which combines an expenditure-based fiscal rule with deficit targets, and a robust growth performance. In addition, gross debt has been pushed down by the amortisation of mortgages granted to the public until the early 2000s, sales of government-owned land and shekel appreciation (which has cut the shekel value of foreign-currency debt) (Figure 16). Currently, the annual real spending-growth ceiling is set at 2.6%, and the deficit targets are 2.9% of GDP for 2017-19 and then 2.5% and 2.25% of GDP in 2020 and 2021. This framework has recently been strengthened to ensure better compliance with these rules (Table 4). Since the 2017-18 budget the government can no longer adopt new spending or tax cuts that breach these spending or deficit limits over a three-year period without offsetting measures. A multi-year defence plan was also introduced to lower fiscal uncertainty in this domain and to slightly reduce these expenditures from their relatively high current level (6% of GDP and 15% of public spending). However, the pre-2009 downtrend in such spending as a share of GDP was not maintained, and military spending has grown steadily since then. Accordingly, further efforts to promote efficiency gains in this area would be desirable.
Figure 16. Factors contributing to the gross debt-to-GDP decline between 1998 and 2016
Share in total decline
Source: A. Brender, “Fiscal Policy – the Journey to Reduce the Public Debt Ratio and Government Size”, forthcoming.
Table 4. Past recommendations on fiscal policy
The budget deficit declined to 2.1% of GDP in 2016, its lowest level since the 2008 crisis. However, with public expenditure growing well above the 2.6% ceiling, the fiscal stance has become somewhat expansionary. Thanks to strong, mostly temporary, tax receipts, such as those arising from the temporarily low tax rate on dividends (which in fact will reduce future revenues) and revenues from capital gains taxation on the sale of Mobileye to Intel, the deficit is projected to have declined to 2.0% of GDP in 2017 before increasing to 2.9% of GDP in 2018, which will lead to a deterioration of the structural balance in 2018, and will slow the public debt decline. However, the planned extra spending of 1% of GDP (BoI, 2017d) is mostly on education, health care and allowances for the elderly and disabled, and is thus likely to promote more inclusive growth, if the measures are well designed and well implemented. In addition, in November 2017 the authorities also unveiled a national nursing care plan offering better protection for seniors in need of long-term care (Barkat, 2017b).
Nevertheless, Israeli civilian spending will remain among the lowest in the OECD even after the 2017-18 increases (Figure 17). Low expenditure, particularly for education, public investment and welfare (see below), limits the state’s capacity to counter large socio-economic disparities. To better accommodate the country’s economic and social needs, the spending-growth ceiling of the existing fiscal rule should be raised. At the same time, Israel needs to retain ample fiscal room for manoeuvre, given its specific geopolitical situation. Therefore, the key fiscal challenge is to maintain fiscal prudence and maintain the downtrend in public indebtedness while providing the additional public resources needed to improve educational outcomes, infrastructure and social cohesion. In particular, since 2017’s deficit decline is essentially temporary, adopting permanent tax cuts or unfinanced spending increases would inappropriately weaken the medium-term fiscal position.
Figure 17. Primary civilian expenditure
2016 or latest available data
Source: OECD, National Accounts Database.
The extra spending recommended here can be financed relatively painlessly, since the current tax burden is quite low. The government could in particular: i) abolish inefficient tax exemptions; ii) strengthen the fight against tax evasion; and iii) increase some green taxes. As recommended in previous Surveys, removing tax exemptions, such as on fresh fruits and vegetables, or the tax credit for medium-term saving in specific funds (Kranot Histalmut), would broaden the tax base (OECD, 2013), even if the former change might be regressive (Table 5). The same applies to the tax and reporting exemption for landlords’ rental income below NIS 5000 per month (Gruber, 2015). Fighting tax evasion can also bring additional revenues without increasing tax rates. Although difficult to measure, the share of the country’s shadow economy is estimated to be about twice as large as in the United States, the United Kingdom or Canada, even if lower than in some other countries (Gruber, 2014; Feige et al., 2012; Gyomai and Van de Ven, 2014). Tax evasion on rental incomes above NIS 5 000 seems particularly high, because the tax authority lacks the necessary information to collect these revenues (Levi-Weinrib, 2017; MoF, 2017b). The introduction of compulsory income tax reporting could reduce this evasion, as it has done in countries requiring reporting (Ben-David and Kimhi, 2017). Such a change would need to be combined with steps to minimise the administrative burden associated with paying taxes by promoting digitalisation. The authorities have, however, given close consideration to this option and believe that the revenue payoff would not justify the extra burden imposed on taxpayers. In any case more should be done to further exploit the information already available to the Israel Tax Authority and possibly to give it access to individuals’ banking data.
Table 5. Past recommendations on tax policy
Moreover, the implementation of the minimum standards, best practices and other recommendations of the OECD Base Erosion and Profit Shifting project will protect the corporate tax base and level the playing field. The move towards the automatic exchange of financial account information for tax purposes between tax administrations will increase tax transparency and further support tax collection. It also creates new opportunities to revisit the way Israel taxes capital income at the individual level. Finally, although green taxes are already fairly high (OECD, 2017b), raising diesel and/or other taxes on fossil fuels and eliminating the tax break for company car purchases would also help reduce pollution (OECD, 2016b). Higher taxes on smoking (including rolling tobacco) and harmful beverages should also be considered.
Savings can also be achieved on the expenditure side by strengthening the effectiveness of public management, promoting e-government and digitalisation and further improving the public procurement process. While the government recently undertook procurement reforms to streamline and standardise tender procedures, centralise e-procurement and encourage staff professionalization, only 10-15% of central government public procurement is processed in accordance with the new programme (IMF, 2017). Conducting regular spending reviews is a good way to explore priorities and thereby identify areas for spending restraint.
Increasing public investment in infrastructure and education and adopting ambitious product-market reforms would have a positive growth impact, which would, in turn, help finance these additional expenditures. Under the assumptions of the “structural-reform scenario” discussed above, the improved budget balance resulting only from the product market reforms (i.e. excluding the expected benefits of measures enhancing the education and training system, given their long and uncertain delay of action), coupled with the gradual removal of identified existing tax exemptions and moderate increases in environmental taxation, would allow the authorities to increase their spending-growth ceiling while keeping the same deficit level and bringing debt down to below 60% of GDP over the 2020-59 period (Figure 18). In this scenario, increasing the annual spending-growth ceiling from 2.6% to 3.6% between 2019 and 2025, would provide enough fiscal room to bring childcare, training and secondary education spending relative to GDP close to the OECD average and to increase the generosity of the in-work benefit scheme (Table 6). Between 2026 and 2059, public expenditure could revert to 3.2% per year, i.e. close to the period’s post-reform estimated average trend growth rate. While debt sustainability would also be maintained even if current trends are extrapolated (in the business-as-usual scenario), failing to continue with the integration of Haredim and Israeli-Arabs would seriously curb government revenues and lead to an unsustainable debt trajectory, assuming no policy change (Geva, 2015; non-convergence scenario).
Figure 18. Public debt sustainability would benefit from the enactment of further reformsref refid="fn-0022" format="note"/>
1. The business-as-usual scenario is the same as that presented in Figure 15. It thus consists of the updated projections for the Economic Outlook No. 102 until 2019. From there on, assumptions are based on Geva (2015), with an average annual real GDP growth of 3.0% and a budget deficit stable at 2.5% of GDP from 2020 onwards. According to the no-reform scenario of Haredim and Israeli-Arabs, which is also based on Geva (2015) as explained in the main text and the footnote in Figure 15, the deficit would be higher because of lower revenues due to a weaker annual average real GDP growth of 2.7%. The structural reform scenario, which incorporates the gains of structural reforms (as discussed in the main text and in the footnote of Figure 15) is based on higher real GDP growth (3.3% per year on average). This scenario assumes higher revenues due to the gradual removal of major existing tax exemptions over the 2019-25 period (see Table 6), while expenditure are projected to increase annually by 3.6% in real terms. Thereafter, tax revenues and expenditure are kept constant as a share of GDP.
Source: OECD calculations based on OECD (2017), Economic Outlook 102 Database; A. Geva (2015), “Demographic Changes and their Implications for Fiscal Aggregates in the Years of 2015-2059”, Ministry of Finance.
Table 6. Illustrative fiscal cost and financing of additional spending in the structural reform scenario
Impact at the end of 2025 as a percentage of 2025 GDP
1. Quantification of the impact of product market reforms in Israel assumes an increase in GDP by 6% on a 10-year horizon, according to OECD (2016b). Product market reform would thus assumed to increase GDP proportionally by 4.8% by 2025.
Source: OECD calculations based on OECD (2017), Economic Outlook 102 Database; A. Geva (2015), “Demographic Changes and their Implications for Fiscal Aggregates in the Years of 2015-2059”, Ministry of Finance; MoF (2014), “Tax Revenues Forecast for 2015-2016”, http://mof.gov.il/ChiefEcon/StateRevenues/StateRevenuesReport/DocLib/2013-2014/Report2013-2014_04.pdf.
Moreover, pressures on public finances would rise if pension expenditures increase. This does not seem to be a serious risk for old-age pensions (OECD, 2016b). On the other hand the situation is different for disability pensions. Although Israel’s disability spending is higher (1.4% of GDP in 2013) than the OECD average (1.0% of GDP), the Parliament has approved in February 2018 to gradually increase the disability benefits for the working age population by 30% to 50% between 2018 and 2021 without taking into account beneficiaries’ income conditions. Official estimates of the resulting annual fiscal cost, which rise from NIS 2.2 billion initially to NIS 4.3 billion (0.3% of GDP) in 2021 could be exceeded, as they do not account for the likelihood of increased demand for these significantly higher allowances, either by older workers or those poorly integrated into the labour market, as shown by other OECD countries’ experience. An increase in beneficiaries would not only be fiscally costly but could also seriously undermine ongoing efforts to bring vulnerable workers into employment, if their 5% share in the working-age population increases to the 8-11% level seen in the Netherlands, Hungary or Norway due to poorly designed regulation and incentives. While it is clearly necessary to ensure adequate incomes for the disabled, international evidence shows that the most effective programmes in this area combine financial support and measures helping these vulnerable people to integrate into the labour market and focusing medical assessments on their work capacity and not only their disability level. Although putting more resources into disability programmes might be desirable, simply increasing benefits is unlikely to produce desired outcomes if the measure’s design is not improved to strengthen its employment focus andto prevent an improper use of more generous allowances (OECD, 2017c).
Pursuing reforms to improve housing affordability and deepen the rental market
Improving the functioning of the housing sector remains a key concern, given its importance for financial stability, inclusiveness and productivity and implications for tax policy. Since the sharp acceleration in house prices in 2007 that followed a 25% price-adjusted plunge the previous decade, the average house price has become internationally high, at nearly eight times average household income (Figure 19). A declining share of young families are owner occupiers (Brender and Strawczynski, 2015), and households’ spending on housing has increased (Figure 20), despite a relatively moderate rise in rents. Moreover, real house prices continue to grow, although there have been signs of stabilisation since end-2016. Purchases remain buoyed by a vigorous labour market and the accelerating number of households, whose growth should rise from around 45 000 per year currently to 60 000 from 2025 (NEC, 2017).
Figure 19. House prices are elevated and still rising
1. Estimate for Israel is based on IMF (2017) and the growth index of the price-to-income ratio in OECD (2017).
Source: OECD (2017), Prices and Purchasing Power Parities – Analytical House Price Indicators database; Demographia (2017), 13th Annual Demographia International Housing Affordability Survey: 2017, Table ES-3; IMF (2017), Israel – IMF Country Report, No. 17/75, March.
Figure 20. Household spending on housing has increased, but total household debt is low
1. Household spending on housing has a slightly different coverage in national and OECD data sources.
Source: CBS, National Accounts; OECD, Prices and Purchasing Power Parities and Economic Outlook Databases; Bank for International Settlements, Credits to Non-Financial Private Sector Statistics.
Housing construction has been insufficient to meet the strong demand for homes, causing shortages and higher prices. Reforms have been introduced to enhance housing supply. Land-use planning procedures have been streamlined to reduce their duration from over 11 years by decentralising small residential project approvals (Table 7). New large residential projects were approved under the accelerated procedure introduced in 2014 for a five-year period (the Vatmal programme) (OECD, 2017d) (Figure 21). A long-term strategic plan to 2040 has been adopted to meet the nation’s needs (BoI, 2017b). Provisions to reduce the housing tensions in Arab localities have been taken with the planned construction of 40 000 new dwellings houses under the five-year (2016-20) plan of NIS 15 billion to promote the economic development of the Arab sector (Iataskforce, 2016). Moreover, several foreign housing companies are set to enter the Israeli market. This should boost competition and productivity in the construction sector, which are low by international standards (Ben-David, 2013), and reduce construction costs.
Table 7. Past recommendations on housing policy
Figure 21. Housing supply has strengthened
Source: Central Bureau of Statistics, Construction Statistics.
Moreover, the authorities have again raised taxes on real estate investment, which had risen sharply in 2007 (Figure 22). After a first increase in mid-2015, a welcome property tax on owners of three or more dwellings was adopted in 2017. This measure, which was invalidated by the High Court in August 2017 for procedural reasons, is expected to be adopted in the next Knesset session (see Table 7 above). The authorities also launched the “Buyer’s Price” programme to facilitate housing purchases by young households by modifying the tendering for public land: public land is sold at fixed, below-market prices to promoters who undertake to build housing at the lowest (bid) prices. By end-2017, 40 000 households were entitled to buy such a house, and their number should reach 100 000 by end-2018. In September 2017 the programme’s termination date was extended from 2017 until 2019.
Figure 22. Investing in real estate picked up sharply after 2007
Percentage share of households owning two or more dwellings, by income quintile
Source: IMF (2017), Israel – IMF Country Report, No. 17/75, March, Figure 6.
These multiple reforms include several useful measures. However, some are costly and could be improved. The Buyer’s Price programme, for example, does not increase the supply of public land, despite a non-negligible budgetary cost (0.2% of GDP in 2017-18; IMF, 2017). It also distorts the market because many beneficiaries of its subsidies (who are selected by lottery) will buy a “bargain” dwelling in a location that does not meet their needs, probably merely to rent it (BoI, 2017b). This ultimately stimulates renting rather than owner occupation, the government’s original intent.
In any case, assisting young households could best be done by facilitating rental rather than housing purchase and reforming the rental market, as recommended in previous Surveys. The recent changes to this weakly regulated market (limiting, for example, the maximum amount of financial guarantees that owners can ask of tenants) are welcome (Table 7). However, other adjustments should be considered to deepen this market, which is somewhat narrower (31% of the total) than the OECD average (37%). Renting would be more attractive, especially for young households, if the minimum landlord-guaranteed duration of leases exceeded one year and the annual increase in rents were capped during the term of the lease, with owners free to adjust them at renewal to avoid the poor investment returns that would eventually limit rental supply. However, such a regulation, which would be similar to a mandatory insurance policy, might raise rents somewhat.
Moreover, the government’s legitimate goal of reducing investor demand in the current monetary and financial environment would be reinforced by removing the income tax exemption enjoyed by rental income, as mentioned above (Gruber, 2015). Municipalities should be provided with adequate resources for financing the local infrastructure services needed for new residential developments. Given the low level of taxes on residential properties and the political difficulty of raising them, Israeli cities have strong incentives to prefer business activities to residential neighbourhoods. The coordination under the Vatmal programme between developing large residential tracts in peripheral areas where public land is available and building public transport to the economic centres where jobs are located could be enhanced (see below and Chapter 2). This would be particularly beneficial to social cohesion and reduction of disparities due to the spatial segregation of disadvantaged communities.
Improving social cohesion would promote sustainable growth
Increasing labour-market integration and employment opportunities for disadvantaged groups
The Israeli labour market has improved markedly over the last decade, with the employment rate reaching historically high levels. While this partly reflects remarkable progress for older workers due to the retirement age increase (BoI, 2017e), more and more Haredim and Israeli-Arabs have also found jobs, though their employment rates remain low (MoF, 2017c); the problem is especially severe for Haredi men and Israeli-Arab women; indeed, progress has stalled for both groups (Figure 23). However, there is no guarantee that gains will continue much longer, since the stock of remaining inactive adults in these communities no doubt includes some of the most resistant to joining the labour market.
Figure 23. Participation rates have improved markedly, particularly for disadvantaged groups
Source: Ministry of Finance.
Moreover, the labour market is still characterised by severe duality. On the one hand, there are productive advanced industries, including high-tech sectors, which attract mostly high-skilled workers with high wages. On the other, low-productivity, often non-tradable, sectors employ many Israeli-Arabs and Haredim who are trapped in low-quality, low-wage jobs. Israel’s share of low-paid workers is one of the OECD’s highest (Figure 24). Moreover, job mobility towards high-productivity sectors is declining, which means that the probability that low-educated individuals will get jobs in high value-added, high-wage industries has decreased over time (Brand and Regev, 2015).
Figure 24. There is a high share of low-paid jobs in the labour market
Share of low-paid workers,ref refid="fn-0026" format="note"/> 2016ref refid="fn-0027" format="note"/>
1. Defined as workers earning less than two-thirds of median earnings. Conscripts with low pay are included as workers in this indicator. However, given the longer duration of military service in Israel (2 or 3 years) than in other countries, an OECD estimate of the population of working poor excluding conscripts (the black triangle) is provided.
2. Or latest available year.
Source: OECD, Labour – Earnings Database and OECD estimates.
This is worrying, as such industries are facing increasing skilled-labour shortages (see Chapter 1), undermining their growth and competitiveness. More than half of their companies recently reported difficulty filling jobs, particularly for engineers (Manpower, 2017). A special visa exists for skilled workers where there is no local expertise. Despite strong demand, the employment share of the high-tech sectors has remained stable around 12% of employment in the business sector for a decade, and they are said to lack more than 10 000 engineers (MoF, 2016). Israeli-Arabs comprise only about 3% of the high-tech workforce, and Haredim are also under-represented. The situation is similar in many other sectors such as financial and professional services (Irac and Imrpj, 2016). This reflects a number of difficulties and barriers including education and transportation issues, but also other obstacles such as language barriers, cultural and social norms – as well as insufficient inclusiveness of policies and programmes (Yashiv and Kasir, 2014).
More needs to be done to improve the outcomes of these groups, not only in terms of employment, but also of wages and productivity. The remaining legal barriers to work should be lifted for those Haredi men who have been exempted from military service if they committed to study religion in order to allow them to join the labour market. Moreover, besides reforms in education (Chapter 1) and infrastructure (Chapter 2), active labour market policies need to be strengthened.
Israel’s spending on active labour market policies in 2014 amounted to just 0.16% of GDP, well below the OECD average of 0.55% of GDP (Figure 25). Spending on training, which is provided through a voucher system in particular, is meagre, while experience from other OECD countries shows that well-designed training measures are effective in keeping skills up to date and improving labour market matching (Card et al., 2015). Additional resources and better work incentives are needed, together with more careful programme assessment. While there are a plethora of Israeli training provisions, their effectiveness is often unclear due to a dearth of evaluations undertaken (OECD, 2015a), which may result in inefficient programmes continuing to operate.
Figure 25. Spending on ALMPs,ref refid="fn-0028" format="note"/> especially training programmes, is low
As a percentage of GDP, 2015 or latest year available
1. Active labour market programmes.
Source: OECD, Labour Market Programmes Database.
More attention should be paid to overall job quality, the sustainability of job placements and levels of pay. Public employment services should offer basic-skills and literacy training before placing the unemployed directly into jobs. Increased training incentives for individuals already in work are also needed, particularly for the low skilled who are less likely to receive training (OECD, 2017e). In Germany workers without qualifications and those working in positions unrelated to their initial training for at least four years may receive grants to be retrained in areas with better prospects (OECD, 2015a). So-called “retention and advancement services” to increase training incentives for individuals exist in many OECD countries (OECD, 2017e). If the Israeli training voucher scheme proves to be effective after careful programme assessment (see above), it should be expanded and its eligibility widened towards low-skilled workers, especially from disadvantaged groups. Support programmes for Israeli-Arab and Haredi entrepreneurs should also be introduced (OECD, 2016c). These measures should be complemented by better enforcement of existing anti-discrimination regulation. It may also be worthwhile using public procurement to increase incentives for firms to hire more Israeli-Arab and Haredi workers (Sikkuy, 2016).
Gender equality also requires policy attention. The median gender wage gap, which is close to 22%, is higher than the OECD average (Figure 26). This gap can be partly explained by lower working hours for women, but also by their choice of education field and industry (Fuchs, 2016): women account for only about 25% of high-tech jobs (Mazuz-Harpaz and Krill, 2017). However, it is also related to the lack of childcare facilities, although corrective efforts are underway (Table 8) (Chapter 2). Although expenditure on child-care and pre-school education relative to GDP is slightly above the OECD average, it is comparatively lower when measured per child under four, given Israel’s large share of this population age group. Increasing the number of subsidised crèche places for these children would foster labour force participation and would help women to pursue better careers, with higher wages (BoI, 2016c). This would be beneficial particularly for Arab women with low labour force participation (Schlosser, 2011) and Haredi women with large share of part-time work, who currently end up doing much unpaid work for their families. On the other hand, the existing eligibility for subsidised childcare facilities for Haredi families whose father is studying in a yeshiva is likely to be counterproductive for labour-market integration and takes available spaces from two-earner working families.
Figure 26. The gender wage gapref refid="fn-0029" format="note"/> is pronounced
2016 or latest available year
1. Defined as the difference between median wages of men and women relative to the median wages of men.
Source: OECD, Labour – Earnings Database.
Table 8. Past recommendations on labour market policies
Reforming the tax-transfer system to support more inclusive and sustainable growth
Inequality and poverty in Israel remain high, despite some improvement resulting from the rising employment rate and recent measures to address the problem, such as increases in the minimum wage and in the earned income tax credit (EITC) (Table 9). In recent years both gross and net income inequality have come down, returning the net measure to the levels seen in the early 2000s, implying important savings on transfer payments. Inequality, as measured by standard Gini coefficient, has decreased from 0.36 in 2011 to 0.34 in 2016. Nevertheless, the fact remains that average disposable income of the 10% richest households was 13.3 times that of the poorest, against a multiple of 9.4 for the average OECD country. Almost one-fifth of the population live in relative poverty (i.e. have a disposable income below 50% of the median), the highest rate in the OECD. All age groups are affected, with a particularly heavy prevalence among children, but also among the elderly. Around half of Arabs and Haredim are poor, against 13.5% of non-Haredi Jews.
Table 9. Past recommendations on social policies
One of the reasons for high poverty rates is the low level of social transfers (BoI, 2016c). While poverty measured before taxes and transfers is lower than in many other OECD countries, poverty after taxes and transfers is higher (Figure 27). As in other OECD countries, transfers do not include in-kind benefits such as free education and health-care services. Israeli social policy follows a “welfare-to-work” approach to tackling poverty in order to avoid measures that may harm work incentives among the Haredi, who value the time dedicated to religious studies, and the Arabs, who have cultural barriers to female employment (Yashiv and Kasir, 2013). Policymakers are concerned that, although easing economic distress in the short term, higher transfers would perpetuate it in the long term by slowing the progress of their employment integration. The critical challenge they face is that many of those subject to (relative) poverty (specifically: Haredi men) do not want to work and are satisfied with a very low material standard of living.
Figure 27. Poverty rate before and after taxes and transfers
Poverty line 50%, 2016 or latest year available
Source: OECD (2017), Income Distribution Database, www.oecd.org/els/soc/income-distribution-database.htm.
The Israeli government’s strategy of encouraging employment among previously non-working families has met with substantial success. Moreover, the average real income of poor households has risen by 2.7-2.9% in the last six years, while the average real income of wealthier households has increased by only 2.2% (OECD, 2017f). But with so many households with only one provider and a persistent and widespread problem of poor job‐related skills, it is just a first step whose benefits have been limited so far by the increase in the working-poor phenomenon. Many disadvantaged workers have been able to find jobs, but their families remain poor, since in most cases these jobs are low-paid. Indeed, the share of the working poor has risen in recent years and is internationally high (Figure 28, Panel A). This is particularly true for the Haredim and Israeli-Arabs, for whom the increased number of breadwinners per family in the last decade (including part-time workers) has had only a limited impact on their poverty risks (Panel B). Therefore, the authorities should focus more on decreasing poverty among those in work.
Figure 28. The share of working poor is high and increasing
1. Those with income below the poverty line, living in households with a working-age head and at least one worker.
2. Break in the time series in 2012.
Source: OECD (2017), Income Distribution Database; National Insurance Institute.
Although increasing the employment rate among the Haredi and Israeli-Arabs is essential, it is unlikely that this will be enough to reduce poverty. Israeli-Arabs and Haredim earn on average only 70% and almost 90% of the median hourly wage, respectively, mostly due to the differences in skills (see Chapter 1) and typically Haredi households have many children and only one breadwinner. According to OECD analysis (see Annex A.1), even if two spouses in these families were working full-time, total family income would not be enough to escape from poverty, given the current tax-transfer system and these households’ large number of children (Figure 29). The earnings of an average Arab family with four children would need to reach around 160% of the median wage in order to have a net income exceeding the poverty line, and, in the case of a Haredi family with six children, it would need to reach around 230% of the median wage.
Figure 29. Higher employment of Haredim and Israeli-Arabs may not be enough to lift them out of poverty
Estimates of a family income according to the numbers of earners and its community groupref refid="fn-0032" format="note"/>
1. One earner corresponds to a family with one earner, one and a half earner corresponds to two-earner family where one works full‐time and the second half-time, and two earners corresponds to two-earner family where both work full-time.
2. Workers are assumed to earn 110% of the average wage.
3. Workers are assumed to earn 70% of the average wage.
4. Workers are assumed to earn 90% of the average wage.
Source: OECD calculations using the OECD Tax-Benefit Model. See Annex A.1 for more details.
One way to address this poverty issue is to further expand in-work benefits. Israel’s “negative income tax” (Earned Income Tax Credit, EITC) boosts take-home pay of the average eligible worker by around 16%. It is an effective redistribution measure that also strengthens work incentives of low-skilled workers, in particular those with children (BoI, 2015). But it could be more effective, since its overall budgetary cost is currently only 0.1% of GDP, a fraction of spending on similar programmes in the United States and the United Kingdom (0.4-0.5% of GDP). To encourage second-earner employment, notably for Israeli-Arab women and Haredi men, as is currently being discussed, Israel could provide a negative income tax “bonus” to families in poverty where both members of a couple are in (low-paid) work. For example, the UK negative income tax is conditioned upon the family’s hours of paid employment (Brewer et al., 2006).
The authorities should also continue making special efforts to overcome child poverty. The incidence of child poverty remains particularly high among Israeli-Arabs and Haredi, above 60% (National Insurance Institute Israel, 2016). Israel’s overall child-related cash support is low by OECD standards, not only for workless households but also for children with working parents (Figure 30; Brender and Strawczynski, 2015). Government support since 2017 for all children in the form of monthly savings deposits accessible at age 18 will be useful for future young adults (see Table 9 above) but does not address acute poverty risks during childhood. To lower child poverty making support conditional on children taking up schooling supplementary to regular learning hours could be considered. This would improve educational outcomes of children from poorer families and reduce poverty (Abhijit et al., 2015). At the same time, working parents’ situation should be enhanced. To enable parents to work the school day should be extended, with hot, nutritious lunches served in adequately equipped school cafeterias (Ben-David and Kimhi, 2017).
Figure 30. Child poverty is high, while effort to overcome it is low
1. The poverty threshold is 50% of median household income, after taxes and transfers. For the OECD, 2015 or most recent data.
2. The income difference comprises child-related support including both cash benefits and tax concessions. The figure shows averages for lone-parent and couple households without any labour income and relying on minimum-income support (“out of work”), and of lone-parent, one-earner couples and two-earner couples with in-work earnings at the 20th percentile (“in work”). The aggregate OECD is the unweighted average of 34 OECD countries.
Source: OECD, Income Distribution Database, www.oecd.org/social/income-distribution-database.htm; OECD Tax-Benefit Models, www.oecd.org/social/benefits-and-wages.htm.
As suggested in the 2016 Survey, the authorities should also moderate the impact of the mandatory pension contributions for low-wage workers, which are higher than in most other OECD countries and tend to unbalance low-income households’ lifetime income flows. Thus, while the pension system offers a high replacement rate for workers earning less than the average wage, it undermines living standards of young families (OECD, 2016b) and may lead to higher informality. The existing tax deduction on this mandatory contribution provides relief for some but is very regressive: more than half its total value goes to the top decile of the income distribution, while around 45% of employees, including the most vulnerable, do not pay income tax and therefore do not benefit (Brender, 2011). To ensure that relief is provided also to low-income workers it should be converted into a non‐wasteable (refundable) tax credit.
Improving the education system to enhance equity
Extensive poverty and inequality in Israeli society are to a significant extent due to the wide dispersion of skills. Israel has one of the largest gaps between adults with outstanding competences and those with weak outcomes (Figure 31, Panel A). The share of adults with top-notch numeracy skills is comparable to the OECD average, but the proportion of low‐skilled adults is exceptionally high: for example, almost one-third of Israelis lack basic maths skills. These differences are particularly pronounced between communities, which exacerbates already strong socio-economic divisions in Israeli society. Large wage gaps between Israeli-Arabs and Haredim and the rest of the population can for the most part be explained by differences in skills (BoI, 2016d): the relation between wages and skills proficiency is relatively strong in Israel (Panel B).
Figure 31. High inequalities are related to differences in skills
1. The measure of variability used is the interquartile range (difference between the third and first quartiles. Data indicated as Belgium correspond to Flanders; GBR1 = England and GBR2 = Northern Ireland.
2. For more details, see Figure 5.4 of OECD (2016).
Source: OECD (2016), Skills Matter: Further Results from the Survey of Adult Skills, Figure 2.15 and 5.4 and Table A5.4; OECD Survey of Adult Skills (PIAAC) Database (2012 and 2015).
Education plays a central role in the acquisition of skills at an early age and is a powerful lever to make society more inclusive. However, international assessments of Israeli students’ outcomes (including PISA) show significant differences among students. Hebrew-speaking students have similar or better scores than the average OECD student, while Arabs lag behind. The share of poorly performing Arabic-speaking students was 45%, against 12% for Hebrew speakers. Almost no Arabic speakers reached the top performing cut-off. Particularly poor performance is found in the Bedouin community, whose children (below the age of 14) currently comprise almost one fifth of all Israeli-Arab children.
This large dispersion in skills and students’ outcomes is related to the segregated education system, which comprises four streams: one for Arabic speakers and three for the Hebrew-speaking communities, including Haredi, state-religious and state schools. In the Arabic stream the instruction language is Arabic, and Hebrew is taught as an additional subject, while all teachers are Arabs. The situation in Haredi schools reflects an explicit choice of studying religious rather than secular subjects. Haredi boys aged 13 usually continue only with religious studies without secular core subjects, while girls spend much more time on secular subjects. These systemic features weaken skills formation in the Haredi and Israeli-Arab communities and contribute to the considerable inequality in socio-economic outcomes. Since merging all the streams into a single system built around a common core curriculum is politically unrealistic, improving the education system requires building bridges between existing streams with the objective of raising the outcomes of low achievers, especially among Israeli-Arabs and Haredim.
This will require higher public education spending, particularly on disadvantaged schools (see below). Despite significant increases in recent years, expenditures per student remain low (Figure 32). Moreover, budget allocations do not provide enough support for disadvantaged groups. Schools receive a basic budget that is equally distributed according to student numbers and a grant (6% of the total budget) that reflects the school’s socio-economic profile. Additional financing comes from the municipalities. Better endowed local governments can provide 10-20 times higher funding per student than their less affluent counterparts, though the amounts involved are small (OECD, 2016d). Consequently, schools in disadvantaged areas are comparatively underfunded, although the nature of this problem is different between Arab and Haredi schools (Chapter 1).
Figure 32. Education financing remains low, especially at secondary level
Annual expenditure per student relative to per capita GDP, 2014
Source: OECD (2017), Education Finance Indicators Database.
Disadvantaged schools need much greater funding. Adjustments are planned, and the five-year Economic and Development Plan for the Arab Sector, mentioned above, includes education measures, which if properly implemented, can help reduce these gaps (Table 10). However, much more is needed. For example, in Chile, a weighted voucher system allocates 50% higher resources for students from low socio-economic backgrounds (Elacqua, 2012) to provide extra teaching time or specialised learning materials. The authorities can also increase salaries for teachers working in disadvantaged schools. International experience suggests that much higher salaries are required to attract the best teachers to such institutions, but that financial incentives will be effective only if teachers are given the means to be successful, such as by complementing higher wages with other incentives like smaller classes. Korea offers multiple incentives to candidates working in high-needs schools, including higher pay, smaller classes and additional credits towards future promotion (OECD, 2012a). A cost-efficient option that has had some success abroad is to set up a system allowing teachers to share good teaching practises. Above all, there is a need to reduce the curricular differences between the education streams (see below), which contribute to wide dispersion of average skills and educational outcomes among students from different communities.
Table 10. Past recommendations on education
In the Arab stream the government should keep trying to improve the teaching of Hebrew, as only 60% of Arabs have a good understanding of it. A better command of Hebrew would help Israeli-Arabs integrate into the job market (Marom, 2015). While the government recognises the problem and is expanding the number of hours dedicated to teaching Hebrew in Arab schools, more needs to be done. Ensuring substantial teaching of practical Hebrew and/or teaching some core subjects in Hebrew would be desirable. A complementary approach should include expanding pre-school education to children between 0 and 3 (see above) and increasing their exposure to Hebrew. To this end moving the responsibility for this sector to the Ministry of Education would be desirable.
Past efforts to increase the share of core subjects in the Haredi curriculum have failed several times, even though most parents are supportive (Gal, 2015). The latest attempt, which provided budgetary sanctions against Haredi schools not devoting a certain minimum time for secular studies, was repealed in 2015 due to opposition by community leaders and insufficient numbers of Haredi teachers and textbooks for these subjects. The authorities should prepare the ground for a possible future situation where teaching core subjects in Haredi schools is politically accepted and provide additional funding for training Haredi teachers and developing core-subject textbooks to schools willing to teach secular subjects. However, this additional funding should also impose more conditionality on teaching core skills, monitoring and student testing. Better enforcing this monitoring and testing in those Haredi schools that are already committed to teach core subjects in exchange for public financing is also needed. This would also improve statistical information on Haredim results, which decision-makers lack. Complementary steps could include the aforementioned introduction of support for poor families conditional upon children taking up additional formal education and systematically subsidising the acquisition of formal knowledge by Haredi students after their religious studies.
Another problem that exacerbates skills differences is the low quality of the initial vocational education and training (VET) system. Firms regularly express concern about VET graduates’ lack of professional and technical skills (Musset et al., 2014). Particularly weak outcomes are found among students from the lower vocational track, which have much lower probabilities of qualifying for the Bagrut and higher dropout rates (Blank et al., 2015). Moreover, studying on the lower VET track worsens graduates’ labour market outcomes compared to those following the academic track (MoF, 2017d) and relative rates of return to VET prior to military service, may be low over the long run (Hanushek et al., 2015). As a consequence many young people who pursue lower vocational tracks are poorly equipped for entry to the labour market. In this regard substantial components of work-based learning can be beneficial as it not only helps students to acquire practical skills, but also to develop key soft skills, such as work discipline, teamwork and problem-solving skills, which can be more effectively learnt in workplaces than in classrooms (OECD, 2010). One way forward is to expand apprenticeship and workplace-based learning, co-ordinating with industry partners. In Spain making workplace training mandatory in VET programmes facilitated the transition of VET graduates to jobs (Homs, 2007).
Israel’s tertiary education is well developed, with impressive academic achievements, including high citation rates, unsurpassed Nobel laureates per capita and large numbers of high-tech start-ups. However, it also faces two serious challenges: i) making tertiary education more accessible for Haredim and Israeli-Arabs; and ii) improving the matching of students’ skills to changing labour-market needs.
The expansion of colleges and Haredi campuses has improved tertiary education access to students from peripheral regions, with lower socio-economic status and from disadvantaged groups. The enrolment rate of Arab and Haredi students in the relevant age cohorts has increased significantly. However, the disparities between social and community groups remain large. The share of young Haredim and Israeli-Arabs completing tertiary education is significantly lower than for the rest of the population (Figure 33). This results mainly from weaker secondary school outcomes (see above), but there are other barriers preventing wider tertiary access (Chapter 1). OECD research suggests that student financial-support systems that provide both loans with income-contingent repayments and means-tested grants improve access to higher education and outcomes for weaker students (OECD, 2012b). At the same time, pre-tertiary preparatory courses for disadvantaged students should be expanded to increase their access and reduce drop-out rates, although these preparatory courses have proved to be less effective for Haredi students.
Figure 33. Poorer students, Haredi and Israeli-Arab students are less likely to enrol in tertiary education
Source: Swirski, S., E. Konor-Attias and R. Zelingher (2015), Israel: A Social Report 2015, Adva Center; Regev, E. (2016), “The Challenges of Integrating Haredim into Academic Studies”, in State of the Nation Report 2016, Taub Center for Social Policy Studies.
Many Israeli tertiary graduates are employed in jobs not matching their field of studies, and this phenomenon is more pronounced than in other OECD countries (Said, 2015; OECD, 2016e). The government is rightly trying to increase the number of engineering graduates to meet labour market demands. At the secondary level it is increasing the number of students completing high-level mathematics and increasing their share from around 10% to 15%‐30%. Empirical research confirms that relatively few pupils study math at higher levels, but those who do so access more prestigious study tracks in universities and enjoy higher pay in employment (Kimhi and Horovitz, 2015). At the tertiary level, the government is planning to increase the number of college and university students with technology-oriented majors by 40% within five years (Israel Innovation Authority, 2017). Complementary steps to reduce such mismatch should involve making publicly available high-quality data and analysis concerning graduate labour market outcomes. Better information on market returns of various career paths would help individuals to better adjust to labour market signals. Students’ choice of field of studies would also be better served through a strengthened and scaled-up career counselling system. For Israeli-Arabs and Haredim these steps should be complemented with measures widening their employment opportunities (see above) to ensure that greater attainment leads to better jobs.
Pursuing product market reform to boost productivity and wages in traditional economic sectors
Promoting competition to boost productivity is an important policy challenge in Israel and a key ingredient for fostering inclusive growth. As highlighted in the 2016 Survey, Israel is less open to foreign trade than most OECD countries and the business environment less favourable (Figure 34). These persistent difficulties contribute to low average productivity gains and large productivity and wage gaps between sectors exposed to international competition and their more traditional counterparts, often made up largely of SMEs (Figure 35), where workers from disadvantaged groups are usually employed.
Figure 34. Israel’s business environment remains less favourable than in other OECD countries
Distance to frontier, from 0 (worst performance) to 100 (best performance)
1. The distance to frontier helps assess the absolute level of regulatory performance over time. It measures the distance of each economy to the “frontier”, which represents the best performance observed on each of the indicators across all economies in the Doing Business sample since 2005.
Source: World Bank (2017), Doing Business 2018: Reforming to Create Jobs.
Figure 35. The productivityref refid="fn-0041" format="note"/> penalty of small firm size is fairly high in Israel
Value added per person employed, manufacturing, index 250+ = 100, 2013ref refid="fn-0042" format="note"/>
1. Labour productivity is measured as gross value added in current prices per person employed.
2. Or latest available year.
Source: OECD (2016), Entrepreneurship at a Glance 2016, Figure 3.2.
Improving product-market functioning has been high on the policy agenda since the 2011 “tent protests”, and helpful reforms have progressed in recent years. Measures have been taken to stimulate competition in the banking sector (see Table 3 above) and to increase domestic market exposure to parallel imports via the Internet. Import tariffs have been reduced on several products, including foodstuffs, and some import procedures have been simplified (Table 11). Moreover, the government has committed to cutting the regulatory burden on businesses implied by the stock of existing regulations imposed by all ministries by 25% by 2019 and now assesses the competition impact of all new laws. It is still early to evaluate the impact of these reforms. However, the recent persistence of price stability in the face of buoyant demand, which seems to have resulted from improved supply conditions, is an encouraging sign. Further progress in streamlining product market regulation could be expedited if co-operation between the multiple government bodies involved in this reform process (Prime Minister Office, Ministry of Economy, Accountant General and Chief Economist in the Ministry of Finance) were enhanced.
Table 11. Past recommendations on improving product market regulation and lowering trade protection
Nevertheless, much remains to be done to ease foreign trade and streamline regulation. Trade-facilitation reforms could, for instance, reduce trade costs by as much as 12% (OECD, 2015b). Further measures should focus on streamlining border procedures and border agency co-operation, with expanded use of “trusted traders” programmes and targeted controls (Figure 36). Import barriers could be further lowered by broadening post-market surveillance of imported goods to new domains, including communication products. Regulatory barriers for personal imports of goods over the Internet implying cumbersome administrative approvals could be also lowered for these products. As recommended in the 2016 Survey, the use of EU health rules for non-sensitive products should be extended to “sensitive” products, such as dairy, eggs and meat, which represent over half of all imported foodstuffs. The agricultural reform process should continue, with the replacement of quotas, price guarantees and customs tariffs by direct payments to farmers to avoid distorting markets (OECD, 2017g).
Figure 36. Israel could do more to facilitate trade
Score from 0 (worst performance) to 2 (best performance), preliminary 2017 data
Source: OECD, Trade Facilitation Indicators Database, www.oecd.org/trade/facilitation/indicators.htm.
Competition in key services, such as telecommunications, construction and postal/courier services, could be also enhanced by eliminating existing restrictions that impose the equivalent of a 10-25% tax on business users (Rouzet and Spinelli, 2016) (Figure 37). For instance, in the fixed high-speed Internet segment some operators hold substantial market power, and Israel maintains a cap of 80% on foreign equity in the sector and stringent nationality and residency conditions for business leaders. Entry conditions for foreign workers should also be relaxed, especially in high-tech sectors and, in this respect, recent provisions streamlining the application and allocation of work permits for foreign experts by high-tech firms through an online application is most welcome (Yefet, 2018). Moreover, competitive pressures in the banking sector would be reinforced if switching banks were simplified, as the authorities plan to do.
Figure 37. There is room to further reduce barriers to trade in services
Services trade restrictiveness index from 0 (open) to 1 (closed), 2016
1. The STRI records measures on a most-favoured-nation basis; preferential trade agreements are not taken into account. Air transport and road freight cover only commercial establishment (with accompanying movement of people). The cross-country average refers to the 35 OECD Members, plus Brazil, China, Colombia, Costa Rica, India, Indonesia, Lithuania, the Russian Federation and South Africa.
Source: OECD, Services Trade Restrictiveness Index Database, www.oecd.org/tad/services-trade/services-trade-restrictiveness-index.htm.
Certain aspects of business regulation, such as the business licensing and permit system administered by local municipalities, remain cumbersome, especially for SMEs. Approximately 40% of existing Israeli companies need a license according to national regulations; however, one-quarter of them operate without one, thus bordering on informality (OECD, 2016c). Key barriers include a lack of information on standardised procedures and long delays in municipal permit issuance. Heavy bureaucratic costs of environmental licensing could also be cut by as much as 30% if the currently fragmented approach were streamlined in an integrated procedure (OECD, 2016b; Eshet and Karni, 2016). More generally, Israel should introduce a “silence-is-consent” rule when appropriate, as Portugal has done. It should also promote the digitalisation of business licensing and permit systems, as Denmark, Estonia and Norway have done. Online procedures for registering property transfers, obtaining building permits and paying taxes (Figure 38) would also reduce unnecessary administrative burdens on firms and households (Lopez-Claros, 2016).
Figure 38. Tax procedures for businesses are onerous
Number of payments and time required to comply with taxes per year, 2017 data
Source: World Bank (2017), Doing Business 2018: Reforming to Create Jobs.
Although Regulatory Impact Assessments (RIAs) have been part of the regulatory management process since 2016 (OECD, 2017h), further progress can be made (Figure 39). Mechanisms for co-ordinating the regulatory policy agenda have been established, but competencies are not yet clearly defined, and ministries and agencies continue working in silos, rather than adopting a whole-of-government approach. The mandatory consultation on draft legislation concerns only the final version and does not apply to the preliminary stages of the process, thereby leaving too little time for improvements. It is also unclear if these consultations with stakeholders are occurring systematically, with only 20 RIAs of draft laws published to date. To reduce administrative burdens it is first necessary to measure them and make more use of evidence in designing regulations. Moreover, the new RIA requirement applies only to laws initiated by the government and not to those introduced by parliamentarians (MKs). While this is also the case in many other OECD countries, 42% of all primary laws are introduced by MKs in Israel, making this exception relatively important.
Figure 39. Regulatory management processes can be enhancedref refid="fn-0044" format="note"/>
Composite indicator, from 0 (worst performance) to 4 (best performance), 2014
1. The results for stakeholder engagement and RIAs apply exclusively to processes for developing primary laws initiated by the executive, which in Israel account for about 58% of all laws.
Source: OECD (2015), OECD Regulatory Policy Outlook 2015, OECD Publishing, Paris, http://dx.doi.org/10.1787/9789264238770-en.
Improving infrastructure to boost productivity and well-being
Suitable and well-functioning infrastructure is crucial for growth, inclusiveness and well-being. It bolsters trade, competition and innovation and enhances access to public services. These benefits are important for Israel because of its relative remoteness from other markets and its high and rising population density, which increases the social returns on infrastructure investment in domains like transport and telecommunications (Chu, 1997; Deole, 2014; Glover and Simon, 1975) (Figure 40, Panel A). However, Israel has a sizeable infrastructure deficit due to its short history and public underinvestment since the early 2000s (Panel B). The biggest gap concerns public transport, which results in very heavy use of private vehicles (Figure 41, Panel A), causing costly road congestion (whose estimated cost was 1.5% of GDP in 2012) and local pollution problems. Moreover, renewable electricity production is low, and the electricity sector is still dominated by the state-owned incumbent whose inefficiency is shown by its high labour costs due to overstaffing and elevated wage levels (OECD, 2016b). The cost and quality of airport services are also substandard. Hospitals are overcrowded. And access to infrastructure services is unequal between regions and communities, with Arab towns often lacking adequate facilities (Panel B).
Figure 40. Public investment in Israel doesn’t match its population density, which is rising rapidly
1. Excluding capital transfers to state-owned enterprises for infrastructure development, which have been significant in Israel.
Source: UN Department of Economic and Social Affairs, Population Division (2017). World Population Prospects: The 2017 Revision; OECD, Economic Outlook Database.
Figure 41. Inadequate public transport and infrastructure, especially in Arab areas, hinders well-being
1. Or latest available year.
2. Percentage share of respondents that were satisfied or very satisfied.
Source: OECD (2015), Environment at a Glance 2015: OECD Indicators, Figure 2.11; CBS, 2015 Social Survey Table Generator, http://surveys.cbs.gov.il/survey/surveyE.htm.
The government is aware of these problems and has taken corrective measures. Over 50% of recent transport investment concerned public transport following its strategy to shift ridership away from private vehicles to achieve a market share for public transport of 40%. A high-speed rail link between Jerusalem and Tel Aviv will open in the course of 2018. The government also aims to develop light rail systems in the country’s three main cities between 2019 and 2023. There is also a plan to increase renewables’ share of electricity. Israeli-Arab communities’ access to infrastructure services is being improved, with a five-year (2016-20) plan worth NIS 15 billion (1.2% of GDP) mentioned above to enhance transport, education, social services and housing in Arab towns. In addition, in mid-2017 an inter-ministerial committee was set up to improve infrastructure planning and to advance, monitor and coordinate these projects (Flug, 2017c).
These positive aspects must, however, not be offset by any weakening of public finances. To this end, the increased use of Private-Public Partnerships (PPPs) planned by the authorities, in particular in public transport, is welcome but must be carefully managed. Most importantly, PPPs should not be chosen just to avoid budget constraints, and the various risks must be carefully and clearly allocated. They can help government make the most of private-sector know-how but are difficult to use and bear a risk of management failure that can lead to additional contingent public debt (Araújo and Sutherland, 2010). PPPs need to be cautiously implemented, with careful planning relying on adequate funding. Entrusting the management of these contracts to a single public agency, as recently decided by the government, will also help centralise public-sector PPP expertise (BoI, 2017b).
Efficient infrastructure pricing helps identify the needs and adjustments of service demand to available capacities. Charging users for the service also ensures more disciplined selection of investment projects (Glaeser, 2016). Promoting user-financed infrastructure is thus desirable, including for roads, which are currently funded by levies and taxes that are only weakly linked to road transport use. A recent Israeli pilot measure has shown that modest financial incentives can reduce private car use during rush-hour in congested areas, with positive impacts on environment (Bar-Eli, 2016). Road tolls can regulate demand effectively and should be used more widely. In the longer term a more ambitious overhaul of the management and funding of road transportation should also be considered. Technological advances now make it possible to price the use of road networks through metering systems, paving the way for user- rather than taxpayer-based financing (Cramton and Geddes, 2017). Australia plans to introduce such a system within the next decade (Infrastructure Australia, 2016), and toll systems for trucks already exist in Germany and Poland (Queiroz et al., 2016), although one failed to gain approval in France.
The infrastructure sector also needs a more rigorous and transparent process of project selection based on a clear long-term strategic planning. Israeli authorities use solid cost-benefit analyses, especially in transport (Shiftan et al., 2008). However, the detailed results of this work are not systematically published, and policymakers do not have to justify their choices, even if they approve projects with negative evaluations. The authorities should create an independent entity, like Infrastructure Australia, which would systematically publish technical analyses before the government decision, with policymakers obliged to formally justify their choices. This specialised entity could also usefully carry out regular ex post audits and monitor the country’s infrastructure needs. The management and implementation of infrastructure projects would also benefit from closer inter-ministerial coordination with local governments and better public consultation, especially during the initial phases of projects. Such difficulties have often led to substantial cost overruns (Chapter 2).
Despite some reforms (Table 12), there remains much room for better infrastructure regulation:
The electricity sector is still dominated by a cost-heavy vertically integrated public enterprise, the Israel Electric Company (IEC). It would benefit from the creation of a separate, regulated infrastructure operator and an efficient wholesale market. A reform proposal currently being discussed between the authorities, IEC and its unions is expected to address some of these issues, reduce IEC overstaffing and stimulate competition in electricity production (Gorodeisky, 2017).
Reforming airport management, currently run by a public monopoly, the Israeli Airport Authority, could reduce the high wages and operating costs and long aircraft turnaround time at Ben Gurion airport (Figure 42). Competition should be introduced by opening up ground services to private firms and adopting best practices such as EU directives on access to these services at airports; creating an independent air traffic control operator; and building an additional privately managed international airport (State of Israel, 2017).
Opening up the taxi market to ride-hailing firms would be desirable, as they are 30-50% more efficient than traditional taxis and can increase options for urban mobility and reduce congestion and urban pollution problems (Cramer and Kruger, 2016; Rayle et al., 2014; Li et al., 2016). However, it should be accompanied by measures helping traditional taxi companies and their employees to adjust to these structural changes.
Table 12. Past recommendations on infrastructure
Figure 42. Lack of competition weakens efficiency in airport managementref refid="fn-0048" format="note"/>
1. Data refer either to the airport of the capital (or the average when there is more than one), or the average of the most important ones if the capital’s is not available.
2. Time from landing till taking off. Data extracted from Flightradar, based on real time flights during January-February 2017, not including flights from hubs, late flights and connection flights.
Source: Air Transport Research Society, Flightradar database.
Better access to infrastructure in disadvantaged areas, especially Arab cities, would ensure more equitable opportunities for all citizens and promote more inclusive growth. The poorest municipalities cannot develop adequate services because of deficiencies in the property tax system (Arnona) (Fitoussi et al., 2016). In 2017 the authorities created an equalisation fund, the Arnona fund, to redistribute resources across municipalities more equally. Moreover, the above-mentioned five-year NIS 15 billion plan will increase the resources of local Arab communities through special budgetary allocations in many sectors. This plan, monitored by a steering committee including central government representatives and the mayors of Arab municipalities, also aims to enhance the skills and management capacity of Arab municipal personnel. These changes are welcome. However, the additional resources transferred to the weakest municipalities from this new equalisation fund may be insufficient. Moreover, the five-year plan’s success depends on its implementation and trust between the Arab municipalities and the central government and between the Arab citizenry and their elected officials. A rigorous evaluation of the results of the reform, in terms of improving the efficiency, professionalism and transparency of municipal administrative management, will thus have a key role in enhancing this trust (Brender, 2007).
Improving Arab municipalities’ public services also requires addressing the lack of public land available for infrastructure. This in turn means solving the problems of urban planning, the lack of accuracy of the cadastre and illegal housing construction in these towns where most of the land is private. As suggested in 2014 by the so-called “120-day” task force, the authorities should limit financial penalties when illegal construction is put in order with a means-testing mechanism to incentivise low-income households to register their property and adopt measures to decentralise and strengthen the transparency of land planning. Arab families have traditionally been unwilling to sell their land, preferring to bequeath it to their children. Because of this longstanding practise, land needed for public use (notably roads) is extremely difficult to acquire. Given local authorities’ reluctance to resort to land expropriation even in areas with high concentrations of illegal construction, experimental land-planning frameworks relying on consultations and agreements of residents could be developed. Moreover, public incentives, including state provision of additional land in areas where this is possible, would be useful, as in the city of Umm al-Fahm (OECD, 2017d).
Greening the economy
Following the 2015 United Nations Climate Change conference in Paris, the Israeli government approved a plan for reducing greenhouse gas emissions per capita by 26% by 2030 compared to 2015 (Table 13). To this end, public funding has been allocated to energy efficiency programmes, including reduction of coal use for electricity generation. The production share of renewables is planned to rise from 2.6% in 2016 to 17% in 2030. These welcome measures, which should not increase electricity prices much, given the declining production costs of solar power generation, need to be well implemented, although they are likely to require additional investment in the electricity grid (BoI, 2017f).
Table 13. Past recommendations on environmental policies
Air quality in Israel is poor, well below the OECD average (Figure 43). As discussed in Chapter 2, more developed mass transport, including a better rail network, would benefit the environment and curb air pollution. Israel already adopted a unique Green Tax scheme in 2009, which adjusted the vehicle purchase tax according to each model’s emissions of five key pollutants. This led to significant reduction of market shares of heavily polluting cars (OECD, 2016f). A complementary approach would be to diversify car taxation by transferring at least part of the burden to vehicle use rather than ownership.
Figure 43. Environmental indicators
1. Includes taxes at both central and lower levels of government.
2. 2014 for the United States.
Source: OECD (2017), OECD Environment Statistics Database (Green Growth Indicators: Exposure to Air Pollution, Patents: Technology Development, Municipal Waste); OECD National Accounts Database; IEA (2017), IEA World Energy Statistics and Balances database; IEA Energy Prices and Taxes database.
Despite a substantial reduction in the use of water from natural sources thanks to Israel’s unique and innovative approach to water management based on a heavy recourse to desalination and water recycling, problems of overexploitation persist. This results from a decline in their natural replenishment following recent droughts, which has led to pollution problems. To guarantee a sustainable management of these natural resources, it would be advisable to set clear objectives for the minimum acceptable water quality in these reserves and to set appropriate upper limits on their exploitation by increasing the production of desalinated water if necessary. To ensure compliance, they could be written into law, as was done for Lake Kinneret.
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