Debt-Financed Investment for Growth

This paper describes a historic opportunity for the Israeli economy. The low interest rate facing the economy makes it possible to raise capital that can be channeled to growth oriented projects, such as public infrastructure. In particular, increasing annual investment in public capital by 2% of GDP between 2023 and 2030 will increase the economy’s rate of growth by about 0.5 percentage points relative to the forecasts of the Bank of Israel for 2027 to 2030. This outcome is based on the fact that the stock of public capital per capita in Israel relative to GDP is about 50%, which is significantly lower than in other developed countries with similar characteristics to those of Israel (the benchmark countries), where the ratio is about 75% and GDP per capita is higher than that of Israel by about 30%.1 As a result, there is a high return on additional investment in public infrastructure in Israel, which makes it particularly worthwhile. During the past five years, there has been a significant decline in the long-term interest rate on government debt in both Israel and other countries. The nominal 10-year interest rate is currently between 1.0% and 1.3% and the real interest during the next three years is expected to be negative. The low real interest rate and the high return on investment in core infrastructures constitute an opportunity for policy change. This paper quantitively evaluates the scenario of expected growth and the debt burden as a result of an increase in public capital investment financed by debt. This scenario is compared to the growth forecasts of the Ministry of Finance and the Bank of Israel for 2021 through 2030. The main scenario recommends making the necessary investments already in 2023 without reducing expenditure or raising taxes until 2025. This policy takes advantage of the period of low interest rates in order to solidify growth at a higher level from 2026 onward. According to this scenario, real growth will be about 4.5% between 2027 and 2030. This is higher than the 3.2% forecast of the Ministry of Finance, which assumes a decline in the rate of public investment relative to GDP, and the 4.1% forecast of the Bank of Israel, which is recommending a gradual increase of public investment but a rapid return to a low primary deficit.
Financing the increase in the stock of public capital in 2023–2024 by means of debt will raise the debt-to-GDP ratio to about 73% in 2024, as compared to about 68% according to the Bank of Israel forecast. However, lowering the primary deficit later on to a target level of 1.5% in 2028 and the additional growth that will be achieved by the investment will reduce the debt-to-GDP ratio to about 66.5% in 2030, a level similar to that expected by the Bank of Israel. The main insight of the scenarios is that when the interest rate is significantly lower than the rate of growth, increasing public investment without raising taxes raises GDP per capita without enlarging the debt burden.