Investment Policy Strategy and Reforms for Enhanced Productivity and Growth

The COVID-19 crisis starting at the first quarter of 2020 has not changed the main growth barrier facing the Israeli economy – low labor productivity – which is the main reason for Israel’s failure to bridge the gap in living standards, as measured by GDP per capita, vis-á-vis the benchmark countries. These benchmark countries are similar to Israel in terms of population size, and in the sources of their economic growth which relies heavily on human capital, however they are marked by higher rates of GDP per capita and labor productivity, and by lower poverty rates. Countries included in this group are Austria, Denmark, Finland, Ireland, Sweden, and The Netherlands. They all share GDP per capita levels which are higher than OECD average, and low poverty rates. In 2019, the GDP per capita in Israel was 37,800 USD, lower by 26% than the average GDP per capita in benchmark countries – 51,300 USD (OECD data, constant 2015 USD, PPP). The GDP per hour worked in Israel is 40.9 USD, compared to 66.2 USD in the benchmark countries – a gap of 25.3 USD per hour worked.
An analysis of the trends in the level of the factors of production in the Israeli economy, along with the demographic characteristics of the population and its growth rate, unequivocally indicates that without government attention to the issue of labor productivity, the productivity gaps in Israel vis-á-vis leading countries will continue to expand. A comparison of the data on the various factors of production indicates that the stock of public capital per capita accounts for 27.5% of the productivity gap, which amounts to 6.9 USD per hour worked. The stock of public capital in Israel, which consists primarily of transportation infrastructures (75%), is lower than the average of the benchmark countries by 65%, and is in fact the lowest among OECD countries, apart from Latvia. Therefore, our main recommendation for addressing productivity gaps is to increase both public and private investment. We also argue that the low level of import is a result of the low rates of investment – both public and private – in the Israeli economy. This paper presents the need for increased investment which exists in the economy; the necessary policy in regard to public investment; a proposed policy for encouraging private investment, and the funding aspects of government investment.