The Challenges Facing the Israeli Economy in Turbulent Times

The Challenges Facing the Israeli Economy in Turbulent Times

The growth data of the Israeli economy for 2022 indicate a complete recovery of the economy from the COVID-19 crisis, with real growth rates of 6.5% in terms of GDP and 4.4% in terms of GDP per capita. This growth stemmed from an increase in employment across the economy (in terms of hours worked), which was higher than it had been prior to the crisis, along with a significant increase in labor productivity, defined as GDP per hour worked. These data encapsulate highly favorable years (2017-2022) for the Israeli economy, despite the COVID-19 crisis (in 2020), marking a trajectory of high growth with an average annual growth rate of 4.2% in terms of GDP and 2.3% in terms of GDP per capita. The level of GDP per capita increased to USD 42,000, hence the gap in the standard of living between Israel and the benchmark countries (Austria, Denmark, Finland, Sweden, and The Netherlands) has continued to decrease, from 35% in 2007 down to 25% in 2017 and 20% at the end of 2022 (OECD data from 2022, in 2015 prices, PPP).[1]

These recent years also reflected a shift in the growth mix, as due to the growth in labor productivity, its contribution to the growth in GDP reached around 64%, nearly double the corresponding figure for the preceding decade. The economic sectors leading this improvement in productivity are the high-tech sector, whose share in employment increased and its share in the GDP rose to 17%, and the financial sector which was streamlined thanks to a change in the mix of workers and investments in ICT (Information and Communication Technologies). In general, we observe a continuation of the improvement of human capital, along with an ongoing increase in the positive difference in the share of workers with ICT skills, as well as a narrowing of the gap in private capital per hour worked, which is still 46% lower than that of the benchmark countries.

Further economic growth and reduction of the standard-of-living gap between Israel and the benchmark countries depend on growth engines – further increase in employment rates and an increase in the growth of labor productivity. Despite the positive trends mentioned above, the GDP per hour worked in Israel is still low – USD 47.5 as opposed to USD 70.2 in the benchmark countries – a 32% gap. This gap, although gradually decreasing (in 2021 the gap was 37%), is the reason for Israel’s inability to match the standard of living enjoyed by the benchmark countries.

Two major events at the end of 2022 threaten to divert the Israeli economy from the strong growth trajectory of recent years: the political crisis in Israel, which began as soon as election results were announced, and gained further momentum following the formation of the government and the unveiling of its judicial reform plan; and the decrease in the rate of capital raising by the high-tech sector.

The aim of this policy paper is to propose a comprehensive economic strategy for the Israeli economy, based on economic analysis and identification of the economy’s weakness points compared to the benchmark countries, including an analysis of economic growth scenarios for the years 2023 to 2025, according to the two events threatening Israel’s growth trajectory. Our policy recommendations in the various areas include actionable measures, as well as monitoring and measuring the progress and effectiveness of implementation.

The essence of our recommendations for increasing labor productivity and reducing the cost of living: investing in human capital in order to maintain high employment rates, while also increasing employment rates among Haredi and Arab men as well as Arab women; in regard to public capital, we recommend improving the level of transportation access to match that of leading metropolitan areas around the world, through the removal of barriers to the implementation of investment plans in transport infrastructures, including private sector investments in the domain of urban development; and increasing the stock of public ICT capital per capita, through the development of a multi-year plan for the advancement of digital transformation, accelerating digitalization processes, and reducing bureaucracy in public services. In order to increase the worthwhileness of business sector investments, we recommend optimizing regulation, cutting down on bureaucracy, and reducing the barriers to entry of foreign firms. Finally, we recommend a series of necessary measures to address the housing market, which is a major component of the cost of living – primarily setting housing targets, which would include among other things reforms in the funding of local authorities, in the Israel Land Authority, in the incentives for construction, and in urban renewal schemes.

[1] The Average GDP per capita in the benchmark countries was around USD 55,800 in 2022 (constant 2015 dollars, PPP).