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Economic
Growth in Israel, 1948-2000
Following the declaration of independence, Israel opened its borders to all Jews wishing to immigrate. Between 1948 and 1950 the population more than doubled, increasing from 600,000 to 1,370,000 people. This huge increase was accommodated only with great difficulty; many lived in tent encampments with minimal facilities for some years. In 1948-50, most of the immigrants came from Europe; from 1951 onward they were mostly from the Middle East and North Africa. The immigration made possible a large increase in the civilian labor force which grew from 343,000 in 1949 to 619,000 in 1955, an increase of 80 percent in six years.
The educational levels (measured in terms of years of formal schooling) of immigrants from the Middle East and North Africa were lower than that of Jews born in the country or those who came from Europe. Over time, however, the educational level of the population as a whole (including the non-Jewish communities) improved steadily. In 1961, 24.2 percent of the population over 15 years of age had 0-4 years schooling. By 1996, this had fallen to 6.1 percent. Measured more positively, the share having 16+ years rose from 9.1 percent in 1961 to 14.8 percent in 1997. Despite major educational achievements, these inequalities still persist between Jews of different origins and between the Jewish and non-Jewish communities. There was therefore an increase in the quantity and quality of labor, something that continues today. One point about education is worth emphasizing. Formal education was a less important source of productivity than informal factors such as knowledge of Hebrew, improved health standards and integration of immigrants.
The second factor was investment, or capital formation. Between 1950 and 1972 the capital stock, that included means of production and housing, increased more than 12 times. Capital per head of the population rose 5 times. The high level of investment was, in large part, made possible by an inflow of capital from abroad in the form of reparations from Germany, the sale of Israel government bonds, loans and gifts. Grants from the US government were important in the early 1950s and after 1973.
The final source of economic growth was increased productivity, which resulted from improvements in education, skill levels, the quality of management, the allocation of resources, and the introduction of new technologies.
It is interesting to note that in the 1950s, large increases in labor and capital inputs were accompanied by improvements in productivity (see Table 1). This was more due to the integration of immigrants than to general government policies, which were highly interventionist and protective. Imports were limited by quantitative restrictions and production in the economy was stimulated by numerous government measures which, to use today’s jargon, overrode the market.
Despite the nature of government involvement in the economy, taxes and government spending were a much lower share of national income than they are today. Labor flowed into industries built with government assistance, using imported machinery and productivity rose as the labor force adapted itself to evolving conditions. There is no complete consensus as to why productivity growth was high then, or why it is low now.
Table 1: Productivity in Industry
Source: Central Bureau of Statistics, Jubilee Series, no. 4, 1998
As well as encouraging immigration - although this was temporarily stopped in the early 1950s when the capacity to absorb them was exceeded - the government encouraged inflows of capital. This was necessary because Israel had a deficit on its balance of payments current account. If funds had not been imported, imports would have had to have been restricted even more tightly than they were, and the level of economic activity would have been lower. By securing sources of finance from abroad, the government was able to maintain a supply of capital equipment as well as basic supplies such as wheat and oil. The main sources of foreign capital in the 1950s were:
Most of this capital was channeled through the government, enabling it to maintain a centralist economic system. In the mid-1950s the government realized that the potential for generating employment and increasing output in agriculture was reaching its limit. Diminishing returns were setting in, and the government decided to shift its policy emphasis to industrial development. However, rather than supporting industry directly, it made a very significant decision to promote the private sector. This meant that entrepreneurs had to be recruited from abroad, as the domestic supply was limited. Given Israel’s geo-political position and its level of economic development, as well as the Arab boycott, few firms in the West were willing to invest. The government therefore turned to the Jewish community, and located a number of entrepreneurs who were interested in opening plants in basic industries (textiles, clothing etc). They were offered a protected market due to import substitution policies, and a virtually guaranteed labor supply, since the government’s major aim in industrialization was to generate employment. Furthermore, prospective entrepreneurs were granted subsidized loans, land, as most land in Israel was and is in effect state-owned, and allocations of a very scarce resource; foreign exchange for importing machinery. Exports were not a criterion for government support of new investment.
By the mid-1960s the limits of the domestic market were being felt in industry, and Israel applied to the newly formed European Economic Community for a trade agreement. It wanted to preserve its traditional markets in Europe, but came to realize that industry, employment and income would only develop on the basis of exports, which would necessitate the opening of domestic markets to imports. The first limited trade agreement with the EEC was signed in 1970, but the more significant agreement that created a free trade area was signed in 1975.
The national water carrier that brings water from the Kinneret to the northern Negev was built between 1959 and 1966. It expanded the amount of land available for agriculture in the south, but did not change the newly apparent emphasis on industry. Israeli economic development since 1970 had been marked by gradual liberalization, bringing the economy closer to that which orthodox economists favor: the free market. Yet productivity during this time period deteriorated, which can be explained by unfavorable developments in the 1970s. The 1973 war was enormously costly in an economic sense. The increase in oil prices that followed affected Israel more than other importers because it returned oil fields to Egypt after the war and therefore had to import larger quantities of oil. In the 1980s, mismanagement of the economy led to inflation at an annual rate of 500 percent in the first half of 1985 (1980-1985 average annual rate just under 200 percent). In the period of hyperinflation - 1980-1985 - the main economic objective of firms was to survive raththan market abroad, research or develop. The 1980s were known as the lost decade; the economy grew slowly, as did productivity.
The 1990s
Between 1990 and 1996, the economy grew at an average annual rate of 5.8 percent as a result of huge immigration and investment. The international environment for Israel improved as the peace process began, and as a result foreign investment increased. However, productivity growth remained low, for which a number of explanations have been given.
The first is that with the rapid increase in labor and capital inputs efficiency became less important: the main aim was to find jobs for the immigrants. Even though many of those who came from the former Soviet Union were highly educated, they did not initially speak Hebrew and did not find jobs which matched their skills. As a result, their productivity was lower than its potential level. This implies that low productivity is temporary, and as these immigrants become integrated, with better language and other skills, their productivity will rise.
Another explanation is the inadequacy of Israel’s infrastructure is. The roads and congested, and there is virtually no railway network. The amount of time needed to reach a peripheral city such as Beersheva from Tel Aviv is surprisingly great. Greater Tel Aviv is one of the few cities in the world at a per capita level of $17,000 or more that has no mass transportation system. The water, drainage, and in some places even the electricity systems are inadequate.
Furthermore, macro-economic factors such as the income tax system contain serious disincentives to work for middle earners. The level of tax and government revenue in GDP is high. Monopolies thrive, as is to be expected in a small economy, but the opening to foreign competition has not changed competitive conditions in all sectors. Government bureaucracies are formidable. There is no planning system, or if there is one it is very inefficient, full of uncertainty and overlapping authority. The impression that Israel has strong government with regard to domestic issues is false. It subsidizes water for agriculture where an increasing number of workers are from the Far East, with low productivity. Importing unskilled labor also lowers average productivity levels. This is permitted largely because the agricultural lobby is strong, and the government is unable or unwilling to stand up to it.
The low productivity growth rates of the 1990s are even more surprising in light of the extensive structural economic change that has been undertaken. Table 2 shows that traditional industries have declined from two thirds of manufacturing output in 1970 to less than half in 1999.
Table 2: Composition of the Manufacturing Sector, 1970-1999
Source: Bank of Israel, Annual Report 1999, p. 9 NB: There was a change in the sample in 1995.
It seems that higher labor productivity in the so-called advanced industries has not been sufficient to raise overall productivity growth, although it did contribute to raising production.
Employment in the advanced sector in 1996: 193,500. This sector accounted for 60 percent of industrial output, two thirds of industrial capital.
Table 3: High-Tech Shares in Manufacturing
Source: Central Bureau of Statistics, Jubilee Series. No. 4, 1998.
Table 4: Advanced and Traditional Industries (annual averages, %)
Source: Bank of Israel, 1999.
Socioeconomic Implications of the Pattern of Growth in the 1990s
Between 1996 and 1999 the economy grew slowly, and GDP per capita either stagnated or fell. Between 1990 and 1999, industrial output rose by 45 percent, but employment in industry increased by only about 5 percent. The high-tech sector continued to grow, as is shown in Table 3 and Table 4. High-tech or advanced production increased its share of the total by growing faster than the traditional sector. It continued to draw in labor, albeit slowly, during the recession of 1996-1999; investment grew and therefore the capital stock rose by nearly 10 percent a year. As a result, labor productivity increased, as did wages. Most significant was the rapid growth of exports: 15 percent a year compared with virtually zero in the traditional sector.
Clearly, two industrial sectors were developing. One had high exports, high investment and positive productivity growth rates (measured either by total factor productivity or by labor productivity). The other, traditional sector witnessed falling output and employment and stagnant exports. Placed in a broader socioeconomic context, this has serious implications.
Inequality in the distribution of income measured before taxes and transfer payments rose in the period 1988 to 1997. The Gini coefficient for earnings of families headed by a wage earner or non-working individual rose from 0.3700 to 0.3946. This was the result of higher returns on education on the one hand, and an increased exposure to imports of labor intensive goods from countries with relatively lower wage costs on the other. The presence of foreign workers, including Palestinians, meant that wages tended to fall, or increase more slowly in traditional industries.
Direct taxes and transfer payments reduced inequality over the same period from 0.3221 to 0.3332. Transfer payments increased from 13 percent of GNP in 1988 to 20.7 percent in 1998. Direct taxes rose from 19.1 percent of GNP in 1988-94 to 20.7 percent in 1994-98. The increase in direct taxes had disincentive effects on workers and caused transfer payments to rise, partly because rising unemployment benefits burdened the budget. These measures did not outweigh the increase in inequality caused by the new earnings pattern, and therefore net inequality increased.
The number in poverty also rose. In 1988, 33 percent of families were below the official poverty line; in 1996 the share was 34.5 percent. The population had risen by 28 percent, and therefore the absolute number in poverty rose more sharply.
After direct tax and transfer payments, the share of the population in poverty in 1988 was 14 percent and in 1996, 16 percent. The figure today equals about one million people, which would be higher if foreign workers were included.
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This
lecture will examine Israel’s economic growth experience in a historical
perspective. It will concentrate on two main periods: that between 1950
and 1973, and the 1990s. The first is of interest to a Palestinian audience
because at this time, income levels in Israel were closer to those in
Palestine in absolute terms. The second period is of interest because
it addresses the current Israeli situation. The lecture will then look
at some of the socioeconomic implications of growth patterns in the 1990s.
In 1950, national income per head in Israel was $3,200 in 1999 prices
and exchange rates. In 1998, it was $16,250.