Article Library / 2016

2016 Annual Assessment

That the issues raised by decisions regarding the exploitation of NG and the resulting income stream it produces should be viewed as part of a larger fabric becomes clearer when we take a broad view of Israel’s development. The 2016 OECD report on Israel’s economy highlighted a tale of two economies.13 The first we may term “Start-up Nation”: technologically innovative, competitive, export oriented, global, highly and increasingly productive, flexible, a provider of high-tax-paying jobs, and an engine of Israel’s growth and revenues. It accounts for a third of Israeli exports, but employs only around a tenth of the labor force.

The second economy could be titled “Stagnant Nation.” Part of it includes public services such as health and education along with similar sectors for which productivity gains are inherently difficult to achieve the world over. (Reducing student-teacher ratios or taking time to gather full health profiles from patients may adversely affect productivity when measured narrowly.) But the focus of the OECD concern is on the other part, based on local old industries such as paper, cement, and food, as well as services such as electricity, real estate, and banking.14 This economy is closed to the outside world, dependent on government protection, and exhibits low and stagnant productivity. It tends toward lower paying and even minimum wage jobs with relatively few extremely highly paid jobs dependent less on actual productivity than on the ability to extract rent15 from Israeli consumers via higher prices to the extent these industries are insulated from competitive pressures. This contributes to the high cost of living in Israel. To use the economic jargon of the OECD, in the Israeli economy “highly dynamic tradable goods industries coexist with an inefficient sheltered sector to an unusual extent, dragging down overall economic performance” while “substantial deficiencies in product market regulation and competition, especially in the entire food chain, banking, and electricity, are weakening productivity and reducing incomes.”16

The two economies of Start-up Nation and Stagnant Nation co-exist through a set of institutions, such as government ministries and regulatory bodies. And these institutions by their conduct (not necessarily their existence) carry some responsibility for the polarization between the two economies, the growth in inequality, the inability of Start-up Nation to expand and of Stagnant Nation to emerge from its torpor.

Much of the service sector within the Stagnant Nation economy as well as many of its industrial branches consists of de facto monopolies and cartels. The provision of electricity, banking, transportation, and other vital services affects the rest of the Israeli economy. If the Israeli public has no access to competitive providers in these sectors, it yields rents stemming from higher prices, corruption, or poor services. The proceeds from these extracted rents may flow disproportionally to a small class of highly unionized and frequently family-related workers in the form of secure jobs, high salaries that are not grounded in the productivity of the salaried, fewer working hours, secure and high pensions, and various other perquisites. This creates two groups – those with the “in”, who have been able to wall off their jobs and privileges, and those outside this wall who lack job security and sometimes the protection of basic labor rights. This “two-caste” system also exists in the industrial sector of Stagnant Nation, in which some sectors, such as food, cement, minerals, and gas, are insulated from competitive pressures through regulation and so may achieve high prices without necessarily delivering goods of commensurate quality.

Israel does possess an open economy by virtue of the need to export globally. But in the reverse direction, some players dedicate substantial resources to securing continued insulation from competitive pressures. This effort operates almost entirely at the level of government decisions and regulation. Such counter-pressure may come from employing the power of the unions to organize politically to prevent reform and the introduction of competition that would force down prices. In this, the owners have every interest in cooperating with their unions. Lobbying and public relations further support these political mobilization efforts. In Israel as elsewhere, in this regard at least there exists a community of interest between owners and unions as the owners use the employees to decry that any introduction of competition will necessarily lead to loss of jobs and therefore present political danger. While employees are critical to the ability of the owners to thwart competition, in Stagnant Nation the resulting rent is not necessarily shared with the employees who may then all the more come to fear loss of their jobs to competition.

The ability of Stagnant Nation to protect itself from competitive pressures is due also to its organization. Substantial sections of this economy are controlled through pyramid structures which enable a few individuals to wield control over numerous industries with relatively small capital investments. These ownership structures may also be used to channel many of the ensuing rents to the CEO’s and top management in the form of high salaries. The other side of the coin is low paying, even minimum wage, and generally insecure jobs. While the pyramid ownership structures have come under attack through the “Concentration of Economic Control” law and the opening up to competition of the communications sector, a key component of many such pyramids, these structures continue to dominate Israel’s Stagnant Nation economy. Recently there have been prominent trials and convictions of such bêtes noirs of economic concentration opponents as Nochi Dankner, the controlling shareholder of the prominent IDB group. But further government pressure would need to be applied to take the major conglomerates apart.

The element that makes this a witches’ brew and the growing inequality in Israeli society difficult to resolve is the low mobility between the two sectors: Those with the skills to find a job in Stagnant Nation do not have the skills to transfer into Start-up Nation. Start-up Nation exhibits high and growing productivity – on par with the upper tier among OECD countries – driven by its export and global orientation. Stagnant Nation exhibits low and stagnant productivity pulling Israel’s entire productivity to the low end of the OECD. This low level of productivity is somewhat mitigated through many more working hours, but this serves also to lower the quality of life of workers in these sectors.

Economic theory suggests that the rise of productivity in one sector of an economy should raise productivity and wages in others as the highly productive sectors compete with less productive ones for the same human resources, forcing them to become more efficient and productive. But this theoretically pure transmission belt becomes all too frequently attenuated in the case of Israel. Many of those who are employed in Stagnant Nation lack the minimal educational attainments that would allow them to acquire the skills to join Start-up Nation. This means that even as Israel is witnessing increasing employment among groups that were not previously participants in Israel’s labor force such as Haredi men, those men, trapped by their limited education, have little choice but to accept low paid and low skilled Stagnant Nation jobs. In addition, despite growth in attendance of higher education in Israel, there is no growth in the study of sciences, math and engineering, an issue that arises already in the high schools, thereby further limiting the ability of Start-up Nation to grow and increase its contribution to the Israeli economy as a whole.17 One report on the Israeli economy described half of the children of Israel as receiving “third world education.”18

While the ability of Start-up Nation to increase its share of the Israeli economy and work force and drive up productivity is limited by the educational profiles of potential employees, the compulsion for Stagnant Economy to achieve rising productivity is limited by insulation from competitive pressures. In fact, those few sectors, such as clothing, which are no longer protected from competitive pressures, have indeed seen productivity gains. But much of Stagnant Nation remains somewhat freed from exposure to global competition.

There is thus a paradox facing those responsible for Israeli policy. Productivity drives wages and growth which, in turn, drive economic transformation. But productivity is simply the value of output divided by hours worked. One may enhance productivity by either improving the value of the goods and services produced or investing to reduce the labor required (or both.) Economic transformation may, indeed, create new employment but often at the expense of already existing jobs. This is the source of much of the economic discontent that has swept the U.S. and Europe in recent years and which has been translated into political upheaval. Unemployment has not really been a major issue in labor-scarce Israel in recent decades. Instead, discontinuities have led not to job layoffs but rather to the growth of disparity among wage earners. The late 20th century “people’s economies” of Eastern Europe and the former Soviet Union deliberately maintained many facilities, especially in light industries such as textiles, so that there would be steady opportunity for employment of less skilled workers or in less developed regions. But this policy contributed to a general inability to accrue economic surpluses which also in the end led directly to the social and political upheaval that terminated these regimes. Thus while the Stagnant Nation economy is not sustainable without cost, simply to raise productivity by replacing workers with machines or sending jobs offshore could entail different adverse outcomes as well.

In Israel the tale of two economies parallels, in some measure, political, ideological and social fissures in Israeli society, and exacerbates them. Startup Nation is geographically concentrated in Israel’s main cities of the center and the strip along the Mediterranean – the Gush Dan and Haifa. Within Israel, there is one nation that often has little in common in terms of values and aspirations with the other. While there are Haredim, Mizrahi Jews, and settlers among those employed in Start-up Nation, its citizenry skews toward young secular men, mostly Israel-born, or immigrants from the former Soviet Union and the West. They are more likely than the rest of Israel to vote for centrist and left of center parties. Their profile makes them the most globally mobile group in Israeli society. Therefore, they have a choice to exit Israel and be employed in the world’s top companies and cities which many others lack. Those who inhabit Start-up Nation care not only about their economic opportunities, but also about the ability to live in a country and society that reflects their values.

Thus the very success that has led to Israel’s growing economic and technological prowess leads it to a crossroads. The current path of sustaining two economies and the two resulting polarized nations within Israel seems an increasingly uncomfortable fit.

Economic concerns are actually intimately bound to political and social developments; it may become increasingly difficult to keep dysfunction in the former from widening fault lines across the latter. Those who are sustaining the Israeli economy and tax base may come to feel that they have the least voice in the making of its policies, whether politically or through social protests, and so participate in a steady and individual exit of the members of Start-up Nation from Israel altogether. On the other hand, as has been seen elsewhere, the rage of the disenfranchised and disadvantaged, if they are simply displaced by computers and robots, or if their jobs are simply sent offshore, may lead to political and social currents threatening to wash away the very foundations upon which Israel has been predicated.

In light of this configuration, the OECD made a series of recommendations of which the following is one:

Enhancing social cohesion would raise sustainable long-term growth…Israel has to make fiscal room for fostering more inclusive growth and preparing for the future. Boosting investment in infrastructure, promoting skills, especially of disadvantaged groups, developing adult vocational education and training and enhancing the redistribution system, including for the elderly, are achievable without sacrificing prudent fiscal policy.19

The issue of more inclusive growth needs to be read broadly. This goes beyond the usual recommendations about Haredim and Arabs. Workers who find themselves in Stagnant Nation make up a good part of the lower middle class. If they are not to become increasingly excluded, policy will need to be framed with that objective in mind rather than from some of the narrower perspectives that have often been the basis for Israel’s economic strategies heretofore.