Expansion grants and tax benefits provided to enterprises under the Encouragement of Capital Investment Law have failed to increase employment and investment, particularly in the periphery, according to a Bank of Israel report.
"Most of the grants (85 percent) awarded in the 1990s were earmarked for the expansion of existing enterprises," Guy Navon and Ronni Frish, of the central bank's research department, wrote in the report. "The study found that these grants, as well as the tax benefits that existing enterprises received, made no statistically significant contribution to increases in employment and investment compared to enterprises that did not receive support."
The Encouragement of Capital Investments Law (ECIL) awards grants and tax benefits to investors who establish or expand manufacturing enterprises. The law favors investment in peripheral areas, where it is a main policy tool for economic development.
The study examined the effect of the ECIL on manufacturing productivity from 1990 to 1999 and the influence of the grants and tax benefits for existing manufacturing enterprises on the extent of increases in the enterprises' investments and employment. It was based on a representative sample of 2,520 manufacturing enterprises.
Industrial activity by districts in 2005 (the last year for which data are available) showed that a large share of Israel's manufacturing production, 40%, was generated in the North and South. The share of manufacturing employment was much higher among those who live in these districts (21%) than in the rest of the country (16%).
Manufacturing production per worker in these districts surpassed that in the rest of the country (due to a higher ratio of capital per worker), while the per-employee wage paid by enterprises in the North and South was only 4% lower than the average wage in manufacturing.
Enterprises that received benefits under the ECIL were no less productive than enterprises that received nonsubsidized capital, the report said.
"Hence, the ECIL grants do not result in wasteful use of capital or distortion of macro-level capital allocation," it said.
The researchers estimated each enterprise's product by means of the factor inputs available to it, such as the quantity and quality of its labor force, physical-capital stock, R&D capital stock and additional control variables, including the share of the enterprise's subsidized capital.
The findings clashed with those from previous studies, which claimed that the ECIL distorts macro-level capital allocation by creating surplus capital stock in enterprises in the periphery, the report said.