Flug: Israeli economy is strong but must become more inclusive

Key to realizing the economy’s potential will be the development of policies that address economic issues like inequality, inefficient regulation and the increase both investment and human capital.

Karnit Flug
To maintain Israel’s competitive edge as a strong global economy, the government must make its fiscal policies more inclusive and minimize over-regulation, Bank of Israel Gov. Karnit Flug said on Sunday.
“Our macroeconomic situation is very good and I think the economy has great potential, but we only utilize a portion of our strengths and our resources,” she told reporters at an annual Jerusalem Press Club briefing on the economy.
Although acknowledging Israel’s strength as a globally recognized innovation nation, consistently ranking highly on international indexes and generating about 640 start-ups every year, Flug discussed the many challenges the country faces as it strives to grow.
Key to realizing the economy’s potential will be the development of policies that address economic issues like inequality, inefficient regulation and the need to increase both investment and human capital, according to Flug.
“If we want to have an inclusive growth, which means that all parts of the society will enjoy the fruits of the growth, and if we want to have sustainable growth, we have to actually have a persistent policy in the areas of our challenges,” she said. “Because of our good macroeconomic situation, this is the time to deal with our challenges.”
The year 2016 ended for Israel with a growth rate of 3.8%, above and beyond that of most advanced economies and beyond what the Bank of Israel projected earlier on, Flug told reporters. Israel’s economy cycle was linked to the global economy cycle, picking up speed toward the end of the year.
“This is an indication that we are at a strong macroeconomic situation,” she said.
Israel’s primary mode of connecting to the global economy is through exports, but with a greater emphasis on business services – like hi-tech – than on goods, Flug said. While exports of goods in 2016 were fairly evenly distributed around the world, exports of services largely went to Europe and the United States, with 34% heading to Europe, 31% to the US, 6% to Asia and 29% to the rest of the world.
The labor market in Israel also performed well in 2016, with unemployment reaching a record low of 3.8% at the end of the year, Flug said. The country achieved such a markedly low unemployment rate “in spite of the fact that more and more people are joining the labor market and in spite of the fact that the participation rate reached a record high of 80%,” according to Flug.
“When we look at the overall, we see a very high rate of participation,” she said. “These new entrances to the labor market were very well absorbed into employment. So the labor market is actually warming up. We are approaching full employment.”
This “warming up” of the labor market is being manifested in the rise in Israeli wages, she explained. While Israelis are experiencing the positives of nearly full employment and increased salaries, Flug did warn that the country is starting to see shortages of labor in some branches of the economy.
“We are certainly in a strong and tight labor market,” she said.
There are currently a number of reforms being implemented in the financial sector that aim to realize significant structural changes, Flug explained. Some of these reforms involve separating credit card companies from banks, reducing the barriers for new banks and other credit providers, establishing a credit registry and credit bureaus, increasing competition in payment services and setting up a Financial Stability Committee to help coordinate among regulators, monitor risks and address them early on.
Although the Bank of Israel has been setting an inflation rate target of between 1% and 3%, inflation has actually been negative over the last two years, Flug said. These circumstances have been caused by a number of factors, including a reduction in energy and commodity prices, a decrease in VAT and enhanced competitiveness within a variety of sectors, she explained. Nonetheless, Flug predicted that the country would achieve the target inflation range by the end of this year.
As far as civilian public expenditures are concerned, Flug stressed that financing for such purposes is too low – among the lowest in the OECD. Particularly lacking are government funds for boosting the country’s public education system, she said.
While the public education system may be sorely in need of additional financing, Israelis do excel in completing tertiary- level schooling, according to Flug. As such, the country is able to rank highly in most international innovation rankings, achieving 10th place in the most recent Bloomberg Innovation Index and second place in the World Economic Forum Global Competitiveness Report’s innovation category. Flug attributed these high rankings to the quality of Israel’s academic institutions, as well as the link between academia and industry.
By the end of 2016, Israel could boast 73 companies listed on Nasdaq, more than 300 international firms with Israeli R&D centers, more than 430 cyber security companies and more than 5,000 start-ups – the highest concentration outside Silicon Valley, Flug said.
“I think that these numbers speak for themselves,” she added.
Providing the example of the country’s water industry, where Israel is a world leader in desalination and wastewater treatment, Flug said, “The combination of need together with innovation and technology actually combines to a very successful story.”
Nonetheless, she reminded reporters that Israel’s booming culture of innovation requires a certain spirit and a capability to cope with failure.
“The number of start-ups in Israel is very, very large,” Flug said. “But most of them are bound to fail. I think there’s something about the willingness to actually try ideas, be willing to take a risk.
“People are learning from that and moving to the next start-up,” she added.
Although Israel ended 2016 with a strong macroeconomic environment, and remains one of the globe’s innovation leaders, Flug stressed that the country still faces many economic challenges as 2017 progresses.
Israel might have very high rates of tertiary education, but standardized test scores among members of the labor force on “problem solving in a technological environment” are actually quite low, Flug said. The level of capital invested per employee in the business sector is also lacking, and companies from abroad often encounter difficulties coming to do business here, she added.
Another important challenge the Israeli economy faces is integrating a diverse population into the workforce and encouraging a more inclusive environment, Flug explained. Ultra-Orthodox men and Arab-Israeli women have particularly low rates of employment, she said.
“The fact that it’s moving up is no consolation because the gap is still very, very substantial and it’s a growing share of our population,” Flug said. “So we have to step up the efforts to provide these groups with the skills necessary for successful integration in the labor market.”