THE FIRST WORD: A 'moral road map' for Israel's economy

Increasing labor mobility will reduce unemployment and inequality while spurring economic growth.

By DIANA FURCHTGOTT-ROTH
money 88 (photo credit: )
money 88
(photo credit: )
Israel's economy has improved substantially since 2002. This remarkable transformation is due in great part to prudent fiscal policy and reductions in tax rates. But some critics remain unsatisfied and suggest devoting greater attention to reducing income inequality. Although concern over income inequality is well-intentioned, many proposed measures to alleviate it would choke off economic growth and reverse the gains accomplished over the past five years. As recently as 2002, Israel's GDP growth was negative. Over the past two years, growth rates have exceeded 4 percent, the budget deficit has fallen, more workers have entered the labor force, and unemployment has declined. The major cause of this progress is the decrease in tax rates and changes in income support measures that occurred in 2003. Criteria to receive unemployment benefits and income support were tightened. It is well-known that increases in incomes and economic growth are accompanied by a wider dispersion of earnings, and more inequality. Incomes at the upper end of the income distribution rise with additional opportunities. At the same time, incomes at the lower end remain the same, because certain entry-level jobs are always low-paying. The G-7 industrialized countries with the fastest growth - the United States, Canada and the UK - have more inequality than countries with slower growth, namely France, Japan, Germany and Italy. The dispersion of earnings in Israel is closer to that of the US and Canada than to the slower-growing countries. And yet, a wider dispersion of earnings is not necessarily a cause for concern. It is acceptable - even desirable - as long as there is movement between income classes. People who start out at low wages need to be given ways to progress into higher-paying jobs. The US, which has one of the most unequal earnings dispersions in the industrialized world, is the location of choice for many emigrants. The US offers a wide array of jobs, as well as unparalleled opportunities for upward economic and social mobility. People on the lowest rung of the economic latter can aspire to retire as millionaires, and many do so. THE CHALLENGE for Israel is not to achieve income equality but to build on its GDP growth and increase income mobility to make it easier to move upward in the income distribution. This is best achieved by making labor markets more flexible, so employers are not discouraged from hiring workers. More flexible labor markets facilitate job change. By trying several jobs, workers are more likely to find a position that meets their skills and preferences. In the US in 2004, the latest year for which data are available, there were 54 million new hires and 52 million separations. In relation to a labor force of 148 million, this is a large rate of turnover. For flexible labor markets, the fixed costs of hiring workers need to remain low. Such costs include minimum wage laws, laws requiring payment of benefits to workers, and taxes on wages for social insurance contributions. Similarly, and paradoxically, firing workers should be simple. If employers find it easy to fire workers, they are more likely to hire them. Conversely, if employers know they will have to pay large penalties or negotiate with unions for firing, they will be reluctant to take on new workers. Some in Israel suggest solving the problem of increased income dispersion by raising the minimum wage for entry-level jobs. In that way, it is argued, incomes at the low end of the scale could rise along with incomes at the top, and the gap between the rich and poor would remain the same. Some go so far as to call increasing minimum wages and income support the "moral road map." But as minimum wages rise, employers make greater use of technology, substituting machines for workers. Raising the minimum wage makes low-skilled workers unemployable, forcing them on to unemployment benefit or income support. Is this moral? Others have proposed raising levels of income support for the unemployed. But this lowers economic growth - and economic growth is the major factor lifting people out of poverty. France and Germany have stagnant economic growth because income support is costly and requires high levels of taxation. The ensuing work disincentives result in unemployment rates approaching 10%. More important, these unemployed have been out of work for substantial periods of time, and their skills have deteriorated. In Germany and Italy, half the unemployed have been without a job for more than a year. In France, the figure is 42%, which led to riots and car burning from disaffected groups. When income support measures make unemployment an easy option it is not worthwhile for workers to take jobs paying low wages. In contrast, in the US, with only a six-month period of unemployment benefit, a low minimum wage and few income support programs, the unemployment rate stands at 4.9%, and only 13% of the unemployed were out of work for more than a year. A system that leaves 10% of the labor force on government support without hope for the future is socially destructive. With its current GDP growth rates and declining unemployment, Israel is not on that path and should not return to it. Any "moral road map" must lead to continued economic growth and jobs, as well as opportunities for upward mobility for all citizens. With the coming election, Israel faces economic choices as well as those of national security. As countries get richer, earnings dispersions increase, because the rich get better off and new entrants to the workforce qualify only for low-paying jobs. The solution is not to turn back economic growth by raising taxes and imposing more regulations on employers, but to encourage hiring and faster income mobility through more flexible labor markets. The writer is director of the Center for Employment Policy at the Hudson Institute and served as chief economist at the US Department of Labor from 2003 to 2005. She made a presentation on this topic at the 2006 Herzliya Conference last month.