BANK OF ISRAELOffice of the Spokesperson and Economic Information

June 19, 2017

Press Release

Remarks by the Governor of the Bank of Israel at the Eli Hurvitz Conference on Economy and Society: “One Society—One Economy”

This Conference’s title is “Two Economies—One Society”.

I will try to show here that this is an impossible situation. If we want to become a cohesive society, without unacceptable social gaps in levels, we will need to change the situation of a dual economy, which exists today, to that of a single economy— the path to, get there passes through inclusive growth. One economy does not mean that the entire economy only produces high tech. One economy is an economy in which all industries make use of advanced technologies with high productivity and innovation, from which is derived the most important aspect—pay an adequate wage to their employees.

To illustrate the situation in which we find ourselves today, consider a slide that Shlomo Dovrat presented at the Aaron Institute several weeks ago, where a train represents the dual economy—a modern and advanced locomotive pulling old and decrepit cars.

We’ll start with the locomotive:

The Israeli economy has about 5,000 start-up companies, in a range of sectors, characterized by remarkable innovation and dynamism. This innovation depends on several characteristics that are expressed in Israel’s high ranking in international innovation indices, such as the universities that supply the economy with high quality human capital, and create scientific and technological srength; excellent collaboration between academia and industry, and a developed venture capital industry. In addition

to these factors, the challenges Israel faces—security-related as well as civilian—were also an impetus for innovation and creativity. This is expressed in the cyber industry, which was established partially as a response to security threats, or for example, in solutions to the shortages of water that the State of Israel has dealt with over the years, shortages that became the basis in Israel for a developed industry of drip irrigation technology, desalination, or use of reclaimed water, which today are a source of this knowledge around the world. These are of course just examples for illustration.

The result is that Israel leads in the share of employed people in high tech industries—approximately 9 percent, more than double the median in OECD countries; in venture capital investment as a share of GDP, and in the value added of IT industries out of GDP—both in goods and services. A look inside, into the composition of employment in high tech industries, indicates that nearly half of the employed people are in the computer programming and consultancy industries; about one-quarter are employed in computer and electronic and optical equipment manufacturing, almost 15 percent are in scientific research and development, and the remainder are in communications services, pharmaceuticals production, information services, and more.

However, when we combine all the employed people in the various high tech industries, despite being world leaders in their share of employment, they are only 9 percent of the number of employees in the economy. A large majority of employees in high tech live and work in the center of the country. In the central district, in which most high tech employees are concentrated, they reach 15 percent of total employees. The share of high tech jobs in Tel Aviv and in the center has remained stable at about 60 percent over the past 20 years.

In terms of a by-industry distribution of workers in high tech and other industries, and the breakdown of wages by the same industry distribution, it can be seen that employees in high tech are concentrated in several fields, in which wages are approximately double the average wage in the economy, but overall they are a small share of employees in the economy. The other 90 percent is employed in industries with lower salaries, and the relatively large number of employees in the hospitality and food and administration and support sectors, where the salary is low, is notable.

The wage picture reflects the fact that most employees in the economy, who earn low wages, work in industries in which the labor productivity is low too.

This picture is in line with a fact that we all know well, which is that labor productivity in Israel is low in international comparison, and that we are not closing that gap. Productivity is particularly low in domestic industries, such as those that are not exposed to international competition. One of the ways to improve productivity is by investment in research and development (R&D) that can lead to innovation in a product or production process, but the investment in R&D—which is high in Israel in terms of GDP, relative to other countries—is concentrated in high tech goods and services industries, and only a little is invested in R&D in industries that are not high tech. The Israel Innovation Authority (previously the Office of the Chief Scientist) operates a track of support for R&D in low tech industries for new developments in the manufacturing industry and to upgrade production processes, but in recent years

the Innovation Authority’s grants for low tech manufacturing have only been about 5 percent of total grants. The relatively low investment by government in infrastructures, and the onerous and inefficient regulation, contributes to private investment in machinery and equipment also being relatively low. This factor, besides limiting the future potential growth due to production function constraints, also prevents adoption of the advanced technologies that are incorporated in new equipment. The insufficient skills in all areas of the labor force in Israel, including the area of problem solving in a digital environment, serve as a barrier both to development and expansion of the high tech industries, as well as to the ability of other industries to adopt advanced technology. This joins together with the severe shortage of workers with technological training at all levels, from technicians through engineers.

The dual economy I described is reflected in various indices of social gaps: the wage gaps in Israel are the highest in advanced economies, and they represent first and foremost the inequality in skills as measured by the OECD’s PIAAC test. Alongside that, among other things due to the low contribution of policy, compared with other countries, to reducing inequality, the gaps in households’ disposable income in Israel are high relative to other advanced economies.

What conclusion can be drawn from this analysis?

Reducing the gap between two parts of the economy is a necessary step in reducing gaps and forging a single society. The path to get there does not pass through slowing the locomotive, but through inclusive growth—such that will lead to an increase in efficiency in “the other economy”, in which 90 percent of employees work. Thus, all sections of the population will gain from its benefits.

How, without switching the entire economy to high tech, can we have one economy, one modern train?

There is no reason that other industries should use outdated technology, even if the products they produce are not pharmaceuticals or information technology items. The construction industry is a well-known example—the availability of a low-cost labor force over the years held back the adoption of technologies that have already been used for many years abroad, and entrenched the low productivity in the industry. The ISCAR company can be seen as an example of the opposite—a company that manufactures a product that ultimately is a low tech one, steel cutting-tools, but uses the most advanced production techniques based on advanced research and development and accumulated information. The services industries also stand to benefit from the availability of advanced production techniques. For example, the large retail chains in the US and Europe use inventory management and sales systems that the trade industry here, for the most part, has not adopted. In our field as well, at the Bank of Israel, we try to lead progress in the part of the economy’s producing section for which we are responsible, such as promoting the use of advanced means of payment, increasing competition in the merchant acquiring market—which will enable even the smallest businesses to avoid allocating excess resources to the whole area of payments—and to benefit from the efficiency and security that advanced technologies can offer.

So what needs to be done now so that all the cars in the train look like the locomotive, even if they don’t necessarily carry the same load?

Human capital—the education and training systems need to provide content and skills that allow the effective integration in the labor market of all sections of the population: expanded affirmative action at all levels of education, studies in math, English, Hebrew, science, and computers and providing broad technological schooling at all levels of education; affording cognitive skills that will provide adaptability to a changing labor market; and an increase in the number of engineers and practical engineers.

Competition—removing import barriers, including in services industries, to enhance competition in the domestic market.

Adopt technology—update the Encouragement of Capital Investment Law so that it will also encourage investment in capital that incorporates advanced technologies in industries that sell to the domestic market and are exposed to competition from abroad.

Encourage innovation—expand the encouragement of innovation in “the rest of the economy” through support from the Chief Scientist.

Improve regulation—update regulation so that it will lead to an improvement in the business activity environment.

Improve physical infrastructure—an increase in investment in infrastructure is expected to make a higher than average contribution due to the low level of infrastructure in Israel, compared internationally, particularly in the area of public transportation.