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 gaps
in levels, we will need to change the situation of a dual economy in which we
find ourselves 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 power in science and technology; 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.