To presentation (Hebrew)

Bank of Israel Governor Dr. Karnit Flug spoke
today at the Sderot Conference for Society. 
The following are the main points of her remarks:


We must examine developments
in the global economy, the current path of economic policy, and the trends and
composition of the Israeli population, and ask whether growth will continue
over time and whether it will reach all segments of the population.  Is the economy on a path of sustainable
growth, and is that growth inclusive?

The future is already
here.  Without a policy focused on
increasing productivity and reducing inequality, we face a significant slowdown
in growth in the coming years.

The key to reducing
inequality in the labor market and to an increase in productivity is in the
human capital of the population.

The performance of the
Israeli education system has an effect on the labor market, on future growth of
the Israeli economy, and on its ability to serve all segments of the
population. Israeli students achieve lower than the OECD average.  The gaps between Israeli students of various
population groups is among the highest.

We must increase
investment in the education system, with an emphasis on expanding affirmative
action.  We must increase the scope of
technological content in all levels of the education system, including
practical engineers and engineers.  We
must increase the level of cognitive skills of Israeli workers, which will
enable them to more fully integrate into a changing labor market.

Improving the Israeli
education system carries huge potential. 
Improving the achievements of Israeli students from the weaker segments
will contribute significantly to the growth rate, in addition to its
contribution to reducing social gaps.


The economy is in good macroeconomic shape,
mainly given the relatively weak global environment.  Growth continues apace, and the labor market
is robust, as reflected in both the rapid increase in employment and continued
decline in unemployment to historically low levels, and in the continued
increase in wages.  While inflation is
below the target range, if the decline in commodity and energy prices does not
resume, it is expected to return to within the range within a year, supported
by the increase in wages.


In light of the relatively good
macroeconomic situation, the question arises as to whether, with the current
path of economic policy, developments in the global economy and demographic
trends, the economy is on a path of sustainable growth—meaning growth
that is expected to continue over time—and whether that growth is inclusive,
such that it improves the standard of living of all citizens.


The Israeli economy faces a variety of
challenges on the road to inclusive and sustainable growth, and I have spoken
about them a number of times previously. 
Today, I would like to focus on the issue of poverty and inequality, and
on the issue of human capital.


The global environment, demographic trends,
and the fact that the contribution to growth made by increased education is
reaching its maximum, are acting to significantly slow economic growth in the
coming years.  As a result, the message
that without a policy focused on increasing productivity, the growth rate will
slow down significantly in the coming years is brought into sharper focus.
World trade, which is the basis for growth of the export industries, is
slowing down, and this may become worse due to global political developments
against globalization and in favor of protectionism; the changes in the
composition of the population in Israel, both in terms of ages and in terms of
sectoral composition, are expected to lead to a lower labor force participation
rate, and may therefore lead to a reduction in per capita GDP; and the increase
in education, which was a significant contributing factor to economy growth in
previous decades, is reaching its maximum. 
All of these will serve as headwinds to growth of the Israeli economy in
the coming years.  Continued effort to
integrate population groups that tend not to participate in the labor force,
and to improve their cognitive skills, may partly offset the effects of these


The growth of recent years has improved the
situation of all those who participated in the labor force and contributed to
increasing the pie.  However, that
increase was not evenly distributed, so we cannot define the growth we have
experienced as “inclusive growth”. 
The poverty rate in Israel is the highest
among the OECD countries, and the level of inequality is also among the highest
in the western world.  Before I come to
the ramifications of policy and how we can deal with the challenge of reducing
poverty and inequality, it is worth analyzing the sources of inequality.


Inequality in financial income, meaning
inequality measured by the gross household income from labor, declined in
recent years, and is currently lower than the OECD average.
contrast, inequality in disposable income, meaning income after taxes and
transfer payments, remains higher than in most advanced economies.
  The difference between these two measures of
inequality—the factor that in all countries reduces the gaps between inequality
in gross income and inequality in net income—is the government’s income
redistribution policy, applied through direct (progressive) taxation and
transfer payments, or allowances.  In
Israel, the contribution of these factors—particularly allowances—to reducing
inequality in net income is relatively low.


Income tax on individuals, which by its
nature is progressive, has declined over the years, and allowances were reduced
in parallel.  This decline in direct
taxes and allowances acted in two opposite directions:  It reduced the contribution of taxes and
allowances to lowering inequality in disposable income, and it increased the
incentive to participate in the labor force, thereby reducing economic
inequality.  In particular, this policy
contributed to an increase in labor force participation of the population
groups that still have relatively low employment integration—ultra-orthodox men
and Arab women.  The sharpest change took
place among ultra-orthodox women, whose employment rate increased from less
than 50 percent to about 73 percent within 15 years.


From the standpoint of household financial
income, the increase in labor force participation is reflected in a decline in
inequality in the number of hours of work per household, which contributes to a
decline in inequality in financial income. 
In contrast, wage inequality, which declined between 1997 and 2003,
again increased.  Wage inequality in
Israel is also prominent by international comparison, as the average (gross)
wage of the upper wage decile is five times that of the lowest wage decile—a
higher ratio than any other OECD country.


Alongside the decline in economic inequality
in the past 15 years, there was an increase in inequality between districts
(between the periphery and the center of the country) until 2012.  Since 2012, there appears to be a change
toward reducing this aspect of inequality.


The high wage gaps in the Israeli labor
market, and the low level and moderate increase in labor productivity about
which I have spoken previously, are closely linked to the level of human
capital in the population, as reflected in various indices.  The performance of the education system will
have an effect on trends in this area in the future, when today’s students join
tomorrow’s labor market.


The questions we will want to answer are:


Does the education
system improve the level of cognitive skills in order to support an increase in
labor productivity?

Does today’s
education system reduce gaps in skill levels, thereby reducing future wage

Does the
professional training system work to reduce gaps in skills and in wages?


The results of the TIMSS study published
yesterday indicate worrying trends in response to these questions.  The achievements of Israeli students are
among the lowest in the OECD countries sampled in the study in mathematics and
sciences.  Moreover, the gaps in Israel
are also among the highest.  The grade spread
(the difference in grades between the 95th percentile and the 5th
percentile) is among the highest of the OECD countries that participated in the
sample, both in sciences and in mathematics.


These findings are consistent with the
results of the PISA tests conducted in 2012 (the 2015 findings will be
published soon), and raise a worrying picture in this context.  The achievements of Israeli students in all
areas examined are lower than the OECD average in those areas, and by this
measure as well, the gaps in Israel are high. 
For instance, the gaps between Hebrew and Arabic speaking students is
high in all areas.  And the response to
the question of equality of opportunity is also worrying:  The chances of a student from the lowest
quarter of the socioeconomic scale achieving in the highest quarter on test
scores are very low.  In other words, the
education system is not acting to create affirmative action that will increase
the equality of opportunity.


Now what about the working-age population,
or those that will soon be of working age?


The findings of the PIAAC survey on
cognitive skills indicate Israel’s weakness compared to other countries, in
numeracy, literacy and problem-solving in a digital environment.  Here too, the gaps between the different
population groups within Israeli society are large, and what is particularly
worrying is the increase in the gaps among the young population compared with
the older population, where the gaps between the ultra-orthodox and the
non-ultra-orthodox Jewish population are lower. 
In other words, young people from the ultra-orthodox community come to
the labor market today less equipped with cognitive skills than ultra-orthodox
Jews in previous generations.


How did it happen that the Israeli students
of today, and the graduates of the past few years, are characterized by low
levels of cognitive skills?  At least
some of the explanation has to do with the fact that per student expenditure in
the Israeli education system is lower than in most of the advanced economies,
particularly in elementary and secondary school.  While it is easy for us to measure this
expenditure, it is more difficult to compare relative efficiency and the
quality of study content.  However, it is
clear that the scope of technological content in secondary schools, as well as
post-secondary technological training, are insufficient.  Another part of the explanation has to do
with the low expenditure on professional training which, in Israel, totals
about 0.06 percent of GDP, compared with an average of 0.14 percent in the
OECD.  Expenditure on broader active
labor market policy is also low by international comparison.


What can we learn from these things?


Government policy
has incentivized entry into the labor market, thereby contributing to an increase
in employment rates in all population groups, and to a decline in economic

Government policy makes
a relatively low contribution to reducing inequality in disposable income, due
to relatively low direct taxation, and mainly due to low allowances.

The education and
professional training systems do not sufficiently provide the skills necessary
for all parts of the population to successfully integrate into the labor
market.  These skills are low by
international comparison, despite the relative abundance of workers with higher


And what do we need to do?


We must act to raise
the level of cognitive skills of Israeli workers, which will enable them to
integrate into a changing labor market. 
We must increase investment in the education system, with an emphasis on
expanding affirmative action.  We must
increase the scope of technological content in all levels of the education
system, including practical engineers and engineers.

We must increase
government investment in training by subsidizing professional training
programs.  We must measure the
effectiveness of training programs and revise them according to their
efficiency and the findings of the measures.

Expanding the Earned
Income Tax Credit will improve the state of workers with low incomes
without reducing the incentive to work.

Investment in
education and training to maximize the potential human capital of the Israeli
population is the key to increasing long-term productivity and growth in a way
that will include all citizens.


To end on a positive note: An OECD study
indicates the immense potential in improving the output of the Israeli
education system.  A simulation carried
out, even if it is quite technical, indicates that if we succeed at improving
the achievements of those with low achievements on the PISA tests, and bring
them up to reasonable levels (a score of 420), the contribution to annual
growth will be almost half a percent of GDP! 
That is more than almost any other country.  And obviously, this kind of a change will
contribute tremendously to reducing inequality.


The road to inclusive sustainable growth
passes through a significant improvement in skill levels and a reduction in
gaps in the human capital of the Israeli population.  It is vital that we act now in this area, in
order to harvest achievements in the future.