Israel
Selected Issues Paper
Author: International Monetary Fund
Publication Date:
02 Apr 2012
eISBN:
9781475502732
Language:
English
Keywords:
ISCR; CR; bank; central bank; inflation targeting; inflation; job skill; Haredi community; Haredi's needs; reservation wage; labor market; Marginal effective tax rate; Human capital
Download PDF (722.1 KB)

This Selected Issues Paper states that Israel’s growth performance is impressive, with real GDP growing at a faster pace than many other OECD countries. The secular Jewish population enjoys a high level of living standards, whereas most Arab and Haredi people are poor, with poverty incidence reaching 60 percent for both groups. Low employment in Arab and Haredi communities is mainly accounted for by the low employment rate of Arab women and Haredi men.

Abstract

This Selected Issues Paper states that Israel’s growth performance is impressive, with real GDP growing at a faster pace than many other OECD countries. The secular Jewish population enjoys a high level of living standards, whereas most Arab and Haredi people are poor, with poverty incidence reaching 60 percent for both groups. Low employment in Arab and Haredi communities is mainly accounted for by the low employment rate of Arab women and Haredi men.

I. Macrosocial Challenges in Israel1

1. Israel’s growth performance of recent years is impressive, with real GDP growing at a faster pace than many other OECD countries. However, poverty remains among the highest in OECD countries (Figure 1).

Figure 1.
Figure 1.

Israel: The Overview of Socio Economic Developments, 1975–2009

Citation: IMF Staff Country Reports 2012, 071; 10.5089/9781475502732.002.A001

Sources: IMF WEO, WB WDI, OECD Stat, Bank of Israel annual reports, and Israeli Central Bureau of Statistics.

2. While the secular Jewish population enjoys a high level of living standards, most of Arab and Haredi (Ultra-orthodox Jewish) people are poor, with poverty incidence reaching 60 percent for both groups. These populations also have a large number of children—typically 6–7 children in a Haredi family, and 3–4 children in an Arab family—and child poverty is dire. This mostly reflects low employment in these two groups, as they are not fully integrated in the labor market.

3. Currently, the number of Arab and Haredi first graders in primary school is estimated at over 40 percent of the total first graders, indicating a major demographic change coming in Israel. 2 If these groups’ contribution to labor markets continues to be low, this will not only result in a further increase in poverty but also undermine Israel’s overall growth potential and fiscal sustainability. Conversely, it also implies that compared to other countries with aging populations, Israel has a large pool of potential human resources, in these minority populations, a key engine for future growth.

A. Why Is the Employment Rate and Wage of the Arab and Haredi Population Low?

4. Low employment in Arab and Haredi communities is mainly accounted for by the low employment rate of Arab women and Haredi men. By contrast, Haredi women’s and Arab men’s employment rates are higher, although there are considerable wage gaps between secular Jewish workers and Arab/Haredim workers.

5. Lower employment and wage of the Haredi male and Arab female reflects a number of impediments for labor participation, including high implicit marginal tax on employment, low human capital acquisition, and high reservation wage. Particularly for Haredi males, rather than religious constraints, incentive mechanisms appear to matter, given that Haredi male labor force participation rates in the US and UK are on a par with the broader population there.

6. How these impediments have developed differs for these two groups. Some are the result of the past policy decisions (specially in the case of Haredi men), culture, discrimination, and linguistic disadvantage problem (in the case of Arab female).3

The Case of Haredi Males

7. The Bank of Israel (2011) estimates that half of Haredi men in their working age population were not employed in 2010. There are four key factors contributing to the underemployment of Haredi men: special education system, government financial support, respectful status in their community, and exemption from military service. These factors are closely interrelated, and reflect the complex political setting which dates back to the compromises reached between the Labor leadership of the Yishuv and the Haredi leadership during the British Mandate (Rivlin, 2011). The Haredi communities has also gained greater political presence at the Knesset since the late 1970s, although they tend to distance itself from the rest of Israeli communities.

Special education system: delaying and lowering human capital acquisition

8. The Haredi community has a special education system—from pre-school/preliminary levels up to Yeshiva/Kollel (seminaries)—, which is not oriented to help students acquire knowledge and skills useful to get a job. Many Haredi men have a strong desire to continue religious study for life and eventually become a rabbis. These religious schools mostly focus on religious studies, and beyond primary levels, no time is devoted to secular subjects, such as mathematics, science, civics, and English (whereas girls’ curriculums basically follow secular subjects).

9. And its education system requires longer school years—many students stay in the school system until their mid 20s and often until late 30s. Only the selected best of the brightest can become rabbis, and the majority of students need to get out of the school system eventually. However, at their late 20s or older, without secular learning and job training, it is hard for most to get a good job.

Government support and respectful status: raising reservation wage

10. The government has provided substantial support to the Haredi community. Religious education is free for life, and Haredi religious students and their families are eligible for a range of benefits—some are exclusively for them—, such as implicit housing subsidies, local tax reductions, reduced national insurance payments, and rent subsidies.

11. Universal child allowances have also been the important source of income for Haredi families. There is statistical evidence that the size and structure of child allowances affect fertility (National Insurance Institute of Israel, 2011). During the 1990s, when Haredi parties increased the number of seats in the Knesset, child allowances were raised significantly, with higher rates of allowance per child for families with a larger number of children. This structure helped poor families with larger number of children, but also incentivizes them, notably Haredi families, to have more children. However, after the 2003 general elections, child allowances and other transfer payments were cut sharply in the context of the Economic Recovery Plan. The fertility rate has since dropped significantly, but poverty incidence has also risen.

uA01fig01

Average monthly child allowance per child and fertility

Citation: IMF Staff Country Reports 2012, 071; 10.5089/9781475502732.002.A001

Source: National Insurance Institute of Israel, 2009 Annual Survery.

12. Furthermore, religious students are awarded with high respect within the community. Being a seminary student also signals a strong commitment to the community, and they are warmly supported by the rest of the community, financially and non-financially. This further raises reservation wages for Haredi men.

Exemption from military service: raising marginal tax rates on employment

13. At the establishment of Israel, the government agreed with the religious parties to exempt 400 religious scholars from military service so that they were able to focus on religious studies (called a Torato Omanuto arrangement). This practice has broadly remained until now—though the government has launched some initiatives to change it in recent years (see below)—, and many yeshiva students are exempted from military service on condition that they continue to study. Now, the Ministry of Finance estimates that around 37,000 Haredi men study at yeshiva schools and do not serve.

14. This practice of conditional exemption disincentives Haredi men to complete their studies earlier and to serve in the military, which is critical in Israel for building social net work and getting a basic job training. It is also considered as an essential citizenship duty, and without fulfilling it, Haredi men are at a significant disadvantage in finding a good job. Thus, conditional exemption from military service effectively raises marginal tax rates for them to get employed.

The Case of Arab Females

15. Arab’s female employment rates are very low at around 20 percent, compared to about 70 percent for Jewish women.4 Impediments reflect typical minority problem—not unique for Israel—, and several factors contribute to the Arab and Jewish differences.

Generally low levels of education: lowering human capital acquisition

16. The average years of schooling for the Jewish population have continued to grow, with nearly half having 13 or more years of schooling. There also has been an improvement in the years of schooling for the Arab population, but the Arab population still lags behind others, with less than ¼ having 13 or more years of schooling. Women’s employment and their years of education are positively associated in general, and more starkly for Arab women.

uA01fig02

Women’s Employment Experience by Years of Education

(Percent share of sample population, women aged 25-29 in 1983)

Citation: IMF Staff Country Reports 2012, 071; 10.5089/9781475502732.002.A001

Source: The Bank of Israel.
Infrastructure constraints: raising marginal tax rates on employment

17. By advanced economy standards, Israel does not fare well in the quality of infrastructure.5 In particular, there is anecdotal evidence that public transportation, school, electricity, telephone lines, and internet access in some regions are not developed as equal standards as in other parts of Israel. For example, only 35 percent of the Arab population (age 20 and over) use internet, compared to 80 percent for non-religious Jews (Central Bureau of Statistics). Given that female workers with children have strong desire to find a job within reasonably commutable areas, the infrastructure bottleneck makes it harder for Arab females to access job opportunities outside their communities.

Double discrimination: raising entrance barriers

18. Arab females face double discrimination problems, one against for being women and the other against for being Arabs. In fact, for every education attainment level, Arab workers earn much less than Jewish workers, and earning gaps are particularly high for those with university degrees (OECD, 2010). This suggests that some non-economic factors exist, including distrust and discrimination towards Arab people (Flug and Kasir, 2003).

uA01fig03

Wage differentials between Arab and Jewish Workers by Education Attainment

(Hourly wage, Jewish men for each education attainment = 100)

Citation: IMF Staff Country Reports 2012, 071; 10.5089/9781475502732.002.A001

Source: 2010 OECD Review of Labor Market and Social Policies: Israel

Output Losses

19. Potential output losses due to low participation rates and wages (i.e., productivity) in these two communities are estimated to be very large. If the employment rates and wages in both Haredi and Arab communities are on a par with the Jewish population, Israel output would be some 15 percent higher than it is, and annual fiscal revenues would also be higher than they are by some 5 percent of GDP.

B. Demographic Challenges

Demographic projections

20. The CBS projects that Israel’s population will grow from 7.5 million in 2009 to 10.2 million by 2029, and further to 15.6 million by 2059 (CBS draft report on 2009–59 population projections). This indicates the average annual population growth of about 1.6 percent, much higher than other advanced economies facing aging problems.

uA01fig04

Dependency Ratio Projections

(Population of age 0-19 and above 65 divided by population of age

Citation: IMF Staff Country Reports 2012, 071; 10.5089/9781475502732.002.A001

Source: Israeli Central Bureau of Statistics.

21. However, the past downward trend of the overall dependency ratio6 is now being reversed because people born during the baby boom after 1948 are reaching older ages. Although the government decided to raise the retirement age for men from age 65 to 67 and for women from age 60 to 62, a demographic advantage over the past decades will gradually turn to a disadvantage.

22. The Haredi population is projected to grow much faster than other groups, due to its high fertility rate, and as a result, will exceed 20 percent of the total population by the late 2030s, and eventually 25 percent by the late 2050s. Meanwhile, the Arab population is projected to stay broadly flat at around 20–23 percent of the total population.

23. All these imply that if employment rates of the Arab female and Haredi male do not improve, the dependency ratio adjusted for structural employment problem of minority groups7 will rise at a faster pace.

uA01fig05

Israel - Long-Term Population Projection. 2009-2059

(In millions of people and percentage share)

Citation: IMF Staff Country Reports 2012, 071; 10.5089/9781475502732.002.A001

Source: Israeli Central Bureau of Statistics.
uA01fig06

Israel - Dependency Ratio Projections, 2009-2059

(Ratio)

Citation: IMF Staff Country Reports 2012, 071; 10.5089/9781475502732.002.A001

Source: Israeli Central Bureau of Statistics and IMF staff calculation.1/ Defined as (Age(0-19)+Age64over+Haredim men and Arab women (20-64)not employed)/(Jews and others excluding Haredim and Arab women (20-64)) not employed.

Demographic implications on growth, poverty, and fiscal prospects

24. To gauge the demographic implications on growth, decompose the growth rate of output into the growth rate of labor productivity and the growth rate of employment (Table 1). Then, long run growth potential can be simulated based on the following assumptions.

Table 1.

Long-term Growth Projections, 1970-2029

(Annualized average percent change)

article image
Sources: IMF WEO database, WB WDI database, and IMF staff projections.

The average for 2006-10 excluding 2009.

  • The employment rate of the Haredi men and Arab female will rise only at a modest rate, 0.1 percentage points a year. This implies that for Haredi men, the employment rate will rise from 0.4 in 2009 to 0.5 in 2029, and for Arab female, from 0.25 to 0.35. For other populations, the employment rates are assumed to stay constant at as they are now.

  • Neither new immigration nor employment in the informal sector is taken into account.

  • Productivity growth will remain constant at 1.3 percent a year, which is the average productivity growth for 2006–10 excluding the 2009 crisis year.

25. The results suggest that the employment growth rate will decelerate and increase only modestly at an annual rate of 1¼ percent from 2015 onward. Combined with the assumed productivity growth of 1.3 percent, this suggests a significantly lower potential growth: the annual rate of growth will fall from around 3¼ percent in the first half of 2010s to 2½ percent from the second half of the 2010s onward.

26. Moreover, potential growth could be further reduced if smaller working population adversely affects labor productivity. Several studies suggest that a higher share of workforce, with experience and education, would lead to higher productivity, through externality effects. In fact, panel regression models suggest positive correlations between labor productivity growth and a change in working age population share—e.g., a one percentage point decline in the share of the working age population would be associated with a 0.2 percentage points decline in GDP per worker growth (Table 2).

Table 2.

Panel Regressions

article image

Standard errors are in Italics (*** p<0.01, ** p<0.05, * p<0.1). All regressions are panel fixed effects regressions, for a sample of 67 advanced, emerging, and developing economies, with the data average for four 10-year periods over 1970-2009.

27. Lower growth could also significantly weaken fiscal prospects. If real GDP grows by 3½ percent a year in line with the past trend, the expenditure rules will allow the government to gradually increase the growth rate of expenditure, up to 3½-4 percent a year by the middle of 2020s, while public debt will fall steadily. However, were real GDP to grow only by 2½, expenditure growth would be reduced from 3½ percent a year currently to 2½ percent a year by the middle of 2020s. Despite such expenditure containment, public debt would continue to rise.

28. Lower output growth and limited fiscal space could further raise poverty. As total population is projected to grow faster than the working age population, the growth rate of per capita GDP will fall from the average of 3¼ percent in the late 2000s to just around 1 percent from the second half of 2010s onward.

uA01fig07

Expenditure growth based on the expenditure rules 1/

(In percent)

Citation: IMF Staff Country Reports 2012, 071; 10.5089/9781475502732.002.A001

1/ GDP growth rates: baseline, 3.5 perfent, alternative scenario, 2.5 percent.Source: IMF staff calculations.
uA01fig08

Public debt 1/

(In percent of GDP)

Citation: IMF Staff Country Reports 2012, 071; 10.5089/9781475502732.002.A001

1/ GDP growth rates: baseline, 3.5 perfent, alternative scenario, 2.5 percent.Source: IMF staff calculations.

C. What Actions Should Be Taken And By Whom?

29. Many of the Haredi men and Arab female want work, given their constraints. And the government wants to support them, too. The government has set forth the medium-term employment rate targets for the 20–64 age group: for the total group, from some 70 percent in 2010 to 76.5 percent by 2020, and for all Haredi and Arab males and females, to above 60 percent by 2020.

Government measures and effects

30. The government has launched a number of initiatives to address their needs over the past several years (Box 1). Most recently, the Trajtenberg Committee recommended several measures to address minority group issues. All these initiatives basically aim at reducing marginal tax rate on employment (e.g., Tal law,8 and child care), supporting human capital acquisition (e.g., various vocational programs and schools), and reducing entrance barriers (e.g., the Equal Opportunity in Labor Market).

31. The government has also strengthened institutions to deal with minority issues. For example, the Authority for the Economic Development of the Minorities Sector was established in 2008, aimed at “fully exhausting the economic potential of the Arab population by encouraging economic activity in Arab communities and by increasing their integration in the broader national economy.”

32. These measures have been complemented with other general labor market policies. Most importantly, the Earned Income Tax Credit (EITC) program has been expanded—which was originally introduced in September 2008 on a pilot basis in selected regions—to cover the whole nation in 2011. The EITC aims at improving welfare of poor households while incentivizing them to work, by providing grants to low wage workers satisfying certain specific conditions (e.g., age and the number of children). In addition, as discussed earlier, since 2002, the government has sharply reversed the past welfare-oriented policy by cutting transfer to households (such as child allowances). This was originally motivated by need for fiscal consolidation but also resulted in raising financial incentives for low-skilled workers to enter into the labor market.

uA01fig09

Government Intervention for the Poorest Households 1/

(In percent of disposable income)

Citation: IMF Staff Country Reports 2012, 071; 10.5089/9781475502732.002.A001

Source: Bank of Israel Annual Report 20101/ Defined as total transfer payments minus direct taxes.2/ Out of five quintiles.

33. These efforts have yielded some positive results, particularly in recent years. The employment rate of the Arab female rose from 19.3 percent in 1997 to nearly 25 percent in 2010. Furthermore, quite recently, the number of Haredi men serving in military has risen sharply, from 288 in 2007 to 1,282 in 2011 (Haaretz, 2012), compared to about 6,000 people who should be enlisted in their early 20s.9

The Case for More Measures

34. However, given the anticipated rapid change in a demographic structure, these reform initiatives should be further expanded, accelerated, and deepened. Key challenges are that in some areas, the implementation of the above-reform measures have been weak or slow, partly reflecting persistent political resistance. For example, the implementation of the Tal Law was strengthened after 2007, but most recently, in February 2012, the Supreme Court ruled that the Tal Law was unconstitutional, as the law violated the right to equality, and the law is expected to expire in August 2012. This decision may have significant fiscal and macro implications.

35. Accordingly, much more is needed, because early substantive progress is essential to secure the long term sustainability of the Israeli economy, and the welfare of all of its citizens. However, making early and substantive progress will require all sides and leaders to adjust and to work closely together, requiring greater political dexterity. Steps in key areas needed are summarized in Text Table 1.

Text Table.

Additional Measures

article image

36. If no effective action is taken, given that labor supply is structurally-constrained, immigration (including informal ones) could rise more, which would be budgetary costly. For example, labor regulations may need to be even further enforced to protect immigrants’ rights, and these immigrants may need to be covered in the formal social welfare framework, including education and health.

D. Concluding Remarks

37. Haredi and Arab participation problem has already caused poverty. If not addressed, this will also cause growth to slow sharply in the medium term. In both cases, low employment rates appear to reflect high marginal tax facing these communities, and high reservation wage. Furthermore, both contributed to lowering human capital acquisition. Solutions should address all these problems quickly, because growth and fiscal implications are urgent.

Government initiatives to enhance minority group employment

article image
Figure 2.
Figure 2.

Israel: Arab Households

Citation: IMF Staff Country Reports 2012, 071; 10.5089/9781475502732.002.A001

Sources: Bank of Israel annual reports, and Israeli Central Bureau of Statistics.

Data

  • A sample of 67 advanced and developing economies is used to examine correlations between per employment real GDP growth and a change in working age population share.

  • Observations are average for four 10-year periods over 1970–2009. The model is estimated with random effects, and includes several control variables, such as proxy variables for the quality of institution and macroeconomic policies, as well as geography and initial income levels.

References

1

Prepared by Kotaro Ishi (Kishi@imf.org) with research assistance provided by Stephanie Denis.

2

Currently, Israel’s population totals 7.6 million (2009), of which Jews accounting for 75 percent, Arabs for 20 percent, and other minority groups of 5 percent. Official statistics measuring Haredi populations does not exist. The Central Bureau of Statistics (CBS, 2011) estimated that the population of Haredim is about 10 percent of total population.

3

Yashiv and Kasir (2011) empirically show that cultural factors in part explain low labor participation among Arab women. Rivlin (2011) refers to discrimination as one of many factors affecting labor participation among Arab women.

4

Arab men’s employment is high, only slightly lower than secular and traditional Jews, in part because Arab men retire earlier. They tend to work more in construction, agriculture, and traditional manufacturing sector—where labor productivity and wages are low—than in high skilled or productive high-tech sector where Jewish men tend to work.

5

The overall infrastructure quality is ranked the 38th out of 142 countries by the World Economic Forum Global Competitiveness Report, 2011–12.

6

Defined as the population of age 0–19 and above 65 divided by the population of age 20–64.

7

Defined as the population of age 0–19, above 65, and Haredi male/Arab female of age 20–64 not employed divided by the population of age 20–64 excluding Haredi male/Arab female of age 20–64 not employed.

8

The Tal law allows haredi men to study Torah and defer army service until age 23. Then, they can leave yeshiva for a year of “adjustment” (supposedly vocational training) without facing immediate draft. If they decide to remain “on the outside” of full-time yeshiva study, these men become draftable, serving either six months in the army with annual reserve duty or a year of civilian service.

9

The most recent BOI’s analysis also suggests that the employment of Haredi men from 39 percent in 2009 to 45 percent in 2011.

Same Series

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Cover IMF Staff Country Reports
Israel: Selected Issues Paper
Author: International Monetary Fund
Volume/Issue:
Volume 2012: Issue 071
Publisher:
International Monetary Fund
ISBN:
9781475502732
ISSN:
1934-7685
Pages:
43
DOI:
https://doi.org/10.5089/9781475502732.002
  • View in gallery

    Israel: The Overview of Socio Economic Developments, 1975–2009

  • View in gallery

    Average monthly child allowance per child and fertility

  • View in gallery

    Women’s Employment Experience by Years of Education

    (Percent share of sample population, women aged 25-29 in 1983)

  • View in gallery

    Wage differentials between Arab and Jewish Workers by Education Attainment

    (Hourly wage, Jewish men for each education attainment = 100)

  • View in gallery

    Dependency Ratio Projections

    (Population of age 0-19 and above 65 divided by population of age

  • View in gallery

    Israel - Long-Term Population Projection. 2009-2059

    (In millions of people and percentage share)

  • View in gallery

    Israel - Dependency Ratio Projections, 2009-2059

    (Ratio)

  • View in gallery

    Expenditure growth based on the expenditure rules 1/

    (In percent)

  • View in gallery

    Public debt 1/

    (In percent of GDP)

  • View in gallery

    Government Intervention for the Poorest Households 1/

    (In percent of disposable income)

  • View in gallery

    Israel: Arab Households

Israel: The Overview of Socio Economic Developments, 1975–2009

Average monthly child allowance per child and fertility

Women’s Employment Experience by Years of Education

(Percent share of sample population, women aged 25-29 in 1983)

Wage differentials between Arab and Jewish Workers by Education Attainment

(Hourly wage, Jewish men for each education attainment = 100)

Dependency Ratio Projections

(Population of age 0-19 and above 65 divided by population of age

Israel - Long-Term Population Projection. 2009-2059

(In millions of people and percentage share)

Israel - Dependency Ratio Projections, 2009-2059

(Ratio)

Expenditure growth based on the expenditure rules 1/

(In percent)

Public debt 1/

(In percent of GDP)

Government Intervention for the Poorest Households 1/

(In percent of disposable income)

Israel: Arab Households