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.
II. Composition of Civilian Expenditure1
1. Israel’s public expenditure as a share of GDP is around the OECD average, but exceptionally high levels of defense spending means that Israel’s civilian expenditure is amongst the lowest in the OECD. This raises concerns regarding the compression of spending on public services.
2. While Israel’s civilian expenditure low, other OECD economies still achieve strong social outcomes with similar shares of civilian expenditures. Israel’s composition of expenditure is strikingly similar to these countries, particularly once demographic factors are accounted for, and relative to them has high health and education spending.
3. The main difference between Israel and the OECD is the amount of social protection expenditure, owing to Israel’s relatively young population, which provides a considerable demographic dividend in the form of lower pension and health costs, though this is partly offset by higher spending on education. But the economic benefit of this dividend is reduced by the exceptionally low participation rates of minority groups (see Attachment I). Bringing those groups fully into the labor force and increasing their productivity levels would secure the full demographic dividend.
4. While Israel’s social outcomes are good, there is a case for higher civilian expenditure in some areas, notably to tackle the roots of low participation among minority groups and raise investment. Alongside, to reduce the high degree of inequality, the social transfer system could be made more targeted and increasingly conditional on employment without significantly increasing the amount of spending.
A. Civilian Expenditure in Israel
5. Israel sits in the middle of OECD countries in terms of the amount of public expenditure as a share of GDP. In 2008, public expenditure in Israel represented 44.3 percent of GDP compared to the OECD average of 43.7 percent. 2 But the size of defense expenditures in Israel sets it apart from all other economies in the OECD. In 2008, Israel spent 7.3 percent of GDP on defense – more than four times the OECD average, and significantly more than the 4.6 percent of GDP of the next highest, the US.
6. High defense and interest spending reduce the amount of resources available for civilian expenditure for any given tax ratio. Taking these into account, Israel’s civilian expenditure falls to 33.4 percent of GDP—amongst the lowest in the OECD.
7. However, Israel is far from alone in having civilian expenditure at this level. Australia, Canada, Japan, New Zealand, the Slovak Republic, Switzerland and the US all have similar shares. Thus, in addition to comparing the composition of Israeli civilian expenditure to the OECD average, which is dominated by large government European economies with large social welfare systems, it is useful to compare Israel’s spending pattern with this group of moderate expenditure countries. To facilitate this comparison, data for these countries in this chart and in all subsequent charts in the attachment are highlighted in blue.
B. Civilian Expenditures Compared
8. This section looks into the composition of expenditure to investigate whether there are any major difference between Israel and these moderate expenditure countries and the OECD overall. The functional composition of expenditure is compared using COFOG functional data, which decomposes government spending into 10 groupings. To compare civilian expenditures, interest and defense are excluded (Figure 1).
Size and Composition of Public Expenditure in 2008
Citation: IMF Staff Country Reports 2012, 071; 10.5089/9781475502732.002.A002
Sources: OECD; and IMF staff calculations.Size and Composition of Public Expenditure in 2008
Citation: IMF Staff Country Reports 2012, 071; 10.5089/9781475502732.002.A002
Sources: OECD; and IMF staff calculations.Size and Composition of Public Expenditure in 2008
Citation: IMF Staff Country Reports 2012, 071; 10.5089/9781475502732.002.A002
Sources: OECD; and IMF staff calculations.9. The composition of Israel’s expenditures is broadly in line with the moderate expenditure countries identified above, and with the OECD average in most areas. The exception is social protection, which falls significantly short of the OECD average. Other differences are also apparent, notably in economic affairs, general public services adjusted for interest expenditure, health (all lower), and education (higher).
10. Most social protection spending goes toward old-age pensions. However, in Israel these are much lower than in both the OECD and moderate expenditure countries3. This alone accounts for almost all of the difference in social protection expenditure. In contrast, family benefit payments and incapacity payments are relatively high in Israel. Finally, Israel has one of the lowest shares of expenditure on active labor market programs – despite the substantial labor force issues faced by the minority workforce.
11. The low share of spending on old-age pensions is almost entirely due to the relatively young age of Israel’s population (Figure 1). Comparing old-age pension spending to dependency ratios across the OECD, Israel sits right on the trend line. Thus, the bulk of difference in social protection expenditure —and by extension of civilian expenditure—is due to a demographic dividend not due to a compression of spending by defense.
Israel’s public health expenditure as a share of GDP is also amongst the lowest in the OECD. However, the majority of health expenditure occurs in the final years of life. Thus, Israel’s young population provides a further demographic dividend, in the form of a lower share of old people, with a subsequent reduction in health expenditure. Adjusting expenditure as a share of GDP for the age- spending-profile-weighted-demographic factors, based on estimates by Hagist and Kotlikoff (2005) increases Israel’s health spending per capita. The total amount of health expenditure also needs to account for private funding which is relatively high in Israel. On this demographically-adjusted measure of health expenditure, Israel moves from amongst the lowest to one of the highest as a share of GDP in the OECD (Figure 2).
Public and Private Spending in Key Functional Areas
Citation: IMF Staff Country Reports 2012, 071; 10.5089/9781475502732.002.A002
Sources: OECD; and IMF staff calculations.Public and Private Spending in Key Functional Areas
Citation: IMF Staff Country Reports 2012, 071; 10.5089/9781475502732.002.A002
Sources: OECD; and IMF staff calculations.Public and Private Spending in Key Functional Areas
Citation: IMF Staff Country Reports 2012, 071; 10.5089/9781475502732.002.A002
Sources: OECD; and IMF staff calculations.12. Israel’s public education spending is amongst the highest in the OECD. This is supplemented by above average private expenditure. However, education expenditure is heavily weighted towards the young, who constitute a high proportion of Israel’s population, offsetting some of the demographic dividend from low pension and health spending. Adjusting education expenditure to account for these factors moves Israel’s ranking down to around the OECD average as a share of GDP (Figure 2).
13. Israel’s expenditure on public investment is low relative to the OECD (Figure 2). However, Israel’s defense investments are not included in these data, while in other OECD countries they are. Given the low level of defense spending in other economies this is unlikely to change results significantly, and gives a reasonable indication of Israel’s rank in non-defense investment.
14. Overall, there is little evidence to suggest that social expenditures are being severely compressed by the defense budget relative to Israel’s peers.
C. Social Outcomes
15. Although Israel’s social expenditures as broadly similar to the rest of the OECD once demographic factors are accounted for, concerns remain over the quality and level of public services, as evidenced by the social protests in the summer of 2011.
16. One way to assess this is to compare welfare outcomes to the rest of the OECD, and compare that to the amount of spending to gain a sense of effectiveness. To account for variances in GDP per capita levels across the OECD, the level of spending is stated in US$ per capita on a PPP basis, rather than as a share of GDP as described above. Where relevant – such as in health and education – these spending measures are adjusted for demographic factors and for levels of private expenditure.
17. Points to the north-west in the scatter plot charts (Figure 3) indicate a country with more effective spending. Of course, how effective and efficient public spending is depends on many factors (like population characteristics, past expenditure, income and education levels and immigration rates) which this presentation does not control for. Furthermore, the direction of causality is not always clear – high levels of spending could be a response to poor initial outcomes.
Comparison of Social Outcomes to Spending
Citation: IMF Staff Country Reports 2012, 071; 10.5089/9781475502732.002.A002
Sources: OECD; and IMF staff calculations.Comparison of Social Outcomes to Spending
Citation: IMF Staff Country Reports 2012, 071; 10.5089/9781475502732.002.A002
Sources: OECD; and IMF staff calculations.Comparison of Social Outcomes to Spending
Citation: IMF Staff Country Reports 2012, 071; 10.5089/9781475502732.002.A002
Sources: OECD; and IMF staff calculations.18. Israel’s health outcomes are very strong. Israel’s infant mortality rate is close to the OECD average, while its life expectancy at birth is amongst the highest in the OECD (Figure 3). Israel outperforms other moderate expenditure in terms of infant mortality, and performs comparably in terms of life expectancy.
19. Israel’s health expenditures appear to be highly effective, lying close to the efficiency frontier of the OECD. Part of this is likely due to Israel’s non-medical determinants of health, such as low alcohol consumption and good diet, which are reflected in lifestyle diseases: with low rates of obesity and diabetes, and low cancer and stroke mortality rates.
20. This conclusion is supported by data on Israel’s health outputs, which are more directly related to spending inputs than the outcomes. Israel also has above average doctor to population ratios indicating a high human capital intensive labor input, although the nurse to population ratio is below average. On the other hand, the capital intensive inputs, measured by outputs such as CT and MRI scanners and numbers of hospital beds, are relatively low. However, their utilization rates are relatively high, indicating efficient use of capital inputs. Finally, the quality of care is relatively high, as indicated by very low hospital mortality rate of myocardial infarction.
21. Israel’s education outcomes are more mixed. Israel’s graduation rate is amongst the highest in the OECD. 4 This is partly a result of policy, whereby students are required to complete secondary school – resulting in greater efforts at keeping marginalized students engaged. These high graduation rates are reinforced by one of the highest university enrollment rates in the OECD.
22. However, Israel’s PISA score is amongst the lowest in the OECD. This is true across the range of subjects covered by the PISA: maths, science and reading.
23. These results call into question the effectiveness of education spending in Israel. While spending per school age capita in US$ terms is below the OECD average, it is similar in amounts to countries that achieve much higher results, and Israeli children spend the 3rd highest cumulative time in school. On the other hand, class sizes in Israel are higher than the OECD average.
Average Class Sizes
Average Class Sizes
| Primary | Lower Secondary | |
|---|---|---|
| Arabs | 29 | 33 |
| Jews | 24 | 29 |
| OECD average | 22 | 24 |
Average Class Sizes
| Primary | Lower Secondary | |
|---|---|---|
| Arabs | 29 | 33 |
| Jews | 24 | 29 |
| OECD average | 22 | 24 |
24. A significant factor in this result is the poor outcomes of minority groups.5 When looking at the PISA reading scores by cultural group, the difference between Jews and Arabs is stark. Jewish students’ scores are on par with the OECD average, while Arab group scores are more than 20 percent lower (Figure 3). This is likely due to a number of reasons, such as geographic vicinity, income levels and parent’s education levels: all of which have an impact on education outcomes. Nevertheless, budgetary spending per child in Arab localities is only half of that in Jewish communities, which is reflected in Arab schools having far higher class sizes, and 25 percent lower teaching hours than in Jewish schools at the elementary level.
25. Similar patterns can be seen in health indicators. Infant mortality rates amongst the Arab population are almost three times that of the Jewish population, which otherwise sits amongst the very top tier of results amongst the OECD. Again, this result is likely due to a number of factors in addition to the provision of health services, including high fertility rates amongst the Muslim population.
26. These poor minority outcomes pose a major challenge. In addition to the direct impacts, they also feed into the broader economic issues facing Israel, with low productivity levels of minority populations to a large extent determined by education quality and attainment. Thus, this is one area where there is a strong case increasing expenditure.
27. The quality of infrastructure in Israel is below the OECD average. Israel scored highly among telecommunication indicators, but relatively poorly on physical infrastructure (Figure 3). Poor transport infrastructure is one of the obstacles to regional Arab communities’ participation in the labour market.
28. If these poor outcomes for minority groups are not resolved, Israel will face a considerable crunch in public spending. The minority groups are rapidly becoming an increasing share of the population. If employment and productivity rates are not lifted, Israel’s potential GDP will be affected, with severe flow through impacts on the amount of civilian expenditure.
29. Social protection outcomes in Israel leave room for improvement. Israel has one of the highest levels of inequality in the OECD. Israel’s relatively high degree of market income inequality reflects the impact of the two low income groups: the ultra-orthodox men (haredi) and Arab women, who make up considerable shares of the population but have very low levels of labor force participation. This is reflected in very low market incomes of the lowest income decile – which are 1/15th that of the highest income decile.
Inequality and Redistribution
(Gini coefficient)
Citation: IMF Staff Country Reports 2012, 071; 10.5089/9781475502732.002.A002
Source: OECD.Inequality and Redistribution
(Gini coefficient)
Citation: IMF Staff Country Reports 2012, 071; 10.5089/9781475502732.002.A002
Source: OECD.Inequality and Redistribution
(Gini coefficient)
Citation: IMF Staff Country Reports 2012, 071; 10.5089/9781475502732.002.A002
Source: OECD.30. While the size of redistribution from the tax transfer system (the difference between market and disposable incomes) is around average in Israel, the high starting point leaves Israel one of the most unequal countries in the OECD, after only the US, Mexico and Chile.
Effectiveness of Transfer System
Citation: IMF Staff Country Reports 2012, 071; 10.5089/9781475502732.002.A002
Source: OECD.Effectiveness of Transfer System
Citation: IMF Staff Country Reports 2012, 071; 10.5089/9781475502732.002.A002
Source: OECD.Effectiveness of Transfer System
Citation: IMF Staff Country Reports 2012, 071; 10.5089/9781475502732.002.A002
Source: OECD.31. Transfer payments typically have a much higher impact on inequality than does the tax system – approximately two-thirds of redistribution occurs through payments. In order to gauge the effectiveness of transfer payments we compare the amount of redistribution, as measured by the change in the gini coefficient stemming from those transfers, to the size of the payments, as a share of GDP. The higher the ratio of redistribution to payments, the more higher the efficiency of the transfer payments.
32. The efficiency of Israel’s transfer payments is the lowest of those countries for which these data are available. This group can be loosely split between the high tax/transfer European countries, with relatively large universal-style transfer payments, and the (largely Anglo-Saxon) countries with smaller, more targeted transfer systems. As would be expected with universal systems, the redistribution is less effective, while the targeted (using means testing), and conditional (often to employment) nature of the latter have higher redistributive effectiveness. Israel’s system is characterized by universality of payments (for instance family benefit payments go to everyone), but the size of the transfer system is more like the smaller targeted systems of the Anglo-Saxon economies, with the resulting lower than average impact on redistribution from transfers.
33. There are a number of options to reduce the degree of inequality in Israel. The first is to lift market incomes of the lower income earners, through improving employment and productivity of the minority populations (which would also have the positive effect of lifting GDP per capita). The second is to increase the size of the transfer payment system, through increasing payment rates. The third option is to make the system more effective without increasing its size, through adopting some of the targeted and conditional programs that are used in the Anglo-Saxon countries. The design of these targeted systems needs to be done carefully, and looked at as a whole (including the tax system) as there can be associated problems of high effective marginal tax rates and potential poverty traps coming from the withdrawal of benefits.
D. Recent Policy Changes
34. There have been a number of policy changes since 2008, including increased education funding through the New Horizon initiative, the introduction of an earned income tax credit, and increased transport infrastructure investments.
35. In response to the social protests, the government formed the Tratjenberg Committee to recommend policy changes to meet the concerns of the protestors. On the expenditure side, the main recommendations that have so far been adopted by the Knesset were to expand child care positions and subsidies; provide free compulsory education for 3–4 year olds; and increase labor market schemes for minority populations.
36. These changes represent moves in the right direction. The new horizon and increased active labor market schemes go some way to improving the quality of education among minority communities, as well as raising the active labor market programs that are otherwise very low in Israel. The expansion of places for pre-primary students may raise human capital levels – with various studies showing that pre-primary education can have a major impact of human capital attainment, while at the same time reducing effective marginal tax rates (in the form of lower child care costs) for working families. However, unlike the earned income tax credit, which is an example of a targeted and employment conditional transfer, the universal nature of the subsidies are unlikely to improve the redistributive effectiveness of the transfer system.
E. Concluding Remarks
37. While Israel’s social outcomes are of a relatively high quality, there is an argument for higher civilian expenditure in activities related to the minority groups. However, there are a number of other moderate expenditure countries which succeed in delivering high quality social outcomes with similar amounts of civilian spending.
38. With its young population providing a sizeable demographic dividend, this should also be possible for Israel, though the size of that dividend is reduced by the underutilization of minority groups. Failure to tackle this problem urgently will lead to a crunch in resources, requiring savings in all areas of expenditure – both civilian and defense.
39. Policy actions taken are moving in the right direction, with increased funding directed to these needs, and the lowering of effective marginal tax rates for the population overall. To increase the effectiveness of spending, particularly in reducing inequality, Israel should look to lessons from those moderate expenditure countries, particularly in the design of policies to increase the degree of targeting and conditionality to provide more bang for the social transfer shekel.
Contributed by Jason Harris (jharris@imf.org) with research assistance provided by Carla Sateriale.
2008 is chosen because this allows a comparison of expenditure before the impact of the global financial crisis.
Some countries data are affected by differing treatment of tier 2 pension systems, which are excluded from Israel’s data.
This measure differs to completion rates, which compares graduating to enrolled students.
Similar information is not available for Haredi schools, which did not participate in PISA.
