Central bank urges new government: Think long-term, make Israel more productive

Israel must look beyond short-term budgetary constraints to support long-term government objectives, a report by the Bank of Israel said Wednesday, as it lay out four strategic steps to help the economy recover from the economic fallout of the coronavirus pandemic.

The costs of the proposed strategic steps should be funded by a mix of debt, taxes and a reallocation or a curbing of public spending, the authors of the report said.

The report, authored by members of the central bank’s research department, comes three years after the passing of the last national budget and as a new government takes the helm, led by Prime Minister Naftali Bennett.

The most pressing issue for the government, post-pandemic, is to get the economy back to full activity and mitigate long-term damage. But policymakers must also look beyond the coronavirus-induced crisis to deal with preexisting economic challenges, the authors said. One of the key aims, the report said, is to increase productivity levels, which are lower than in other developed nations and are the main factor behind income inequality in Israel.

Developing human capital is the first step proposed by the authors, a “critical component” in the growth of modern economies. This should be achieved by improving the quality of the education system, with a focus on students from weaker economic backgrounds, and setting up vocational training programs for adults.

Incentivize investments in infrastructure and technologies. The quality of transportation, housing, communications and energy infrastructure, along with the adoption of technology, has a direct impact on workforce productivity and on quality of life, the authors said. Thus, capital investment should be encouraged in all these fields, and the housing supply in areas of demand should be increased by promoting urban renewal and incentivizing local authorities to absorb new residents.

Develop the financial system. Remove barriers for the development of the financial system and promote the development of new products and credit tools to increase the efficiency of the credit market and public access to credit sources. This will help increase the range of financing options for savers and investors, streamline credit allocation and pricing, and better distribute risk among financial institutions.

Israeli students return to school in Tel Aviv on April 18, 2021. (Avshalom Sassoni/Flash90)

Improve regulation and use technology to streamline government work. Effective, accurate regulation and transparency facilitates business activity, reducing direct costs arising from compliance and bureaucracy costs for businesses and government entities. Increased use of technology in government activities, such as advanced information systems, improve processes within the government and improve services to the public and businesses.

The recommendations, which include steps on how to tackle these four challenges, involve “significant fiscal costs” in the medium term, the authors said. Thus, it is necessary to set up an institutional-economic framework existing “in isolation from short-term constraints” that can support the long-term government objectives that the economic plan seeks to promote.

This framework should include effective fiscal rules that take into account the volatility of the macroeconomic environment and tax receipts, and proper work preparing the state budget, the report said.

The four proposed steps will help address core strategic issues that will contribute to long-term growth by creating the conditions for increasing productivity in the real economy, development in the financial markets, and reducing gaps in earning capacity and employee capabilities. The fruits of some of the proposed measures will be seen only in the medium and long term, such as transportation and human capital development, but “without immediate activation, the problems will worsen and will not be solved even in many years.”

The central bank clarified in a text message later on Wednesday that raising taxes too early, like in 2022, could hurt economic growth and recovery from the crisis. The idea is for a gradual raising of taxes, accompanied by a cutting of government expenditure according to priorities set by policymakers, starting from 2023.