Government’s short-term focus is pricey in the long run — central bank governor

Why wait for a crisis to invest in needed reforms and address fundamental weaknesses in the economy, asks Karnit Flug

Shoshanna Solomon is The Times of Israel's Startups and Business reporter

Bank of Israel Governor Karnit Flug speaks during a press conference in Jerusalem on March 31, 2015. (Yonatan Sindel/Flash90)
Bank of Israel Governor Karnit Flug speaks during a press conference in Jerusalem on March 31, 2015. (Yonatan Sindel/Flash90)

Israeli governments in recent years have set out policies with a focus on attaining short-term goals, even at the cost of causing long-term harm, Karnit Flug, the governor of the Bank of Israel, said on Thursday. They also “do not place sufficient emphasis on future-oriented policy.”

Israel’s economy is doing well in macroeconomic terms, Flug said. But it is precisely when the economy is in good shape that the time is right to “adopt reforms and to deal with fundamental weaknesses.” It appears, though, she said, that the good economic situation “just doesn’t create a sense of urgency.”

“Quite a bit has been written on a crisis essentially being an opportunity,” Flug said. “But do we really have to wait for a crisis in order to deal with the fundamental problems of the Israeli economy?” she asked, addressing the annual conference of the Israel Economic Association.  

Israel’s economy is growing at a pace of 3.5-4 percent per year; and, in contrast to previous years, in which growth was based on private consumption, growth is currently more balanced, with exports and investments also contributing.

The growth is reflected in continued demand for workers; unemployment is low and salaries are rising among all population groups; and companies say that a lack of human resources is what is limiting their expansion.

However, employment rates among ultra-Orthodox men and Arab women still remain “particularly low,” Flug said, even after steps were taken by the government in 2002-2003 to reduce handouts to help increase the participation of these population groups in the workforce.

The poverty level in Israel is the highest of all OECD countries, especially among the Arab and ultra-Orthodox populations, she said.

Productivity levels in Israel continue to remain below the OECD average in nearly all industries, except for those that are export oriented, which means they are directly exposed to global competition.

This challenge of lack of productivity growth is expected to become even greater, in light of what looks to be shaping up as a slowdown in the growth of world trade, and because of domestic factors, including “the inferior quality of human capital, inferior quality of physical infrastructure, and a business environment that is not at all friendly,” Flug said.

On international tests, the achievements of Israeli students are relatively low compared to the OECD average, and Israel is “notably poor in terms of the gaps in educational achievements.”

The weakness in these skills among a large part of the population is expected to weigh on their future integration into employment, particularly when processes such as digitalization, automation of workplaces, and use of artificial intelligence will lead to a growing decrease in demand for workers in routine jobs and in manual labor. On the other hand, “demand for workers in analytical jobs relying on a high cognitive level and creativity is increasing and is expected to continue to increase,” she said.

Thus, to increase productivity for inclusive and sustainable growth in the economy — which will lead to an increase in the standard of living and to reduced poverty — steps must be taken. These include improving the quality of human capital, by improving the quality of education; improving infrastructure and promoting reforms and competition; reducing bureaucracy; providing incentives for people to seek employment and adjusting the retirement age to the higher life expectancy, particularly for women.

“We should take advantage of the Israeli economy’s good situation in order to require handling the long term challenges, which will contribute to growth that is more balanced, that is sustainable and inclusive,” Flug said.

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