Unemployment could be Achilles’ heel of Israel’s road to recovery – experts

New finance minister Katz must get people back to work as a first priority, with uncertainty about the coronavirus pandemic persisting and employers wary of the future

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

Self-employed and small business owners participate in a rally in Jerusalem on March 30, 2020 (Yonatan Sindel/Flash90)
Self-employed and small business owners participate in a rally in Jerusalem on March 30, 2020 (Yonatan Sindel/Flash90)

The first task Israel’s new finance minister Israel Katz will have to tackle, as he takes the reins of an economy stricken by the coronavirus pandemic and the lockdowns it has caused, will be to get people back to work, experts say.

At a later stage, he will need to raise taxes to keep the nation’s soaring budget deficit in check, and, if wise, use the crisis to undertake investments and wide-ranging reforms in such areas as infrastructure, transportation and education, they say.

Katz has a reputation as a bulldozer for his ability to undertake reforms. During his stint as transportation minister he implemented an “open skies” policy that brought competition and cheaper flights. He also sought to bring competition to the ports.

He is now likely to need all of his bulldozer abilities in his new job at the Finance Ministry, where he faces the herculean task of fixing a battered economy, in which unemployment rates have soared to unprecedented levels and growth is forecast to contract for the first time this year since 2002 due to the coronavirus pandemic.

Israel Katz in Jerusalem on October 22, 2019. (Noam Revkin Fenton/Flash90)

The pandemic, which has infected over 5.5 million people around the world and killed over 350,000, is causing economic havoc as governments worldwide have implemented lockdowns in a bid to curb the spread of the virus.

In Israel, the virus has killed 281 people, and almost 17,000 have been infected.

Lockdown measures, which began in mid-March, brought the economy to an almost-total standstill. Unemployment figures jumped from a record low of under 4 percent at the beginning of March to some 28% in late April, as many businesses were forced to close their doors. The number of unemployed surpassed 1 million for the first time in Israel’s history.

Prof. Karnit Flug, Vice President of Research and the William Davidson Senior Fellow for Economic Policy at the Israel Democracy Institute (Courtesy)

“The finance minister’s first priority should be the most rapid and most extended return to employment of as many employees as possible,” said Karnit Flug, a former governor of the Bank of Israel, in a phone interview. Flug is today vice president of research and the William Davidson senior fellow for economic policy at the Israel Democracy Institute.

As the virus abates, Israel has incrementally eased restrictions. Restaurants, bars, hotels and swimming pools are being allowed to open on Wednesday after over two months of closure.

Even so, figures show that businesses are not hurrying to reinstate all of their furloughed workers, said Victor Bahar, the chief economist at Bank Hapoalim, in a phone interview. That is worrisome, he said.

Despite the reopening of most businesses over the last several weeks, the unemployment rate remains at 24.4%, according to government figures.

Data compiled by the Central Bureau of Statistics show (Hebrew) that at the beginning of May, even as many restrictions were lifted, workers continued to remain unemployed. The tech industry, which was not directly impacted by the virus because its employees could largely work from home, still had 7% of its workforce on unpaid leave, the CBS statistics showed, in a survey undertaken on May 5 and 7. Some 33% of retail workers were also still on unpaid leave.

“If it continues this way, then unemployment rates will continue to be in the double digits,” Bahar said. “In economics we say that the short run has an effect on the long run.” Current unemployment could become a protracted problem, he warned, as workers who don’t go back to work start losing their skills.

Self-employed workers and kindergarten owners participate in a rally calling for financial support from the government outside the Knesset in Jerusalem, on April 19, 2020. (Yonatan Sindel/Flash90)

On Monday, as it left its key lending rate unchanged at 0.1%, the Bank of Israel issued an updated forecast for the economy, predicting a slower than originally thought recovery next year.

The central bank forecast came as data released by the CBS showed that the economy contracted by 7.1% in the first quarter of 2020, the sharpest decline in 20 years. The contraction of the economy was more severe than after the 9/11 attacks and the 2008 global financial crash, the CBS noted, as the data showed a decrease in consumer spending.

According to the updated central bank forecast, gross domestic product (GDP) is expected to contract by 4.5% in 2020, compared with 5.3% in its April forecast, and to grow by 6.8% in 2021, compared with 8.7% growth in the earlier forecast.

The 2020 contraction would mark the first time since 2002 that the economy has posted negative growth.

The central bank said that most of the restrictions on the economy would be fully lifted by the end of June, and the actual pace of the lifting has been more rapid than originally assessed. However, the gradual recovery expected in the second half of the year “is expected to be longer than our April assessment” due to the continued impact of social distancing measures and the potability of a second wave.

Industries that are likely to remain vulnerable even after the lifting of restrictions will be tourism and hospitality; export manufacturing as global demand remains slow; and startup companies, as they face a funding squeeze.

Change in sentiment

Unemployment in the second half of 2020 will be 8.5% and by the end of 2021 it will be 5.5%, the central bank forecast. So even at the end of 2021, the economy is not expected to return to the level it was before the start of the pandemic.

Victor Bahar, Chief Economist at Bank Hapoalim (Yossi Zliger)

Hapoalim’s Bahar said the coronavirus pandemic had sharply cut into several years of strong economic growth and high employment levels. With the disruption of this positive momentum, the crisis became a trigger for businesses to “think differently,” cutting costs on unnecessary activities and new initiatives in the face of continuing uncertainty about the future.

While efficiency measures are generally good for the economy, when these steps are taken abruptly and not gradually, as in the case of the pandemic, things can go sour for the economy.

“If in the short term everyone is taking efficiency measures, then there is no employment alternative for those who have been let go,” he explained. Had it happened over time, those who lost their jobs would have been better able to find other jobs. This sudden jump in unemployment could easily become chronic, he said, dubbing it the apparent “Achilles’ heel” of the crisis.

Meanwhile, the government has come under heavy criticism from big and small business owners and from economists for dragging its feet on rescue packages and for not providing enough certainty in the economy for them to get back to work. Israel could see a 50% jump in the number of businesses shutting down this year, to some 70,000, because of the coronavirus crisis, business data firm Dun & Bradstreet forecast in a report on the pandemic and its impact on the Israeli economy.

At a cabinet meeting on Sunday, the government approved an injection of an additional NIS 14 billion ($3.9 billion) into the economy, to make up for virus-related losses. With the added money, the recovery program now stands at some NIS 100 billion, up from the NIS 80 billion originally earmarked for the recovery.

On Tuesday, the Finance Ministry released details of a proposed NIS 6 billion ($1.7 billion) plan to reduce unemployment by providing incentives over four months for businesses to rehire workers who lost their jobs due to the lockdown. The program gives NIS 7,500 to businesses that take employees back from unpaid leave as of June 1; businesses that took employees back to work as of May 1 will receive half that sum. The government will also allocate a further NIS 500 million for vocational training programs.

Katz said the program was “simple and effective and aimed at getting over one million unemployed back to work as quickly as possible and to get the economy back to rapid growth.”

The program had been stalled over disagreements between business associations and the Finance Ministry over how to implement the idea without inadvertently providing employers with a motive to fire their workers in order to qualify for the grants, if there is a second wave of virus infections. Even after it was published, critics said it did not help employers who re-employed workers in April and those that did not put workers on unpaid leave at all.

The NIS 6 billion plan may not be enough to help get everyone back to work, Hapoalim’s Bahar said, because people have grown more pessimistic. Businesses “may take the money, rehire the workers and then get rid of them again” when the plan expires, he said. “But we must try.” Even if the plan helps reduce unemployment by just two percent, “then it is good enough,” he said.

Bank of Israel Governor Amir Yaron, speaking at the Eli Hurvitz Conference on Economy and Society organized by the Israel Democracy Institute, December 17, 2019 (Michal Fattal)

Bank of Israel governor Amir Yaron also underlined the urgency of getting people back to work.

“The more rapidly employees return to work, the more the risk of a continued impact on the economy will decline,” he told ministers at the Sunday cabinet meeting. The most important thing at this time for the government, he said, is “speed of performance and reduction of uncertainty.”

Spend now, tax carefully later

The cost of all of these government rescue plans, alongside a drop in tax revenue due to lower economic activity because of the crisis, will also cause a marked increase in budget deficit levels and in the debt-to-GDP ratio. A low ratio indicates an economy that produces and sells goods and services sufficient to pay back debts.

Indeed, according to the latest central bank forecast, the budget deficit in 2020 is expected to surge to 11.5% of GDP and the debt-to-GDP ratio is expected to grow to 74% at the end of the year, the Bank of Israel said, up from some 61.2% in 2019.

The new finance minister, said Bahar, will need to eventually curb this spending spree — even though it’s warranted at this time of crisis — with higher taxes. But timing will be crucial because higher taxes could further hamper economic growth.

“There has to be a right balance of when to raise taxes so as not to hurt growth,” he said. “That is a big short-term challenge.”

Economic crises — with all parties feeling a sense of urgency and responsibility to save the economy — are good starting points for carrying out much-needed reforms, economists believe. And in the longer term, Israel’s new finance minister should leverage the crisis to push through these reforms, the experts said. We should use this crisis “as an opportunity to put into place reforms,” said Flug.

These include lowering chronically high house prices, closing gaping income inequality gaps, injecting money in infrastructure projects, and addressing flaws in the public transportation and education systems.

Severe traffic on the Ayalon Highway in Tel Aviv on October 28, 2015. (Simcha Simon, courtesy)

Katz should use this opportunity to invest in green energy projects and green construction, said Flug, as well as promote vocational training to “maximize the potential for employment.”

Meanwhile, economists at the ratings agency S&P remain optimistic about Israel’s economic rebound options, forecasting a growth of over 6% in 2021, after contracting 5.5% in 2020.

“We assume the COVID-19 shock will be short-lived,” S&P economists said in a May 15 report in which they reiterated Israel’s AA- rating, its fourth highest, and its stable outlook.

“Strong macroeconomic fundamentals and high monetary flexibility should allow Israel to absorb the shock, while the large high-tech sector should aid economic recovery,” the economists wrote.

As Israel and global economies gradually recover from the crisis, Israel “is well positioned to make the most of the bounce back” because of the high-tech services it provides, said Etai Rappel, director, country coordinator and lead analyst of Infrastructure Ratings Israel at S&P Maalot, in a phone interview. There is still high demand globally for these services, he said, and the tech sector will help lead Israel out of the crisis.

“Israel has shown a lot of flexibility, dynamism and stamina in over the last 20 years. We hope that will continue going forward,” he added.

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