בחודש ינואר התארחה משלחת ה- OECD בישראל כשלב נוסף בדרך להצטרפות ישראל לארגון. ד"ר מומי דהן בחן את דוח המשלחת המנתח את כלכלת ישראל בצורה מעמיקה ויסודית בהרצאה שנשא בביה"ס למדיניות ציבורית באוניברסיטה העברית בה התארחו חברי המשלחת.
The Fragile Foundations of Growth Policy in Israel
OECD Economic Survey- Israel, 20.1.2010
I am very impressed by this report. The authors of this report cover almost every corner of the Israeli economy with great care. To give you the feeling of how detailed is this report let me mention that they are not happy with the fact that Kranot Histalmut are tax exempt. I use the Hebrew words because the authors themselves have used them. They have learned the Hebrew words for many of the institutions that are particular to Israel, which reflects the intimate knowledge the authors have acquired on our economy.
For those who believe in market economy but also aware of its limitations, and for those who believe that efficiency is an important consideration but we should care also about poverty and inequality, this report is not less than a celebration. Reading this report one can see that the authors don't hesitate to say that, for example, the central rule that guides budgeting policy - the limits on public spending increase - makes little sense for the long term (OECD survey, p. 12) or that some increase in income support should be made (OECD survey, p. 14).
Let me sum up this short introduction by saying that I encourage you to read this report. I must admit that this suggestion is also because I share many of the views and policy recommendations that are expressed in this survey. However, we are in a seminar and must be a BUT. Indeed, there is a BUT also here. In my view, some key issues should have been framed differently in this report.
Given the time constraints I would focus on one or two key policy issues. The first important policy issue is economic growth policy of recent governments. I would advise the authors of this report to frame it this way. All the pieces are there, in the report, but they are not integrated to tell a coherent story about long-run growth policy in Israel. This is what I am going to do next.
While a policy of small government and low taxes is a legitimate political agenda it is not a safe road to long run growth. This is the main message of my talk. The OECD report shows clearly how Israel has gone into the far right of the economic spectrum.
The macroeconomic policy in Israel is based on two fiscal rules. First, the budget deficit should not be more than one percent of GDP in the long run. It implies a more stringent limit than what most European countries are using according to the Maastricht Treaty (no more than 3% of GDP). In my view, this fiscal rule is justified given our level of public debt: Israel has a high ratio of debt to GDP. The level of debt should be at a moderate level so that the Israeli economy would be able to absorb negative shocks that are more frequent in Israel than elsewhere.
The second fiscal rule specifies a cap on government expenditures; the real annual increase in total government expenditures should not exceed 1.7%. This fiscal rule implies a reduction in the ratio of government spending and taxes relative to GDP at relatively fast pace given the expected long run growth of the Israeli economy.
The main motivation for this expenditures ceiling is rooted in a very simplistic view of economic theory. I would even say that this is a wrong interpretation of economic theory and in fact, it is not backed by empirical data either.
The argument for reducing the share of government goes as follows: reducing government share in the Israeli economy would allow a cut in taxes which in turn will spur economic growth. The fruits of economic prosperity will be shared by everybody in Israel. Thus, everybody should be in favor of this policy. The current prime minister has even suggested at some point that tax cuts are self financing: reducing tax rates generates higher rather than lower tax revenue. For those who are familiar with public finance literature this idea, which was central theme in our prime minister speeches, is more of an 'urban legend'. The OECD survey is very clear about it, "cuts in headline rates generally reduce tax revenues, at least in the short run. International evidence suggests cuts in headline rates are not typically self financing through "Laffer curve" effects." (OECD survey, p. 55)
I think it is extremely important to discuss the reasoning behind long-run growth policy in the case of Israel. Let me first talk about the first link in this chain: It might come as a surprise to non economists but economic theory does not predict a clear relationship between taxes and economic growth. In particular, a tax cut may even lower economic growth. Suppose that a tax cut is financed by reducing very productive public infrastructures (for example roads). This type of macroeconomic policy would lower economic growth to the extent that the positive effect of lower taxes is smaller than the negative impact of a lower level of public infrastructures. Thus, the effect of taxes on long run growth depends on the productivity of public activities.
Obviously, it is not easy to come up with good estimates of how productive are government expenditures on human infrastructures such as education and health. As a first approximation I would first look at the level of government expenditures in international perspective although it is far from a sufficient statistic to address this question. As can be seen from Figure 1, the share of primary civilian government expenditures in Israel is now one of the lowest in the developed world. Suppose that goods provided by the government are subject to decreasing marginal product/utility. Under this assumption, it means that every thing else equal, the marginal productivity of an additional unit of public activities is higher in Israel as compared to OECD due to our lower level of public expenditures (Unless, Israel has invented a very efficient way to provide public goods).
Thus, further tax cuts are more likely to hurt economic growth in the long run in case of Israel. The OECD report raises also this concern: first the report states that the fiscal rule that limits public spending increases to 1.7%, as I have already mentioned, makes little sense. Second, they say that "tax issues are not the only driver of investment and location decisions. For example, the quality of transport networks and other infrastructure as well of housing, health and education can make a difference..." (OECD survey, p. 54).
There is at least one additional important indication that the productivity of government expenditures should be high. The level of poverty and inequality in Israel is now one of the largest in the world. There is extensive economic evidence on the positive effect of more equal distribution of wealth on economic growth. A recent survey, done by Oded Galor, who is one of the prominent economists in this field, concludes, based on high quality empirical works, that inequality is likely to have an adverse effect on long run economic growth.
The high level of poverty in Israel is not distributed evenly among Arabs and Jews. Almost a half of Arab citizens in Israel are below the official poverty line. The very high poverty rate among Arabs is only partially explained by cultural differences such as a lower rate of participation of Arab women in the labor force and a larger number of kids. These economic gaps introduce more political and social tension between Arabs and Jews that is already high given the well known circumstances. Put aside other possible implications of that tension, the risk to economic growth that may emerge from this tension is very evident to me. Therefore, reducing poverty, and in particular among Arabs, is likely to be very productive in terms of economic growth in the long run. Of course, it has other important rewards.
A second link of that chain of reasoning is that economic growth is shared by everybody. Between 2000 and 2008, the average household net income per capita in Israel grew by 11% but the rising tide did not lift all the boats. Figure 2 provides very sad news on the distribution of economic prosperity. Income per capita (adjusted for equivalent adults) of the lowest decile have declined by more than 20 percent while the top decile enjoys an increase of almost 18 percent.
As we see not everybody is taking part in this party. The above picture is partially so because some people enjoy more than others from reduced taxes. Those people who are at the top of the income distribution took a larger share of the cake not only because of economic growth but also due to lower taxes.
One last related point, the report should have asked the following question: why is poverty rate in Israel is so much higher than in OECD countries. Phrasing it this way would have helped streamline the discussion on poverty. The report shows that the poverty rate in Israel is around 20 percent as compared to 11 percent on average in OECD countries. I don't pretend to say that I have a full answer to this important question but some pieces of the answers is already in the report. The first important factor is the restricted opportunities many Arab Israelis face in the education system and in the labor market. The second important factor is the size of aid to poor people in Israel.
This report shows clearly that the size of monetary support to disadvantageous groups in Israel is substantially smaller than a typical OECD country. The OECD simulations show that the monetary support to a household that has been unemployed for long time (the 60th month) is substantially lower as compared to OECD average. This finding should not be surprising given what we have already seen in the first figure: the size of civilian government expenditures in Israel is one of the lowest in OECD countries.
To sum up, I think that this report will have important implications on economic policy in Israel. The facts that are outlined in this report together with international perspective will put some discipline on the debate over economic and social policy in Israel.
I am frequently invited to give popular lectures outside the university territory on poverty. Almost in every lecture, after several slides on how less generous we are to poor people in Israel, a hand is raised and asked me: "could you please tell us- had someone else gave this lecture would the facts be different?" My reaction is always that "you should invite someone else to get a real answer." Now, I have a new answer in my next lectures. Go and read the OECD Survey on Israel.
הרצאתו של מומי דהן התפרסמה באתר ביה"ס למדיניות ציבורית באוניברסיטה העברית בירושלים.