An Overview of the Israeli An Overview of the Israeli Economy Economy

Prof. Manuel TrajtenbergHead of the National Economic Council

The Prime Minister’s Office, Israel

May 2008

• BackgroundBackground

• Economic PolicyEconomic Policy

• Challenges and OpportunitiesChallenges and Opportunities

• R&D and InnovationR&D and Innovation

3 3

A Brief Economic History – 60 Years of Growth

Average annual

Growth rate

Total Growth over 60 Years

Product 7% 60-fold

Population 4% 10-fold

Product per Capita 3% 6-fold

4 4

8.1

10.59

6.99

8.62

1.34

0

1.41

6.5

-1.9

1.2

2.4

-0.1

3.4

-4

-2

0

2

4

6

8

10

12

GDP Growth (% per annum)

7.0%6.6%

5.4%

2.8%

4.2%

2.9%

8.9%

2.3%

5.2% 5.3% 5.2% 5.3%

4.2%

-0.4%-0.6%-1%

1%

3%

5%

7%

9%

Source: Central Bureau of Statistics and Ministry of Finance Projections

Current Economic Performance –Robust Growth, Low Inflation

Israel Average (4.2%)

OECD Average (3.2%)

Inflation rate

%

5 5

-1.3%

-3.5%

-5.1%

-3.3%

-4.3%

-2.1%

-5.1%

5.6%

0.3%

-1.2%

-1.5%

-1.2%

-1.3%

-0.6%

1.2%

2.4%

3.3%

3.2%

-6%

-5%

-4%

-3%

-2%

-1%

0%

1%

2%

3%

4%

5%

6%

7%

8%1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

Sources: Central Bureau of Statistics and the Bank of Israel

The Current Account Current Account Deficit/Surplus

as % of GDP

• BackgroundBackground

• Economic PolicyEconomic Policy

• Challenges and OpportunitiesChallenges and Opportunities

• R&D and InnovationR&D and Innovation

7 7

2.6%2.3%

0.7%

4.2%

3.6%

5.4%

3.7%

1.8%

1.0%

0.0%

2.2%

3.6%

3.9%

1.6%

1.0%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

5.0%

5.5%

6.0%

Source: Bank of Israel and Ministry of Finance Projections

Fiscal Policy: Government Expenditure & Budget Deficits

Government Budget Deficit (% of GDP)

52.4% 52.2%

50.2%

48.4%

51.0%

52.2%

44.0%

52.6%

51.2%

48.1%

46.3%

45.6%

44.6%

51.0%

41%

43%

45%

47%

49%

51%

53%

55%

General Government Expenditure (% of GDP)

Deficit Ceilings

8 8

78.9

81.0

86.7

95.9

99.9101.7

99.8

91.9

87.1

97.5

103.3101.8102.5

104.5

75

80

85

90

95

100

105

110

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008F

Public Debt as % of GDP

%

Source: Bank of Israel and Ministry of Finance Projections

9 9

Tax Burden

Year Tax rate

2003 36%

2004 35%

2005 34%

2006 31%

2007 29%

2008 27%

2009 26%

2010 25% Monthly income, NIS, 2007 prices

Average tax rate on personal incomeAverage tax rate on personal income

10%

15%

20%

25%

30%

35%

40%

45%

50%

55%

2007

2002

2010

Corporate tax rateCorporate tax rate

Source: Ministry of FinanceSource: Ministry of Finance

10 10

Oil Refinery Ashdod & Haifa

Bezeq (telecom corp)

Bank Leumi

Discount Bank

El Al Israel Airlines, Ltd

ZIM (Israel navigation corp)

Tax ReformsTax ReformsPension Pension

Fund Fund ReformsReforms

Capital Market Capital Market ReformsReforms

Investment Investment in in

InfrastructureInfrastructure

Domestic Domestic GovernmentGovernment

Bonds Bonds ReformsReforms

Sea Ports Sea Ports StructuralStructural ReformReform

Recent Reforms & Privatizations

• BackgroundBackground

• Economic PolicyEconomic Policy

• Challenges and OpportunitiesChallenges and Opportunities

• R&D and InnovationR&D and Innovation

12 12

Israel’s highly heterogeneous society, with a tremendous range of different

» backgrounds» cultures » religions

Exposed to the rigors of the global economy

Challenged by its geo-political situation

The Snapshot on the Israel’s Challenges

13 13

In the Global Environment:

A massive influx of new players in advanced R&D, challenging Israel’s standing in this field.

Geo-political instability.

Domestic Issues:

A high incidence of poverty, particularly among the ultra-orthodox and the minorities.

High inequality – (Gini Index of 0.38).

Socio Economic Agenda 2008 – 2010 Main problems and challenges

14 14

1. Increase employment, reduce poverty.

2.Reinvigorate the education system, expand and upgrade its pool of human capital

3.Refocus innovation and R&D in the incipient scientific and technological frontiers

4. Improve Governance, reduce frictions within its governing bodies

5. Pursue further structural reforms, investments in infrastructure.

From Challenge to Action: the Current Agenda

15 15

Ultra-Orthodox Ultra-Orthodox and Minoritiesand Minorities

Targeted ToolsTargeted Tools

Enhanced Enhanced enforcementenforcement

of theof the Labor Law Labor Law

Negative Negative Income TaxIncome Tax

Reduce the Reduce the NumberNumber

of Foreign of Foreign WorkersWorkers

Innovation in Innovation in Traditional & Traditional &

Services Services Sectors Sectors

From Welfare to From Welfare to Work programsWork programs

Socio Economic Agenda 2008 – 2010 Quantitative Targets and Main Policy Tools

(1)The employment target: “increase the employment rate to the OECD average ”

(2)The poverty reduction target: “increase the income of the lowest quintile by more than the per capita growth rate. ”

• BackgroundBackground

• Economic PolicyEconomic Policy

• Challenges and OpportunitiesChallenges and Opportunities

• R&D and InnovationR&D and Innovation

17 17

Background and Features of Policies

Background (1970’s):

Israel had little resources, but highly skilled manpower, scientific prowess – how to mobilize them for growth?

Strategic Decision: Jump-start a “science-based” sector by providing broad financial support, and making up for market failures.

Hallmark of policies: “Neutrality”: respond to market demand/signals, do not

“pick winners.” Dynamic/Innovative: create new and varied support

programs according to evolving needs; avoid “self-perpetuating” programs.

18 18

Main R&D-Support Programs in Israel

Matching grants to commercial R&D projects - criteria: innovativeness, tech and commercial feasibility.

“Magnet” Program for support of generic R&D consortia: corporations + academia; longer term, higher support. Examples: Nano Functional Materials, Streaming Media Messaging, Digital Printing.

Technological “Incubators” Program: from innovative ideas to start-ups.

“Yozma” Program 1993-97: Jump-started the Venture Capital Industry – success, hence discontinued

19 19

Silicon Miracles from the Holy Land:Highlights of Israel’s High Tech Sector

ICT growth since 1990: ~ 15% per year

~ 4,000 high tech companies, most of them start-ups.

2nd largest VC market after the US

The most foreign IPO’s in Nasdaq

World’s fourth in US patents per capita

Major innovations: ICQ, disk-on-key, Centrino chip, advanced firewalls, GPS software, Pill-camera, etc.;

R&D/GDP= 4.6% (world highest)

20 20

The Ingredients of Israel’s “Silicon Miracle”

1.Entrepreneurship, Israeli style

2.High-quality human capital, technical skills

3.Government support for commercial R&D.

4.Venture Capital, local and US-based

5.Very open economy, strong ties with the global main players

21 21

But Israel’s Silicon miracle not for all

Wide disparity between thriving High Tech and rest of the economy: HighT grew 5 times as fast!

Low productivity of non-tradables, non-ICT sectors – a “dual economy”.

Rising socio-economic inequality, in part consequence of dual economy : concern in itself, and narrowing future pool of human capital.

22 22

Why? Innovate here, benefit elsewhere…

1. Innovations mainly for exports, some spillovers internal, but benefits realized mostly abroad.

• not much “Wal-Mart effect” in Israel

2. Gov. supports mostly product rather than process innovations; hence little R&D in traditional industries, services.

3. VC-backed startups: must exit, mostly by selling off to US-based corporations – who benefits?

Israel: powerhouse in generating innovations, but not quite in benefiting from them.

23 23

Some lessons from the Israeli experience

1.Cannot have economy-wide growth by relying just on one fast-growing sector (ICT),

Need to encourage and channel innovativenessalso to non-High Tech sectors

2. Cannot have sustained growth with widening socio-economic gaps :

Need policies of inclusion, of expanding the pool of human capital.