Recommendations for a Macroeconomic Policy

The 11th Caesarea Forum, July 2003

Policy Paper No. 43

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  • Cover Type: Softcover
  • Number Of Pages: 98 Pages
  • Center: Eli Hurvitz Conference on Economy and Society
  • Price: 60 NIS

In 2001-2002, Israel’s GDP decreased for two years in a row. This paper, prepared for the 2003 Caesarea Economic Forum, aimed to formulate a suitable economic policy to improve Israel's economic performance and lay the groundwork for future growth.

In Israel's economic history it never happened that the GDP decreased two years in a row, as occurred in 2001-2002. Below is an English summary of a paper prepared for the 2003 Caesarea Economic Policy Planning Forum about remedies that may prevent Israel's financial decline towards a financial crisis, and create factors for long-term growth. This paper aimed to formulate a suitable economic policy to improve Israel's economic performance and lay the groundwork for future growth in the aftermath of the financial crisis of 2001-2002.

A. Fiscal Policy

The short term 2003-2004:

  1. The deficit in the budget will not exceed 3 percent of the GDP in 2004.
  2. Under present market conditions, greater urgency should be given to decreasing the public debt over decreasing the tax burden. The full decrease in expenditure should therefore be allocated to decreasing the budgetary deficit.
  3. It is extremely important to change the composition of direct taxes without changing the average tax burden. Thus, the reduction in income tax and social security tax commencing from July 2003 will be accompanied by a parallel raise in the scope of taxes on income from financial assets, so that this reform will be neutral.
  4. Tax discriminations among various types of capital will be abolished and a uniform tax rate will be established on the basis of the real profit that each asset yields.
  5. The defense budget should be reduced by NIS 2 billion in 2003, according to the original Ministry of Finance recommendation, and the remuneration should be allocated for maintaining the deficit goal.
  6. It is recommended to further reduce the defense budget in 2004. The amount of the reduction will be determined following a careful examination of the changes in the scope of the military threats directed at the State of Israel, the army’s modes of operation, structure of manpower and pension conditions of the regular army personnel. Policy makers should take these aspects into consideration, along with other goals – social and economic – that also influence the national resilience.
  7. See the next chapter for the changes required in the welfare budget and work incentives.
  8. A necessary condition for improving the reliability of the Ministry of Finance’s economic policy is the creation of far greater transparency of the budget data than was in place up to now.

Principles of the budgetary policy from 2005:

  1. Commencing from 2005, it is recommended to change the decreasing deficit law with the following rules (rules 2 to 5 constitute an integrated whole):
  2. Expenditure will increase at a rate of half a percent above the rate of population growth (linkage with population growth is intended to cope with the great demographic fluctuations that characterize the State of Israel). This rule requires a fundamental change in the rules of “automatic pilot” when planning the budget.
  3. The size of the budgetary expenditure will be subject to the deficit ceiling, which will not exceed 3 percent of the GDP. In other words, the deficit ceiling is the decisive limitation in the event of a contradiction between it and the total expenditure.
  4. Sharp fluctuations in geopolitical conditions, exacerbation of the war or a return to the political process may necessitate updating the policy outlines.
  5. The proposed multi-annual deficit of the full government, which amounts to 4 percent of the GDP since 1988, will be reduced to 2 percent of the GDP. A rule will be established for required regular periodic adjustments, to ensure that the deficit returns to the proposed target when the accumulated deviation exceeds the rate established. The required rules of operation for the government budget presented to the Knesset should be derived from the rules of operation pertaining to the full government.
  6. The direct investment of the government in infrastructure should be expanded, so that the capital stock in infrastructure for which the government is responsible (in terms of GDP) will correspond with the usual trends in Europe within 10 years, with consideration for the product per capita and the development of specific demands for infrastructure services.

Preferred government size:
It is recommended to gradually reduce the rate of public expenditure within the GDP, while presenting the European average (in addition to American aid) as a long term marker.

B. Monetary Policy

The negative growth rate, high unemployment rate, very low level of inflation and the adopted economic plan require and enable a reduction of the interest rate, in the gradual and careful manner required by the economy’s characteristics and the fiscal policy. It is recommended that the interest policy be based on the following rules:

  1. The nominal interest should be reduced gradually, but in greater increments than those characterizing the Bank of Israel in the years 1998-2001 and according to the inflation goals to be achieved.
  2. The intensity of the interest change should be tailored to the gap between the inflation goal and the actual rate of inflation. The dimensions of the interest adjustments in both directions (up and down) will be greater the more the deviation from the inflation goal (up and down).
  3. The interest rate should be determined with consideration for the development of the exchange rate, reflecting the gap between the interest overseas and the interest in Israel, along with all the risks of Israeli currency.
  4. It is recommended to reduce the lack of symmetry in the general response of the Bank of Israel to external shocks. The lowering of the interest rate, once the shock has passed, should be carried out faster than has been the practice to date.
  5. Consideration should be given to the GDP gap (unemployment rate) arising from cyclical factors in determining the Bank of Israel interest rate.
  6. Financial stability and stability of the banking system should be regularly monitored, including quarterly reports, according to accepted standards of transparency (for detailed recommendations, see the report presented by the team on this issue).

C. Policy Recommended for the Israeli labor market

Foreign Workers

  • Tax laws regarding income, withholding of expenditure, national insurance payments, health insurance, pension allocations and the rest of the labor laws and collective work agreements should be applied to all foreign workers and workers from the territories, so that the marginal cost [employer’s payments beyond salary] involved in employing workers who are not Israeli residents will be identical in all its elements to that of Israeli workers. The 8% tax imposed on the employment of foreign workers in the context of the economic plan is a step in the right direction, but it does not cancel the economic advantage of employing foreign workers, so that it should be raised in the short range (see recommendation below).
  • Institutional changes should be made to facilitate significant enforcement of the labor laws at the level usual in EU countries, relating to the employment of workers who are not state residents.
  • Enforcement focus on the employers of illegal workers: Policing resources should be increased in order to augment enforcement among the employers of illegal workers (and the imposition of heavy fines) instead of the detainment and expulsion of foreign workers. In addition, the strict enforcement of labor laws should be expanded and mechanisms should be created for preventing the employment of illegal workers through tax collection systems applied to the employers.
  • The number of licenses for the employment of foreign workers should be limited to 4% of those employed. The sale of licenses should be via tender. This method will pass the remaining rent inherent in the employment of foreign workers from their employers to the general public. In the short time remaining until the required changes are made, one should raise the tax rate beyond that established in the economic plan as 8%. This tax profit must be such that the cost for the employer should be equal (at least, or higher) to the cost of an employee who is a resident of Israel. The tax rate should be about 30% of the employer’s expenses.

Minimum Wage

  • A government system for enforcing the minimum wage for all those employed in Israel should be established. The existing minimum wage law should be amended according to the majority recommendations of the minimum wage committee, presented in the summer of 2000. These recommendations included improving the legal enforcement mechanisms, and defining the minimum wage as wages for regular work, so that most of the wage elements are part of the minimum wage. Moreover, the average wage should be replaced by the median wage for the purpose of updating the minimum wage, and an annual inspection process put into place before updating the minimum wage so that the update will not significantly harm employment.

Reform in the Welfare System

  1. The team recommends that a committee be set up to examine the possibility of reform in the support and taxation system, with the aim of increasing the rate of employment among people with low income (below the median wage), by means of creating employment incentives. The team views the implementation of an active market policy within the labor market as an economic-social mission that will increase the GDP by increasing the employment of Israelis. The main motive is not the reduction in public expenditure, but the routing of funds, at least during the first stages of the reform, in order to change the work supply of Israelis with low-level employment skills.
  2. The following are a number of key points that the committee should examine as possible options:
    • Implementation of a welfare reform that will take macro-economic background conditions into consideration, i.e., conditions wherein the labor market produces available work alternatives for non-skilled workers offering better wage conditions than welfare payments.
    • Implementation of tax incentives, in particular those that apply to the decision to join the labor force while weighing existing tax incentives.
    • Limiting the correlation between the entitlement to welfare payments and the accompanying benefits, by allowing them to remain in place for a limited period of time after joining the labor force.
    • Substantial subsidy of the expenses involved in joining the labor force (cost of child care) while examining the currently implemented policy tools.
    • Conditioning unemployment payments on proof of efforts to find work.
    • Limiting unemployment payments to a number of years for individuals who have been found fit for work.
    • Individual help to train those receiving support to join the labor force.
    • Individual assistance should be given in conjunction with market mechanisms such as professional training vouchers and vouchers that provide the individual with employment subsidy for a limited period.
    • The active policy in the labor market should be tailored to the unique lifestyle of different population groups such as the Haredi sector, the Ethiopian population and other minorities.
    • Those individuals who have limited ability to join the labor force should be identified and exempted from participation in programs for the transition from welfare to employment. They should be assured of a level of income that will allow them to maintain a dignified existence.

D. Structural Reforms in Branches of the Economy

  1. The list of reforms required in the various branches of the economy is quite long. It is especially recommended to carry out the reforms for creating competition among infrastructure branches such as electricity, refineries, fuel stations, local media, ports, public transport, and more.
  2. The intended reform in pensions will also contribute, in addition to solving the actuarial deficit to the greater sophistication of the capital market, but this reform is not enough to create sizeable competition in the capital market and banking systems. These latter systems require a reorganization of the financial system that will introduce more players into the market and minimize conflicts of interest, while maintaining system stability. Accordingly, steps should be taken to dissociate the provident funds from the banks, and also reconsider the totality of banking activity in the capital market.
  3. Some of these reforms have been included in an economic plan that has been recently presented by the Ministry of Finance and approved by the government and the Knesset. Although improvements are needed in the details of the various reforms, the resumption of the process is a positive trend. It is recommended to complete the steps already taken as soon as possible and to extend the reforms to additional areas (as noted above).