Can Israel sustain rising wages, low unemployment?

Ultra Orthodox women in high tech

The figures are encouraging but delving into the statistics more deeply reveals some problematic trends.

In April 2013, then-Governor of the Bank of Israel Stanley Fischer declared that a miracle had taken place in the Israeli labor market. More and more people were entering the market, and the rate of participation in the workforce among the population was growing. "A miracle has happened that we still don’t understand. This is undoubtedly one of the most important developments in the economy," Fischer said, speaking at a conference of the Institute for National Security Studies.

"In general," Fischer added, "The situation in the labor market here is excellent. The unemployment rate is at its lowest in thirty years. That's an achievement." In the years since then, that achievement has only strengthened: the unemployment rate has continued to drop.

Later in the decade, after years of relative stagnation, mean average income also started to rise, and in the past few years median income has risen even faster, indicating a narrowing of gaps in earnings.

Falling unemployment, rising participation in the workforce, and rising wages - these are the outstanding trends of the past decade, and they are certainly encouraging. But when one delves more deeply into the numbers, and when one speaks to researchers in the field, other trends emerge, some of them not so encouraging: haredi (ultra-Orthodox Jewish) men have been left behind; the middle class has not really grown but has only returned to the proportions it had at the end of the 1990s; and poverty rates and wealth gaps in Israel remain among the highest in the OECD. Then there is the question whether the economic achievements of the past decade will be sustained in the future. Has the miracle of which Fischer spoke faded, or is it about to fade? What has happened in the employment market in the past decade? We shall try to sketch out the big picture.

In order to understand what has happened in Israel's labor market over the past decade, we have to go back to the beginning of the previous decade, to the far-reaching reforms introduced in 2002-2003 when Benjamin Netanyahu, and before him Silvan Shalom, were ministers of finance. That at least is what Dr. Tali Larom, a senior researcher at the Aaron Institute for Economic Policy at the Interdisciplinary Center Herzliya, suggested when we talked to her.

Larom describes these years as a very significant turning point. "A very large collection of policy measures started at that time: a cut in child allowances, a cut in income support, and stricter conditions for obtaining these allowances; a cut in unemployment benefit; and later, additional measures, such as negative income tax and a higher retirement age.

"All these things together led to a change in direction in the labor market," Larom says, in particular to a jump in the rate of employment in the past decade and a half. "The rate of employment rose for everybody, both men and women, Arabs, haredim, of all ages and levels of education. Nevertheless, the rise was very much skewed towards weaker groups in society, towards Arabs and haredim, older people, people with lower levels of education, and large families." More and more Israelis, including those who had not participated in the workforce in the past, started to look for jobs and to work. That was the miracle of which Fischer spoke, and the improvement lasted at least until 2016."

What happened to wages in that period? For most of it, Larom says, real wages were fairly stagnant. An unchanging pay slip is frustrating for workers, but Larom explains that the figures conceal a very significant achievement: weak groups entered the labor market, and wages did not decline. In addition, she says, "we did continue to see rising pay for strong groups, mainly non-haredi Jews and people with higher education."

In recent years, she says, the processes that began in the previous decade have affected not just the rate of employment, but have translated into rising income: "To some extent, we have started to see a rise in wages."

When a household has two wage earners instead of one, and when wages also start rising a little, the result is a jump in household income, as seen in the past few years.

"We do indeed see that this change is more pronounced in Arab and haredi households," Larom says. "Their earnings have grown much more rapidly than those of non-haredi Jewish households."

While Larom attributes the dramatic change in the labor market to the reforms that pushed people into working, Prof. Momi Dahan puts the emphasis on a completely different phenomenon: the fall in unemployment. Dahan, an economist who teaches at The Federmann School of Public Policy and Government at the Hebrew University of Jerusalem, says: "When someone weighs up whether or not to participate in the labor market, one of his most important considerations is his chances of finding work. If the unemployment rate is 11%, participation will be low: there's no point in looking for a job when the chances of finding one are very low."

The economic boom is what brought about the decline in unemployment, says Dahan. At the beginning of the decade, the unemployment rate was a little over 8%, and it fell to 4% by the end. This fall is what drew people into the labor market, he argues.

"The decline in unemployment is not unique to Israel," Dahan stresses, "and we shouldn't make the mistake of attributing it to our policies. Unemployment has fallen in almost all the OECD countries, and this reflects the recovery in economic activity after the great crisis of 2007. The decline in unemployment also explains the reduction in inequality, and the rise in wages, as well as the rise in participation in the labor market. There are additional factors that explain the rise in participation in the labor market, such as the cut in welfare payments, but the rise would have taken place even without the great cutback of 2003."

"Globes": When we see both the mean and the median wage rise, is this simply a matter of supply and demand in the labor market?

Dahan: "It was a riddle, in Israel and in other countries, including the US, how it could be that unemployment fell and yet pay was stuck. Apparently, in order for wages to rise, we have to fall to a very low unemployment level. As long as the fall in unemployment was from 10% to 7%, or from 7% to 6%, there was no appreciable effect on wages. Now that unemployment is less than 4%, standard economic theory seems to be working very well - unemployment is falling, and wages are rising."

In the middle of the decade coming to a close, between 2013 and 2017, a prominent trend was identifiable: alongside the decline in unemployment, the number of vacant jobs was rising. That is a pattern of economy prosperity, which translates into demand for workers. In a situation like that, the workers' bargaining power increases, and pay rises. Since 2013, average real wages in Israel have been rising at an average annual rate of 2.1%.

In the past two years, according to Ministry of Finance chief economist Shira Greenberg, the trend has changed. Unemployment continues to fall, but there has been a noticeable decline in the growth in demand for workers. On the other hand, another development has contributed to the rise in pay in this period: since the beginning of 2018, productivity has grown faster, by 1.4% annually, instead of 0.9% beforehand. It should be stressed that we are talking about a short period of time, and that it is too early to draw far-reaching conclusions.

The comeback of the middle class

The story of the past decade can also be told through another question: what happened to the middle class? To answer it, however, we must first determine what the middle class is. Most people tend to describe themselves as belonging to the middle class.

Osnat Peled-Levy, a senior economist in the Bank of Israel Research Department, suggests defining the middle class as households whose net income is between 75% and 200% of the median income in Israel. This definition is fairly broad; it includes both the lower and upper middle class. In monetary terms, it consists of the income range between NIS 13,799 and NIS 36,797.

Expansion in the relative size of the middle class

After defining the middle class, Peled explains what has happened to it in the past decade: "If we look at the past decade, we see an increase in the proportion of the population that is in the middle class, and also an increase in its proportion of total income," she says. In other words, more people belong to the middle class, and their share of the pie has grown.

Peled says that this is good news, but immediately qualifies it: "The not-so-good news is that this is mainly a correction of what happened in the preceding decade. If we look at the 20 years starting in 1997, there was a decline at the beginning and an increase starting 2010, which was quite significant. To a great extent, there is a correction here of what happened in the preceding decade."

Both Peled's analysis and that of the chief economist show a significant development in the middle of the preceding decade. There was a fairly substantial rise in income among the lower middle class in 2012-2017, meaning households below the median income - the point at which half of the households in Israel are below and half above. Some of this, she explains, is due to the halt in allowances cuts since the beginning of the preceding decade, when allowances resumed their growth linked to the Consumer Price Index. Tax cuts, which benefited mainly households above the median income, were also halted.

To this should be added the development mentioned repeatedly in the various analyses: more people entered the labor market. In the case of the group about which Peled is speaking, spouses entered the labor market, as a result of which the household no longer depended on a sole wage earner.

Another important development since the past decade should also be added: the minimum wage rose in periodic increases at the initiative of previous Histadrut (General Federation of Labor in Israel) chairman Avi Nissenkorn, with the support of Minister of Finance Moshe Kahlon. From NIS 3,900 at the beginning of the decade, the minimum monthly wage rose to NIS 5,300 at present. Peled says that the bottom income deciles, many of the people in which do not work or work part time, are not necessarily the ones affected by the minimum wage. The middle class contains many households in which one spouse works at a relatively high salary and the other at a low salary. An increase in the minimum wage will raise the income of such households.

According a study by the chief economist department, the increase in the minimum wage explains no less than 40% of the increase in the average wage between 2015 and 2018. At least in this boom, it does not appear that the increase in the minimum wage had a negative effect on the employment rate.

Haredim: Women enter the labor force, men stay out

The unemployment rate, rate of participation in the labor force, and even the middle class are general macroeconomic concepts. When we take a closer look, however, we start to understand the details and see what happened to different population groups.

On the positive side, the most prominent group is haredi women, who more or less closed the gap between them and non-haredi Jewish women in employment rates long before the government expected them to.

The biggest beneficiaries were non-haredi men and haredi women. The fact that haredi women accomplished this without a fall in the birth rate is the closest thing to what Fischer called a miracle. Is this really the case? "They talk a lot about how good haredi women's situation is, that they are all working," says Larom, "but the average monthly wage of a haredi woman is only 65-70% of that of a non-haredi Jewish woman. This gap is closing very slowly."

Larom attributes this to the number of hours worked by haredi women. "The current hourly wage of haredi women is very close to that of non-haredi Jewish women, but they work far fewer hours and at far more part-time jobs," she states.

What about haredi men? The picture there is less rosy. The rise in employment rates among haredi men has come to a halt in the past two years, with the rates falling below 50%, and wages have also fallen.

According to figures from the National Insurance Institute for 1997-2016, the salaries of haredi men fell 18% in real terms. "This is a phenomenal decrease," says Greenberg. Haredi men are both working fewer hours and earning less per hour. Greenberg says that the reason is the occupations in which haredi men are employed. "Their lack of study in core subjects is eventually reflected in their pay," she declares.

The fierce opposition by haredi politicians, such as MK Moshe Gafni and MK Yakov Litzman (United Torah Judaism), to core studies does not leave much room for hope that the situation will improve in the coming decade.

The situation of men in Arab society is not much better than that of haredi men. "Wage gaps between Arab and non-haredi Jewish men did not close in 2010-2017 (they only decreased by 2%)," Greenberg says. "This means that a lot has to be invested in human capital of Arab men in order to see how these gaps can be closed in the future." Programme for International Student Assessment (PISA) figures published this year indicate that the problem is only getting worse.

"When we look at the employment and wages of Arab women, there are still very wide gaps," says Larom. She finds a positive aspect for the future, saying, "There is a very significant increase in education in this group. A higher level of education means that employment rates will increase, and in time, wages will also rise."

For the population as a whole, wages gaps between women and men are narrowing at a very slow pace. In 1988, 30 years ago, the gap in average salary between women and men was 49%, and as of 2016, it was 34%.

"We do not come off well in comparison with the OECD," Greenberg says. According to her, the lower employment rates explain 60% of the difference in salaries, while 30% is attributable to differences in occupation: underrepresentation of women in high-paid fields and overrepresentation in low-paid fields. "In the technology industry, for example, 22% of employees are women, who make up 50% of the population and who are no less talented," she claims.

Inequality and poverty are still high

The improvement in the Israeli labor market is evident in the inequality figures, especially inequality in economic income. Economic income is what we get in the labor market before the government collects taxes and distributes allowances. In the past 15 years, the fall in unemployment and the increased participation in the labor force have caused inequality in economic income in Israel to plummet.

Reduction in inequality

This phenomenon is causing wonder among visitors to Israel, and justifiably. Greenberg says that in comparison with OECD countries, Israel is rated 29th in economic inequality, putting it among the most equal OECD countries in this aspect. With all due respect to gross income, however, what households are interested in is net income. Greenberg says that the situation in income after taxes and allowances is less glorious; inequality has fallen and Israel's rating on the international scale has improved, but not at the same rate; Israel is still in the top third of the OECD in net income inequality.

The welfare state is more restricted than in other countries, which explains the difference in Israel's rating for the two kinds of inequality. Peled says, "On an international scale, our middle class is very small. Even after the increase in the past decade, we are still lagging behind."

In other words, the improvement in the labor market has closed some of the gaps, but these are still wide. "The negative side of the coin, of which note should be taken, is that despite the very dramatic fall in the unemployment rate to below 4%, something not seen in Israel since the 1970s, inequality and poverty in Israel are still higher than in most of the developed countries, and we should find this disturbing. Anyone who regards the labor market as a solution or cure for inequality and poverty must now look elsewhere."

Fewer poor people, but Israel is still among the OECD leaders in poverty and inequality indices

Dahan makes it clear that the policy of cutting allowances, which helped push people into the labor market, also had a price, "which some people don't understand." He says that cutting allowances also harms people who are in any case unable to enter the labor market, i.e. the most disadvantaged people. He says that this raises a moral question: "How much damage are you willing to inflict on certain people in order to push others into the labor market?" In other words, there is a tradeoff there. A similar message may emerge from Greenberg when she describes the tax system. "In comparison with the OECD, the composition of taxes in Israel is more based on consumption taxes and less on direct taxes, and therefore tends more to support growth than to reduce inequality. These things frequently clash," she says.

Future: The struggle to improve productivity

Looking ahead, the economists we spoke with agree on something that can be found in the Bank of Israel's reports, at economic conferences, and quite a few other places: the improvement in the labor market over the past decade will not necessarily persist in the coming decade. "The unemployment rate has already taken us as far as it can," says Dahan, for example, referring to inequality. "I don't think that the unemployment rate will fall below 3%. Even if it does, it will not be as dramatic as it was in the past decade, when the unemployment rate was halved."

How can the labor market nevertheless improve? In addition to more people working more hours, more people should work in more profitable occupations and earn more per hour, i.e. higher productivity. "The gap between our productivity and the rest of the world has remained more or less the same. I think that the coming decade is important," says Larom, who adds that reforms putting more Arabs and haredim into the labor market will not be enough to narrow the gap. "It is true," she says, "that it is easier to take people and put them to work than to take them, advance them, and raise their salary and productivity and put them to work in other occupations. If you look at the occupational distribution of these groups, it is very different from the occupational distribution of Jews and non-haredi Jews. There's unquestionably a long way to go. It's a great challenge."

It is impossible to discuss the difference between the technology sector and other parts of the economy without mentioning the metaphor used by former Governor of the Bank of Israel Dr. Karnit Flug, who called the Israeli economy an innovative locomotive hauling a train composed of beat-up carriages.

For Greenberg, maintaining a high employment rate as a basis for future progress is the key. She explains, for example, that from an international perspective, countries with relatively narrow gaps have high employment rates. "I think that this illustrates the need to continue raising the employment rate, because this will make it possible to much more focused tools for the relevant population groups, act more effectively to bring out the potential of individuals in the labor market, and narrow the wage gaps between the groups," she says. In addition to narrowing gaps in the Israeli economy, she explains, it will also affect economic growth.

Achieving this change will require a shift in government policy, especially because the proportion of haredim and Arabs in Israel's population is projected to increase in the coming decades. "In recent years, the rates of participation in the labor force were fairly stable," Greenberg says. "From the perspective of the rate of population growth in the various groups and their rate of participation in the labor force, we can say that without a change in the current situation, the future will see a drop in the rate of participation in the labor market."

Published by Globes, Israel business news - en.globes.co.il - on January 5, 2020

© Copyright of Globes Publisher Itonut (1983) Ltd. 2020

Ultra Orthodox women in high tech
Ultra Orthodox women in high tech
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