Download Why is Labor Productivity in Israel Lower Compared with Other

Why is Labor Productivity in Israel Lower Compared with Other
Developed Countries?
Key points:1
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Labor productivity in Israel is lower than the average level in other developed
countries. Furthermore, the gap in the labor productivity between Israel and
the USA has increased by 10 percentage points in the last decade. This issue is
of great macro-economic importance since labor productivity affects directly
and significantly the average standard of living, both through real wages and
through services offered to the public.

There isn't one single factor that can explain low labor productivity in Israel.
A combination of several factors leads to that outcome. These factors include
the physical capital stock, the geo-political impact, seniority of employees,
labor market trends, the scope of the shadow economy and technical
measurement factors. Some of these factors are fixed and changing them is
neither doable nor desirable. The increase in labor productivity may be
achieved through focusing on several factors which are policy dependent, such
as the inclusion of the Arab and Orthodox Jew sectors in the labor market and
the minimizing the shadow economy.
Further detail:
According to the OECD, labor productivity in Israel (which is measured as GDP per
working hour) is low relative to other developed countries. Thus, labor productivity in
2013 totaled 36.7 USD, lower by approximately 24 percent than OECD average.
1
This review is a summary of a research written by the Chief Economist's Department. The
summary does not include methodological details. The full version of the research will be
published in the future.
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Why is Labor Productivity in Israel Lower Compared with Other
Developed Countries?
Figure 1: output per working hour
2013, USD PPP
48.2
36.7
Luxembourg
Norway
United States
Belgium
Netherlands
Denmark
France
Ireland
Germany
Switzerland
Sweden
Austria
Australia
Finland
Spain
Italy
United Kingdom
Canada
OECD
Iceland
Slovenia
Japan
New Zealand
Slovakia
Israel
Greece
Portugal
Czech Republic
Korea
Turkey
Estonia
Hungary
Poland
Chile
Mexico
100
90
80
70
60
50
40
30
20
10
0
Source: OECD
According to economic theory (conditional convergence), countries characterized by
relatively low labor productivity are expected to register high growth rates and narrow
the gap. However, this is not the case for Israel where both labor productivity and its
growth rate were relatively low in recent years. In fact, while labor productivity in
Israel amounted to approximately 70 percent of the labor productivity in the United
States in the early nineties, in 2012 Israeli output per employee amounted to less than
60 percent of the labor productivity in the United States. This issue is significant in a
macro-economic perspective since the output per employee affects directly the
average standard of living, both through real wages and through public services
offered to the public.
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Why is Labor Productivity in Israel Lower Compared with Other
Developed Countries?
Figure 2: conditional convergence in output per working hour:
Labor productivity and growth rate, 1995
Source: annual report, 2012, Bank of Israel.
While the fact that labor productivity in Israel is low is well known for many years,
the reasons for this are less known. We have tried to quantify the influence of the
factors that may affect labor productivity in Israel, in various methods, according to
available data.2
2
For example, the influence of the level of capital per employee was quantified using the
growth accounting method while the quantification of the influence of the security situation
was done using an econometric model. Due to missing data, several factors which may affect
labor productivity, such as bureaucratic efficiency and entrepreneurship were not examined.
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Why is Labor Productivity in Israel Lower Compared with Other
Developed Countries?
Factors that were examined as influential on labor productivity:3

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Capital per worker- the level of capital per worker in Israel is relatively low,
which affects product and productivity.
Security expenditure- is at the expense of civil-economic expenditure and is a
dummy variable (proxy) to the geo-politic situation in Israel.
Average working experience per worker- the relatively young age of the
working population in Israel and the mandatory military service result in a
relatively low seniority for the average worker in Israel.
Unique properties for the Arab and the orthodox Jews population in the labor
market- both populations are characterized by low wages and productivity.4
Developments in the labor market- an increase in the participation rate and a
decrease in unemployment rate may reduce the average wage and labor
productivity.
The scope of the shadow economy- unreported economic activity is not
included in the national accounts and therefore reduces the labor productivity
as measured by official authorities.
Method of measurement for the national accounts- adjustments in the
measurement methods are expected to narrow the gap in labor productivity,
following the change in intangible assets definition.
Human capital- the Israeli work force is characterized by high level of
education, which affects positively on the labor productivity.
The sectorial structure of the Israeli market-the Israeli economy focuses on
highly productive sectors, which contribute to the labor productivity.
The following chart illustrates the change in labor productivity, caused by the change
in each of the listed factors, making them equal to the OECD average. For example, if
the capital per worker changed in Israel to the OECD average, labor productivity
would increase by approximately 5 dollars.
3
The summary does not include methodological details. This will be included in the full
report which will be published in the future.
4
In this article, labor productivity was examined by using the counterfactual situation where
the features of these populations were equal to the general population.
4
Why is Labor Productivity in Israel Lower Compared with Other
Developed Countries?
Figure 3: quantification of the effect of various factors on output per worker
USD 2013, PPP
The results of the report indicate that the gap between labor productivity in Israel and
the OECD average cannot be explained by one single variable, but by a combination
of a number of factors. Moreover, changing some of these factors is not possible, or
desirable. For example, the recent changes in the labor market are positive for the
Israeli economy, even if its effect on labor productivity is negative. Also, under the
given geopolitical situation it would be impossible to reduce the defense expenditure
to the average OECD level, though it is desirable to reduce it as much as possible. The
results also indicate other main factors which contribute to the low level of labor
productivity, such as capital per worker and the shadow economy. However, we
recommend for further research on this subject in order to produce policy conclusions.
For example, more research is needed in order to understand in which sectors the
capital per worker is lower than others and whether there are objective reasons for this
low level of capital.
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Why is Labor Productivity in Israel Lower Compared with Other
Developed Countries?
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