An Overview of the Israeli Economy Prof. Manuel Trajtenberg Head of the National Economic Council The Prime Minister’s Office, Israel May 2008

Background Background Economic Policy Economic Policy Challenges and Opportunities Challenges and Opportunities R&D and Innovation R&D and Innovation

3 3 A Brief Economic History – 60 Years of Growth Total Growth over 60 Years Average annual Growth rate 60-fold7% Product 10-fold4% Population 6-fold3% Product per Capita

4 4 GDP Growth (% per annum) 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 Sources: Central Bureau of Statistics and the Bank of Israel The Current Account Current Account Deficit/Surplus as % of GDP

Background Background Economic Policy Economic Policy Challenges and Opportunities Challenges and Opportunities R&D and Innovation R&D and Innovation

7 7 Source: Bank of Israel and Ministry of Finance Projections Fiscal Policy: Government Expenditure & Budget Deficits Government Budget Deficit (% of GDP) General Government Expenditure (% of GDP) Deficit Ceilings

8 8 Public Debt as % of GDP % Source: Bank of Israel and Ministry of Finance Projections

9 9 Tax Burden YearTax rate % % % % % % % % Monthly income, NIS, 2007 prices Average tax rate on personal income Corporate tax rate Source: Ministry of Finance

10 Oil Refinery Ashdod & Haifa Bezeq (telecom corp) Bank Leumi Discount Bank El Al Israel Airlines, Ltd ZIM (Israel navigation corp) Tax Reforms PensionFundReforms Capital Market Reforms InvestmentinInfrastructure DomesticGovernment Bonds BondsReforms Sea Ports Structural Reform Reform Recent Reforms & Privatizations

Background Background Economic Policy Economic Policy Challenges and Opportunities Challenges and Opportunities R&D and Innovation R&D and Innovation

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 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 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 Ultra-Orthodox and Minorities Targeted Tools Targeted ToolsEnhancedenforcement of the Labor Law Labor Law Negative Income Tax Reduce the Reduce theNumber of Foreign of ForeignWorkers Innovation in Innovation in Traditional & ServicesSectors From Welfare to Work 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. ”

Background Background Economic Policy Economic Policy Challenges and Opportunities Challenges and Opportunities R&D and Innovation R&D and Innovation

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 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 : Jump-started the Venture Capital Industry – success, hence discontinued

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.  2 nd 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 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 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 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 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 innovativeness also 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.