Economic Trends in Israel

Economic Trends in Israel • General data • Product and employment • Balance of payments and external stability • Fiscal policy • Monetary policy and inflation rate

General data • Level of technology • Level of education

Expenditure on Civilian R&D as percent of the GDP in Israel and in OECD Countries, 2001 Israel is a leader in technology fields and ranks first in the percent of its GDP that it invests in R&D.

ICT Product out of total business sector product, 1997 Israel ranks first in its proportion of ICT production in total business sector product.

General data • Level of technology • Level of education

Percent of population with 12 or more years of schooling, ages 25-64, 1999 One measure of the country’s level of education is the percent of its population that has at least twelve years of schooling. By this measure, Israel ranks rather high by international standards.

Product and Employment • Domestic growth rate • GDP Per-capita – international comparison • Factors affecting growth • Characteristics of growth • Unemployment and the labor market

GDP GrowthQoQ,at annual rate The growth rate is expressed as the rate of quarter-on-quarter change in annual terms. In 1999–2000, Israel had a very vigorous growth rate relative to the economy’s past performance and by international standards. Since October 2000, the growth rate has been declining due to the global economic slowdown, which has dampened demand for the high-tech products on which the Israeli economy relies. the decline on the Nasdaq index, which reduced investments in Israeli start-up companies and in high-tech industry at large, and due to the adverse effects of Palestinian terrorism on tourism, construction, agriculture, and exports to the Palestinian Authority areas. The tight monetary policy has been an additional impediment to growth. In 2002, a slump in private consumption caused the negative effects to spread to a larger number of industries. The growth rate in the first quarter of 2003 is mainly a reflection of an upturn in exports and a downturn in imports. The reversal of this trend in the second quarter contributed to the contraction of GDP that occurred then.

GDP/Person Growthannual percent change Average 1987-2000: 2.0% Average 2001 - 2003: -2.3% GDP per capita is an indication of a country’s standard of living. Israel’s per-capita GDP declined in 2001-2003 by 7% in cumulative terms. This is an unprecedented decline in the standard of living. A modest increase in GDP per person is projected for 2004, the first year after three consecutive years of decline.

Product and Employment • Domestic growth rate • GDP per-capita – international comparison • Factors affecting growth • Characteristics of growth • Unemployment and the labor market

GDP/person (PPP-adjusted), index (USA = 100), 2001 In 2001, per-capita GDP was lower in Israel than in the U.S. and most Western European countries, but higher than in many OECD countries. Israel’s per-capita GDP in 2001 was 75% of the OECD average and 59% of the U.S. level.

The U.S. Economy, 1995-2002real growth rates of GDP and business investment The domestic slowdown in 2001 and 2002 was affected by the growth slowdown in the U.S. and by the composition of the GDP decline there. In the main, a downturn in investments by American firms led to a decrease in demand for Israeli exports, which are heavily tilted in the direction of these products. American corporate investments increased in the second quarter of 2003, although more slowly than GDP.

World Growth(weighted average: US - 44%, Euro area - 37%, Japan - 4%, UK - 8%, Asian NIEs - 7%) The slowdown in Israeli exports was influenced by the slump in global growth. The growth rate of global GDP was calculated as a weighted average in terms of its share in Israeli exports. Current projections are that the global growth rate will recover in 2004 (relative to 2001 - 2003) but will be lower than in the past.

The Nasdaq Index and Investment of VCs in Start Ups in the U.S. and in Israel The steep decline in the Nasdaq index in 2000–2002 had a severe downward effect on capital raised by VC funds. This, in turn, dampened investments in Israeli and American start-up companies. The decline accounts for much of the blow inflicted on high-tech and the domestic economic slowdown that began in late 2000. The Nasdaq index recovered somewhat in the first half of 2003, although it is lower than in the past.

Tourist Arrivalsthousands per month The global and domestic security situation has depressed Israel’s number of inbound tourists by some 55% relative to the early-2000 level. The share of tourism in GDP has fallen from more than 3% before the beginning of the Intifada to about 1% of GDP today. Tourism has recovered in the past few months, due to some improvement in the security climate and the effects of the end of the war in Iraq. However, the level of tourism is still lower than that preceding the eruption of Palestinian terror offensive.

Person-Nights at Hotelsthousands per month The adverse effects on tourism were eased somewhat by promotions that aimed to encourage Israeli tourists to replace foreign ones.

The Short-Term Real Interest Rate(Derived from the Bank of Israel’s key lending rate)* * Discount Rate Deflated by Implicit Inflation Expectations Contractionary monetary interest rates in 2001–2003 contributed to the deceleration of GDP growth and delayed recovery from the recession.

Industrial Production Index The slowdown is reflected in a decline in industrial production from late 2000 to the end of 2001. In 2002 and in the first half of 2003 industrial production has been stable at the new low level.

Private consumption expenditure In 2001, despite the economic slowdown, private consumption increased in absolute terms and as a share of GDP. In 2002, private consumption declined moderately as the duration of the recession prompted households to adjust their estimates of permanent income downward. This trend continued and accelerated in the first quarter of 2003. In the second quarter, due to the temporary improvement in the security situation and the optimism that followed the end of the war in Iraq, private consumption increased impressively.

Commerce and Services Sectorsreal monthly revenue Monthly revenues in trade and services declined in 2002 and in the first half of 2003 after recording no change in 2000 and 2001. These developments reflect an adjustment to changes in private consumption.

Gross capital formation (NIS millions, 2000 prices) Fixed investment decreased by 9 percent in 2002 after a 5 percent decline in 2001. Most industries in the business sector participated in the decline, which reflects security and economic uncertainty, the global economic slump, and domestic monetary restraint.

Housing Starts and Fixed Investmentin residential construction Housing starts attest to the trend of future activity, since homebuilding lasts about a year and a half. Housing starts declined from mid-2000 until the first quarter of 2003, and then increased slightly in the second quarter.

Real Change in Domestic Demand (excl. defense imports) Domestic demand (excl. defense imports) decreased by 1.0 percent in 2002 after rising by 1.4 percent in 2001. Domestic demand is expected to decline by about 1.3 percent in 2003 and to increase by 2.6 percent in 2004 (composed of a 1.2 percent increase in private consumption, a 1.8 percent upturn in fixed investment, and a 2.9 percent decline in public consumption).

Structure of Industrial Exports 23% 24% 26% 26% 35% 77% 76% 74% 74% 65% *Jan-Aug at annual rate The recession is also reflected in a decline in exports since 2000. In 2002, exports of traditional industries did not decline. However, high-tech exports decreased both in absolute terms and in percent of GDP. There was a moderate recovery in the first eight months of 2003 relative to the 2002 average, reflecting the effect of the real currency depreciation against the currency “basket,” the effect of the decline in real wages, and efficiency gains in the business sector.

Net Inflows of ForeignInvestmentUS $ billions Due to the global economic slowdown, the Nasdaq crisis, and the security situation, net foreign investment (direct investments in Israeli enterprises, portfolio investments, and other) declined from $11.7 billion in 2000 to $2.0 billion in annual terms in the first seven months of 2003, and net direct investment in Israeli enterprises (FDI) declined from $5.0 billion in 2000 to about $1.6 billion 2002 but increased in the first seven months of 2003 to $3.5 billion in annual terms.

Employee Posts and the Unemployment Rate The recession in 2001–2002 is also manifested in an increase in the unemployment rate, from 8.8% in the second half of 2000 to 10.6% in the second quarter of 2003. The unemployment rate depends on the growth rate, wage developments, the number of non-Israeli workers, and Government’s labor and transfer-payment policy.

Non-Israelis employed in the Business SectorPercent of total employees Non-Israelis (Palestinians and foreign workers) account for 14% of persons employed in the domestic business sector. The proportion has been rising gradually since the early 1990s, partly due to the replacement of Palestinian workers in response to security quarantines. Israel ranks second in the world in the share of foreign workers in its employed labor force (after Switzerland, where the unemployment rate is very low). The number of foreign workers is having a serious effect on unemployment and on inequality in income distribution.

Real wages (CPI-adjusted)index (1999=100) The economic slowdown was reflected in a decline in average real wages in the business sector and the public sector in the first six months of 2003 relative to 2002, following a sharp decline in 2002.

Israeli and Non-Israeli Employees in Constructionthousands The issue of substitution between Israeli and non-Israeli workers is reflected in the construction industry, where the advent of foreign workers has pushed wages down, made construction work less attractive to Israeli workers, and lowered the number of Israelis in the industry. In 2001 and 2002, employment of Israelis in construction increased somewhat even though the construction industry was mired in a severe recession. This is due to a decline in the Palestinian labor force after the onset of the terror attacks and the decline in the number of foreign workers during 2002.

Participation rate of Men ages 25-54, 2000 One reason for the lower standard of living in Israel than in Western Europe and the U.S. is that Israel has a low labor-force participation rate, especially among men. This is due to a low participation rate among the ultra-Orthodox, to the large population of foreign workers who depress wage levels in industries such as construction and agriculture, making them unattractive to Israelis, and to the level of transfer payments.

Balance of Payments and External Stability • Balance-of-payments • Foreign reserves • External Debt

The Current Accountmillions of dollars & percent of GDP The current account of the balance of payments is the net balance of total export receipts less total payments for imports of goods, services, and factors, and unilateral transfers (including the American grant in aid). This is the most important indicator of the state of the economy vis-a-vis the rest of the world in terms of imports and exports. The current-account deficit in the past 12 months (ending in March 2003) has been 0.5% of GDP. This is lower than the 6% level observed in the mid-1990s and is low by international standards, indicating that the balance of payments does not pose a threat to the Israeli economy.

External Reserves The reserves include foreign currency held by the Bank of Israel in short-term accounts abroad (mainly U.S. Treasury bills). Israel’s reserves are high both by international standards and in terms of months of imports. This assures Israel’s ability to finance its liabilities in the short term and to meet its import needs, and it corroborates the assessment of the low probability of a balance-of-payments crisis.

External Debt, Gross and Net(percent of GDP, end-period) Israel’s net external debt (total debt liabilities less debt assets) was 0.6% of GDP at the end of December 2002. This is a lower level than in the past, giving further evidence of the improbability of a balance-of-payments crisis.

Fiscal Policy • Public expenditure • Analysis of Changes in the Components of Public Expenditure • Public expenditure – international comparison • Budget deficit • Public debt and government debt • Public debt – international comparison • Tax burden • Tax reform

General Government Expenditure(as percent of GDP) Government expenditure as a share of GDP increased in 2001 and 2002 due to the recession (which reduced GDP) and the need to increase the defense budget despite cutbacks in other public expenditure.

Fiscal Policy • Public expenditure • Analysis of Changes in the Components of Public Expenditure • Public expenditure – international comparison • Budget deficit • Public debt and government debt • Public debt – international comparison • Tax burden • Tax reform

Economic Trends in Israel