Life in Israel never lacks for things to worry about: Iranian nukes, tens of thousands of missiles in the hands of Hamas and Hizbullah, a critical water shortage, the religious-secular divide. But at least the Israeli economy is strong – or so I thought.
Titles like the recent Start-Up Nation: The Story of Israel's Economic Miracle celebrate Israeli entrepreneurship and portray little Israel as an economic titan. Israel attracts 2.5 times the venture capital per person of the United States; 30 times that of Europe. Israel leads the world in patents on medical devices and is a world leader in biotech and cleantech. More Israeli companies are found on the NASDAQ than those Europe, China, and India combined.
But such statistics, unfortunately, tell only part of the story, as I learned in two recent meetings with Professor Dan Ben-David, director of the Taub Center, Israel's leading independent think tank providing information and analysis to government officials. He paints a gloomy picture of Israel's economic future strangely at odds with the boyish enthusiasm of his presentations.
From 1948 to 1973, Israeli living standards and productivity grew at a rate that placed Israel on a trajectory to overtake the United States within a few decades, even encumbered by a socialist bureaucracy. Today, despite Israel's "economic miracle," the country is falling further and further behind Western living standards. The United States' GDP per capita was 39% greater than Israel's in 1973; it is 61% higher today.
One startling statistic captures the paradox of startling creativity coupled with economic stagnation. In 1990, the number of U.S.-approved Israeli patents per capita was 6% below that of the G7 countries, while Israeli productivity, measured by Gross Domestic Product (GDP) was 7% behind. By 2003, the number of Israeli patents was 69% greater. Yet Israel's productivity was now 23% less than that of the leading G7 economies.
Why has Israeli creativity not translated into standard of living gains vis-à-vis the West? Clearly the hi-tech sector has been insufficient to compensate for the lag in other sectors of the economy. That lag is reflected in ever worsening poverty. In 1979, roughly one-fourth of Israeli families would have been under the poverty line, but for welfare assistance. Over the last thirty years, that percentage has grown to one-third.
Israel has developed a vast social safety net of welfare assistance to compensate for growing family poverty and income inequalities. But the increases in welfare payments are unsustainable in the long-run. Since 1970, per capita GDP has doubled, while welfare payments have quintupled. That ratio cannot continue indefinitely. There are too many other urgent demands on the government's purse, including defense and the investment in the infrastructure and human capital needed to maintain Israel's ability to compete economically. At some point, Israel will simply run out of money to keep papering over the increase in impoverished families.
Accompanying the increase in poverty has been a dramatic increase in income inequality. Israel was once one of the most egalitarian countries in the world. Today it's has the steepest income inequality in the Western world. And, as Professor Ben-David explained, that inequality is not measured only in the gap between the richest docile and the poorest; the gaps are widening between each docile and the one immediately below. Those disparities will greatly strain the Israeli social fabric.
One of the major factors underlying Israel's declining productivity relative to other economically developed countries is its low rate of labor force participation. In 2008, the percentage of non-employed males between 25-54 was 20.4% in Israel. No other Western nation comes close to that. The comparable rates in the United States and Switzerland were 14% and 6.3%.
Lack of investment in infrastructure and human capital (i.e., education) serves as another major brake on the Israeli economy. Israelis own half the number of cars per capita as the Western average, but Israel's road congestion is three times as high as the Western average. The educational situation is even grimmer both in terms of quantity and quality. Seventeen per cent of Israelis in the prime-working age group (25-54 years old) dropped out before completing high school versus 11% of Americans.
Worse, they do not learn much while in school. In five international exams over the last ten years, Israeli schoolchildren ranked last among 25 Western nations in all but one. (Israeli students ranked near the very top in the first such exams in 1963.) Israeli youth are simply not being prepared for modern economies in which workers can expect to change jobs many times.
Professor Ben-David points to many factors behind the educational decline. First is the low quality of teachers. Most primary and secondary school teachers are produced by teachers colleges whose entrance requirements are considerably below those for university. Second, school principals have little authority to reward good teachers or fire incompetent ones. Most important, students spend dramatically less time on the basic core subjects – reading, writing, science, math, and English – than the average in other developed nations.
Higher education is also beset with problems. Since the mid-70s, Israel's population has more doubled, but the number of senior faculty positions at the Technion, the MIT of Israel, increased by one. At Hebrew University and Tel Aviv University, the number of senior faculty positions has dropped 14% and 21%, respectively. As a result Israel, whose survival depends primarily on brainpower, is experiencing a brain drain unparalleled by any Western country. From 2002-2004, the rate of emigration of academics doubled.
Holders of academic degrees are 2.5 times as likely to emigrate as those lacking them. The latter figure points to the long range threat to Israel. Those who can command much higher salaries abroad – academics, research scientists, those in hi-tech, doctors, in short, the leaders of Israel's "economic miracle" – are leaving in ever greater numbers.
No doubt Professor Ben-David hopes that he and his children will live in Israel. That is why he is so passionate about dealing with the long-range trends threatening Israel's economic viability. But, in the end, he knows that his children will have other options. If all those who can emigrate to countries with higher standards of living and no compulsory military service, do so, our children and grandchildren will be left to deal with the mess.