Demographics and Israels Economy

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"Herzlia Conference"

Prepared by Dr. Yacov Sheinin
Translated from Hebrew

The Long Term Ramifications of GDP Growth and the Economic Burden
Analysis of the low level of economic development in Israel reveals three key causes:

1. A low rate of participation in the labor force. 2. A high fertility rate (natural increase). 3. A high proportion of population under 15. Due to these factors, GDP per capita remains low, the budget deficit is high, the tax burden is one of the highest in the developed world and the Israeli economy has difficulty allotting resources for fixed asset investments.

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The Effects of Demographic Composition on Growth
GDP per capita is much lower in Israel compared with developed countries - $16,400 in Israel versus $37,500 in the U.S. and $27,500 in the EU. From 1975-1999 (before the recent wave of terror and the collapse of the Hi-Tech bubble in 2000), GDP per capita grew by an annual average of 1.6% in Israel versus 2.2% in the U.S. and 1.7% in the E.U. If this trend continues, the gap between Israel and the developed countries will widen and may result in a social crisis.
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Population Breakdown
We have divided Israel’s population into three broad categories, based on labor force participation, the natural rate of increase and a tendency to form an identifiable category. Haredim (Ultra-Orthodox Jewish) – 6% of population. Arab – 19% of population. General & Other – 75% of population.
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Characteristics per Household by Category 2030 Estimates
Arab Children per Woman Persons per Household % of Pop. below Age 15 Participation in the Labor Force Average Yrs. Education Haredim General Total

4.4 5.0 41.2% 39.0% 9.6

5.8 4.4 47.4% 45.0% 14.5

2.3 3.2 23.6% 58.0% 12.6

2.9 3.4 28.4% 54.3% 12.2

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Economic Data by Category 2030 Estimates, NIS ’000’s
Arab Production per Employee GDP per Capita Income per Household, Total Of which: Income, not from Allowances Income, from Allowances % of Income from Allowances Haredim General Total

158 32 99 75 24 24%

169 35 87 52 35 40%

226 89 145 128 17 12%

216 75 138 119 19 14%

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The Effects of Demographics on Growth
The Arab and Haredi populations have a natural rate of increase of above 3% a year, compared with 1% in the general population. Since 1970, participation in the labor force has increased from 50% to over 54%, as a result of waves of immigration and the entry of women to the labor force. The base assumption is that the period of growth through immigration has ended and the fertility rate of the majority population will remain constant.

On these assumptions, we forecast a decline in labor force participation, and a change in the trend of increasing participation since the founding of the State.

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The Effects of Demographics on Growth
We estimate that the decline in the rate of participation in the labor force, and the increase in the percentages of Haredim and Arabs in the population, will reduce GDP growth per capita by 0.4% a year. In comparison, if the labor force participation rates, fertility rates and GDP per Employee (wages) of the Haredim and Arabs were to match the general population, GDP per capita would be 20% greater.

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Economic Burden on the General Population

The excess taxes, required from the general population, to finance social services and allowances that flow to the Haredi and Arab populations. This economic burden is calculated by the percentage in gross income (without allowance payments) of each household in the general population, and has reached in 2003, by our calculations, to 9%.

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Calculation of Economic Burden on the General Population
Transfer payments to minorities, (+) Proportion of public expenses to minorities, based on size of population (Education, Health). (-) Tax revenues , both direct and indirect, from minorities. (=) Excess of payments to minorities, as financed by taxes to the general population. The cost of fixed public expenses (Defense, Foreign Affairs, etc.) are not part of the economic burden.

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The Effects of Demographics on Growth
Arabs and Haredim have a natural rate of increase above 3% a year, compared with only 1% for the general population. If current trends continue, the General population will reach only 63% in 2030 and participation in the labor force will fall to 52.6%.
This forecasted decline in labor force participation will be a change in the trend of increasing participation since the founding of the State (since 1970, labor force participation has risen from 50% to above 54%).
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Three Possible Scenarios
Status Quo Scenario – A continuation of current trends of fertility rates, labor force participation, etc. Investment in Education Scenario – To implement the suggestions in this presentation to reinforce education (to be explained), that will bring in-line the characteristics of the minority populations with the General population in the areas of fertility rates, labor force participation and production per employee. Alternative Scenario – A sensitivity analysis to the Investment in Education Scenario, that we propose, that will show an equalization of all factors, but fertility rates will remain as per status quo.

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Basic Assumptions for each Scenario
Economic productivity will increase by 1.3% a year, the average increase in productivity over the past 25 years, before the current outbreak in terrorism (i.e. 1975-2000). General population participation in the labor force will remain at 58%. By 2010, the economy will shift to full employment with unemployment remaining at 6%. Fertility rates and immigration rates – according to the middle forecast of the Central Bureau of Statistics. Public service spending will rise in proportion to the rise in GDP but without incurring a budget deficit.
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Demographic Composition in 2030 Status Quo Scenario
Arab Population (Thousands) % of Population % of Households Labor Force Participation Rate Haredim General Total

2,830 27.3% 18.9% 39.0%

1,040 10.0% 7.5% 45.0%

6,489 62.6% 73.6% 58.0%

10,359 100.0% 100.0% 52.6%

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Forecast for GDP Growth and the Economic Burden in 2030 in Status Quo Scenario
The economic burden on the General population will reach 17% of household income. GDP growth per capita will reach 1.3% a year (of which 0.2% derives from the move to full employment). The gap with Europe in GDP per capita will increase by 23%. GDP per capita will be 49% of European levels. The gap with the U.S. in GDP per capita will increase by 26%. GDP per capita will be 35% of U.S. levels.

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Significance of the Status Quo Scenario
The increasing par in economic conditions between Israel and the developed economies will increase the discord between the General population and the minorities. Increase of the economic burden on the General population will also increase the discord between the populations. The combination of these two factors may lead to a social crisis with serious consequences for social rights and welfare policies.
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Barriers to GDP Growth in the Haredi Population
The very low participation rate of men between the ages of 25 - 40 is due to barriers related to compulsory military duty. The fact that the average wage is only 75% of the average wage of the General population, indicates the lack of professional training required by the job market. A very low participation rate of young women between the ages of 20 - 40 (apparently due to the high fertility rates and the lack of suitable daycare).

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Barriers to GDP Growth in the Arab Population
The rate of participation in the labor force by Arab men declines after age 45 as over 50% of Arab men are employed in professions requiring hard physical labor. The fact that the average wage is only 70% of the average wage of the General population, indicates the low level of education. The usage of cheap foreign labor has repressed, for the nearterm, the representation in the labor force of populations with low income levels. The presence of cheap foreign labor acts to prevent a shift to more advanced technologies and methods in labor intensive sectors and works to keep the wage level down. There is a very low level of participation of Arab women in the labor force (only 17%) with a very low level of income.
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Suggested Solutions
Investment in education, leading to a change in the levels of education, especially for the Arab and Haredi populations. Reformation of the educational system, including: 1. Move to a long learning day. 2. A focus on educational areas with a high demand for work. Move to a long learning day will allow weak populations to advance to post- high school education. Establishment of sufficient daycare centers for children below age 5, allowing mothers to find full time employment.
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Suggested Solutions – Cont.
Implementation of the Tal law and offering an option of national service, instead of military duty, will result in a higher level of participation of the Haredi population in the labor force. A prohibition on hiring foreign workers at marginal wages will lead to a switch to the higher skilled methods being used today for labor intensive sectors. We believe, that by taking these steps (and others that will become necessary) , production per employee will rise (higher wages) among the minority populations and match the General population.

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The Investment in Education Scenario
Educational levels in all populations will be equivalent. Production per employee (wages) in the minority populations will rise and match the General population. There will be an increase in fixed asset investments and a shift from work in labor intensive industries to knowledge intensive industries (hi-tech). An increase in the participation rate of the minority populations in the labor force to match that of the General population. A decline in fertility rates to match that of the General population.

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Demographic Composition in 2030 Investment in Education Scenario
Arab Population (Thousands) % of Population % of Households Labor Force Participation Rate Haredim General Total

2,251 23.7% 21.9% 58.0%

772 8.1% 7.8% 58.0%

6,489 68.2% 70.2% 58.0%

9,512 100.0% 100.0% 58.0%

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Forecast for GDP Growth and the Economic Burden in 2030 in Investment in Education Scenario
There will be no economic burden on the General population. GDP growth per capita will reach 2.2% a year (of which 0.2% derives from the move to full employment). The gap with Europe in GDP per capita will decrease by 3%. GDP per capita will be 62% of European levels. The gap with the U.S. in GDP per capita will decrease by 1%. GDP per capita will be 44% of U.S. levels.
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The Alternative Scenario
This scenario is a sensitivity analysis to the Investment in Education Scenario. Similar to the Investment in Education Scenario, all our recommendations will be implemented. The difference is that in this scenario, though the Haredi and Arab populations will be integrated into the job market, their fertility rates will not decline (from the trend for the past 15 years for the Arab population).

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0 Yemen Saudi Arabia Oman PA Iraq

1

2

3

4

5

6

7

6.8 6.2 5.9

25 Source: The CIA
5.3 4.5 4.4
Israel (Arabs) Ssyria Lybia UAE Kuqait Egypt Qatar Jordan Morroco Bahrain Algeria Israel (Maj.) Iran Lebanon Tunisia

3.7 3.5 3.1 3.1 3.0 3.0 3.0 2.9 2.7 2.6 2.3 2.0 2.0 1.9

Fertility Rates among Arab Countries

Demographic Composition in 2030 Alternative Scenario
Arab Population (Thousands) % of Population % of Households Labor Force Participation Rate Haredim General Total

2,830 27.3% 18.9% 58.0%

1,040 10.0% 7.5% 58.0%

6,489 62.6% 73.6% 58.0%

10,359 100.0% 100.0% 58.0%

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Forecast for GDP Growth and the Economic Burden in 2030 in Alternative Scenario
There economic burden on the General population will decline to only 2% of household income. GDP growth per capita will reach 1.9% a year (of which 0.2% derives from the move to full employment). The gap with Europe in GDP per capita will increase by 4%. GDP per capita will be 57% of European levels. The gap with the U.S. in GDP per capita will increase by 7%. GDP per capita will be 41% of U.S. levels.
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Summary of the Different Scenarios
Status Quo Population (Millions) General Population as % of Total GDP per Capita (US$ ‘000’s) GDP Growth per Capita Economic Burden on the General Population Alternative Investment in Education

10.4 62.6% 23.2 1.3% 17%

10.4 62.6% 27.5 1.9% 2%

9.5 68.2% 29.5 2.2% 0%

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Development of the Gap Between Israel and the E.U. from 2004-2030
Status Quo Avg. GDP Growth Per Capita in Israel Avg. GDP Growth Per Capita in the E.U. Accumulated Gap w/ the E.U. (2004-2030) GDP per Capita in Israel vs. E.U. in 2030 Alternative Investment in Education

1.3% 2.1% 22.7% 49%

1.9% 2.1% 3.7% 57%

2.2% 2.1% -3.2% 62%

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Development of the Gap Between Israel and the U.S. from 2004-2030
Status Quo Avg. GDP Growth Per Capita in Israel Avg. GDP Growth Per Capita in the U.S. Accumulated Gap w/ the U.S. (2004-2030) GDP per Capita in Israel vs. U.S. in 2030 Alternative Investment in Education

1.3% 2.2% 26.2% 35%

1.9% 2.2% 6.7% 41%

2.2% 2.2% -0.5% 44%

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Summary - I
The current demographic composition necessitates action to change the trend in growth. Without any action, growth is expected to be slow and accompanied by an increase in the economic burden on the General population, and increase social tensions. An increase in the educational levels of the minority populations and integration into the modern job market is of prime importance. A reform in education requires a switch to a long school day, leading to an increase in the amount of higher education among the minority populations. Establishment of sufficient daycare centers for children below age 5, allowing mothers to find full time employment.
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Summary - II
A ban on employment of foreign workers is necessary for the development of higher use of technology and more modern methods in all sectors. Implementation of the Tal Law and an option of national service in place of military duty is necessary in order to integrate the Haredi population into the job market. Adoption of our recommendations will put a halt to the current deterioration of the situation and allow reasonable growth, comparable to developed markets. Any delay in implementation will worsen the situation, and so our plan must be put into action immediately.
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Conclusions
Steps to integrate the Arab and Haredi populations into the labor force are also expected to lead to an increase in participation of the General population in the labor force and rise above 58%. A gradual increase in participation in the labor force, to U.S. levels of 65%, will lead to an annual 3% GDP growth per capita and reduce the gap between Israel and Europe by 50% by 2030. We are of the opinion, that at the current time, the economy has a rare opportunity to create sustainable growth per capita, for many decades, through both investment in education and in investments in infrastructure.
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