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Economic Development Strategy of ISRAEL

The challenge of high and inclusive growth within the ISRAEL 15 Vision 1. The ISRAEL 15
Vision sets the goal of turning Israel into one of the fifteen leading countries in terms of its
citizens' quality of life. To fulfill this goal, Israel must experience an economic and social
leapfrog that results from rapid and sustained growth at a minimum annual real rate of 3.5%. In
order for this growth to be inclusive, and for the existing gaps in Israeli society to narrow, the
weaker societal layers and the geographically peripheral areas must grow at an annual rate of at
least 5%.The ISRAEL 15 Vision, originally espoused by the Reut Institute since 2006, is now a
formal national objective. However, while Reut emphasizes the need to appreciate Israels
standing through the complex indicator of quality of life, which refers to available income and
quality of public services and sphere, the government focuses on the simpler statistical indicator
of per capita income. Leapfrogs are a rare phenomena and a result of a 'perfect storm' of
successful economic policy, societal, political and ideological ripeness; leadership; and strong
global trends. The leapfrog phenomenon is meta-economic and, therefore, economic theory is
insufficient to understand it and economic policy alone will not generate it. Furthermore, there is
no 'recipe' for leapfrogging, and each country that leaped carved out its own unique path. With
that, international research and the studying of common traits of countries that have leapt reveal
broad common denominators. A key lesson is that a necessary condition for leapfrogging is
growth, which is inclusive and sustainable. In other words, the fruits of growth must benefit the
entire society by raising average real income and improving the quality of public services.
Inclusiveness entails providing a fair opportunity for all residents to take part in the growth and
enjoy its fruits by accumulating and materializing capital. It is expressed in financial capital, in
the form of owning an apartment or a retirement fund; human capital of education or health;
or social capital, of personal networks of connections and acquaintances that create employment
and business opportunities or political influence. All countries that have leapt created a unique
hybrid of a highly competitive market economy, where the prices of goods and services are
determined by forces of demand and supply, and targeted government interventions in a number
of fields critical to growth or inclusiveness by means of development policy or regulation. As
such, the challenge facing Israel is to generate such leapfrog by means of inclusive growth. In
contrast, in recent years societal gaps have widened and the circle of poverty enlarged to the
point that Israel's middle class has been eroded and struggles to bear the burden. This distress
mounted in recent months and exploded over the past few weeks around issues of housing, food,
healthcare, or/and the costs of parenting.

Inclusive growth in Israel

Israel's economic and social legacy uniquely combines market economy and entrepreneurship
with social values of mutual responsibility based on Jewish communal structures of the
Diaspora. This legacy dates back to the first and second waves of Zionist immigration (1882-
1914), and provided for a powerful force of internal cohesion, prosperity, and resilience of the
Jewish settlement in the Land of Israel (the Yishuv). During the first 25 years of Israeli
statehood, its society and economic life were dominated by large and strong government
institutions that espoused socialist values. This model reaped immense achievements and
generated a social and economic leapfrog amounting to an annual average of 5.5% per capita,
between the years of 1951-1972, while multiplying the population sixfold. This system
exhausted itself in the mid-1970s with the political decline of MAPAI, which ruled Israel and the
Yishuv since the 1930s. The 1973 War ushered in a period of stagnation in the form of no real
growth, high deficit, inflation, rising debt and declining foreign reserves that peaked with the
collapse and nationalization of the banking system, hyper-inflation and near-default in the early-
1980s. This period, which is known as the 'lost decade of the Israeli economy', ended with the
Economic Stability Package of 1985. It can be viewed as a time of adaptation and transition to a
new economic and social approach of liberalism and capitalism, which has since reigned in
Israel. The current economic approach is rooted in the values of liberalism and capitalism and is
based on the principles of market economy, a policy of exposure to imports and privatization of
public assets and services under the assumption that the private sector is more efficient and
flexible than the public sector. This approach, which has been promoted by all Israeli
governments over the past 25 years since the Stability Package of 1985, spawned many
achievements, but created complex problems:

o On the one hand, Israel extracted itself from the ruins of the economic crisis that
lasted from 1974-1985, returned to a path of growth and economic and fiscal stability,
suppressed inflation, alleviated the debt burden while keeping unemployment low;

o On the other hand, this policy increased societal gaps, eroded the middle class and
enlarged the circle of poverty, and failed to precipitate a leapfrog. In other words, not
only is Israel not growing fast, but its growth is not inclusive.

The sustained systematic erosion in the quality of life of the majority of Israeli citizens in recent
years stems from a triple whammy of deteriorating real wages; rising cost of basic services and
products e.g. housing, food, education, parenting, health, pension, financial services or
communication; and declining public services. Hence, most Israelis need to do much more with
unchanging means. Children are the silent victims of this reality: The growing financial
challenges of many households and the erosion of public services compromise the education,
health, and future assets of Israels next generations, and, consequently their ability to participate
and compete in the labor market and provide for their future families. The long-term implication
hereof is not only declining human capital, but also erosion of solidarity with and loyalty to the
State of Israel and its institutions.

The underlying trends, incentives and institutions that are driving these outcomes are the

- Globalization, which generously benefits the global class marginalizing unskilled

labor, thus amplifying societal gaps; exerts harsh pressures on individuals and businesses
to continuously learn and update their professional and personal skills, which many find
unbearable and drop out;

- The continued crisis in the capacity of the Government of Israel to govern i.e. to sustain
multi-agency collaboration in designing and executing policy toward complex societal
challenges, which has been lingering for nearly 35 years;
- Population growth at annual rate of 1.8%, whichrenders Israel the only developed
country with a fast-growing population. Most of this growth emerges from the
socioeconomically weak stratum of society, namely Arab citizens and the Jewish ultra-
orthodox (haredim);

- The Government of Israel's policies in a range of areas such as taxation; privatization of

public services; land use and housing, under-compensation for key sectors, such as social
workers and police; and conservative policies towards small businesses;

- Israels national labor union (The Histadrut), and especially the powerful unions which
increase labor-market inflexibility, decrease productivity, shortchange non-unionized
workers, perpetuate monopolies that increase the cost of living and harm services;

- Corporations and individuals (so-called tycoons) that have gained monopolistic

positions, primarily in the markets of basic products and services, extracting
extraordinary profits by limiting competition. Israels tycoons often control both
financial institutions and real operations and enjoy disproportionate access to capital;

-Israels security burden and the disproportional political power of sectoral groups of the
Haredim and the settlers;

- The high-tech sector has been a growth engine has not propelled inclusiveness. While it
increased GNP and exports, drew foreign investment to Israel, improved the balance of
payments and provided for Israels technological edge, the high-tech sector also increased
societal gaps, and failed to contribute to overall national productivity or to create new
jobs in recent years.

As such, the erosion of the middle class, the growing poverty and widening societal gaps are the
inevitable outcome of Israels present social and economic ecosystem. The remedy requires a
systemic approach and a joining of forces by government, civil society, the Histadrut, the
corporate and business sector, and academia. In the absence of such a response, these issues will
escalate and will ultimately compromise not only social and economic stability, but also the
political system. Hence, turning a corner requires vision, leadership, determination, consistency
and creativity.

Israels New Social Contract

The urgent need for a New Social Contract, which will articulate the principles of the revised
social and economic approach and outline its realization, stems from the combination of the

- The need to avoid near-term escalation and possible bloodshed, as well as intermediate-
term stagnation as a consequence of on-going social unrest and political
instability. Israels last transition required the lost decade of 1974-85 and near collapse
to coalesce the forces of necessary reform;
- The complexity, interdependence, cost and duration of the reforms, which may even last
a decade (Israels last transition entailed at least 15 years of reforms beginning in
1985). Hence, the new social contract can rebuild toward a vision of inclusive prosperity.

Hence, Reut views the New Social Contract as an essential and urgent platform at this
moment. Its purpose is to outline over-arching principles agreed upon by the government, labor
unions, employers and the public that will offer a unifying vision and serve as a force-for-good
that contributes to pragmatism on all sides, helps avoid escalation and violence and prevents
deterioration into chronic instability. In addition, this contract should establish trust and bridge
this moment of great social unrest and distrust with the longer-term vision of Israeli society that
will take a decade or more to establish. The principles of the social contract are: Inclusive
growth toward realizing the ISRAEL 15 Vision is Israel's national goal; Communities are the
foundation and building blocks of Israeli society; Shaping the future of Israeli society requires a
partnership among government, local municipalities, and civil society; Mutual commitment to
long-term savings and building human capital; Free market and fair competition; The IDF,
national service, colleges and universities will remain engines of inclusiveness; Flexible labor
market and a learning society; Basic package of goods and services will be guaranteed for
all. The New Social Contract is a first step and the platform for a series of reforms that will span
a few years and will focus on three primary goals: Raising real disposable income (personal
income that remains after direct taxes and government charges have been paid); decreasing
prices of basic goods and services, primarily by ensuring a truly free market competition;
and improving public sphere and social services.

Quality of life: Real available income and public sphere

Quality of life in Israel is a product of a combination between real disposable income, the quality
of public services and the public sphere, as well as of the spiritual, ethical and cultural
environment, e.g. deriving a special spiritual value from living in the Holy Land.
Therefore, realizing the ideal of inclusive growth requires increasing real disposable income and
significantly improving the quality of social services and the public sphere in order to increase
the financial, human, and social capital of Israelis. The conundrum of disposable income in Israel
stems from the quality of its work force. The excess of talent and of skilled and educated workers
suppresses compensation, particularly in the absence of a concentrated effort to turn Israel into a
global high-end service and R&D center. The desired integration of the Orthodox and Arab
sectors into the labor market exacerbates this problem. Still, the government can increase real
disposable income by decreasing costs of basic products and services and by increasing
productivity. However, in order for growth to be inclusive, the following actions should be

- Decreasing costs of basic products and services and correlating it to average income;

- Encouraging the accumulation of financial capital of households through pensions, home

ownership, and long-term savings for the benefit of children;

- Developing Israel's peripheral regions by leveraging their unique assets;

- Incentivizing small and medium-size businesses and traditional industries;

- Promoting 'flexicurity,' i.e. greater flexibility in the labor market and more earning-security
through professional training that ensures life-long learning in order to increase overall
productivity and growth. Special effort should be directed to reforms in the civil service;

- Integrating the Arab and Orthodox sectors into the workforce, as well as other excluded
populations, such as the elderly or disabled;

- Reforming the tax policy to relieve the burden from the middle class.

Community-building and improving services and the public sphere

Israels conundrum of disposable income requires focusing in parallel on improving social

and community services such that they are able to support or ensure a basic basket of goods
and services, accumulation of financial, human and social capital and a better quality of
life. Reut views communities as key to local prosperity, inclusiveness, and resilience and the
building block of Israeli society. Communities not only shape the public space where
children are raised but also contribute to the quality of life of adults. Reut calls this
perspective: The community-building approach and its principles are:

- Ensuring eight 'platforms', which are core institutions that are the basis of a prosperous,
resilient, and inclusive community. Institutions become community platforms if they meet
certain criteria, primarily substantive flexibility, civic leadership and physical infrastructure.
The platforms are Community centers (MATNASIM), early childhood centers (Tipat Halav);
sport and recreation frameworks and facilities; culture, art, and music centers; schools and
other educational institutions; medical centers (Kupat Cholim); youth movements and
centers; and parks and public spaces. Each of these platforms needs to be comprehensively
reformed, their presence in the community formalized and regulated, and cooperation among
them incentivized;

- Improving services that are critical to prosperity and inclusiveness, such as education,
vocational training, healthcare and preventative medicine, home economics, and financial

- Security, accessibility and opportunity with an emphasis on community policing, intra-

regional and intra-community transportation, and availability of finance for small

- Civic leadership by elected representatives of local stakeholders that will assume

responsibility for shaping the platforms such as in school boards or in community centers. In
this context, Reut recommends designating a 'Civil Society Day', in which local community
representatives will be elected.
The vision: a network of prosperous and resilient communities One outcome of the
community-building approach is that the vision for the Israeli society is of a network of
communities, whose interconnectedness enhances local prosperity, inclusiveness and
resilience, and, consequently, quality of life; a sum that is greater than its parts.

Principles and guidelines for realizing the vision

Concluding and realizing a new social contract requires a long process of dialogue and
deliberation among the government; a wide range of relevant civil society associations such
as the Histadrut, the Industrialist Association or the Chamber of Commerce; the business
sector; various non-profits and academia. Such a process will inevitably require top-down
legislation, policy and resource-allocation, as well as bottom-up local leadership and
initiatives that provide a creative response to unique local needs. The Jewish world can play a
central role in realizing the vision of inclusiveness and the community-building approach by
nurturing direct connections among Diaspora and Israeli communities. In addition, the
platforms and their civic leadership can carry content of religion and spirituality. The Reut
Institute will initiate a cross-Israel campaign of meetings with a variety of stakeholders in
order to present and discuss these ideas, and to mobilize community members and public
sector professionals towards endorsing this vision and realizing it.

Israels New Social Contract

High and inclusive growth is Israels shared national goal, with the objective of becoming
one of the 15 leading countries in terms of quality of life. The test of progress will be the
accumulation of financial, human and social capital by all citizens and particularly children.

Communities are the foundational unit of Israeli society and the basis for local prosperity,
resilience, and inclusiveness. Vibrant community life is the basis for the individual to form his
or her identity, realize capabilities, and accumulate capital, and therefore, must be available to
every citizen. Each community should be entitled to all platforms and to a standard of
resources and services. Micro, small and medium enterprises and initiatives are an inseparable
component of a vibrant and prosperous community with the active support of the government.

Locally elected civic leadership has a right and an obligation to participate in shaping
their community and its local institutions, together with the municipality and Government of
Israel. The Knesset and the government will regulate, broaden, and incentivize civic
involvement herein, primarily in schools, community centers, youth organizations, sports
associations, and arts and culture institutions.

Long-term saving and investments are a shared responsibility of the government and
households. The state will incentivize individuals to accumulate financial capital for their
children through pensions and long-term investments designated for home ownership,
education or entrepreneurship.
Free market and fair competition are the foundations of the Israeli economy and
society. Government intervention will take place in market failures that compromise rapid and
inclusive growth.

The IDF, National Civil Service, universities and colleges are engines of
inclusiveness. The state will broaden programs that support the involvement of weaker
populations in these frameworks.

Flexibility in the labor markets and life-long learning of professional skills are shared
national goals which are essential for productivity and high employment. Government will
improve transportation and communication infrastructures, as well as employment incentives
for hired and independent workers.

Israeli society will be a working society, in which wages ensure dignified living. The
national goal is a full integration of two-thirds of the labor force in an appropriate employment
framework. The average salary will be higher than the cost of basic goods and services. The
government will utilize the tools at its disposal to lower the price of basic products. Educated
and skilled civil servants will be entitled, at the minimum, to the average salary in the market.

Corporate Social Responsibility will expand to include the value of inclusiveness by

enhancing the human capital of employees, restraining monopolistic conduct in basic products
and services, providing equal employment opportunity to excluded populations, operating
fairly vis--vis providers, and preserving the environment.

The basket of 'basic goods and services' will be determined in a shared process and will
represent the right to include the following components: Housing, education, transportation,
cost of raising a child, food, communication, health, water, electricity, and banking. This
basket shall be the right of every citizen.