Growth, Poverty and the Productivity Puzzle

Prof. Rafi Melnick

Herzliya Conference

January 2007

GDP per GDP per Capita in Israel in Israel))Rates of Growth, Percent)Rates of Growth, Percent)

-5

0

5

10

15

20

1950

1954

1958

1962

1966

1970

1974

1978

1982

1986

1990

1994

1998

2002

2006

1985

Actual and Potential per Capita GDP in Israel

(U.S. Dollars, Constant 2000 Prices)

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

1950

1954

1958

1962

1966

1970

1974

1978

1982

1986

1990

1994

1998

2002

2006

Actual Potential with 1/2 pre - 1973 growth

Relative per Capita GDPIsrael/U.S.

0

10

20

30

40

50

60

70

80

1950

1954

1958

1962

1966

1970

1974

1978

1982

1986

1990

1994

1998

2002

2006

Actual Ratio Potential Ratio with 1/2 pre - 1973 growth

Two Conclusions

I. Sustained economic growth is necessary (but perhaps not sufficient) to reduce poverty.

II. Policies that slow economic growth worsen the problem of poverty.

GDP per Capita in Israel)Rates of Growth, Percent)

-5

0

5

10

15

20

1950

1954

1958

1962

1966

1970

1974

1978

1982

1986

1990

1994

1998

2002

2006

1985

Testing Two Hypotheses: The Main Issues Discussed

during the Last Economic Crisis in Israel (2001-2003)

I. The policy needed to restore growth is increasing government expenditure and increasing the fiscal deficit.

II. The Israeli economy cannot grow without a political horizon.

Government Consumption 2000-2006 (Rates of Growth, Percent)

-3

-2

-1

0

1

2

3

4

5

6

2000 2001 2002 2003 2004 2005 2006

Control Experiment?

General Government Deficit 2000-2006 (Percent of GDP)

0

1

2

3

4

5

6

7

8

2000 2001 2002 2003 2004 2005 2006

Public Debt 2000-2006 (Percent of GDP, Gross Debt)

75

80

85

90

95

100

105

2000 2001 2002 2003 2004 2005 2006

Economic Outcome

GDP and Business GDPGDP and Business GDP 2000-20062000-2006 (Rates of Growth, Percent) (Rates of Growth, Percent)

-4

-2

0

2

4

6

8

10

12

2000 2001 2002 2003 2004 2005 2006

GDP GDP Business

Rate of InflationRate of Inflation 2000-20062000-2006 (CPI, Percent) (CPI, Percent)

-3

-2

-1

0

1

2

3

4

5

6

7

2000 2001 2002 2003 2004 2005 2006

Unemployment 2000-2006 (Percent)

8

8.5

9

9.5

10

10.5

11

2000 2001 2002 2003 2004 2005 2006

Current Account 2000-2006)Percent of GDP(

-2

-1

0

1

2

3

4

5

6

2000 2001 2002 2003 2004 2005 2006

Foreign Investment 2000-2006(Million U.S. dollars)

0

5,000

10,000

15,000

20,000

25,000

2000 2001 2002 2003 2004 2005 2006

Direct Securities

Production Function Decomposition

LaborCapitalTotal Factor Productivity

Business GDP

Output and Total Factor Output and Total Factor Productivity Productivity 1961-20061961-2006

(Average Rates of Growth, Business Sector GDP, Percent)(Average Rates of Growth, Business Sector GDP, Percent)

Period Output Labor

Contribution Capital

Contribution TFP

1961-2006 5.7 1.9 1.9 1.9

1961-1972 9.2 2.2 2.8 4.2

1973-2006 4.5 1.8 1.6 1.1

1986-2006 5.2 2.5 1.7 1.0

2003-2006 5.2 1.1 1.0 3.0

Necessary Conditions for Growth and Necessary Conditions for Growth and the Reduction of Povertythe Reduction of Poverty

Fiscal RetrainA prudent rise in government expenditure serving

as the anchor for fiscal policyLow fiscal deficitsFiscal consolidation

Financial StabilityAchievement of the inflation targetsCredibility, transparency and effective regulation

Structural Reforms