Effective macroeconomic stabilisation policies along with market-oriented structural reforms have helped support a high average rate of growth. Also, the economy has weathered the recent global downturn well, and the policy responses have been generally appropriate.

Israel’s economic development has certain parallels with that of some OECD countries, in particular its earlier move towards market-oriented policies that aided an expansion of high-value adding export sectors. A sea change in macroeconomic policy and a shift towards market-oriented structural reforms was prompted by chronic hyperinflation and unsustainable public-debt levels in the mid-1980s. Anti-inflationary measures were particularly successful, allowing the introduction of inflation targeting in the early 1990s, which brought price increases down to low, single-digit levels by the end of the decade. The early 1990s also saw the emergence of a world-class, export-based high-tech sector specialising in computer hardware and software, medical technologies and pharmaceuticals. Thus, the economy rode high on the dot.com bubble but also slumped following its collapse, with a recession in the early 2000s.

Israel’s economy has admirable strengths but also some serious weaknesses. Rapid expansion of hi-tech activities over the past two decades has contributed significantly to an impressive rate of GDP growth; an environment of low inflation is firmly established; and the economy has weathered the recent global recession relatively well. However, the economy is particularly vulnerable to shocks, and per capita growth has been less remarkable. Furthermore, public debt remains uncomfortably high. Also, high rates of poverty and weak labour-market attachment among the rapidly growing Arab-Israeli and Ultra-orthodox Jewish communities as well as wider weaknesses in the country’s human capital hinder growth. Though tertiary educational attainment statistics are impressive, PISA results show core skills among secondary school students to be weak. This is undermining the environment for business, which is also hampered by regulation, according to preliminary analysis of the OECD’s product-market indicators.

Israel’s monetary policy framework is broadly sound. Inflation targeting was introduced in the early 1990s, and low single-digit inflation was established by the end of the decade. However, fast transmission from the exchange rate to inflation means the operational challenges differ somewhat from those in many OECD countries. Also, the Bank of Israel has been intervening heavily in the foreignexchange market, marking a departure from standard practice in inflation targeting. Past progress in fiscal consolidation has been affected by several economic shocks, including the recent downturn. The government’s strategy of lowering tax rates on corporate profits and on personal income is assessed. Also, various avenues for raising revenues on other fronts are suggested. Primary civilian spending is now relatively low in international comparison, the room for savings has narrowed, and many of the necessary future structural reforms probably require initial fiscal outlays. In budgeting, which is strongly controlled by the Ministry of Finance, there is room for various process improvements.

Israel’s education system is complicated by multiple streams at the primary and secondary levels and by military conscription. Population growth and economic expansion have brought a massive increase in demand for all levels of education. Educational attainment statistics are impressive, but results show high-school students have poor basic skills. Reform efforts to tackle this are underway, including increased teachers’ pay in combination with more contact hours and increasing the length of compulsory education. As in other socio-economic spheres, there are significant gaps between Arab-Israelis and the rest of the population. Also, the Ultra-orthodox community’s independent education system presents specific concerns and challenges. In tertiary education, progress has been hindered by the collapse of a reform package that envisaged increased state funding combined with increased student tuition fees, expansion of government-backed student loans and a range of other structural reforms.

Welfare-to-work measures are a central theme of Israel’s labour and social policies to tackle relative poverty, which is concentrated among the Arab-Israeli and Ultraorthodox (Haredi) communities. Policies include pilot programmes involving private-sector job placement (the “Wisconsin” programme) and an earned-income tax credit. Also, there is increased policy attention to help parents to combine work and family through improvements to daycare and early education. Microeconomic simulations of taxes and benefits suggest room for augmenting these policies with adjustments to benefits and tax expenditures. In the labour market, hiring and firing regulations are light, while the minimum-wage is relatively high in comparison with OECD countries, but it is not strongly enforced. Poverty among pensioners is set to fall in the future with the recent introduction of mandatory second-pillar pension saving. But this reform has also raised questions about the structure of tax breaks on pensions.

Israel is assisting businesses and promoting market competition in ways that are familiar to many OECD countries. Nevertheless, red tape is overly burdensome. Active policies to support business include incentives geared towards foreign investors, innovation policies and various aids for small and medium-sized enterprises (SMEs). As in many other countries, the agriculture sector receives considerable support. Ground still needs to be covered in bringing a healthy level of competition in electricity, post and sea ports. Transport infrastructure has struggled to keep pace with the rapid pace of population growth, and the mix between private and public transportation has become unbalanced, adding to problems of congestion in urban areas.