GLOBAL ECONOMY AND IMPLICATIONS FOR ISRAEL

GLOBAL ECONOMY AND IMPLICATIONS FOR ISRAEL Aaron Institute for Economic Policy Annual Conference May 4, 217 Craig Beaumont, European Department, IMF

Outline World economic outlook (WEO) Broader trends in global economy Policy priorities for Israel 1

Japan United Kingdom United States Germany France Spain Italy Brazil Russia India China South Africa Mexico Turkey Japan United Kingdom United States Germany France Spain Italy Brazil Russia India China South Africa Mexico Turkey Market sentiment has improved since mid-216 1.5 Change in bond yields since August 216 (percentage points) 3 Equity price changes since August 216 (percent) 1..5. -.5-1. -1.5-2. 25 2 15 1 5-5 -1 Source: IMF staff calculations. 2

Along with business and consumer confidence Manufacturing PMI (three-month moving average; deviations from 5) Consumer Confidence (index; 21 = 1) 6 5 4 Advanced economies Emerging market economies 12 115 Advanced economies Emerging market economies World 3 11 2 15 1 1-1 95-2 -3 212 13 14 15 16 Sources: Haver Analytics; and IMF staff estimates. Feb. 17 9 212 13 14 15 16 Feb. 17 3

As global activity has begun picking up steam World Trade and Industrial Production (three-month moving average; annualized percent change, unless noted otherwise) 1 8 6 4 2-2 -4 Industrial production World trade volumes -6 Sources: Haver Analytics; and IMF staff estimates. 211 12 13 14 15 16 Feb. 17 4

Import growth Import growth Trade growth reflects improved investment Advanced Economies (percent; 216) Source: IMF staff calculations. 6 5 4 3 2 1-1 -2-3 -4-2 2 4 6 8 Fixed investment growth Emerging Market and Developing Economies (percent; 216) 25 2 15 1 5-5 -1-15 -2-25 -3-3 -25-2 -15-1 -5 5 1 15 2 25 3 Fixed investment growth 5

Forces shaping the outlook Advanced economies Emerging market and developing economies Ongoing forces Cyclical rebound & monetary stimulus Post-crisis repair varies Expansionary U.S. fiscal policy Rebalancing in China Adjustment to lower commodity prices Geopolitical and political factors overlaid on Demographic headwinds Demographic trends Weak productivity growth 6

World growth rises to 3.8% by 222, from 3.1% in 216, led by Emerging and Developing Economies 7 6 5 World GDP Growth (percent) World Advanced economies EMDEs Advanced Economies Cyclical recovery in near term, subdued growth in medium term, at 1.7% in 222. 4 3 2 1 Emerging Market and Developing Economies Stressed economies bottoming out, commodity importers generally 1995-24 25-215 216 222 Source: IMF staff calculations. projected to maintain high growth, overall growth of 5% by 222. 7

Core inflation little changed even as headline inflation up recently Euro Area inflation reaches 2% gradually, led by Germany Advanced Economies (three-month moving average; annualized percent change) Euro Area Headline CPI Inflation (percent) 4. 4. 3 Headline 3.5 Euro area 3.5 2 CPI 3. 2.5 Germany Italy 3. 2.5 1 Core CPI 2. 1.5 1..5 2. 1.5 1..5-1. -.5. -.5-2 212 13 14 15 16 Source: IMF staff calculations. Feb. 17 2 24 28 212 216 22 Source: World Economic Outlook, April 217. 222 8

But global growth risks skewed to downside Protectionism. Inward-looking policies could hurt demand and productivity. U.S. macroeconomic policy mix. Faster-than expected U.S. interest hikes and dollar appreciation could temper U.S. growth and stress vulnerable economies. Financial threats to EMs. Some EM countries are exposed to sudden shifts in investor confidence. In China, continued reliance on credit and slow restructuring mean that the risk of an eventual disruptive adjustment is growing. Sharp rollback of financial regulation. Higher risk of costly financial crises. Weak demand and balance sheets. In parts of Europe, adverse feedback among low demand, low inflation, weak balance sheets, and anemic productivity growth. Non-economic shocks. Geopolitical tensions, political discord, extreme weather events, and terrorism and security concerns. 9

Impact of U.S. Fiscal Stimulus on Other Economies: Depends on Supply-Side Effects and thus Interest Rate Reaction Illustrative fiscal stimulus of 1% of GDP in 218, and 2% of GDP in 219-221 Advanced Economies Real GDP (percent deviation from case with no change in U.S. fiscal policy).4.2. -.2 -.4 Less productive fiscal stimulus Highly productive fiscal stimulus Emerging Markets Real GDP (percent deviation from case with no change in U.S. fiscal policy).4.2. -.2 -.4 Less productive fiscal stimulus Highly productive fiscal stimulus -.6 217 219 221 223 225 Source: IMF staff calculations. -.6 217 219 221 223 225 1

Implications of Global Outlook for Israel? Export growth stronger: about 4% in 217-19, from almost flat in 214-16 Real GDP growth solid: about 3% in 217-19 Employment growth about 2.5%, so unemployment remains below 5% But productivity growth low, about.5% Inflation rises: low unemployment aids wage growth, higher global inflation Interest rates rise in time: yet low global interest rates may limit increase Housing prices: recent stability welcome, but potential for renewed upward pressures if interest rates remain low and supply gains are not lasting 11

Some Broader Trends in the Global Economy Slowing international trade World Economic Outlook, Oct. 216, Chapter 2 Declining productivity growth Gone with the Headwinds: Global Productivity Growth, IMF Staff Discussion Note, SDN/17/4, April 217 Low interest rates Global Financial Stability Report, April 217, Chapter 2 Falling labor share of income World Economic Outlook, April 217, Chapter 3 12

Productivity Growth Has Slowed Around the World Total Factor Productivity Growth, 2 22 (PPP GDP-weighted; dashed lines indicate period average) Partly a crisis legacy, as investment hit by: weak corporate balance sheets and tight credit 5 Advanced economies weak aggregate demand 4 3 2.8% Emerging market and developing economies uncertainty about economic policy 2 1-1 1.% 1.3%.3% 1.9%.7% But structural headwinds continue to slow productivity: ICT boom waning aging workforce, slower human capital gains -2 2 24 28 212 216 22 Source: IMF staff estimates. global trade integration slowing, e.g., China benefits of earlier EMDC reforms fading 13

Israel s Labor Productivity Growth has also Slowed Primarily in Manufacturing Labor Productivity Growth 15 (Percent) 15 Productivity 1996 211 1 1 Growth % -27-216 5 4% 1.3%.5% 5 Total 1.3.5 Manufacturing 4..4.4% Other.8.7-5 Whole economy -5 Manufacturing -1-1 1996 1999 22 25 28 211 214 Sources: Central Bureau of Statistics; and IMF staff calculations. 14

Labor s share of income has fallen in many countries including Israel Israel 15

Decline in Israel s labor share broadly in parallel with AE But Israel s labor share decline continued post crisis? Labor Share of Income (Percent) 6 55 6 55 Ratio of Israeli Labor Share to Advanced Economy Labor Share (Index, 1995=1) 14 12 5 5 1 45 4 35 3 Israel Advanced Economies (AE) Emerging and Developing Economies (EMDE) 19719751981985199199522521215 45 4 35 3 98 96 94 92 9 (May reflect terms of trade gains over 2% since 28, rather than real wages rising slower than labor productivity.) 1995 1997 1999 21 23 25 27 29 211 213 215 Source: World Economic Outlook, April 217. Sources: World Economic Outlook, April 217; and Fund staff calculations. 16

Technology key driver of declining labor shares in AEs, and Global Value Chain participation in EMs. Hollowing out of medium-skilled Aggregate Results: Contributions to Aggregate Labor Share Changes, 1993 214 (Deviation from regression constant) Contributions to Aggregate Labor Share Change by Skill, 1995 29 6 4 Technology Financial integration Unexplained GVC participation Policy/institutions Actual change 12 1 8 Technology Financial integration Actual change Global value chain participation Skill supply and other composition shifts 2 6 4 2 2 4 2 6 4 6 8 AEs EMs EMs exluding China 8 High skill Middle skill Low skill Middle-skill AEs

LTA EST KOR POR GRC CZE ISR SVN NZL 1/ SVK JPN ISL 1/ ITA ESP GBR CAN FIN AUS AUT CHE SWE DEU FRA NLD DEN USA BEL IRL NOR LUX Implications of broader trends for Israel Global productivity growth may remain below prior trends Labor Productivity Comparison, 215 (GDP per hour worked, USD constant prices 21PPPs) Reduce Israel s productivity shortfalls to 9 8 9 8 the major advanced economies to help 7 7 sustain solid growth 6 5 6 5 4 4 3 3 2 2 Technology appears to be reducing labor 1 1 shares which constrains real wage growth Improve the skills of Israel s labor force to limit these pressures on living standards Sources: OECD; and IMF staff calculation. Note: 1/ 214 data is used due to data availability. 18

Policies for strong and inclusive growth in Israel Education and infrastructure investment Reform education to reduce achievement gaps 12 Labor Force Participation Rate by Cohorts (percent) Haredi Male Haredi Female Arab Male 12 Training to boost skills of those already in work 1 Arab Female Jewish Male Jewish Female 1 Upgrade public transport infrastructure Product market reforms to boost productivity 8 8 Lower barriers to external competition 6 6 Reduce regulatory burden, e.g., one-stop-shop Reform state enterprises 4 4 Broaden labor participation Expand active labor market policies (ALMP) Enhance environment for job creation by SMEs Raise the EITC welcome recent MoF proposal Sources: CBS; and IMF staff calculations. 19 2 23-5: Cut child allowance 25-7: Mehalev Program 27-9: Visions for Employment Program 21 23 25 27 29 211 213 215 2

Macroeconomic policies for global growth recovery subject to downside risks Supportive environment for structural reforms while protecting fiscal buffers: Monetary policy: remain accommodative pending a durable rise in inflation Fiscal policy: ensure Israel has substantial fiscal space to help cushion shocks Achieve central government deficit of around 2% of GDP over the cycle, which will keep public debt around 6% of GDP Generate spending savings and revenue gains to enable enhanced investment in education and infrastructure, plus expanded ALMP and EITC. Housing: reforms to generate lasting supply gains to meet rising population needs Macroprudential policy: appropriately tight, Bank of Israel to monitor closely Financial sector: safeguard stability during reforms to promote efficiency 2

Thank you! תודה! 21

Growth projections: Advanced economies (percent change from a year earlier) World Advanced Economies U.S. U.K. Japan Euro Area Germany Canada Other Advanced Asia 216 3.1 1.7 1.6 1.8 1. 1.7 1.8 1.4 2.3 217 3.5 2. 2.3 2. 1.2 1.7 1.6 1.9 2.5 Revision from Oct. 216.1.2.1.9.6.2.2.. 218 3.6 2. 2.5 1.5.6 1.6 1.5 2. 2.6 Revision from Oct. 216..2.4.2.1..1.1.1 Sources: IMF, World Economic Outlook October 216 Update; and IMF, World Economic Outlook April 217. 22

Growth projections: Emerging markets and LIDCs (percent change from a year earlier) World Emerging Market and Developing Economies China India Brazil Russia Commodity Exporting Economies Low Income Developing Countries 216 3.1 4.1 6.7 6.8 3.6.2 1. 3.6 217 3.5 4.5 6.6 7.2.2 1.4 2.3 4.7 Revision from Oct. 216.1.1.4.4.3.3.2.2 218 3.6 4.8 6.2 7.7 1.7 1.4 2.9 5.3 Revision from Oct. 216...2..2.2.1.1 Sources: IMF, World Economic Outlook October 216 Update; and IMF, World Economic Outlook April 217 23