1. The Israeli Economy: Challenges and Opportunities Objectives of Economic Policy for 2011-2012 State of Israel Ministry of Finance Click here for attached press release

2. Topics: Israel’s economy: strengths, weaknesses, threats, and opportunities Challenges of economic policy Key points of economic policy

3. Challenges of Economic Policy Resilience of the economic system to shocks Increase in per-capita GDP and improvement of relative positioning Strengthening disadvantaged population groups and reducing social inequalities

4. Key Points of Economic Policy Chapter I – The future of human capital and the sophisticated industries Chapter II – Infrastructure development and promotion of internal growth drivers Chapter III – Addressing the labor market Chapter IV – Responsible fiscal policies

5. Strengths and Opportunities A tradition of structural reforms and responsible fiscal policies Coped impressively with the challenges of the last decade Strong starting point compared to peer countries The Israeli Economy: Strengths, Weaknesses, Threats, and Opportunities

6. A Tradition of Structural Reforms and Responsible Fiscal Policies Five years of high growth rates (until the crisis) Consistent surplus in balance of payments; strong currency Responsible, growth-supporting fiscal policies:  Gradual reduction of level of public expenditures  Falling levels of deficit and debt  Competitive tax rates  Balance and stability in the public-sector wage system Monetary stability Strengths and Opportunities

7. Security situation escalates; dot- com bubble; global slowdown Second Lebanon War Operation Cast Lead Global economic crisis Coped Impressively with the Shocks of the Last Decade Strengths and Opportunities

8. Strong Starting Point Compared to Peer Countries Growth-supporting fiscal environment High national expenditure on R&D Outstanding knowledge-intensive industries High quality of human capital Flexible business-sector labor market Strengths and Opportunities

9. Signs of Erosion and Threats Erosion of human capital and knowledge-intensive industries Worsening competitive conditions in the global arena Rapid changes in composition of population – education and employment Quality of services for citizens and businesses in need of improvement Infrastructure gaps – overloaded transportation systems; land and real estate Heavy burden of defense along with security risks Uncertainty in the global economy The Israeli Economy: Strengths, Weaknesses, Threats, and Opportunities

10. Relative advantage in leading fields Ongoing improvement in macro data Good launching point at emergence from the crisis High growth potential for the Israeli economy Window of opportunity to take advantage of success One Economy – Two Stories Trend towards erosion of advantages Demographic scenario: decline in employment and productivity, increase in social inequalities Uncertainty in the global economy Regional / security-related instability Doubts regarding growth potential; level of competition and level of inequality Need to inject new fuel into growth engines An opportunity to set the direction of the economy for the coming years The Israeli Economy: Strengths, Weaknesses, Threats, and Opportunities

11. Challenges of the Economic Policy Resilience of the economic system to shocks Increase in per-capita GDP and improvement of relative positioning Strengthening disadvantaged population groups and reducing social inequalities

12. Key Points of Economic Policy Chapter I – The future of human capital and the sophisticated industries Chapter II – Infrastructure development and promotion of internal growth drivers Chapter III – Addressing the labor market Chapter IV – Responsible fiscal policies

13. Chapter I – The Future of Human Capital and the Sophisticated Industries  Promotion and development of knowledge-intensive industries  Human capital – education and reform of higher education  Increasing the relative advantage of export industries while granting precedence to industry in peripheral regions Key Points of Economic Policy

14. Chapter II – Infrastructures and Promotion of Internal Growth Drivers  Physical infrastructures – land, real estate, transportation  Improved services for citizens and reduced bureaucracy Improved ability to do business More efficient court system Better management and execution capabilities in the public sector  Structural reforms – energy, ports, communications, and defense industries Key Points of Economic Policy

15. Chapter III – Addressing the Labor Market  Adoption of policy targets in the area of employment  A national plan for employment of chronically unemployed persons based on the “Employment Lights” format  Removal of barriers for Haredi (ultra-orthodox) men to seek work  Improvement of tools for the encouragement of employment of Arab women  Reduction of the number of foreign workers  Addressing the problem of illegal entry Key Points of Economic Policy

16. Section IV – Responsible Macro- Economic Policies  A continued responsible fiscal policy – a sustainable fiscal rule: Desirable government size Falling deficit trajectory Debt reduction  Two-year budget Key Points of Economic Policy Maintaining fiscal credibility

17. Effect of Change in Debt to GDP Ratio in 2009 on Government Resources Rate of debt out of GDP Interest expenses (NIS billions) Amount freed (NIS billions) 60%269.2 80%350 100%449.6-

18. Israel’s Credit Rating Current credit rating  Moody’s - A1 (Stable)  S&P – A (Stable)  Fitch – A (Stable) Nov 2007 S&P upgrade Israel to A Feb 2008 Fitch upgrade Israel to A April 2008 Moody’s upgrade Israel to A1 All Three Credit Rating Agencies Re-affirmed Israel’s Rating/Outlook in 2009

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20. Strengths: Indicators

21. Five years of high growth, rapid recovery from the crisis Recovery Starting in Q2 2009 1999-2010, annual rates of change

22. Confidence in the markets – a surplus in the current account of the balance of payments Percent of GDP (right axis) In USD millions and in percent of GDP

23. Falling rates of debt Source: CBS; Economics and Research Division, MOF Reduction of Public Debt as a Percentage of GDP

24. Assuming growth rates of 4% in 2011-2013 and 3.5% from 2014 forward. 67.8% Test point Trajectory for Reduction of Debt-to-GDP Ratio, 2003-2020 Responsible, balanced fiscal horizon Simulation ActualMaastricht Treaty

25. Gradual reduction of level of public expenditure Source: CBS; Economics and Research Division, MOF Reduction of Public Expenditure as a Percentage of GDP

26. Assuming growth of 4% in 2011-2013 and 3.5% from 2014 forward. Responsible, balanced fiscal horizon Trajectory for Reduction of Public Expenditure, 2003-2020 Simulation Actual

27. The economic crisis: Late, moderate damage; early recovery Quarterly growth, annualized rate Growth of Gross Domestic Product, in Israel and Globally

28. Expenditure for Civilian R&D, 2007* (in percent of GDP) * 2007 or latest year for which data are available. High rates of expenditure on civilian R&D

29. Rate of Contribution of Technology Sector to Exports, 2001-2009

30. Source: Education at a Glance 2009 High quality of human capital Rate of Academic Degree Holders out of Total Population in OECD Countries

31. Flexible labor market in the business sector Quick response by employers:  Early, rapid response at onset of crisis  Early recovery at emergence from crisis Examples of adjustments in the business sector:  Cutback of full-time positions and expansion of part- time positions  Decrease in nominal wages  Prudent, rational reduction of number of employees

32. Signs of Erosion and Threats: Indicators

33. Low achievement at all levels, including excellent Pisa 2006 Signs of Erosion and Threats Level 6 Level 5 Level 4 Level 3 Level 2 Level 1 Below Level 6 IsraelOECD average

34. Aging of academic staff, moving away from optimal academic productivity age Average age of senior academic staff in Israel, 2010 Source: B. Jones, “Age and great Invention”, Review of Economics and Statistics, January 2010 Signs of Erosion and Threats

35. Rates of employment, ages 25-64, 2008 Source: Bank of Israel Report 2008, manpower surveys 83% 82% 74% 40% 62% 74% 23% 57% 72% 78% 48% % TotalWomenMen OECD averageOthersArabHaredi

36. Gender differences in wages Average Wages, in NIS per Employee Position, 2007 Source: Karnit Flug, “The Israeli Labor Market: An International Comparison,” Sept. 2009. Calculations based on CBS data.

37. Source: CBS Statistical Almanac, 2009. Calculations by Taub Center. Rapid change in composition of population of students Composition of Students in Schools, 1960-2014, in Percent Signs of Erosion and Threats

38. Gap between supply and demand in the housing market Source: CBS Cumulative gap over one decade: 116,000 housing units, ~10,000 units per year Signs of Erosion and Threats Construction starts Increase in households

39. Original budget 26.6% growth within a decade! Development of IDF/Defense Ministry Budget NIS millions, 2010 budget prices (net budget) Heavy burden of defense budget Original budget

40. Changes in Net Defense Budget for 2006-2009 (2010 prices) 46.0 48.3 46.2 51.6 Original budget Changes during the year Combat expenses

41. * Government expenditures excluding defense expenditures and interest payments. Source: Calculations by the Economics and Research Division, based on data from the IMF, OECD, and CBS. Heavy burden of defense – low civilian expenditure Broad Government Civilian Expenditures* International comparison, 2008, in percent of GDP Signs of Erosion and Threats

42. Source: Dr. Michael Sarel, Israel Economic Association conference, May 2010. In the “business as usual” scenario – a negative demographic effect at an annual rate of 0.45% (per-capita GDP) Men: Effect of Demographic Composition for Ages 20+ Analysis of the “business as usual” trend with regard to the adoption of employment and wage patterns in the non-Haredi Jewish population. One Economy, Two Stories Employment rate Productivity for adults (20+) Wages per employee