Poverty by Choice
Jul 13, 2006
Serhan Cevik (from Jerusalem)
The rise in poverty reflects structural adjustments as well as institutional factors. After simultaneously suffering a wave of violence and the collapse of the global technology bubble, Israel has enjoyed a remarkable turnaround in the last three years. Real GDP growth accelerated to an above-trend pace and the unemployment rate declined to the lowest level in six years, thanks to prudent macroeconomic policies and structural reforms. Of course, there is no such thing as a free lunch, and structural changes, while raising the economy’s potential output, have also led to a deterioration in some socio-economic indicators, at least in the short term. For example, the number of people living below the ‘poverty line’ increased from 1.08 million in 2000 to 1.53 million in 2004, along with a worsening in the distribution of income and wealth. However, we caution against the ‘blame game’ and prefer to look beyond politically motivated arguments in analysing the latest income figures. Although fiscal tightening and structural reforms have certainly contributed to the increase in poverty, statistical and, more importantly, institutional factors play a far more critical role, in our view.
The poverty rate increased from 17.5% in the 1996-2002 period to 20.3% in 2004. The proportion of poor households exceeded 20% for the first time in 2004 — a significant increase from an average of 17.5% in the 1996-2002 period. Moreover, the average income of the poor was 33% less than the poverty threshold, compared to 25% in the previous years. Some argue that this is simply a consequence of ‘pro-rich’ fiscal measures hitting low-income groups while making the rich even richer. Of course, this would be a headline story in any country, and especially in Israel with its long-standing ‘welfare state’ credentials. But do the figures really support such a line of popular reasoning? Without a doubt, the reduction in welfare payments and other allotments (including unemployment benefits and children’s allowances) contributed to the increase in poverty in recent years. On the other hand, changes in the income tax system have resulted in a growth divergence across the spectrum, raising disposable income of the richest quintile by 6.8% versus a mere 0.1% increase for the lowest quintile. Nevertheless, we need to be careful about generalising short-term developments and policy adjustments.
Relative poverty could be a misleading concept, especially in times of strong growth. Israel’s poverty threshold is defined as half of the median income (after transfer payments and direct taxes) standardised to the family size. In our view, such a relative measure of poverty could be misleading, especially when the economy experiences a strong recovery. In other words, the poverty rate may increase along with economic expansion simply because the income of the upper quintiles tends to grow faster, as it has been the case in Israel in the past three years. Likewise, social expenditures — increasing at an irrational pace in the 1990s — have clouded underlying problems. However, the crisis made it clear that Israel’s welfare system was based on unsustainable policies siphoning as much as 19.1% of GDP. Therefore, the subsequent fiscal correction merely unveiled the hidden poverty resulting from structural and institutional factors. This is why we prefer to focus on a poverty rate based on net income excluding transfer payments and direct taxes. Despite all the difficulties, the poverty rate before transfer payments and direct taxes showed only a small increase from 32.2% of all families in the boom year of 2000 to 33.9% in 2003, and then declined to 33.7% in 2004. Though this is of course no consolation, it is still marginally lower than the average of 33.8% in the 1990s.
Poverty in Israel is primarily a result of the ‘dual economy’ and personal preferences. A closer examination dismisses populist interpretations of the data. Israel’s poor are predominantly Arab and ultra-Orthodox — two demographic groups that share specific institutional factors and cultural preferences limiting their participation in the labour force. For example, about 75% of ultra-orthodox men do not work, thanks to a generous system of allowances. Not surprisingly, Jerusalem, the only Israeli city where most of the residents are either ultra-Orthodox or Arab, is the poorest city in the country. As a result, the reduction in transfer payments led to an increase in poverty incidence. However, the rationalisation of the welfare system should incentivise, to a certain extent, participation in the labour force and reduce poverty. Of course, we should not overlook the role of globalisation and the evolution of Israel’s technology-intensive economic structure. The rise in the demand for skilled workers relative to that for less-skilled workers, for example, has led to an increase in earnings inequality and thereby a worsening in relative poverty. But this is a global phenomenon, and cannot be ‘fixed’ by increasing welfare spending or the minimum wage. That said, the solution is not a mystery to us. As the data show, the risk of poverty is primarily a function of educational attainments — increasing from 7% among households with 16 years of schooling to 36% for families with less than eight years of schooling. Therefore, the recommendation is simple: cut the defence budget and increase spending on education, especially on vocational training.
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