|M.Sc Student||Gat Dina|
|Subject||The Neoclassical Growth Model and the Israeli Economy|
|Department||Department of Industrial Engineering and Management||Supervisor||Dr. Benjamin Bental|
|Full Thesis text|
This work aims at explaining the cause of the Israeli economic depression during 1997-2003 from the point of view of a neoclassical model. The method applied in this paper follows Cole and Ohanian (2002). They use data to evaluate the deviations from the first-order conditions in the neoclassical growth theory to diagnose the key sources of the U.S. and the U.K. long depressions which occurred between the two World Wars. Similarly to Cole and Ohanian (2002), this work presents an application of the neoclassical growth model to the business sector of the Israeli economy during 1987-2004. The data were mostly collected from the Bank of Israel web site and were used to assess the first order conditions of the growth model during 1987-2004 compared to 1987.
Large deviations in the efficiency conditions of the labor market were found. Starting in 1991, the labor supply is much higher than that predicted by the model. For the 1990-1998 period, labor demand by firms is lower than that predicted by the model. The firm-capital first order condition was also distorted, indicating that the amount of capital used was lower than predicted during the 1989-1997 period, and higher than predicted during the 2000-2003 period.
A possible explanation of the high labor supply of the households and the distortions of the firm-capital first order condition is the massive immigration from Russia in the early 1990s. These immigrants had a lower initial wealth than the local population, which lowered their marginal utility of leisure, increasing their labor supply. The firm-capital efficiency condition violation is explained by the capital stock adjustment process originating from the low capital stock during 1990-1998. The capital stock shortage followed the rapid growth of population and the labor force. However, these violations of the first order conditions do not explain the severe Israeli economic depression during 1997-2003.
A likely reason to the Israeli depression is found in the firm-labor efficiency condition distortion. The low labor demand seen in this violation indicates hidden wage costs, which may have led to a substantial loss of output. This phenomenon may be due to the high costs of employee recruitment and firing costs, resulting from rigid labor market institutions and strong labor unions.