Journal Issue

Japan and Israel

International Monetary Fund. External Relations Dept.
Published Date:
June 1966
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Orville J. McDiarmid

THE GREAT ECONOMIST Alfred Marshall warned that all economic generalizations are fallible; those about fast economic growth are perhaps even more fallible than others. Therefore, discretion is advisable when making generalizations based on observations of the growth process under particular circumstances. In this respect, economists are rather like the blind men of Hindustan whose observations, it will be recalled, were of limited validity in appraising the elephant as a whole, though fairly accurate for the particular portions of the beast with which they were individually in contact.

Thus we can hardly hope to draw lessons of universal validity from recent experience in Israel and Japan, the two frontrunners in the growth sweepstakes during the last decade. We may, however, identify some factors common to both countries which appear to have contributed to their success.

But even while we are looking for similarities, we see striking differences between these two countries, located at either extremity of Asia. Israel’s area (about half that of Switzerland) is only about 6 per cent of Japan’s, and her population is less than 3 per cent of the larger country’s. About a third of Israel is arable with a water supply that is adequate at present; the mountains and cities of Japan leave only some 15 per cent of her area to be used for agriculture. Thus the pressure of population on the soil is roughly four times greater in Japan. Nevertheless, an outstanding feature of the recent history of both countries has been their successful application of mature and sophisticated techniques to scarce natural resources.

The Growth Achieved

A decade and a half ago, few predicted even a normal economic future for Japan and Israel. Official Washington certainly placed them both high on the list of “difficult” cases likely to require U.S. largesse for a long time to come. As late as 1952, Secretary of State Dulles observed, perhaps in a rare humorous vein, that suicide was not an illogical step for anyone concerned about Japan’s economic future. To spread the laurels of prescience further, the World Bank, in 1955 and even later, was appraising Japan’s total future creditworthiness at a figure much below what it now lends to that country in a single year. Israel was not considered as a serious candidate for hard loans until after 1960. Even in retrospect, these judgments do not seem unreasonable, given the facts then available and the tendency that we all have to overlook the intangible elements in economic progress.


Yet the economies of both countries have grown more than 10 per cent a year during the last decade, Israel’s at a fairly steady rate and Japan’s at varying rates depending on the phase of her economic cycle. Japan’s greatest expansion took place in 1959-61, long after the prewar level of output was regained in 1952. In those three years, the annual growth rates were 14-18 per cent, compared with 7-14 per cent since 1961. Both countries enjoyed their most rapid growth when they were already well off by comparison with other developing countries. In 1954, Japan had a per capita gross national product (GNP) of $232 and Israel $745. Now these have grown to about $714 and $1,177, respectively.

Structural Features and Resources

Exceptional labor forces and strong entre-preneurship plus large inflows of capital are the assets most frequently cited as contributing to the economic growth of the two countries. The Japanese are undoubtedly exceptional among developing nations; their literacy and technical competence rank near the top. On the other hand, the labor force of Japan is not unique and does not explain why that country has far outdistanced the economic growth rates of the United States and of European countries, which have labor forces of at least comparable quality.

Israel’s problem of assimilating and retraining her labor force has been difficult and far reaching. About half of her immigrants (contributing about half of her population growth) have come from Africa, where the Jewish people were poorly educated and without experience in modern industry. While she has obtained highly capable technicians and professionals from Europe, many of them had to seek a livelihood in new ways, erstwhile professionals frequently joining agricultural communities. A common tradition combined with a strong sense of national purpose no doubt has helped to mold this heterogeneous population into an instrument for rapid economic growth. Also, for the new arrivals from Europe, the desire to regain a European standard of living (consumption has been increasing at a rate of more than 6 per cent a year) probably stimulated an all-out productive effort. In Japan, too, the effort to make up for the wartime losses in personal well-being has been an extra stimulus.

Both Japan and Israel have been able to draw on a substantial number of competent persons who were at or near the peak of their productive powers. Also, thanks largely to these new entrants to the labor force, the two countries enjoyed their most rapid economic growth when they had surplus or underutilized labor. This condition persisted in Japan up to 1960 and in Israel even later. Yet even when the supply of labor ceased to be abundant, there was no significant setback to the rate of growth of either country.

The limitations to the physical resources of Israel and Japan are very similar. Japan is almost completely dependent on imports for such vital materials as petroleum, ferrous and nonferrous ores, natural textile fibers, and rubber. Israel lacks nearly all industrial materials except some phosphates and potash extracted from the Dead Sea brine. Areas suitable for agriculture are limited in both countries. In fact, the growth records of Israel and Japan (and more recently of the even more overcrowded Taiwan) almost suggest the hypothesis that constraint on agricultural and primary industrial expansion is a precondition for rapid economic growth. There is no doubt that the transfer of labor resources from agriculture to industry has been associated with the increase in the productivity of labor in both industry and agriculture. Limitation of space has forced both countries along the difficult road toward high technical competence and managerial efficiency.

As for their environments, both Japan and Israel have been fortunate in being able to draw on new foreign techniques in a period of rapid technical change. Failure to recognize this potential was a principal cause of the mis-judgments made immediately after World War II, when both countries did indeed seem to be at a disadvantage. Israel, cut off from contact with the outside world except by sea and air, subject to the Arab boycott, and outside all the world’s preferential trading blocs, appeared ill-placed to compete. Japan seemed to be severely handicapped because of the loss of her former Asian territories, the trade restraints of the cold war, and the reluctance of many Western powers to admit Japanese products on a basis of parity. Some of these disadvantages have persisted.

Under these handicaps, the 5½-fold increase for Israel and the nearly 5-fold increase for Japan in the volume of their exports in the decade 1954-63 indicate their capacities to seek out and exploit their comparative advantages. Their rapid adaptation to new lines (light to heavy industry in Japan and cheaper to more expensive textiles, diamond cutting, and other labor-intensive products in Israel) and their maintenance of realistic export exchange rates (by a somewhat undervalued rate set in 1949, followed by conservative monetary and fiscal policies in Japan and several devaluations in Israel) were among the causes of this success.

Mobilization and Use of Resources

The immediate conditions for rapid economic growth in Japan and Israel have been the high commitment of total national resources to investment and a high return on this investment. Japan has invested a phenomenally high proportion of her GNP; investment averaged 39 per cent during the first five years of this decade, and rose to 44 per cent in 1961. Net capital imports contributed only a small portion of the resources required. Israel’s investment rate has also been high, averaging about 30 per cent of GNP between 1960 and 1963. (These figures compare with less than 20 per cent for relatively fast growing economies, such as Pakistan.) However, in contrast to Japan, 50 per cent of Israel’s investment resources came from abroad. It follows that Israel’s gross savings have been comparatively modest, 10-12 per cent of GNP in the last few years. But the spread between the two countries’ ratios of private savings to national income has not been great. Private savings in Japan have been about 28 per cent, and in Israel about 20 per cent, of national income. Because of the heavy expenditures for the settlement of immigrants, the Israeli Government has been unable to save. By comparison, about a third of Japan’s savings has been generated in the public sector.

Israel’s progress, even up to the present, is widely thought to depend on the flow of grants and other transfers from her friends abroad. However, these have probably contributed more to consumption than to investment in recent years. In fact, while Israel’s growth in the first decade or so of the State would have been impossible without liberal outside support, in recent years growth has been based largely on domestic savings and foreign borrowings on conventional terms. Neither in Israel nor in Japan can the continuing rapid progress of the economy be explained by the inflow of foreign capital.

Both countries have obtained a very high return on investment (their capital/output ratios have been between two and three), and the authorities have made sure that the private sector has had great freedom to invest. This freedom has led to a lower level of public investment than would have been desirable in the long run. The compensation has been in the growth achieved in the private sector.

What has accounted for this very efficient use of new capital investment? First, Israel and Japan have a great variety of industrial and agricultural establishments highly differentiated as to capital intensity and technology. The size of plant is well adjusted to the economics of the production process. Because of her small size, Israel, more than Japan, is a country of small-scale industry with more than 60 percent of the industrial labor force employed in plants of less than 100 workers. In both countries small industrial establishments apply large amounts of highly skilled labor to inexpensive machinery.

The second factor that has contributed to the favorable capital/output ratio is also structural. The capital stock of both countries is relatively “new” and has been used very flexibly. Entrepreneurs have diverted corporate savings (or communal savings of the Israeli Kibbutzim) from lines with little promise to those giving greater hope for profits. The Japanese shift from textiles to light industry to heavy industry all in the space of a few years, and the Israeli shift from agriculture to light but high-quality industrial products, illustrate this. The recent change in the direction of Israeli investment is the more remarkable because during the 1950’s agriculture was growing faster than the rest of the economy (agriculture’s contribution to GNP grew from 8.6 per cent to 12.7 per cent).

With the approaching labor shortage, both Japan and Israel are using labor more economically in industry and agriculture. In Israel, from 1958 to 1963, capital stock per worker in agriculture increased by 83.8 per cent and in industry by 41.2 per cent. In Japan, from 1957 to 1961, fixed capital investment per worker increased by 7.6 per cent a year, compared with 3.4 per cent a year from 1951 to 1957. Over the three years 1961-63, output per worker in manufacturing increased by 24 per cent in Japan, compared with only about 11 per cent in the United States.

Institutional Factors

Both the Israeli and Japanese people have an extraordinary capacity for improvising institutions conducive to economic development at the particular time they are needed. However, these institutions do not include a strong central planning system. There is relatively little effort made at detailed planning of the private sector. In Israel, the “private” sector includes the powerful National Labor Federation, or Histradrut, which not only strongly influences labor policy for the country as a whole but owns a large segment of Israeli industry and, through the Kibbutzim and Moshavim (cooperatives), has large agricultural interests. The Histradrut and its affiliates have performed a useful function in the field of collective saving and capital formation, particularly in the early years of the State. The cooperative system is also extremely strong in Israel, as it has long been in Japan. Thus collective elements are influential in the private sector.

These institutions have helped their countries to develop along essentially capitalistic lines without a capital market considered efficient by U.S. or European standards. In both countries, private savings are mobilized to a very large extent by and through the commercial banking mechanism, and the relations between banks and industries are very close. From their experience, it is difficult to contend that a broadly based capital market with a wide diffusion of equity ownership is necessary for rapid economic growth.

The experience of Israel suggests that financial stability achieved by orthodox fiscal and monetary policies may not always be a necessary precondition to sustained economic growth. To a much lesser extent, this is true of Japan, which has experienced substantial fluctuations in monetary stability. Japan’s fiscal policy has been conservative since Occupation times, and little recourse has been made to either the banking system or the money market to finance public expenditures. On the other hand, commercial bank credit to the private sector has increased considerably faster than the growth of the economy. Money supply increased from about 26 per cent of gross national expenditure at the beginning of 1961 to more than 32 per cent in 1963, despite the fact that in 1962 Japan was experiencing one of its well-known liquidity crises, when a “tight money” policy is used to correct an adverse balance of payments. The vigorous growth in the productivity of Japan’s manufacturing sector has restrained the impact of monetary expansion on wholesale prices over the years, despite considerable year-to-year fluctuations. However, consumer prices rose about 40 per cent during the decade following the Korean war. The relatively inefficient distribution sector, combined with rising costs of food, explains part of the striking divergence between wholesale and retail price trends.

Israel has followed a much less orthodox course. Monetary expansion has been kept within the bounds of the real growth of the economy in only a few years; and in recent years it has been two or three times that growth. As in Japan, bank credit to the private sector has been the dominant factor, though the financing of government deficits has also been important. Particularly in the last few years, large net inflows of foreign exchange have produced inflationary pressures.

For better or for worse, Israel has played a pioneering role in “accommodating” herself to the problems of a growth cum inflation economy by linking the wage and debt structure to the consumer price index and/or to the exchange rate. The exchange rate, in turn, has been adjusted whenever domestic prices and wages have threatened to drive the current account deficit above the net inflow of capital. These linkage arrangements have been viewed with consternation by the orthodox, since, like so many palliatives, they tend to perpetuate the ailment they are designed to relieve. However, they have reduced the distortions and inequities that otherwise would have flowed from long-sustained inflationary pressures.

The fiscal and monetary management in both countries has not handicapped the growth process, though in Japan at least it has made it more jerky than perhaps it needed to be. One would be hard pressed to maintain that a lesser response to the underlying demand for credit would have produced more economic growth. The fact that the spigot had to be turned halfway off from time to time seems only to have whetted the thirst of the business community for another long draught of credit when the balance of payments was restored to health, or whatever other malaise was brought under control.

Neither country has a genuinely free labor market. Insofar as wage determination is concerned, the restraints on market forces are greater than those to be found in most free enterprise economies with trade unions and collective bargaining. In Israel, in addition to the fact that the results of the periodic wage negotiations between the Histradrut and the Manufacturers’ Association are accepted as the bases for wage adjustments throughout the economy, the linkage between wages and the cost of living further limits the scope of wage flexibility. In Japan, while the labor movement is highly fragmented, the traditional stratification of the wage structure by age groups, and the custom of lifetime adherence to a single employer, also reduce the adjustment of wages to economic change. In both countries, however, the growing shortage of young skilled labor is imparting more and more flexibility to wage agreements. While real wages have been rising in both countries, they have lagged behind increases in productivity.

The Future

What of the future? Lack of water is probably the most important hindrance to future economic growth in Israel. Only a massive technological breakthrough in desalinization can remove this constraint. Israeli agricultural production, after a decade of rapid growth, may have to be stabilized after another five years or so. No such physical limitation applies in Japan.

Some time, perhaps a decade hence, a labor shortage may be a constraint on the economic growth of both these countries, though this cannot now be predicted with any assurance. Japan, of course, looks only within its own border for its labor, while Israel looks both within and without. Thus the latter’s situation may be regarded as the more hazardous. The age structures of the population of both countries are still very favorable to high productivity. In Japan, two thirds of the population is between 15 and 64 and the working age is being extended because of greater longevity. Fuller utilization of the capacities of older workers is one basis for believing that labor shortage will prove to be less important than it now appears to be. Today, dual employment is common in both Israel and Japan (one third of the male agricultural workers in Israel are also in nonagricultural pursuits).

It would be unwise to predict that shortage of capital is likely to limit economic growth in either country in the near future. However, both countries have problems. Japan’s is to maintain her phenomenally high savings rate in the face of all the enticing consumer items her factories are turning out. Israel’s is that of replacing by domestic savings the reduction in net capital inflow that seems certain to occur a few years hence. Neither task should be beyond the capacity of these two countries that have accomplished so much against much higher odds than they now face. Adaptability has been possibly their greatest advantage, and neither country is likely to lose it.

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