Policy variables and growth: evidence from Israel

Abstract

This paper estimates the impact of policy variables on the per-capita Business Sector GDP in Israel in the framework of an extended neo-classical model. The methodology assesses the impact of policy variables on the components of the production function: factors of production (capital and labour) and total factor productivity. Using the cointegration approach, both long-run and short term specifications are tested. It is shown that: i) in the long-run the reduction of taxes, public sector deficit and inflation enhance growth mainly through an increase in total factor productivity; ii) in the short-run transitory changes in taxes do not affect business sector GDP, while persistent changes in taxes do affect it. It is also shown that persistent mass immigration waves to Israel enhanced production through a ‘scale effect’, since they implied an increase in the market size.