Israel's macroeconomic policy, driven by the Ministry of Finance and the Bank of Israel, has received many compliments from the International Monetary Fund and other international institutions and foreign governments. The success of their policies is evident: low deficit and inflation, as well as decreased unemployment and national debt. Yet inspite of its high-performing economic institutions, Israel's primary economic problem remains the weakness of its government system.

While Israel's private sector is one of the most sophisticated in the world, its public sector is one of the weakest among developed states. According to data from the 2006 Global Competitiveness Index of the World Economic Forum, Israel's private sector ranks 8th in the world in terms of its financial sophistication, availability of high-level human capital and level of management. The public sector however, is ranked at the bottom of the list of developed countries in the 29th place.

The significance of this data is clear: The engine of growth and prosperity in Israel is the private sector while the public sector actually puts on the brakes. The gap between them is the largest compared to other countries in the developed world.

The significance of this gap is even more serious as a result of the relative size of the public sector. Israel's public sector still constitutes over 45% of its GDP (a 20% decrease in recent years notwithstanding). In other words, Israel's exposure to the weakness of its public sector is very high.

The high tech industry is another example of the gap between the two sectors. Israel is ranked first in the world in relative investment in research and development. The vast majority of this investment is made by the private sector. However, a large part of the knowledge that is developed in Israel ultimately turns into industry in other countries. One reason for this is Israel's distance from international markets. Another however, is the inefficiency of the public sector and the extremely slow and unreliable supply of public inputs that are essential to business development such as legislation, regulation, licensing, permits, infrastructure or international agreements. These factors significantly contribute to the decision of many business entrepreneurs not to translate their inventions into industry here.

Another example of the far-reaching consequences of Israel's governmental weakness is the problem of low labor force participation. The average GDP per capita in Israel is one of the lowest of all developed countries, even though the average productivity of Israeli workers is quite high. In fact, some estimate that the Israeli worker is of the ten most productive in the world. It's the low participation in the labor force that holds Israel back. This problem is mainly political. The main challenge here is obvious: the employment level within the Ultra Orthodox (Haredi) and Arab sectors must be increased. It is also clear why Israel is dawdling on this issue due to short political tenures, chronic instability and fragmentation in the government and Knesset.

Recently, Professor Ricardo Hausmann - one of the most prominent economists in the world on the issue of economic growth - visited Israel as a guest of the Reut Institute. In the summary of his visit he pointed out the outstanding level of frustration surrounding the government's performance. While in most countries it is normal for the private sector to criticize the public sector's efficiency, in Israel, even senior members of the Government doubt its ability to efficiently make and implement decisions.

What is the common denominator among dealing with poverty, education, transportation, law enforcement, the weakness of distant communities in the 'periphery' or the low level of labor force participation among the Arab and Ultra Orthodox communities? One answer is that in all of these areas Israel is dawdling. Yet, another answer is that all of these issues require ongoing cooperation among branches of government in planning, taking and implementing decisions. They require a government that can lead a systemic change in priorities and patterns of conduct.

This is why strengthening the capacity to govern is essential if Israel wishes to leapfrog its socioeconomic performance. If we want to prosper, we will have to reform our electoral system, ensure longer and more stable tenures and reduce the fragmentation within legislative and executive branches. In parallel, we should improve the effective conduct of government while neutralizing (to the extent possible) their exposure to political instability.

Israel has excellent macroeconomic institutions led by the the Ministry of Finance and the Bank of Israel. In spite of exceptional political turbulance, in the past twenty years, their conduct and policies have secured economic stability and moderate growth.

Yet, these institutions cannot lead the societal transformations and realignmnets necessary for rapid economic development. This is the job of the political system. It requires a government that can lead and stay the course.

Hence the conclusion that Israel's primary obstacle to rapid development is its governance and politics. If we wish to prosper, this should be our focus.