The war in the Gaza Strip is a long one, and we still don’t know how it will end from the economic, diplomatic, political, and social points of view. It’s interesting to compare it with the Yom Kippur War of 1973, which was costly in both blood and treasure. The war began with Israel taken by surprise, and ended with military victory, but with great sadness, political change, an economic crisis, and a "lost decade". The two situations seem similar, but in fact the economic background is different in each case.
The Yom Kippur War
On the eve of the Yom Kippur War, Israel was economically euphoric, with annual growth running at 10%, and an unemployment rate below 3%. Private consumption was high, and government spending on creating a welfare state was also high, following the Black Panther demonstrations. Defense spending was 11% of GDP, and the annual inflation rate was 13%. We had a closed economy, not integrated into global processes. The balance of payments deficit was high, and foreign exchange reserves were low. The shortage of foreign currency was the economy’s main vulnerability.
The Yom Kippur War was a breaking point. It caused a quadrupling of world oil prices and steep rises in raw materials and commodity prices which considerably worsened the balance of payments position. US aid was given in the form of loans bearing high interest rates. In 1974, the Rabin government sought to deal with the complex economic reality, and introduced important reforms in income tax and VAT, and changed the devaluation policy from once every few years to 2% monthly creeping devaluation. Defense spending averaged 27% of GDP in 1974-1977, and there was a high fiscal deficit.
The crisis in national morale after the Yom Kippur War led to the political turnaround in 1977. The inexperienced Likud government that rose to power pursued a mistaken economic policy that led to a worsening inflationary spiral and a severe balance of payments crisis. Fiscal and monetary policy were dysfunctional. The crisis lengthened into the "lost decade", and came to a head in the mid-1980s.
At the beginning of the 1980s, the growth in defense spending led to a fiscal deficit of 13-15% of GDP, and government debt of more than 250% of GDP by the end of 1984. The economy was saved by the "stabilization program" of 1985, which was a watershed. The program rested on the unity government, on a "safety net" provided by the US, which was concerned for Israel’s stability, and on reforms introduced over decades that rescued Israel’s economy from an economic crisis that threatened the country’s very existence.
The Gaza war
Israel’s economic position when the Gaza war broke out in October 2023 was better than it was before the Yom Kippur War, mainly in foreign exchange. This is despite the deteriorating economic trends before the war because of judicial overhaul plans. There were high foreign currency reserves (about $200 billion), a good balance of payments (a $20 billion surplus), full employment (a 3.4% unemployment rate), a low government debt to GDP ratio (61%), and a low expected fiscal deficit (under 2% of GDP). In addition, right at the start of the war, the US announced a generous defense grant.
After 100 days, the war in Gaza is not over, and the uncertainty on the northern front is growing. The government’s military and civilian expenditure will be high - over NIS 200 billion in 2023-2024 - while government debt as a proportion of GDP will rise to 65-66%. Israel can cope with the size of the economic challenge, on condition that fiscal and monetary policy are businesslike and professional. The precise effects will be felt after 2025, and will flow from the way the war ends, from the lessons learned on both the military and civilian sides, and from the government’s economic policy.
A lost decade is avoidable
The Gaza war, like any war or big crisis, will have a long-term impact on the Israeli economy. There is no reason for the economic crisis that followed the Yom Kippur War to be repeated. Israel has an independent central bank with the tools and abilities to cope with crises, and fiscal policy can deal with them. Government ministries have shown themselves to be the weak link in governance and in Israel’s social and economic resilience, and the public’s faith in government needs to be restored through professional appointments.
But, and it’s a big but, our economic fate will be determined by the government’s economic conduct. In the hundred days since the outbreak of the war, the government has demonstrated a low level of leadership and decision-making in the supplementary budgets for 2023 and 2024. There is a risk of uncontrolled expansion of the defense budget after 2025, which may or may not lead to greater security, but which will certainly cause damage to already sub-standard civilian public services.
The greatest challenge for the coming years does not stem directly from the war, but it is critical for the economy and society, and indirectly for security as well: the existence of a large community that is not given an appropriate education for a modern economy, with a low rate of participation in the workforce, and employment in low-paid occupations. If the growth of the haredi population continues accompanied by the same patterns of behavior seen in the past few years, the economy’s functioning and growth will suffer. It won’t be "a lost decade", but "lost decades". Add to that an economic policy that fails to deal with the main problems, and, despite good opening economic conditions, the economy could fall into prolonged crisis.
The crisis must not be wasted. A "muscle building" budget must be formulated that promotes national and social strength, that deals with the behavior patterns of haredi society, and does not hesitate to introduce reforms that promote efficiency, and the flexibility to cope with changing economic and geo-political conditions. Today’s Israeli economy is integrated into the global economy, and is monitored by the international credit rating agencies. Military and diplomatic victory will help Israel’s image in international capital markets. Wise economic conduct will restore Israel to economic and financial stability and to a path of growth and economic development, and will preserve its credit rating.
David Brodet was budgets commissioner in the Ministry of Finance from 1991 to 1994, and director general of the ministry from 1995 to 1997. He has served as chairperson at several Israel companies, among them Bank Leumi (2010-2019) and El Al (2020-2021).
Published by Globes, Israel business news - en.globes.co.il - on January 11, 2024.
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