ISRAEL’S ECONOMIC GROWTH: SUCCESS WITHOUT SECURITY By Linda Sharaby*
While economic development theorists generally hold that security is a prerequisite for economic growth, Israel’s war-torn history has not prevented it from creating a strong, modern, and diversified economy, one which rivals European countries instead of its neighbors in the region. This article considers the factors that allowed for Israel to succeed economically despite its persistently poor security situation. It specifically cites the importance of the location and type of violence Israel has faced, the consistent arrival of highly educated immigrants, the influx of foreign capital driven by political motives, and the development of a robust domestic military-industrial complex.
Since independence in May 1948, Israel has Foreign Policy magazine’s Globalization fought six wars, two intifadas, a continuing Index.(3) Over the past decade, Israel’s high- terrorism threat, an economic boycott, and technology industry, second only to California’s intermittent diplomatic isolation. It is currently Silicon Valley in concentration of firms, in a formal state of war with two of its powered economic growth and attracted neighbors (Syria and Lebanon) and has only a massive Foreign Direct Investment (FDI) to the cool peace with the other two (Jordan and country, a figure that reached $4.4 billion in Egypt), despite peace treaties. In effect, all of its 2000.(4) land borders are relatively closed to trade. More Israel today ranks third in the world in the generally, it is an outcast in the Middle East, number of university graduates per capita, after deprived of any opportunity to benefit from the the United States and the Netherlands.(5) It commerce generated by regional oil wealth but possesses the highest per capita number of having to bear the costs of living in a scientists in the world, with 135 for every neighborhood characterized by arms races and 10,000 citizens (compared to 85 per 10,000 in instability. the United States),(6) and publishes the highest Nonetheless, Israel has a strong, modern, number of scientific papers per capita.(7) and diversified economy that in 2000 posted an According to one recent survey, almost 81 annual Gross Domestic Product (GDP) of percent of Israelis own cell phones, placing it $104.1 billion, 40 percent of which consisted of sixth in the world. Another survey found that exports of goods and services. Growth for 2000 54 percent of Israelis own personal computers, reached six percent.(1) Israel’s per capita Gross in comparison to only 42 percent of U.S. National Income (GNI) for 2000, at almost respondents.(8) $17,000, placed the state ahead of Spain, Measured against the performance of other Portugal, Greece, and New Zealand.(2) No countries that gained independence after World longer classified as a “developing country” by War II, Israel’s economic success has been the World Bank, 54-year-old Israel now ranks nothing short of remarkable—and highly as a high-income economy and was identified unexpected. In creating a modern industrial as one of the most global emerging markets by economy rivaling those of several Western
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European countries, Israel has defied a host of and then again in the 1990s, the influx of so conventional predictors of sustainable many people, including highly educated and economic development, most conspicuously the skilled workers, created an instant domestic premise that security is a necessary, if not market and a rich reservoir of human capital. sufficient, prerequisite for economic growth. Third, partly because of its precarious Given its historic lack of security, how has military position, resource-poor Israel attracted Israel managed to achieve such high levels of large amounts of foreign capital driven by economic prosperity? What accounts for political, rather than economic, motives. Israel’s unexpected economic success? Foreign loans and outright transfers in the form It is essential at the outset to define what of donations from Jewish communities, “security” means in the Israeli context. reparations from Germany, and military and Generally, threats to a country’s security can be economic aid from the United States facilitated divided into two categories: internal and the country’s development as well as its external. Internal threats refer to issues of law citizens’ relatively high living standard. and order, and include demonstrations and Last, and perhaps most important, Israel’s street violence connected to political instability urgent defense needs gave rise to a domestic and regime illegitimacy. External threats are military-industrial complex that became an those posed by foreign armies or militant unmatched engine of economic growth, groups and can range from occasional cross- spurring technological advancement and netting border raids to full-scale invasions. For this significant export income. article’s purposes, the term “security” will be Of course, these were not the only factors used expansively to encompass both internal responsible for Israel’s unanticipated economic and external threats to Israel’s continued success. But they are the most salient in the existence and well-being. Moreover, in keeping context of the country’s economic development with the multifaceted reality of the Arab-Israeli in the absence of security. By historical conflict, this paper will discuss threats to accident, many of these elements are specific to Israel’s security on both the military and the post-Holocaust emergence of a Jewish state, economic fronts.(9) casting doubt on whether Israel’s experience This article argues that a combination of can be replicated by other emerging markets. conventional and unconventional factors, However, several contributing factors that will economic and otherwise, allowed Israel to not be discussed at length in this paper can overcome the barriers posed by an enduring potentially be applicable elsewhere, chiefly lack of security. Foremost among them is the Israel’s adoption of a democratic form of fact that until the advent of Palestinian suicide government and its strong base of social capital. bombings in 1990s, much of the violence Part I of this article provides a brief associated with the Arab-Israeli conflict never overview of the literature linking security and entered Israel proper (i.e., inside the Green Line market-building and discusses its relevance to dividing Israel from the West Bank and Gaza the Israeli case. Part II will explain the history Strip), so the physical infrastructure of Israel’s of Israel’s economic development and examine economy remained largely unharmed. the discrete challenges that the country faced. Second, the lack of security did not deter Part III will elaborate on the above-mentioned successive waves of Jewish immigration to the reasons why Israel was able to surmount those state -- immigration propelled mainly by non- challenges. And Part IV, the conclusion, will economic forces. Although the task of consider what lessons may be gleaned from absorbing so many immigrants drained the Israel’s economic history that could be applied country’s budget, especially in its early years
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to other similarly situated developing apply, to an extent, to relations between Arabs economies. and Jews in Ottoman- and mandate-era Palestine, it never applied within the Jewish SECURITY AND MARKET BUILDING economy itself. Among the most fundamental and important In any case, the establishment of the state of underpinnings of the market-building approach Israel effectively put an end to such small-scale to development is the idea that uncontrolled hostilities. Indeed, until the first Palestinian violence and positive economic development intifada broke out in the Gaza Strip and the are incompatible. As Robert Bates (10) West Bank in December 1987, Israel’s main explains, economies of all sorts are founded on security threats were external, emerging from a base of capital investments. These the surrounding Arab states. Thus, Israel’s investments, whether of money or time, energy, security situation must be analyzed from both and skill, entail risks because investors may not inside Israel’s borders and outside, be able to recoup their present-day costs complicating the security-economic through future payoffs. In the absence of development thesis laid out above. security, when the uncertainty of future events Another twist specific to Israel’s is compounded, such risks run especially high. development is that from 1950 and onward, Citizens, much less outsiders, will not invest in Israel was subject to an Arab boycott which a state if what they produce will likely be eventually came to include many non-Arab destroyed or taken from them in the future. companies around the world. This harmed Hence, conventional wisdom does not expect Israel’s economy, but cannot be said to have there to be any considerable productivity in the endangered its security. To the extent, then, that absence of a peaceful order.(11) Israel’s economy developed under different A similar notion has traditionally held with conditions from those analyzed by theorists regard to the determinants of FDI. Socio- such as Robert Bates and Mancur Olson, any political instability and the resulting “political evaluation of the Israeli experience will risks” are often thought to influence FDI flows necessarily stray from the predictions set forth to specific countries.(12) Indeed, a 1966 survey by these authors. of corporate executives ranked political instability as the most important variable HISTORY OF ISRAEL’S ECONOMIC guiding their foreign investment decisions.(13) DEVELOPMENT Based on such a proposition, Israel’s The Pre-State Yishuv economy should not have succeeded as well as The foundations of Israel’s economy date it has. Averaging a war per decade and facing back to the pre-state Jewish settlement (yishuv) constant terrorist attacks, Israel, at least that began in the early 1880s, in what was then superficially, has plainly lacked the kind of Ottoman-controlled Palestine.(14) Indeed, “peaceful order” envisioned by development much of the yishuv’s economic activity set the theorists. A closer look, however, will reveal pattern for Israel’s later development. that in Israel’s case, it is important to Led by mainly young, socialist immigrants distinguish between a lack of security due to from Russia and Eastern Europe and fueled by foreign threats and a lack of law and order. continuing immigration that saw almost Much of the literature that is devoted to 550,000 Jews arrive in Palestine between 1882- economic development and security considers 1947,(15) the yishuv focused its energies on internal violence, such as bandit raids or tit-for- building communal agricultural settlements that tat clan skirmishes. Although such a model may were meant to make the return to the land
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Linda Sharaby practical as well as symbolic. Numbering 12 in Driven by Jewish immigration and capital, 1918, these collective settlements grew to 19 in the yishuv economy, based largely on 1921, and to 25 in 1925. By 1945, they reached agriculture and small manufacturing, grew at an 179.(16) The early emphasis on agriculture—in annual rate of 13.7 percent between March a land with a limited water supply, and in 1950, 1919 and December 1947.(20) Although violent of which two-thirds consisted of desert and skirmishes with the local Arab population barren hills (17)—would prove lucrative in later (which had doubled during the same period) years as Israeli agricultural productivity and (21) did occur, the yishuv economy was able to innovation allowed the country to become prosper in a relatively secure environment given largely self-sufficient in terms of food that, beginning after World War I, the British production, and a leading exporter of produce mandate authorities maintained basic law and and agricultural technology. order while the Haganah, forerunner of the Agriculture, a labor-intensive occupation, modern-day Israel Defense Forces (IDF), was particularly well-suited to employ the protected specifically Jewish interests.(22) thousands of Jewish immigrants who arrived each year. From 1882 to the eve of The First Twenty Years: 1948-1968 independence, the Jewish population grew at a Following independence, the new state’s rate of 4.9 percent annually from immigration economy was structured around three basic alone.(18) Immigrant absorption, particularly elements: high defense costs, mass immigration the distribution of jobs, was controlled by the absorption, and the building of new institutions yishuv organizations and the powerful, such as banks, a national insurance institute, politically active Histadrut trade union, which and government agencies, all of which functioned not only as a labor advocate but later necessitated massive infusions of public money came to own many Israeli businesses. After the into the economy. Almost immediately, the state’s creation, political parties, especially the government implemented an austerity program, Labor party that held power uninterruptedly including rationing basic goods and limiting the during Israel’s first three decades and was amount of foreign currency individuals could identified with the Histadrut, continued to exert hold. It also poured money into agricultural and a heavy influence on the state’s employment water development projects.(23) structure. A formidable challenge, however, arose with In a trend that would continue well into the early immigration explosion that more than Israel’s future, the yishuv was financed in large doubled the Jewish population from May 1948 part by the donations and investments of to 1951. Annual Jewish immigration for those Diaspora Jews, whose money contributed to years reached a rate of 22.6 percent.(24) Many construction, manufacturing, and agricultural of the immigrants arrived from Middle Eastern production, as well as public funds used to and North African countries, among them a purchase land.(19) Such ideological foreign high proportion of children, and they were investment was and remained vital to the almost completely dependent on the state for yishuv’s, and later the state’s, development housing, language instruction and education, given that the country attracted little foreign job training, and employment. Their numbers commercial interest until the 1990s. But by led to labor shortages and strengthened the placing vast amounts of capital in the hands of Histadrut’s job-dispensing position in the a central authority, it also furthered the state- economy. dominant economic model that Israel would Although the state had inherited a well- follow for almost forty years. developed bureaucracy from the yishuv, capable of administering the government’s social and
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economic programs, it remained dependent on that produced inflation and a growing trade outside funding. Lacking exploitable natural deficit. Following the war, unemployment was resources and offering only a small and greatly reduced, productivity and private fledgling domestic market, as well as heavy- consumption began to rise, industries related to handed government intervention, Israel defense (from metals to computers) benefited, attracted little foreign investment. as did tourism, and new immigration began. Contributions and loans from Diaspora Jews, Further, the domestic market expanded to often in the form of low-interest Israel bonds, include the newly occupied West Bank and helped finance the state’s imports of energy, Gaza Strip, which also provided a source of raw materials, and production inputs. Far more cheap labor.(29) significant, however, was the reparations In sum, Israel saw tremendous economic agreement that the government signed with growth in the 1950s and 1960s. Its GDP West Germany on September 10, 1952, which increased by an astounding 30.1 percent in provided a massive infusion of much-needed 1951, and averaged a rate of 9.2 percent for the foreign currency into Israel’s economy.(25) The 1950-1968 period, second in the world only to agreement pumped about $850 million directly Japan’s 9.7 percent.(30) Private consumption into state coffers until 1964 and financed the grew by 9 percent for the same period.(31) A lion’s share of Israeli imports, mainly with World Bank mission to Israel in October- German goods, between 1953 and 1965.(26) November 1968 labeled Israel’s performance an While immigration and the war effort “economic miracle” given its dearth of natural sapped the government’s budget (the latter resources, hostile neighbors, and large-scale especially necessitating large foreign currency immigrant absorption. The mission attributed expenditures to purchase weapons, as well as Israel’s success to two factors: human skill (“a diverting the productive labor force resulting in capable and determined population with a broad a loss of national product), they also stimulated base of well-educated and energetic people who the economy, galvanizing production – often proved able to overcome the difficulties of underwritten by the state–to meet defense and economic development with great ingenuity”) consumer needs. German reparations helped and foreign capital (“originating chiefly from fund continued large-scale government private donations of American Jews and from investment in agriculture and manufacturing reparation payments by West Germany.”) (32) through joint ventures, subsidies, loans and grants to private investors.(27) Ups and Downs: 1968-1989 Meanwhile, the Sinai campaign in which The most significant change in Israel’s Israel joined forces with Britain and France in economy following the 1967 War took place in attacking Egypt following the nationalization the country’s government-financed defense and closing of the Suez Canal, led to a mini- industry.(33) Forged during the pre-state yishuv economic boom in 1956. Immigration numbers and expanded in the 1950s when attempts to rose to 70,000 in 1957 (the highest number buy abroad were often unsuccessful,(34) since 1951), unemployment declined, Israel’s military sector until 1967 focused on productivity grew (especially in agriculture and producing light arms and communications industry), and the state’s balance of payments equipment.(35) After the war, with its improved.(28) Similarly, the 1967 War brought ambitions stoked by its fantastic victory, Israel Israel out of the recession that had been began to produce sophisticated weapons deliberately induced by the government the systems including fighter jets, tanks, and previous year to combat high consumption rates missiles both for its domestic market and, later,
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Linda Sharaby for export. The acceleration of military most powerful Arab country–in 1979 did not production was driven by a number of factors, result in deep reductions in defense chiefly: necessity in light of the War of spending.(41) Attrition with Egypt in the late 1960s as well as Despite the added jobs and export revenues continued cross-border terrorist attacks; the generated by an invigorated defense industry, as French arms embargo following the outbreak of well as a 1975 free trade agreement with the 1967 hostilities, which cut off Israel’s main European Community (Israel’s largest trading supply of weapons; the U.S. refusal, until the partner from that point to the present), 1970s, to sell Israel any major weapons’ economic growth slumped from 1973 through systems; and the government’s desire to the 1980s. The decline was attributable to post- respond to military needs in a way that 1973 defense demands (which may have come developed local industry.(36) at the expense of investment) as well as the rise The surge in military production was also a in energy costs and the global recession. Israel’s quest for technological superiority, given the GDP grew a modest 2.7 percent annually from population ratio between Israel and the 1981-1989, with a per capita GDP rise of only surrounding Arab states. Defense spending as 1.1 percent.(42) share of Gross National Product (GNP) doubled Inflation reached double digits by the early from 10.4 percent in 1967 to 20.2 percent in 1980s, as public sector employment–long 1969 and reached 25.7 percent in 1970,(37) as protected by the Histadrut labor union – grew the government poured massive resources into to 30 percent of the labor force, forcing Israel research and development (R&D), boosting into heavy debt to finance rising levels of employment in the defense industry from private consumption in the face of stagnant 14,000 in 1966 to 34,000 in 1972,(38) and output.(43) Only in 1985 did a coalition setting the industry up as a major engine of government institute a salutary economic economic growth. program, overhauling the Israeli currency and The 1973 War sent Israel’s defense budget adopting reforms designed to curb public soaring even higher as Arab countries, flush spending. Privatization reforms severely with newly acquired petrodollars or aid from weakened the Histadrut, which had used its oil-exporting states, could now purchase the political influence to acquire significant most advanced weaponry. When the Middle construction, insurance, health services and East arms race, exacerbated by Cold War other businesses (simultaneously representing rivalries, took off, Israel’s defense costs reached big business and “big labor”), and paved the an annual average of approximately 32 percent way for the 1990s economic boom. of GNP for 1973-1976,(39) an amount that could only be financed by the U.S. grants and The High Tech Revolution: 1990-2000 loans that started in 1972 and paid for an Since 1990, Israel experienced substantial increasing amount of U.S. military equipment. economic growth powered by massive (Between 1972 and 1979, U.S. military aid immigration from the former Soviet Union and amounted to about one-quarter of the country’s a dynamic “high tech” sector, both of which total defense consumption.) (40) Throughout operated under the relatively favorable the 1970s, Israel continued to devote about 30 geopolitical climate created by the Middle East percent of its national product to defense, peace process. The collapse of the Soviet Union though the numbers fell toward the end of the and the ensuing political and economic turmoil decade and stabilized around 20 percent drove almost 900,000 new immigrants to Israel throughout the 1980s. Significantly, Israel’s from 1989 to 1998, augmenting Israel’s signing of a peace treaty with Egypt–the largest, population of 4.56 million people by 19.3
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percent.(44) Many of these immigrants were 1994 peace treaty with Jordan, positioned highly educated and assimilated fairly easily Israel–by far the most technologically advanced into the Israeli market. More than 55 percent country in the region – to take advantage of had post-secondary education, and more than globalization and its corresponding half held academic and managerial positions in international flow of capital. FDI became a their former countries: 15 percent were novel and pronounced element of the economy engineers and architects, 7 percent were totaling more than $7 billion between 1993 and physicians, 18 percent were technicians and 1997,(50) and hitting a record high in 2000 other professionals, and 8 percent were with almost $5 billion.(51) managers.(45) Their arrival contributed to At the same time, Israel’s high tech industry annual GDP growth of 6 to 7 percent in the first went global, providing the third highest number half of the 1990s, one of the highest rates in the of initial purchase offerings (IPOs) on the world.(46) The pace of expansion slackened NASDAQ in New York, after the United States during the latter half of the decade, plunging to and Canada, and the second highest number on only 2 percent in 1998, though FDI flows–a London’s Alternative Investment Market, novel addition to Israel’s economy–continued behind Britain.(52) Today, high tech goods and to climb. services account for one-third of Israel’s Dovetailing with immigration in the 1990s exports.(53) Although the industry has been in was the unprecedented growth of the country’s decline in the opening years of the twenty-first high tech sector which currently achieves total century, largely mimicking the U.S. new annual sales of more than $7 billion and ranks economy downturn, it is expected to recover as among the top five world leaders in the soon as U.S. firms did. field,(47) with Tel Aviv identified as one of the There are mixed reviews as to how the 10 top high-tech centers in the world.(48) 1990s’ peace process affected Israel’s economic Indeed, as of December 2000, 9 out of every performance, if at all, during the last decade. 1000 Israelis were employed in high tech Certainly, the illusion of progress in solving research and development, almost twice the one of the world’s most intractable conflicts concentration of the United States and made the region a more attractive investment Japan.(49) target in general. The Middle East-North Africa Israel’s high tech history has its roots in the (MENA) economic summits, which brought IDF’s Science Corps, created in 1948 to Israelis together with representatives from Arab develop advanced military equipment. Indeed, governments and businesses throughout the the military-industrial complex has long served decade, lent Israel a sense of legitimacy as an as a mechanism for transferring scientific economic partner and may have helped assuage knowledge from the army to the civilian sector, fears about Israel’s precarious position in the as will later be explained. With the scaling region, both of which impacted incoming FDI down of Israel’s defense budget beginning in flows. In addition, tourism, long a strong sector the late 1980s, thousands of skilled workers left of Israel’s economy, may have increased as a the army to form a base of start-ups, which result of the peace agreements. Yet, analysts found a receptive business environment as a have noted that Israel achieved high growth result of sustained government deregulation, levels (slightly above 6 percent) beginning in privatization, and liberalization since 1985. The 1990 – a year before Madrid and three years Middle East peace process, initiated with the before Oslo.(54) Moreover, the peace process Madrid Conference in 1991 and continuing did not lead to reductions in defense spending through the 1993 Oslo Declaration and the (55) nor any regional water, transportation, or
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Linda Sharaby energy projects, as was hoped. It is Private economists agree with the Israeli understandable that the promise of regional government that two-thirds of the decline in trade never materialized given that Israel’s Israel’s GDP from 2000 to 2002 is due to the economy is not complementary to those of its high tech downturn rather than the intifada.(61) neighbors. In fact, there has already been under- Indeed, Israel’s economy is the most tech- the-table trade that probably cannot expand dependent in the world, with 15 percent of the beyond current levels.(56) country’s GDP and 31 percent of all exports It is important to note that the economic originating in the high tech sector; thus, the prosperity of the 1990s coincided with a new, global high tech slowdown has hit Israel harder deadly dimension of the Arab-Israeli conflict: than other countries.(62) Nonetheless, despite the advent of Palestinian suicide terrorism the intifada, the Tel Aviv 100 Index inside the Green Line. The Israeli Government outperformed the U.S. S&P 500 over the period Press Office reported in 1998 that more Israelis from May 2001-May 2002. It also tracked the were killed by Palestinian terrorism in the 5 U.S. index more closely than it did the pattern years following the Oslo Accords than in the of suicide bombings.(63) preceding 15 years combined.(57) Israel’s A report by Israel’s Ministry of Industry and economy has not escaped the violence Trade reveals that despite major suicide unscathed but it is hard to isolate precisely the bombings in Israel’s city centers and Israeli economic impact of the terrorism. Israel’s retaliation in the Palestinian territories, Israel’s productivity started to dip in 1996, when the ports, communications, transport, power and first wave of bombings began. But many water sectors (i.e., its economic infrastructure) analysts point to the Asian economic crisis of have been operating undisturbed. Significantly, 1997-1998, followed by the bursting of the U.S. both Goldman Sachs and McKinsey and Co. high tech bubble, as an explanation for why reported in 2001 that Israel’s high tech Israel has not yet recovered its early 1990s economy had not been affected by the attacks, momentum. noting that many R&D centers are far from the flashpoints of violence. Many foreign The Second Palestinian Intifada: 2000-2002 investors do fear traveling to Israel, but Israeli A look at Israel’s performance since the businesspeople have more frequently traveled Palestinian uprising began in September 2000 to them and have exported goods at a higher reveals a similarly mixed picture. The rate.(64) dangerous security situation has combined with However, many non-high tech industries a global economic slowdown triggered by the have been deeply affected by the violence, bursting of the U.S. high tech bubble to throw especially industries that rely on Palestinian Israel into one of the worst recessions in its labor such as agriculture and construction. A history. Israel’s GDP contracted by .06 percent marked decline in tourism, which accounts for in 2001 and is expected to decline by about one 3 percent of GDP and has declined even further percent in 2002.(58) Unemployment has after September 11, has reverberated in the reached over 10 percent–a jump of almost 20 hotel and hospitality sectors prompting the percent since the beginning of 2001.(59) government to announce an almost $100 Tourism dropped more than 50 percent from million emergency loan to the hotel 2000 to 2001, at a cost of $1.7 billion, and has industry.(65) The Palestinian violence has also continued to fall.(60) Defense expenditures cost Israel about $200 million in property have increased as government receipts have damage, payments to victims, extra security, fallen, and the Israel shekel has lost value police, and hospital expenses. In addition, against the dollar. exports to the Palestinian Authority are down.
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In all, the Bank of Israel estimates that the cost shelter and, after the Gulf War biological- of the intifada in 2001 was $2.6 billion.(66) chemical attack scare, that every new home contain a sealed-off room; the construction of Challenges Particular to Israel bypass roads; the value of land held by the army In total, Israel’s economic success is quite for training; and the diversion of the best unique among developing countries given the scientific minds to the military sector’s needs. conditions under which it evolved: few natural Indeed, the costs of defense in Israel have resources, a socialist legacy, regional warfare, taken a pronounced human and social toll as and mass immigration absorption–all of which well. Compulsory military service at age 18 combined should have brought failure. Israel’s exists for every Jewish Israeli, lasting three case must be further distinguished from other years for men and two years for women.(71) As successful development stories such as those of a result, most Israelis start their post-secondary the Asian tigers because of the challenges education and careers later than their particular to Israel that stemmed from its contemporaries in other countries. Moreover, security situation. during their compulsory service, soldiers earn a The most enduring challenge since the fraction of what they could in the civilian state’s creation has been the social and market, diminishing their incomes and the economic cost of a heavy defense burden. economy’s productive capacity. That capacity is Throughout the years, Israel has consistently also distorted by compulsory reserve duty for topped any list of developed economies in most men (and some women), which can take percentage of national product devoted to employees away from their jobs for more than a defense. At the height of its defense spending in month each year. Another claim is that the 1976-1977, Israel’s military expenditures enormous investment in Israel’s defense budget totaled more than 30.7 percent of its GNP. In came at the expense of a redistribution of comparison, the United States spent 5.7 income to the weaker segments of society, percent, the United Kingdom 4.9 percent, and namely Jews whose ancestors came from Arab France 3.85 percent for the same period.(67) A and Muslim countries, not to mention Israeli quarter-century later, despite massive Arabs. These communities have remained reductions, Israel’s defense budget in relative underprivileged as inequality persisted and terms remains three times higher than that of grew.(72) the United States or European countries at a Presumably, Israel’s economy could have rate of around nine percent of GDP.(68) Of developed at a much faster pace had it not had course, since the early 1970s, Israel’s defense to devote such a large share of its resources– burden has been cushioned by annual U.S. economic and human–to defense. It is true that military aid transfers that by the late 1980s had many developing countries, especially the Arab reach almost $2 billion.(69) Nonetheless, countries situated around Israel’s perimeter, throughout the 1990s – after the Cold War and spend similar if not higher percentages of their in the thick of the peace process – defense national product on the military. But they have expenditures as a percentage of total done so at the expense of the economic, social, government spending remained above 20 and political achievements that Israel can claim. percent.(70) Thus, while Israel’s economy in per capita Beyond direct military expenditures lay the terms has approached that of some of the hidden costs of defense: the special world’s most advanced countries, its military construction costs mandated by the provision spending has had to keep pace with countries that every residential building contain a bomb whose leaders have traded butter for guns,
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Linda Sharaby subordinating their citizens’ basic socio- transnational companies may have stayed away economic welfare to the acquisition of arsenals. from Israel because of its scant natural While the costs of maintaining a superior resources, high wage structure, and small defense capability have been mitigated to an domestic market, not to mention the extent by the substantial value Israel’s military- government’s heavy hand. Investors could not industrial complex has added to the economy, have been encouraged by the decision of Israel weathered another challenge–the Arab Israel’s first prime minister to grant the economic boycott–less successfully. The Arab Histadrut’s demand to be part of any foreign boycott of Israel actually preceded the state’s investment.(78) creation. It began with a December 1945 Arab The boycott certainly increased Israel’s League decision to refuse all commercial energy costs, though until the 1979 overthrow contact with the Jews of Palestine, with the of Iran’s shah, Israel was able to purchase oil stated goal of thwarting the establishment of a from Iran. Afterward, Israel’s peace treaty with Jewish state. By 1951, the boycott extended Egypt allowed Egyptian (and other) oil to flow beyond direct business contact with Israel to to Israel. With the exception of oil, the direct any foreign firm that “aided” Israel.(73) A boycott (prohibiting state-to-state economic third-tier boycott introduced later–of firms relations) probably did not harm Israel at all, doing business with firms that did business with given the incompatibility of the Israeli and Arab Israel–was a logistical failure from the outset. economies. In any case, Israel’s gaze always lay Regardless, at its height the boycott was beyond the Middle East to the advanced states enforced by 18 Arab countries and 10 non-Arab of Europe and North America. Muslim states, including Pakistan, Indonesia, and Malaysia.(74) WHAT ACCOUNTS FOR ISRAEL’S International companies employed one of SUCCESS? two strategies to deal with the boycott. The The success of Israel’s economic more sophisticated firms continued to do development despite its lack of security is business with Israel but managed to hide any attributable to four main factors: overt ties to the country. Others simply caved in. Often, firms from a single country would Location of the Violence (79) divide up the Arab and Israeli markets among Although Israel has been in a state of war (or themselves. For example, Japanese automobile cold peace) with surrounding Arab states for its manufacturers allocated the Arab market to entire existence, the violence associated with Honda, Nissan, Mazda, and Toyota, and the the Arab-Israeli conflict rarely penetrated Israeli market to Subaru, Daihatsu, and later Israel’s borders on a significant scale until the Mitsubishi.(75) 1990s. Thus, economic development proceeded There is no clear indication of how much unscathed by the destruction of war. Terrorism, actual damage the boycott did to Israel’s on the other hand, did reach Israeli targets economy, though one private study put the inside the country and around the world since figure at $40 billion since 1948.(76) Israel’s the pre-state era. But terrorism, as will be success certainly belies any notion that the explained, does not threaten development in the boycott significantly impeded the country’s same way that war does. growth. The most harm done was likely in In its first 40 years, Israel fought a war per deterring foreign investment. Indeed, until the decade with surrounding Arab countries. late 1970s, foreign firms accounted for no more However, only on two occasions–in 1948 and than 5 percent of all investment in Israel.(77) 1973–did Arab armies launch full scale On the other hand, quite apart from the boycott, invasions of the Jewish state. Both times,
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Israel’s army repelled the offensives before they indicator that new economy business can be made serious inroads into Israeli territory, and conducted almost anywhere (i.e., there is no managed to push the fighting into Arab land. factory to inspect, construction to oversee, etc.) Thus, the brunt of the attacks was absorbed by As a result, despite the terrorism, the risks Israel’s military in terms of lost lives and associated with investment in the 1990s were damaged equipment. Spared the widespread fewer than in the previous 40 years. destruction and occupation usually associated In sum, the violence of the Arab-Israeli with war, Israel’s economic infrastructure was conflict did not have much of a direct influence able to develop unharmed. Its transportation on the development of Israel’s economy. and communications networks were Israel’s physical infrastructure was largely undisturbed; its ports remained open; its insulated from the fighting, and its factories and production facilities continued to “intellectual” infrastructure has not provided a produce, as did its farms; its offices and ready mark for attack. businesses operated regularly; and its laboratories and universities were able to thrive Sustained Immigration far from the war front. Of course, Israel’s One would expect that a country perpetually workforce was affected by the wars as reserve at war with its neighbors, with a compulsory soldiers were called into active duty, but not to military draft for men and women (and reserve the extent of crippling productivity. duty thereafter), and under constant terrorist The suicide bombings of the past decade threat, would not attract large numbers of changed the equation by bringing the violence immigrants. Yet Jewish immigration to Israel into the hearts of Israel’s major cities, into has continued unabated since the yishuv era, points of mass transit and commerce such as peaking in the early state period and again after buses and shopping malls. Paradoxically, Israel the fall of the Soviet Union. High rates of saw enormous economic growth in the 1990s immigration led to expanded consumer demand spurred by mass immigration and foreign and the growth of a domestic market; job investment. The key to understanding why the creation and home construction; a larger violence did not deter growth lies in the nature workforce and increased productivity; and, with of terrorism and the fact that it aims at the arrival of highly educated immigrants, psychological rather than physical destruction. scientific progress and commercial innovation. Terrorism does not stop industrial activity. The unstable security situation exerted little, Terrorists targeted wedding halls and cafes, not if any, impact on immigration because most of the Tel Aviv Stock Exchange or high tech the immigration was propelled by non- industrial parks. Israelis have continued to economic forces. (The 1990s immigration from work and produce, even if they have stopped the former Soviet Union is an exception, as will visiting crowded places. later be explained.) Many Jews, especially in Similarly, while waves of terrorism have the early years of the state, immigrated to Israel frightened away tourists, causing heavy losses because of religion and ideology. During the to tourism-related sectors of Israel’s economy, pre-state era, the idea of building a Jewish state they have not discouraged foreign investment in the biblical land of Israel was a practical and mainly because “new economy” goods and logical alternative to the antisemitism that many services are often intangible and thus are not in Russian and Eastern European Jews endured in danger of physical destruction. Moreover, when their native countries. Similarly, after the foreign investors have been fearful of traveling decimation of European Jewry during the to Israel, Israelis have traveled to them–another Holocaust, Israel served as a haven for many
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Linda Sharaby survivors and their families. For many religious in the USSR, which then did not allow Jews to Jews around the world, Israel held a strong pull emigrate. It maintained a prominent role as the realization of a promised return to the throughout the 1990s, when more than one Jewish homeland. Such religious motivation million Soviet immigrants arrived in Israel. has continued to bring Jews to Israel, The Soviet immigration of the last decade particularly from Anglophone countries. stands out from previous waves both because of After the state’s creation, Israel’s “pull” was its sheer volume and because of its economic complemented by a “push” from Arab and motivation. In fact, for many of the immigrants, Muslim countries to expel their Jewish Israel was a second-choice destination; the residents. The anti-Israel sentiment in Middle United States was the first. The political and Eastern countries, especially those that had just economic disarray in the former Soviet fought against Israel’s independence, caused republics, including Russia, drove the mass many Jews to fear for their safety. Many Jews exodus of Soviet Jews who were undaunted by fled countries such as Iraq, Yemen, and Iran in the prospect of military service in the face of secret, leaving behind their homes and the first Palestinian intifada, which began in possessions. Today, they (and their December 1987, or the Iraqi Scuds that fell near descendants) comprise roughly half of the Tel Aviv during the 1991 Persian Gulf War. country’s Jewish population. These immigrants brought to Israel a It is important to remember that successive tremendous reservoir of skill and education that Israeli governments have actively encouraged helped fuel the high tech boom of the last immigration as a means of strengthening the decade. country against the vastly more numerous surrounding Arab population. (Officials have Foreign Transfers also made an ideological plea for an Like many emerging markets, Israel could “ingathering of the exiles” to attract Jewish not have achieved such a high rate of immigrants.) Even in 2002, the government of development without significant infusions of Prime Minister Ariel Sharon called for massive foreign capital. Private capital usually gravitates fund-raising to help Argentina’s approximately toward resource-rich, stable areas. Israel, of 250,000 Jews escape their country’s current course, lacks both precious resources and stable political and economic turmoil, which has left borders. Yet it still managed to attract them in a precarious position. The Jewish substantial foreign transfers, the main sources Agency, a governmental body with of which–donations from world Jewry and representatives around the world, vigorously wealth transfers resulting from Jewish recruits Jewish immigrants and helps settle immigration, German reparations, and U.S. them once they arrive in Israel. The Agency aid–were driven by political and ideological played an important role in airlifting thousands motives. The non-economic character of the of Yemenite Jews to Israel in the 1950s in transfers–the fact that the money came “Operation Magic Carpet” and again in the explicitly for development purposes, rather than 1984-85 “Operation Moses” which brought for profit–afforded successive Israeli almost 17,000 Ethiopian Jews to Israel, and the governments considerable leeway to direct 1990-1993 “Operation Solomon” during which development and subsidize a high standard of 15,000 Ethiopian Jews were airlifted to Israel in living. It was also essential given the high one day.(80) levels of government spending necessitated by The Jewish Agency was also instrumental in Israel’s defense burden and immigrant engineering early Soviet immigration to Israel absorption. In fact, foreign aid to Israel on a per starting in the 1970s when it operated covertly capita basis is the highest in the world.(81)
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The security threat to Israel has actually The local success and global expansion of resulted in higher levels of foreign transfers. Israel’s military industry following the 1967 For example, contributions from world Jewry to War had a number of positive effects on Israel’s Israel have increased during wartime.(82) More economy. Traditionally, military production has important is the U.S. military aid that Israel has been the most modern sector of the economy, received annually since the early 1970s. Most benefiting from massive R&D investment. of the military aid, totaling almost $2 billion Indeed, during the 1980s, an estimated 65 annually, consists of imports of U.S. military percent of all government R&D expenditures equipment–a condition stipulated by the were defense-related (compared to 13 percent in American government.(83) The aid helps civilian sectors).(86) The advanced technology relieve Israel’s heavy defense burden and developed in military research centers has been provides Israel with the most advanced transferred to civilian sectors largely by former weaponry necessary to maintaining its soldiers trained as army technicians, qualitative edge in the region. programmers, and engineers. The result has With the exception of the American military been industrial innovation and the creation of aid, the foreign “gift” transfers to Israel are Israel’s high tech economy. slowly coming to occupy a less prominent Israel’s military production has also netted position in the Israeli budget. German the country significant export income. Military reparations to the state ended almost 40 years exports grew in the 1970s parallel to Israel’s ago (though payments to individual survivors battlefield success and reputation. From 1973 to continue) and donations from Diaspora Jews 1997, arms exports increased 25 times over are becoming less important relative to from $40-70 million to $1.52 billion.(87) By GDP.(84) There has even been talk, most 1986, the New York Times reported that arms notably by former Prime Minister Benjamin and security services accounted for more than Netanyahu, about ending the non-military 25 percent of Israel’s industrial exports.(88) component of the annual U.S. aid package, That number is still accurate today.(89) Such which amounts to about $1 billion a year. high production has also ensured employment for many Israelis. Today 20 percent of all The Military-Industrial Complex industrial employment is military related.(90) The final factor accounting for Israel’s Finally, financing a large defense industry also economic success despite its perilous security allowed the government to direct development– situation is the emergence of the country’s and employment–to less developed parts of the formidable and internationally competitive country. defense industry, which became a crucial Although Israeli military procurement has engine for export-oriented growth. Created to shifted in recent years to become more supply the defense needs of constant warfare dependent on U.S.-made weapons, especially against Arab neighbors, Israel’s government- given the annual “strings-attached” U.S. funded military-industrial complex eventually military aid package of grants and loans to grew to become the fifth largest arms exporter Israel, Israel’s defense industry remains strong. in the world.(85) By pursuing a goal of It became even stronger after September technological superiority in military equipment 11,2001, as global demand for Israeli security and strategy, the defense sector triggered a services rose. However, its influence on Israel’s “spillover” effect that powered Israel’s economy is slowly declining as the private high commercial industries and the 1990s high tech tech sector, which produces dual use boom. technologies and offers young scientists greater
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Linda Sharaby financial rewards, comes to dominate.(91) religious and national past helped sustain the Nonetheless, the military-industrial contribution ideological devotion of many Israelis to the to Israel’s economic growth cannot be state’s success. This kind of social capital emphasized enough. allowed Israelis to resolve collective problems more easily, and build a strong civic base to CONCLUSION support economic development.(93) Many of the factors accounting for Israel’s In sum, the Israeli experience probably creation and its subsequent economic success cannot be identified as a model for are unique to the Jewish state and to Jewish development given the many unique factors that history. In particular, the existence of a large converged to result in Israel’s economic Jewish Diaspora living under conditions that success. Israel does, however, provide a lesson facilitated immigration and economic and that defies conventional expectations of ideological support is an historical accident that economic growth in the absence of security. hardly, if ever, exists elsewhere in the world. Similarly, the timing of the state’s creation– *Linda Sharaby is completing a law degree at after the Holocaust and at the very outset of the Columbia Law School. She was previously an Cold War–was instrumental in inducing assistant editor of MERIA and an editorial desperately needed German reparations and assistant at Foreign Policy magazine. Her later U.S. sponsorship. The combination of recent publications include a book review local ingenuity and foreign funding is a entitled “Sadat the Strategist” in the Foreign fundamental reason why Israel was able to Service Journal (June 2001). develop as well as it did. There are, however, several elements of the NOTES Israel experience that can travel across time and 1. World Bank Israel data profile, available at distance. Israel’s adoption of a democratic form
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7. Yair Aharoni, The Israeli Economy: Dreams 17. David Horowitz, The Enigma of Economic and Realities (London: Routledge, 1991), p. 3. Growth: A Case Study of Israel (New York: 8. The cellular phone statistic comes from a UN Praeger Publishers, 1972), xiii. report on global human development, reported 18. Neuman, Table 2, p.57. in Shahar Ginosar, "Am Bchira: Totzaot ha- 19. In this manner, much of the land of present- Emet" Yediot Ahronot, August 2, 2002, "7 day Israel came to be owned by the state. Days" section, pp. 14-22, 86. The survey on 20. Aharoni, p.67. computer statistics was conducted by the 21. Ibid, p.5. Global TGI market research company in New 22. It is important to recall that at the time, York and was reported in Hani Barbash, “Israel Palestine’s Arab population did not yet field an outranks U.S. in home computers and cellular organized fighting force and was therefore not phones,” Ha’aretz, January 24, 2000. cohesive enough to direct anything more than 9. A third aspect – the diplomatic front – will sporadic, if dangerous, violence at yishuv not be addressed. settlements. 10. See generally, Robert Bates, Prosperity & 23. Aharoni, p.72-3. Violence: The Political Economy of 24. Neuman, Table 1, p. 57. Development (NY: W.W. Norton & Company, 25. Aharoni, pp. 167-168. Note that a separate 2001). agreement was signed by which the West 11. For the specific prediction, see Mancur German government paid additional private Olson, “Dictatorship, Democracy, and restitution either in lump sum payments or in Development,” American Political Science pensions to Holocaust survivors and their Review, Vol. 87, No. 3 (September 1993), pp. descendants living in Israel. Such payments 567-575, especially p. 567. ranged in the hundreds of millions of dollars 12. Such a broad assertion, however, has been and easily total several billion dollars. questioned by Harinder Singh and Kwang W. 26. Ibid, p.278. Jun in “Some New Evidence on Determinants 27. Ibid, pp.74-75. of Foreign Direct Investment in Developing 28. Moshe Sanbar, ed. Economic and Social Countries,” Policy Research Working Paper Policy in Israel (MD: University Press of 1531, The World Bank (November 1995). America, Lanham, 1990), p.13. 13. Ibid, p.5. 29. Ibid, p.15. 14. Note than in discussing the pre-state 30. Neuman, pp.33-34. economy, it is important to distinguish between 31. Aharoni, p.74. the Jewish economy and the Arab economy, 32. Horowitz, xii-xiii. which were almost completely separated. For 33. Most of Israel’s military research and more see Chapters 1-6, Yuval Elizur, Economic development, as well as production, has Warfare: The One Hundred Year Economic historically taken place in state-owned firms Confrontation Between Jews and Arabs (Israel: connected to the Defense Ministry. These firms Kineret, 1997) (in Hebrew). are Israel Aircraft Industries, Israel Military 15. Neuman, p.1. Note that Jewish immigration Industries, and Rafael. to Palestine was limited after 1929 by British 34. Sharon Sadeh, “Israel’s Beleaguered mandate authorities in a plan to ensure that Defense Industry,” Middle East Review of Jews would not exceed more than one-third of Foreign Affairs (MERIA) Journal, Vol. 5, No.1 the Palestinian Arab population, though Jews (March 2001), p.1. continued to arrive illegally. 35. David Kochav, “The Influence of Defense 16. Aharoni, p. 206. Expenditure on the Israel Economy,” in Sanbar,
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Linda Sharaby p.41. 55. According to the CIA World Fact Book, 36. Ibid. military spending for 1992 was $5.3 billion; for 37. Kochav, p.30. 1995, $6.5 billion; for 1997, $9.3 billion; and 38. Sadeh, p.6. for 1999, $8.7 billion. 39. Kochav, p.31. 56. Stuart Cohen, Eliyahu Kanovsky, and 40. Ibid, p.34. Efraim Inbar, Military, Economic and Strategic 41. Ibid, p.31. Aspects of the Middle East Peace Process, 42. Neuman, p.36. Security and Policy Studies No. 24 (December 43. Aharoni, p.85. 1995), Begin-Sadat Center for Strategic 44. Neuman, p.15. Note that that number of Studies, Bar-Ilan University, Ramat Gan, Israel. former Soviet immigrants has since surpassed 57. Ministry of Foreign Affairs Background one million. Paper on Terrorism and the Peace Process, 45. Ibid, p.21. September 14, 1998, available at 46. 1993 was an exception with 3.5 percent
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Hotels Going Bankrupt,” Jerusalem Post, Democratic States and War,” The American August 7, 2002. Political Science Review, Vol. 86, No. 1 66. Wasser presentation. (March 1992). 67. Aharoni, p.255. 93. For more on social capital, see R.D. 68. D. Peled, p.5. Putnam, Making Democracy Work: Civic 69. Aharoni, p.278. Traditions in Modern Italy (Princeton, NJ: 70. Henry and Springborg, Table 4.2, p.104. Princeton University Press, 1993) 71. Ultra-Orthodox seminary students – currently almost 10 percent of the military age population – are exempt from army service, as are other individuals on a case-by-case basis. 72. Aharoni, p.81. 73. Elizur, p.123. 74. Note that the boycott is still formally in effect, though only Iraq, Syria, Libya and Saudi Arabia pay it any attention today. Saudi Arabia in particular has stepped up its boycott efforts since the second intifada began, recently banning 200 companies from doing business in Saudi Arabia for exporting more than $150 million of Israeli products into the kingdom. See a report by the Associated Press reproduced in Ha’aretz, August 5, 2002. 75. Elizur, p.126. 76. Ibid, p.149. 77. Shafir and Peled, p.8. 78. Sanbar, preface. 79. Most of the information for this section is derived from two conversations that took place in March-April 2002 with Zohar Perry of the Economic Affairs Department of Israel’s consulate in New York. 80. Neuman, p.14. 81. Shafir, p.6. 82. Kochav in Sanbar, p.37. 83. Sadeh, p.7. 84. Shalev in Shafir, p.138. 85. Sadeh, p.1. 86. D. Peled, p.5. 87. Sadeh, p.6. 88. Aharoni, p.266-67. 89. D. Peled, p. 5. 90. Ibid. 91. Ibid. 92. See David Lake, “Powerful Pacifists:
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