By Matija Šerić
The 1977 Knesset elections marked a major turning point in Israeli political history as Menachem Begin’s right-wing Likud party took control from the Labor Party, which had ruled for nearly 30 years. Later that year, Egyptian President Anwar El Sadat visited Israel and spoke before the Knesset, the first recognition of Israel by an Arab head of state. In the two years that followed, Sadat and Begin signed the Camp David Accords (1978) and the Egyptian-Israeli Peace Accords (1979). In return, Israel withdrew from the Sinai Peninsula and agreed to negotiate autonomy for the Palestinians in the West Bank and Gaza Strip. (Click here to read Part I)
Begin’s government encouraged Jews to settle in the West Bank, increasing friction with Palestinians in the area. In 1980, the Basic Law was passed: Jerusalem, the capital of Israel, which, according to some interpretations, confirmed Israel’s annexation of Jerusalem in 1967, which caused international controversy. In 1981, Israel annexed the Golan Heights, although the annexation is not internationally recognized. In June of the same year, in the midst of the Iran-Iraq war, the Israeli air force destroyed the only Iraqi nuclear reactor under construction not far from Baghdad, in order to prevent the development of the Iraqi nuclear program.
Israel did not want a conflict with its northern neighbor Lebanon. However, when the Palestine Liberation Organization (PLO) redeployed in southern Lebanon after being expelled from Jordan (1970) and committed terrorist acts against the towns and villages of the Galilee, causing many casualties and extensive damage, the Israel Defense Forces moved border of Lebanon in 1982. Operation Peace for the Galilee resulted in the removal of the vast majority of the PLO’s military infrastructure from the area. Although Israeli forces withdrew from most of Lebanon by the end of 1986, until 2000 Israel maintained a small security zone in southern Lebanon to protect its population in the Galilee from enemy attacks.
During the 1970s, inflation began. The Yom Kippur War of 1973 forced the country to conscript most of its workforce for the military effort, which halted business activity. Government policies that artificially raised wages led to increased debt and tax rates were increased. Today, Israel is recognized as a kind of Silicon Valley of the Middle East. However, not so long ago, in 1984, Israel looked a lot more like a modern day Zimbabwe or Venezuela. Namely, that year the inflation rate in the country amounted to 450%, and in a few months it reached a peak of an incredible 950%. The economy was on a path of self-destruction. But that crisis had a good side, because it initiated economic reforms that would lay the foundations for today’s Israeli prosperity.
The four moves that revived the Israeli economy at the end of the 20th and the beginning of the 21st century are: economic reforms, the arrival of skilled imported work force, the technological boom and the prudent policy of the Israeli central bank.
Like every case of (hyper)inflation, the one at that time also had several culprits. It all started with the build-up of military forces during the Yom Kippur War, which resulted in increased spending in the public sector that continued after the war. By the end of the 1970s, government spending was as much as three-quarters of GDP, and it was generating huge budget deficits that it tried to finance by having the Bank of Israel print money. The fact that workers’ wages rose with the cost of living only made the situation worse.
The fight against strong inflation usually implies the willingness of the government to accept the increase in unemployment as a bitter but necessary solution for a certain period. However, Israeli politicians were obsessively focused on providing jobs for their citizens and didn’t do much. The economic situation further worsened as, on top of the inflation problem, there was a banking crisis: investors began to withdraw their money from the country and it became unclear whether Israel would be able to pay its foreign debts.
In 1985, a stabilization plan was adopted under the leadership of the Minister of Finance, Simon Peres, with the assistance of experts from the UN and the IMF. The most important provisions of the plan were: cutting public spending, reducing public debt, privatizing government companies, strong currency devaluation (the Israeli new shekel was introduced). Also, new rules have been set for a more independent central bank. This was the beginning of the modern Israeli economy, a departure from the early socialist state and a step towards the modern capitalist model. Although public spending in Israel was still high, the government gradually reduced its role in the economy while focusing on keeping inflation low and cutting the deficit. Privatization of companies and measures of economic liberalization strengthened the competitiveness of the Israeli economy on world markets, which was visible during the 1990s.
The First Intifada, a Palestinian uprising against Israeli rule in the West Bank and Gaza, broke out in waves of demonstrations and violence in 1987. Over the next six years, the Intifada became more organized and included economic and cultural measures aimed at breaking Israeli control over these areas. A total of around two thousand people were killed in the violence. During the 1991 Gulf War, the PLO supported Saddam Hussein and Iraqi Scud missile attacks on Israel. Despite public anger, Israel heeded American calls to refrain from participating in that war. The following year, Yitzhak Rabin became prime minister after an election in which his Labor Party called for compromise with the Palestinians and other Arabs. The following year, in 1993, Shimon Peres on behalf of Israel and Mahmoud Abbas on behalf of the PLO signed the Oslo Accords, which gave the Palestinian National Authority the right to govern parts of the West Bank and the Gaza Strip. The PLO also recognized Israel’s right to exist and promised an end to terrorism.
In 1994, the Israeli-Jordanian peace treaty was signed, making Jordan the second Arab country to normalize relations with Israel. Arab public support for the Agreement has been undermined by the continued construction of Jewish settlements and checkpoints, and by worsening economic conditions in the West Bank and Gaza. Israeli public support for the Oslo Accords has waned as Israel has been hit by Palestinian suicide attacks. In November 1995, Yitzhak Rabin was assassinated by a radical Jew who opposed the peace process.
As previously mentioned, in the 1980s the Israeli economy began to recover when the government began to practice successful capitalist economic practices. This was followed by an extremely useful immigration policy, i.e. the influx of Jews from abroad. When the Soviet Union began to disintegrate, American immigration policies prevented large numbers of Russian Jews from coming to the United States. Instead, they chose Israel. Between 1990 and 1997, more than 710,000 Soviet Jews arrived in their ancient homeland, increasing the working-age population by 15%. About 60% of newly arrived immigrants had a college education compared to 30 to 40% of the previous Israeli population. In most cases, immigration is good for economic growth. More people means more people doing business, shopping in stores and paying taxes. When these immigrants are engineers, managers and professors, it is even better for economic growth. The influx of Russian Jews gave Israel a stimulating intellectual and financial injection.
At the end of the 20th century, Israel became an integral part of the global economy, and the export orientation adopted by many companies proved particularly useful. Israel is often referred to as the “country of start-ups”. Thanks to the (business) culture of the Jewish people – ambition, ingenuity and adroitness, the country has become an incubator of high technology. In the early 1990s, investments in military research and a highly educated population were key prerequisites for a high-tech boom. Only one important factor was missing: investors.
Until then, the Israeli economy was still dominated by state-backed giants. That began to change with the Yozma program, a $100 million government venture capital fund launched in 1993. Some of the money was invested directly in start-ups. More importantly, the program convinced foreign investors to create funds by cutting taxes and promising to return some of the money they collected from investors. Thus, a virtuous cycle was started that created a successful, independent venture capital market that, until 2000, supported hundreds of start-ups annually. While the market started to work, the government privatized Yozma in 1998. In 2005, a major round of deregulation was launched, which helped the development of the financial sector.
Under the leadership of Benjamin Netanyahu in the late 1990s, Israel withdrew from Hebron and signed the Wye River Agreement, giving greater control to the Palestinian National Authority. Ehud Barak, elected prime minister in 1999, began his mandate by withdrawing forces from southern Lebanon, conducting negotiations with Palestinian leader Yasser Arafat and US President Bill Clinton at the Camp David summit in 2000. During the summit, Barak offered a plan for the establishment of a Palestinian state. The proposed state included the entire Gaza Strip and more than 90% of the West Bank with Jerusalem under joint administration. Both sides blamed each other for the failure of the negotiations. After Likud leader Ariel Sharon’s controversial visit to the Temple Mount in September 2000, the Second Intifada began, which lasted until February 2005. Some commentators claim that the uprising was pre-planned by Arafat due to the collapse of peace talks. The result of the Second Intifada was a total of more than 4,000 dead, Israel’s complete withdrawal from the Gaza Strip, the construction of a wall between Israel and the West Bank, and the suppression of the uprising in the West Bank.
In July 2006, Hezbollah’s artillery attack on Israel’s northern areas and the cross-border kidnapping of two Israeli soldiers precipitated the month-long Second Lebanon War. On September 6, 2007, the Israeli Air Force destroyed a nuclear reactor in Syria. In late 2008, Israel entered another conflict when a cease-fire with Hamas collapsed. The war in Gaza in late 2008 and early 2009 lasted three weeks and ended after Israel announced a unilateral ceasefire. Hamas announced its own ceasefire. Although neither Palestinian rocket fire nor Israeli retaliatory airstrikes have completely stopped, a fragile ceasefire remains in place. In response to more than 100 Palestinian rocket attacks on southern Israeli cities, Israel launched an eight-day operation in Gaza in November 2012. Israel again conducted military operations against Hamas in Gaza in July 2014 and May 2021 with many military and civilian casualties on both sides.
There are a number of reasons why Israel was able to withstand the global financial crisis of 2009. First, it was able to properly implement something close to classical Keynesian consumption policy, reducing its deficit during good times and then letting it grow when the economy began to decline. The country was very fortunate that the head of the Bank of Israel was the banker Stanley Fischer, born Zambian, educated in the USA. A former MIT professor, chief economist of the World Bank, deputy director of the IMF and vice president of Citigroup, Fischer was not an Israeli citizen when he was hired to manage the country’s monetary policy. However, since taking office in 2005, he has managed to keep the country’s currency relatively stable against the fluctuating dollar, which is crucial for exports, while steering the economy towards steady growth. Israel’s GDP and inflation moved in opposite directions, more precisely, GDP grew and inflation fell.
By 2010, growing regional cooperation with Arab League countries was established, although no formal recognitions followed. However, that started to change in 2020 when, after Egypt and Jordan, four more Arab states recognized the State of Israel: the United Arab Emirates, Sudan, Morocco and Bahrain, which is a great victory for Israeli diplomacy. In recent times, the Israelis are not so concerned about the unresolved conflict with the Palestinians, but the main problem is the conflict with Iran and its partners in the region such as the Assad regime and Hezbollah.
One of Israel’s greatest economic achievements is its responsible fiscal policy. Governments keep spending within the budget, reducing the state deficit and do not go beyond the given framework. The national debt-to-GDP ratio decreased to 68.8% at the end of 2021, which is a big improvement compared to the beginning of the 21st century, when the debt was around 110% of GDP. In September 2010, Israel was invited to join the OECD. Israel has signed free trade agreements with the European Union, the US, the European Free Trade Association, Turkey, Mexico, Canada, Jordan and Egypt. In 2007, Israel became the first non-Latin American country to sign a free trade agreement with the South American trade bloc Mercosur.
Currently, there are about 350 active foreign research and development centers in Israel, including giants such as Google, Facebook, Apple, Alibaba, Amazon, Toshiba. According to Bloomberg’s 2021 Innovation Index, which measures performance in research and development, technological education, patents, etc., Israel ranks 7th in the world. This means that Israel has become a global technological and entrepreneurial power. When one knows the unfavorable circumstances in which the state of Israel was created and continues to exist, the results are fascinating and an indication of how creative, diligent and consistent policies can create a successful nation.
*Matija Šerić is a geopolitical analyst and journalist from Croatia and writes on foreign policy, history, economy, society, etc.