Economic Transition

Israel’s first twenty-five years also stand apart in economic terms. Before the 1970s, Israel was judged to be one of the world’s true economic success stories. With the help of reparations payments from Germany and private aid from Jewish communities, economic growth averaged around 10 percent a year. This was achieved despite the pressures of massive immigration and a level of defense spending (8 to 10 percent of the gross domestic product, or GDP) heavier than that in any other democratic state. Israel did suffer from a chronic negative balance of trade, as well as an overall negative balance of payments, which helped to fuel a high rate of inflation. Nevertheless, until 1966 taxes were sufficient to cover domestic government spending, and taxes consistently took about a quarter of the GDP—not a particularly heavy burden by Western European standards.^[64]

The wars of 1967 and 1973 ratcheted defense spending up to new levels where it remained stuck for the time being. After 1967 it rose to over 20 percent of GDP and to 28 percent or more after 1973, peaking somewhere above 30 percent (by most calculations) in 1975.^[65] At the same time, with a sixfold increase in world oil prices during this period, the costs of imported energy skyrocketed. Yet there was no offsetting reduction in governmental social spending; in fact pubic services continued to expand, with real spending on health rising 60 percent per capita and on education 80 percent per capita during the 1968–1978 decade. By 1978 Israel ranked fifth in the world in public education expenditure as a proportion of GDP, at 8.5 percent.^[66] Though growth had slowed down by this time, the standard of living continued to rise. The result was “the overburdened polity”: a state with unrealistic goals on one side and limited resources, growing demands, loss of cohesion, and a protracted conflict on the other. Part of this problem was that the decline in the level of ideological commitment left the public less willing to delay personal gratification in order to achieve common goals (as earlier Zionists did).^[67]

Though there were tax increases, they were insufficient to close the broadening gap between revenue and consumption. Many public services were being provided free of charge or well below cost, and reliance on external sources of funding inevitably grew. “A pattern of over-consumption was created”; in other words, the country was simply living beyond its means.^[68] The government’s response to this situation was described by one economist as “schizophrenia”: pressing economic realities were being willfully ignored, and deficit financing was pursued as though large-scale foreign aid and massive borrowing could continue indefinitely into the future.^[69]

The results were entirely predictable. As defense spending, public services, and private consumption all rose, gross investment fell from 33 percent of GDP in the 1973–1975 period to 24 percent in the 1980–1983 period.^[70] The growth rate of the economy fell to an average of 3.2 percent in the 1976–1989 period, with a low point of 1 to 2 percent in the early 1980s.^[71] Israel was not keeping pace with other developed countries; while per capita income stood at 83 percent of the average of the twenty-three most developed economies in 1960, this figure had dropped to 48 percent by 1978.^[72] One index of the underlying problem was the level of governmental expenditure in relation to the size of the economy. The weight of public spending in Israel had always been impressive by world standards, running at around 50 percent of GDP, but by the early 1980s this had risen to 75 percent or more of GDP by most accounts, and for some years and by some measures even exceeded the official GDP.^[73] The difference was made up by borrowing; net external debt increased from $500 million in 1964 to over $17.7 billion in 1983—a 35-fold expansion.

By the mid-1980s inflation was running at a 300–400 percent annual rate. Despite its supposed commitment to a market economy, the Likud after its 1977 victory found itself no more able politically than Labor to tame the runaway economy (indeed, the Likud’s base of support was disproportionately, and paradoxically, among those most dependent on a continuing high level of government subsidies and services). Though taxes had risen from about 25 percent of GDP to around 50 percent and austerity measures were intermittently attempted (only to be abandoned before elections), the economy remained out of kilter. Inevitably, public services began to decline as the crunch grew more severe, contributing to the development of “gray education,” “gray medicine,” and the other alternative private social service networks described above.

The need for a massive restructuring of the economy was one of the major incentives for formation of the National Unity Government (NUG) after the elections of July 1984. This forced the two major blocs to share responsibility for the unpopular steps required, thus removing the issue from politics. After some false starts, the NUG used its emergency powers in July 1985, to impose a sweeping Economic Stabilization Plan (ESP) that was, like most larger economic policies, the result of hard bargaining among the government, labor, and industry. The ESP included dramatic cuts in government spending and subsidies, strict price controls, severe wage restraints, and devaluation, as well as measures to encourage private sector growth and the liberalization of trade restrictions in order to expose more of the economy to open competition. In part, cuts in government spending were made possible by the 1979 peace treaty with Egypt, Israel’s most powerful enemy; defense spending had already fallen in the early 1980s to under 20 percent of GDP, and the downward trend continued as Israel disengaged from its heavy involvement in Lebanon in the middle of the decade.

The ESP set in motion a gradual turnaround in the Israeli economy. In the short term, of course, it accelerated the deterioration of public services, as well as threatening economic collapse in the agricultural sector (the kibbutz and moshav movements were overburdened with debt). But it was a textbook success in curtailing inflation to the low double-digits; the annual increase in the consumer price index averaged only 18.5 percent from July 1985 through 1991 and fell to 9.4 percent in 1992 (the first single-digit increase since 1970).^[74]

In the short term, the ESP also cut the purchasing power of wages by about 30 percent. Wage increases that were intended to compensate for part of this loss were overly generous, however, because the likely rate of inflation was overestimated, and as a result private consumption rebounded and the previous imbalance reappeared in 1988–1989. Fortuitously this distortion was corrected by the wave of mass immigration that began in 1989, with 500,000 new Israelis, mostly from the former Soviet Union, arriving by mid-1994. This increase of roughly 10 percent in the population pushed wages downward again; together with lower interest rates and a more stable and predictable exchange rate for the Israeli shekel, this triggered a period of sustained and impressive growth.^[75]

From 1990 to 1995 the Israeli economy grew by 42 percent, near the top among developed economies. The 1995 GDP was $86 billion or $15,500 per capita, putting Israel ahead of many European states. Government spending had returned to a more normal level of about 49 percent of GDP, with defense spending below 10 percent of GDP at that point and falling. Unemployment had fallen to 6 percent.^[76]

Serious problems still remained in Israel’s economy and in the scramble over scarce resources; Israel was still an “overburdened polity” by any standard. But after the dramatic economic turnaround it was clear that Israel of the mid-1990s was a modernizing state increasingly drawn into the converging social and economic currents that pull such states together. In some ways Israel, ranked very highly in the number of videocassette recorders and personal computers per capita, was even in the vanguard of the electronic age. More is at work here than economics alone; whether labeled as “modernization” or “Westernization,” Israel, no less than other states and perhaps more than most, was becoming a part of the global village. Are cellular phones, Scandinavian vacations, and TV-age electoral campaigns replacing pioneering ideologies as the universalizing counteweight to reassertive Jewish particularism? Will hard disks rather than hard dogmas serve as the vehicle of civicness and secularization? The very success of Israel’s economic transition calls attention to the changing nature of challenges to tradition in Israeli life and politics.