Israel’s Potential For Economic Growth

Israel is a modern free market economy located in the Middle East, surrounded by Syria and Lebanon to the north, Egypt to the south, Jordan to the east, and the Mediterranean Sea to the west.

It is not very large, with a total land area of 20,330 square kilometers and a population around 8.4 million people (1). Israel has a long history of conflict in the Middle East, having been engaged in a war with every one of its neighbors at some point in the past 50 years. Currently Israel occupies parts of East Jerusalem and the West Bank, both of which are claimed by Palestine and are current locations of combat between Israeli forces and the Islamist group Hamas. Israel claims Jerusalem as its capital; however, most foreign embassies are in the financial center and second largest city of Tel Aviv. Despite its size and history of conflict, Israel is one of the most advanced economies in the Middle East and North Africa. Israel has a GDP per capita of $38,540, placing it in the top half of Middle Eastern countries by that metric, and currently has projected annual GDP growth of 3.3% (2). Two main factors have helped to propel Israel into its strong economic position in the region: high spending on scientific research and a workforce that has been consistently growing while staying young at the same time.

Before getting into those two factors, it is important to address inflation, the factor that has historically had the largest negative impact on Israel’s economy. There is an interesting thing to note about how Israel dealt with inflation starting around World War II. Wages were legally tied to the consumer price index (CPI), meaning that while prices rose real wages were kept relatively similar. Over time, more and more parts of Israel’s economy became “linked” to the CPI. Israel battled inflation rates near or above 10 percent for about 30 years, from the late 60s until the late 90s, but the worst hyperinflation occurred in the mid-1980s. At this point, it became too hard for average citizens to keep up with the constant “linkage” adjustments, so the government froze prices until inflation calmed (3). The effects of this period were felt in the form of lost productivity and are still seen today in the monetary policy of the Bank of Israel, who have worked themselves into a set interest rate that is a ridiculously low 0.25% (4). It is easy to wonder what actions the Bank could take to stimulate the economy if they needed to at this point.

Having such high inflation for so long could cause anyone to wonder how Israel still enjoys such low unemployment and great GDP growth. A major factor is having a young, consistently growing population. Israel has a policy that essentially allows any person of Jewish faith to come back to Israel and claim citizenship. This policy has gone a long way towards keeping their working population young. In addition, a life expectancy that is the best in the Middle East and North Africa as well as high fertility rates show health on par with most western countries, but with a population growth rate around 1.9% (1). Amazingly, Israel also has some of the lowest youth unemployment among Mediterranean countries (5). Not only is Israel increasing their labor force, which pushes out their production possibility curve, but they are keeping them employed and learning skills that can further innovation.

Israel is not a particularly large nation in terms of sheer numbers of people, though it is rapidly growing.

It is surrounded by countries with which it has historically had fractious relationships. In order to provide for its own defense as well as obtain the economic leverage it needs to maintain regional interests, Israel has long relied in part on technological advancement to push out its production possibilities. Over the past 20 years Israel has been among the two highest spenders every year on research and development as a percent of GDP (5). Historically this technological advancement has been largely driven by government spending and has primarily had a military focus. Hamas rockets give large incentives to creating defense systems that can cope with the attacks. Recently, however, Israel has seen technological growth not only from military spending, but rather in the form of foreign direct investment in tech startups based out of Tel Aviv. In the past 3 years Israel has had the largest net inflows of foreign direct investment in the Middle East, largely focused on the potential for further growth in high technology products (5). This boost to investment is an obvious boon to GDP and a strong signifier of future potential for growth.

Looking at all these things together now gives a bit clearer of a picture of Israel’s macroeconomy. Expansionary fiscal policy in the form of defense spending and mandatory military service has helped to support the youth of Israel, creating low youth unemployment and giving job skills to the population before they even enter higher education or the private sector. Low interest rates and well managed monetary policy has created an environment where investment is welcomed. New businesses can grow and thrive, ready to tap into a labor pool that is growing to accommodate their needs. In the immediate future, I predict that GDP and wages will grow as businesses flush with foreign cash look to spend. As for the long term, it should be noted that an occupation of territory that directly borders their country as well as strained relationships with many other regional powers provide a few worries. How will Israel integrate religious and ethnic minorities from occupied territories into the economy? Israel already sees trade hindered with some nations due to humanitarian concerns about their treatment of those very minorities. If Israel can manage to not overextend into proxy wars in neighboring territories, I foresee a strong economic future with the kind of growth a lot of countries will envy.