Israel Essay

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Israel is a world leader in technologically advanced products  and services. Growth  has been impressive in recent years, and macroeconomic policy has been well managed. However, significant structural  problems need to be addressed in order for Israel to reach its full economic  potential.  Israel is a highly open, developed economy with gross domestic product (GDP) of $162.75 billion, or $22,500 per capita (unless otherwise noted, figures are from 2007, and are taken from the Central Bureau of Statistics [CBS] or Bank of Israel [BOI]). According  to the  Organisation  for Economic Co-operation and Development  (OECD), Israel’s per capita purchasing power adjusted GDP, an indicator  of living standards,  is 21st in the world, at 88 percent of the OECD average and 63 percent of the U.S. level (using a different methodology,  the International Monetary Fund ranks Israel 18th). Israel has been invited to join the OECD.

Israel’s  population  is 7.282 million—75.5 percent Jewish,  20.1 percent  Arab,  and  4.4 percent  others (May 2008). From 1998–2008, annual population growth   averaged  2.1  percent;  during   1989–2000, over one million people immigrated from the former Soviet Union. Israel has a small land area and high population  density.  It is poor  in natural  resources, except minerals. The leading population and business center is the Tel Aviv metropolitan area; other population centers are Jerusalem, Haifa, and Beersheba. Life expectancy  is slightly above the  European  average, but infant mortality is high. Health expenditures  are 8.7 percent of GDP (2006). Basic health is 70 percent publicly funded. Although hospitals are overcrowded, medical care is generally excellent. Israel has a high rate of homeownership and an underdeveloped rental market. Land is 93 percent government owned.

Water  is very scarce.  The world’s largest  desalination  plant opened in Israel in 2005; another  plant was  added  in  2007. Agriculture  is  technologically advanced, capital intensive, and highly productive, but also highly protected  and subsidized. Major exports are produce, flowers, and wine.

Defense expenditures  average 8.5 percent  of GDP (1998–2007). Since 2002, Palestinian  suicide bombings and the associated economic costs have declined sharply. The economy was robust to the Second Lebanon War of 2006; the direct cost in lost GDP was just 0.5 percent. In 2008 Israel received $2.4 billion in U.S. military aid; civilian aid has been phased out.


In   2001–03,   Israel   experienced   a   major   recession,  caused  mainly  by  Palestinian  violence.  During 2004–07, real GDP grew steadily at 5.2 percent per  year. Israel has free trade  agreements  with the United  States,  Canada,  and  the  European   Union (EU). Exports are 45 percent of GDP, and are divided approximately equally between the United States, the EU, and others. Leading export sectors are high and medium-high-tech industry,  including  pharmaceuticals  (36 percent  of exports),  general  services (19 percent),  diamonds  (15 percent),  and high-tech  services (11 percent). Exports grew 8.6 percent annually (in nominal terms) over 2004–07, led by information and communications technology  (ICT). The weight of ICT in total business product  is the highest in the world (2006).

In balance of payments, the current  account/GDP ratio  rose  from  minus  5 percent  to  6 percent  over 1997–2006, falling to 3.1 percent  in 2007. The capital account has been liberalized since 1991. Israel is among the frontrunners in receiving foreign direct investment (FDI); FDI is concentrated in the ICT sector.

Israel ranks first in the world in availability of scientists  and engineers  and in research  and development  (R&D) expenditures  as a percentage  of GDP. Israel ranks third in patents  per capita. R&D is concentrated  in ICT. IBM, Intel, and other multinational corporations conduct  R&D in Israel. There is limited government support for R&D.

Israeli venture  capital  funds  raised  $10.6 billion from 1998–2007. Over 2004–07, Israel’s country risk premium was halved to 30 basis points; Israel’s sovereign debt ratings have improved steadily. The financial system has become  more  competitive,  efficient and stable, but further improvement is necessary. The Tel Aviv Stock Exchange maintains  ties with NASDAQ and the London  Stock Exchange (LSE). NASDAQ lists 75 Israeli companies; LSE lists 50.

Banking is dominated  by two large banks. Many analysts see consumer  banking as a cartel; corporate banking  includes  foreign players and  is more  competitive.  A corporate  bond  market  has  developed; the  banks’ traditional  dominance  of credit  markets is being gradually eroded.  In 2005, the  banks were forced to sell off their  provident  funds; many funds were purchased by insurance companies. From 2008, pensions are mandatory by law.

Over  2003–07  the  deficit/GDP   and  debt/GDP ratios  have declined  from 6.2 percent  to 1 percent, and from almost 102 percent  to 80.6 percent.  Government  spending/GDP  declined from 50.8 percent to 44.9 percent,  while taxes stayed near 37 percent. Privatization has contributed to the reduction  in debt/GDP.

Historically,  the  tax  burden   fell  disproportionately on middle-class workers; financial income was untaxed. Since 2003, financial income has been taxed, while income taxes have been reduced. VAT and corporate taxes have also been reduced; current tax rates are 15.5 percent and 27 percent, respectively.

Monetary policy has succeeded in achieving price stability; currently, the inflation target is 1–3 percent. Stanley Fischer,  a world  renowned  economist,  has served as BOI governor since 2005. In 2007, the Bank of Israel’s  interest  rate  was below the  U.S. Federal Funds Rate, a historically unprecedented situation.

Exchange rates are flexible. Over 2006–early 2008, the shekel appreciated by over 20 percent against the U.S. dollar, leading the BOI to intervene in currency markets for the first time since 1997. Israel joined the Continuous  Linked Settlement  (CLS) system in May 2008, making the shekel fully convertible worldwide.

Business firms have invested  in quality improvement;  ISO  9000  certification  is widespread.  Some Israeli companies  have attained  world-class quality, but traditional industry and construction lag behind.

Education And Employment

Primary and secondary education are plagued by inadequate  infrastructure, poor  discipline, and  low teacher   salaries.  Internationally   standardized   test scores  are  low, despite  large expenditures.  Student achievement  is  highly  stratified  by socioeconomic status. Israel’s research  universities are excellent but public funding (traditionally 70 percent  of university budgets)  has stagnated.  Access to higher  education has been expanded dramatically through the opening of teaching-oriented colleges (public and private). The “brain drain” of academics and physicians (especially to the United States) is an acute problem.

Public  administration suffers from  severe  structural  problems.  Coalition  governments  average two years in office, public services are limited, and dissatisfaction with bureaucracy is widespread. Construction planning is centralized, rigid, and slow. Law enforcement   has  serious  weaknesses.  Israel  ranks 30th in corruption perceptions, second-worst  among Western nations. A significant deterioration occurred over 2002–06. Many local authorities suffer from corruption, mismanagement, and inefficiency.

Inequality is high, and has risen since 2000, in part due to reductions in real transfer payments. The poverty rate is 23.7 percent  overall, 34.9 percent  among children (2006/7). (Because the poverty line is defined in relative terms, it actually measures inequality.) Poverty is concentrated in the Arab and Ultra-Orthodox sectors, which have poverty rates near 60 percent.

In the final quarter  of 2007, unemployment was 6.7 percent,  versus 10.7 percent  (average) in 2003. The private  sector  labor  market  is highly flexible, and resembles U.S. and UK labor markets. The public sector is less flexible, and resembles the European model. Unionization  has declined, especially in the private sector.

Long term  growth  of per  capita  GDP has  been slow;  Total  Factor  Productivity  (TFP)  growth  has been disappointing,  especially in trade and services, construction, and low-tech industry.  Labor productivity is close to the OECD average (2006); the BOI cites foreign workers as an important cause of slow TFP growth. Israel suffers from low labor force participation among prime-aged males. High unemployment and low labor market participation  are strongly correlated  with  low education  levels. Arab  women and Ultra-Orthodox Jewish men have the lowest participation  rates.  The general  participation   rate  has improved somewhat since 2004. The government spends little on active labor market policies.

Non-Israeli  workers  (79 percent  foreign, 21 percent  Palestinian)  comprise  8  percent  of  the  labor force; many are employed illegally. Foreign workers are concentrated in agriculture, construction, hotels, and  restaurants, and  elder  care. “Contract employees” compromise  5–10 percent  of the civilian labor force. They are employed through  manpower  agencies (“contractors”) at low wages and with few or no benefits, often against the law. They are concentrated in the service sector; surprisingly, the government  is a major employer. Public sector strikes are a chronic problem,  affecting essential  services and  education on  all levels;  many  analysts  blame  Israel’s unusual labor  laws. Public monopolies  (e.g., ports,  utilities) pay abnormally high salaries.

Historically,  the  government   has  underinvested in roads and rails. However, road congestion has declined somewhat since 2000; intercity rail is gradually being expanded, and light rail projects are under way in Tel Aviv and Jerusalem. The Cross Israel Highway, Israel’s first toll road, opened in 2002. Israel lags behind  Western  nations  in  traffic safety. Ports  are inefficient and domestic shipping costs are very high. Air transport is uncompetitive;  regulations  strongly favor domestic carriers.


  1. Eyal Argov, Endogenous Monetary Policy Credibility  in  a  Small  Macro  Model  of Israel (International  Monetary  Fund,  European  Dept,  2007);
  2. Bank of Israel, Annual Report (2006 and  2007);
  3. Avi Ben-Bassat, ed., The Israeli Economy, 1985–1998: From Government Intervention to Market Economics (MIT Press, 2002);
  4. Guy Ben-Porat, Israel Since 1980 (Cambridge University Press, 2008);
  5. Central Bureau of Statistics, (cited March 2009);
  6. Robert Owen Freedman, Contemporary Israel: Domestic Politics, Foreign Policy, and Security Challenges (Westview Press, 2009).

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