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Chartbook 251: Israel's national security neoliberalism put to the test
The brutal assault by Hamas on Israel on October 7 and the massive Israeli response are exacting a horrible toll. The extreme destruction begs the question of Gaza’s future. But this crisis also puts to the test the economic grand strategy that Israel has developed since the second intifada (2000-2005), a strategy of national security neoliberalism, closely associated with Benjamin Netanyahu, first as Ariel Sharon’s Finance Minister and then as Prime Minster.
As Arie Krampf has argued, Israel’s strategy followed from the collapse of the hopes associated in the 1990s with the promise of the peace economy. Shimon Peres and other Israeli strategists had hoped to combine a final settlement with the Palestinians with broader regional economic integration, along the lines of West European integration. As Krampf puts it:
The outbreak of the Second Intifada in September 2000 turned the game upside down. The failure of the Camp David Summit in that year marked the end of the peace economy.
The intifada dealt a heavy blow to Israel’s economy. According to Central Bank estimates the Palestinian uprising was costing Israel as much as 3.8% of gdp per annum. The idea of a deeply integrated regional economy no longer seemed realistic. Even less so after 911 and the assault on Iraq in 2003. This put strain on Israel’s alignment with the United States, as Washington needed to find new allies in the Arab world and Israel’s right-wing no longer wanted to compromise on the road to a two-state solution.
As Krampf describes it:
The right-wing governments in the post-Intifada period faced a new dilemma: How to restore economic growth without a peace process? This dilemma was the origin of a new economic-security doctrine. In the early 2000s, the Israeli economy was in a recession … The government of Ariel Sharon, led by Finance Minister Benjamin Netanyahu, implemented an austerity policy. In April 2003, a month after his appointment as minister of finance, Netanyahu announced the Economic Recovery Plan, which included a budget cut, a lowering of government deficits, and severe reductions in social spending and allowances. He also reduced government subsidies to the private sector. For Netanyahu, private sector growth was a means to improve Israel’s economic power in a globalized world. … privatization and liberalization were processes designed to improve Israel’s capacity to withstand external political pressure and pursue an independent foreign policy. … By late 2003, Israel’s current account had become positive and was growing, indicating that foreign currency was pouring into the economy. This change, which went unnoticed by the Israeli public, was nothing less than a transformative moment, a revolution in Israel’s economic history. … Ben-Gurion’s doctrine assumed dependency on foreign capital. This dependency, I argue, was a key element in the national vision and identity: the dependence of the state-building project on foreign assistance. By becoming a “surplus country” …. Israel had become less vulnerable than it had been before. The Bank of Israel hoarded part of the foreign currency. The Bank of Israel’s foreign reserves, having rocketed since 2007, currently are among the highest in the world per gross domestic product. At the same time, despite the deadlock in the peace process with the Palestinian Authority, Israel’s risk premium on government bonds stayed low and matched the risk premium of some countries in Europe.
The shift in Israel’s relationship to the United States was embraced by the Israeli right-wing as essential if they wanted to pursue their aggressive line on the Palestinian question. As Krampf argues in a recent piece:
In 2001, after the election in Israel and before embarking on Operation Defensive Shield in Gaza, Ariel Sharon, now the Prime Minister, declared that "we," Israel, "have only ourselves to rely on." (quoted in Barnea and Kastner 2006, 20). Sharon's declaration referred to Israel's intention to reject the Road Map multilateral peace negotiation track endorsed by Bush and shift to a unilateral track. When Sharon rejected the plan, the left-wing parties warned that it would have devastating implications for the US-Israel relationship (FC 2002a). The right-wing camp hailed Sharon's approach.
A strong current account surplus was essential if Israel was to make this “bid for autonomy”.
The concomitant was a decline of US aid as a share of Israeli GDP.
Source: Krampf 2023 Export-led growth
Within Israel’s political economy, the new focus on private-sector, export-led growth implied a shift away from the absolute priority of the military.
In social and political terms, the new growth model effectively divided Israeli society into several separate parts with different economic and cultural trajectories. The familiar pattern of rising inequality under neoliberalism was compounded in Israel by the rapid expansion of the ultra orthodox community, which does not participate in mainstream education, and the structural discrimination of the Arab community within Israel.
Netanyahu’s strategy was to make the modern segment of Israel’s economy so competitive that it would enable not just independence from American (or European) pressure, but turn Israel into a magnet for regional economic interests, above all of the Gulf. Foreign Direct Investment became a crucial component of Israeli investment.
Developing better relations with the growing Arab economies of the regione would allow an “economic peace” (one of Netanyahu’s favorite slogans) to be built over the heads of the Palestinians whose resentment and frustration would be contained through a strategy of divide and rule.
Gaza under Hamas would be quarantined and maintained just above the level of total collapse. A logic spelled out with stark clarity in conversations with US diplomats, whose cables subsequently leaked to European journalists:
“As part of their overall embargo plan against Gaza, Israeli officials have confirmed to (U.S. embassy economic officers) on multiple occasions that they intend to keep the Gazan economy on the brink of collapse without quite pushing it over the edge,” one of the cables read. Israel wanted the coastal territory’s economy “functioning at the lowest level possible consistent with avoiding a humanitarian crisis,” according to the November 3, 2008 cable. In a speech in January 2008, then-Prime Minister Ehud Olmert appeared to spell out that policy, which has since been eased in the wake of an international outcry over a deadly Israeli raid last May on a Turkish aid ship trying to break the blockade. “We will not harm the supply of food for children, medicine for those who need it and fuel for institutions that save lives,” Olmert said at the time. “But there is no justification for demanding we allow residents of Gaza to live normal lives while shells and rockets are fired from their streets and courtyards (at southern Israel)”.
Withdrawing from Gaza and placing it under siege was consistent with what Israel’s Institute for National Security Studies called "externalizing” the conflict. Netanyahu also pushed for the construction of a separation barrier and made this into a key trial of strength with the Bush administration.
With Hamas, Israel existed in what Tareq Baconi of the Palestinian research network Al-Shabaka describes as a “violent equilibrium”. A lopsided balance of force and coercion that both sides could live with. The cost to Israel of its “small wars” in Gaza was affordable. The Bank of Israel estimated that the 2014 war in Gaza cost the economy 0.4% of gross domestic product, and the 2006 war in Lebanon no more than 0.5%. By 2022 this balancing even included the opening of Gaza’s boundaries to permit up to 20,000 Gazans to join the Israeli labour pool.
Meanwhile, the PA-run West Bank was incorporated in a much more open regime, allowing a dramatic increase of Palestinian migrant labour in the Israeli economy. “Shrinking the conflict”, as Micah Goodman called it entailed allowing more than 200,000 Palestinians to work in Israel, 80,000 alone in construction.
This was not so much development, as the classic strategy of dependency and it went hand in hand with an aggressive program of settler development. The ongoing violence of the occupation regime thus sat side by side with Israel’s global economic integration.
In recent years, as Krampf has argued, it seemed that the main source of tension within this model lay in Israel’s domestic politics. Think back only a few months ago. The question was whether Israel’s tech economy would survive a right-ward lurch under the influence of Netanyahu’s coalition. Western news outlets were carrying worrying reports about the halving of investment in Israeli startups, which in 2021 had reached a record $27 billion in 2021. Already before the Hamas attack, in the first half of 2023 the Start-Up Nation Policy Institute reported that investment was down 68% year on year.
Israel’s left mobilized on a dramatic scale to oppose Netanyahu’s government. But, as was noted at the time, it largely bracketed the Palestinian question. The struggle in Israel could thus be discussed, out of context, as simply one more case of right-wing illiberal regression. That it is, of course. But one that was perched on a violent precipice. Hamas’s attack hurled Israel over that cliff.
The extraordinary violence unleashed by Hamas on October 7 exposed the horrifying reality of deep antisemitic and anti-Israeli hatred bred by the prevailing regime. It made unmistakably clear how hollow are the promises of security offered by the status quo. As cool-headed strategic analysts have pointed out, the threat is not that of 1973. Egypt and Syria, once Israel’s main enemies, pose no threat to Israel. Egypt’s decline was the subject of Ones and Tooze a couple of weeks back. But the sheer nightmarish violence of the Hamas attack induced an existential shock and not only in Israel.
That shock has been compounded by the scale of the Israeli reaction. Israel has conducted a mobilization that at least according to The Economist is larger in quantitative terms than 1973 - 360,000 reservists, or 8% of the country’s workforce. Even assuming the possibility of a Hezbollah assault this seems hard to justify in purely military terms. One wonders whether beyond military necessity it is designed to recreate a sense of a “nation in arms” - a solidaristic national militarism that has become attenuated in recent years. Whatever the motivation the impact on the economy is so serious that it has been compared to that of the COVID pandemic.
The tech lobby in Israel estimates that a tenth of its workforce has been mobilized. Construction is paralyzed by the quarantining of the Palestinian workforce in the West Bank. Consumption of services has collapsed as people stay away from restaurants and public gatherings are limited. Credit card records suggest that private consumption in Israel fell by nearly a third in the days after the war broke out. Spending on leisure and entertainment crashed by 70%. Tourism, a mainstay of the Israeli economy, has come to an abrupt halt. Flights are cancelled and shipping cargo diverted. Offshore the Israeli government ordered Chevron to halt production at the Tamar natural gas field, costing Israel $200 million a month in lost revenue.
In response to this real economic dislocation, the finance ministry outlined plans to ramp up defence spending and provide for those pushed out of work. Meanwhile, in the markets, the blue-chip TA-35 index of Israeli shares has sold off and the shekel has fallen to the lowest level since the last major confrontation over Gaza in 2015.
The central bank has intervened, selling $30bn of foreign-exchange reserves to slow the slide. With ratings agency Moodys warning of a hit to Israel’s credit rating, the cost of insuring Israeli debt against default with Credit Default Swaps, has also surged.
What no one should imagine, however, is that these kind of pressures will make much immediate difference to Israel’s strategy. Washington is scrambling to Israel’s aid with promises of up to $14 billion in aid. That is no doubt welcome, but Israel no longer depends on American aid. The Netanyahu strategy of national security neoliberalism has worked at least to the extent that Israel, even after the latest round of interventions has at least $170 bn in reserves and its debt to gdp level stands at no more than 60 percent of GDP. Even a protracted war on Gaza would be unlikely to raise by more than a few percentage points.
Israel has more than enough financial resources to continue its extraordinarily destructive assault on Gaza for as long as it wants. If it needs to resort to deficit finance, it is in good stead to do that. It can afford any punishment it wants to mete out. The real question is, is Israeli society willing to pay the price of ongoing disruption?
The most alarmist forecasts on Wall Street, from JPMorgan, suggest that the Israeli economy might shrink this quarter by 11% on an annualized basis. This is a far cry from any of Israel’s more recent wars. And the longer the war continues, the more the nagging questions surrounding Netanyahu’s strategy will press in.
Hamas’s attack was at least in part motivated by the desire to sabotage the deal-making between Israel, Saudi Arabia and the Gulf. Israel’s massive reaction seems set to make Hamas’s wish come true. Any serious negotiations between Israel and the Gulf region are presumably on hold for the foreseeable future. Whatever the cynicism of the Arab leadership, public opinion is too riled up to make a deal with Netanyahu worth the risk.
Inside Israel itself, the battle between contending political forces that was raging with such intensity before October 7 has shifted gear. Netanyahu’s opinion poll ratings are terrible. Within Netanyahu’s own cabinet there are divisions over the aid package.
Finance Minister Bezalel Smotrich - leader of the Religious Zionist and a major opponent of Gaza disengagement - is at logger heads with Economy Minister Nir Barkat, a pro-business establishment figure over the design of the relief package. As the Jerusalem Post reports:
… Smotrich is struggling to maintain an image of being in control of the situation, as he absorbs criticism for his ministry’s absence and lack of response during this time, alongside criticism and weaker support from his fellow ministers. With his Religious Zionist Party losing seats in recent polls, he may need to exhibit more control and effectiveness to win them back.
Outside the government a powerful coalition of mainstream economic opinion is seeking to use the war as an occasion to rollback the influence of the religious right . In an open letter signed by 300 leading figures including Prof. Jacob Frenkel, former governor of the Bank of Israel, govenrment-advisor Prof. Leo Leiderman of Tel Aviv University and 2021 Nobel Prize winner in Economics Joshua Angrist of the Massachusetts Institute of Technology, have warned Netanyahu and Smotrich: “You do not understand the magnitude of the economic crisis that Israel’s economy is facing. Continuation of the current conduct harms Israel’s economy, undermines citizens’ trust in the public system, and undermines the State of Israel’s ability to recover from the situation it finds itself in.”
Tellingly, what they call for is a revision to the 2023-2024 state budget, which included more than NIS 13 billion in discretionary coalition spending, much of which is allocated to educational programs for the ultra-Orthodox community. Those budget give aways should be place instead at the disposal of the war effort.
The war over the future of Gaza thus becomes entangled with inner-Israeli anxieties about the division of Jewish society between the Ultra-orthodox and non-ultra-orthodox Jews. At stake, no less than in the Gaza, question is the future of Israel. As think tanks like INSS warn
The figure clearly shows that the Israeli economy is hurtling toward a substantial decrease in GDP per capita. If there is no significant overhaul of the ultra-Orthodox education system, GDP per capita in Israel will shrink by 5 percent at the start of the next decade, 10 percent by 2050, and 15 percent by the start of 2060s. These forecasts are in comparison to Israel’s predicted GDP per capita if the current distribution of the population remained unchanged. This worrying assessment is, in fact, an underestimate of the damage to GDP per capita in light of the current trends in the ultra-Orthodox education system,
The war provides the growth-orientated Israeli mainstream with the chance to argue that the funding for ultra-Orthodox educational institutions that imposes no obligation to teach the core curriculum, should be slashed. The ultra-orthodox are of course dramatically underrepresented not only in the workforce but also in the ranks of the IDF. The war thus sharpens the resentment at funding their carve outs.
If this sounds mundane, the linkage established by Israel’s leading economists between the war economy and religious education, actually reflects the degree to which the future of Israel is in question not just from outside but from within. At the same time harking back to anxieties form before October 7, Dr Tomer Simon Chief Scientist of Microsoft Israel R&D addresses himself to National Security Advisor Tzachi Hanegbi in an open letter, warning that:
"The war has created a substantial vacuum in the workforce of the high-tech sector. This scenario is especially noticeable in multinational corporations located in Israel, where the percentage of employees recruited to the reserves is significantly higher than the national average. … These workers are often key figures in their organizations - senior managers, entrepreneurs, engineers, developers, project managers and a host of other roles critical to the day-to-day operational success and long-term strategic initiatives of their companies. The absence of these professionals from the day-to-day functioning of the high-tech sector has a wider impact. This not only harms the current projects but also sends a worrying message to their global headquarters about the reliability and stability of their Israeli operations, and of Israel in general. This concern is heightened amidst the background of the last ten months in which a political storm took place that already had a bad effect on the confidence of foreign investments, and was even expressed in the closing of five R&D centers even before the beginning of the current crisis. This concern may cause multinational companies to freeze or reduce their investments after the conflict, and even to close their R&D activities here. Such actions would constitute a strategic retreat that would carry with it harmful results for Israel's economic landscape and the future of innovation, weaken our global position and undermine our internal stability even more."
Clearly, the struggle in the Middle East is about life and death in the most stark and extreme sense. In Gaza the struggle for millions of people is already one of bare life against death. In Israel, despite the existential shock of October 7, the play of political economy goes on and this reflects the fact that Israel’s economic success for the last 20 years has always stood under the sign of violence. It was built on what was obviously an illegitimate and unstable order. As one interlocutor of the FT remarked.
“We built the high-tech industry during security challenges … What’s bizarre is how normal it’s become,” he said. “People realise that there is risk everywhere. It’s just a matter of mitigating it.” Even amid the turmoil, some workers in the high-tech sector are returning to work. “People will have to go — as crazy as what I’m about to say is — [back] to some normality”
The question, after October 7 and Israel’s destruction of Gaza is what that normality can possibly look like.