Israel at 50 – Economic Achievements
by Moshe Felber
The achievements of the Israeli economy in the country’s first 50 years are no less impressive or fascinating than those in any other area of Israeli history. These achievements – especially those in the early years of the state – have amazed economic experts worldwide. From the very beginning, the country faced awesome challenges. The fledgling country found itself in a brutal war of existence and, at the same time, hundreds of thousands of refugees from the Holocaust in Europe and from persecution in Arab lands were knocking at the door of the newborn state, which did not even have enough tents to house them, let alone food to feed them. These challenges were enough to crush economies larger and stronger than that of Israel, which then was a country with a population of about 650,000 people living in an area of less than 8000 square miles (nearly 21,000 km2), most of it desert and rocky mountain.
Looking back, it seems that the history of the Israeli economy – like that of Israel, in general – has been a story of recurring dangers and crises threatening to destroy it. The economy’s success in rescuing itself from all these crises, emerging each time stronger than it had been previously, is perhaps its biggest achievement. Each of the achievements described below, and it is not possible to list them all, is important in its own right. However, it is when they are considered together that they constitute building blocks in the country’s main economic achievement: Israel’s current economic strength, as testified to by its membership in the group of 20 countries with the highest per capita national income in the world, and Israel’s return in the 90s to the group of countries with the world’s highest rates of economic growth.
Meeting the Quadruple Challenge
Two of the four main challenges that faced the Israeli economy for most of its existence, the security burden and immigrant absorption, have already been mentioned. The two other major challenges that the economy has had to face have been the need to build a physical infrastructure for the economy’s activity and to provide welfare services (health, education and assistance of various types) for a population growing at a rate greater than its ability to contribute to its own welfare. Each one of these four challenges, on its own, is a difficult test that would require strict discipline on the part of any ordinary economy to be handled successfully. However, the ability to meet all four of these challenges simultaneously borders on the miraculous and, indeed, at the end of the country’s first decade of existence, economists often referred to Israel’s “economic miracle”. Before this “miracle” is explained, each of these four challenges must be addressed.
The security burden is a constant factor in the Israeli economy. Such a burden was understandable and to be expected in the years when wars took place (the War of Independence in 1948/49, the Sinai Campaign in 1956, the Six-Day War in 1967, the Yom Kippur War in 1973 and the Lebanon War in 1982). But even during other years, Israel was burdened by security-related pressures. At times, this took the form of wars of attrition following the aforementioned wars. During other periods, the main threat was various forms of terrorism along and within Israel’s borders – terrorism supported by Israel’s neighbors.
This situation called for constant vigilance, the maintenance of forces to ensure security along Israel’s borders and on the home front and continuous training of the army reserves which serve as the backbone of the army during times of war. It also required Israel to continuously obtain the latest technological innovations in order to allow the Israeli army (which is small relative to the armies of the neighboring countries who always saw Israel as their enemy) to successfully stand up to those who attacked it. The mere existence of this strong, though small army served as a deterrent, causing Israel’s foes to abandon belligerent intentions. These security necessities were costly.
The economic burden of Israel’s security needs is best expressed in terms of the percentage of the GNP spent on defense. While in most Western countries this percentage ranges from 1% to 3% (and the United States was considered to have a “war economy” when this figure reached 9% at the peak of the Vietnam War), in Israel this percentage rose from an average of 10% during the first nineteen years of the country’s existence to 25% after 1967, and then reached a peak of 45% [!] during the Yom Kippur War in 1973. This ratio began to drop only after peace agreements were reached with Egypt (1978) and Jordan (1994), and after these borders – Israel’s two longest – proved to be calm. In the present decade, the percentage of the GNP spent on defense has fallen further thanks to the faster growth of the GNP, from 13.1% in 1990 to 9.5% in 1996.
There are many countries worldwide that have taken in a great deal of immigrants, but it is doubtful that there is any other country that doubled its original population within three years (by 1951) as a result of immigration. The immigrants that came to Israel were not young, educated people with capital or a profession – the kind preferred by most countries. Rather, these were primarily refugees from the Nazi death camps in Europe (most of whom were broken in body and spirit) and, later on, immigrants from the developing countries of Asia and Africa.
By 1997, more than 2.6 million immigrants had come to Israel, with the overwhelming majority arriving during the first two decades of the country’s existence. This number is four times the amount of Jews that lived here at the time of the establishment of the state. The absorption of these immigrants necessitated tremendous resources, from shelter (tents in the early years, followed by shacks, caravans and small apartments and then larger ones – all according to the country’s economic ability at the time), and education, health and welfare services (including buildings for the provision of these services) to vocational training and the creation of jobs. A very large proportion of the public expenditure was allocated for this task.
In “ordinary” countries, the economic infrastructure – roads, railroads, ports, airports, water carriers and sewage removal, electricity generation stations and lines for delivering electricity and communication systems – was built over the course of the history of the national economy, at the rate of development of their economies. However, after 400 years of Ottoman rule, the land of Israel was a backward territory. While there was significant improvement in this area during the 30 years of the British mandate, the infrastructure inherited by the State of Israel was minimal.
In order to create a modern economy, capable of absorbing millions of immigrants in productive labor, first and foremost in industry, it was necessary to set up a suitable physical infrastructure, starting almost from scratch. In addition, in the absence of accumulated capital – either private, from previous generations, or imported from outside – the public purse had to finance the establishment of economic enterprises in this land of refugee immigrants. After all, even among those who lived in Israel prior to the establishment of the state, 80% were the first or second generation of immigrant families. Obviously, reaching these objectives called for large amounts of money.
This requires a great deal of public resources in all countries. However, in Israel’s case, the resources required were even greater. This was not because the needs of immigrants were greater, but also because it became clear by the end of the 60s that it would be necessary to make efforts to rescue from poverty quite a few of the immigrant families that had arrived during the early years of the state. As a result of the lack of funds available when these immigrants arrived in Israel, their physical and social absorption had not always been successful. Thus, the Israeli economy had to allocate resources to deal with a variety of issues in the areas of housing, education, health and social rehabilitation. Again, this cost much more than the country could allow itself from an economic point of view.
The ability to simultaneously meet the four challenges described above constitutes an impressive economic achievement of the Israeli economy, second only to its ultimate achievement of establishing a strong flourishing economy.
The Economic Miracle
This achievement entailed, or at least so it would seem, contravening a law of economic theory (based on the principle of the “scarcity of resources”) – allowing the consumption of only as much as is produced – because throughout Israel’s existence the economy has used more resources than it produced, despite the rapid growth in its national product. In national accounts terms, this is illustrated by the fact that the value of Israel’s imports has constantly been greater than the value of its exports. It was only due to the ability to finance this deficit (the annual difference between imports and exports) that the Israeli economy was able to meet all of the challenges cited above. How did it do this?
Basically, it financed this annual deficit through tremendous financial assistance that the country succeeded in raising around the world. The annual trade deficit increased from $220 million in 1949 to about $12.9 billion in 1996 (all in nominal terms). Each year, the Israeli Finance Minister would recruit resources to cover this annual deficit. A small portion of this money came in the form of investments by foreigners in businesses in Israel; an even smaller amount came from pensions and other income from abroad of individuals in Israel; a significant amount came from appeals organized by Jewish institutions, and a large part came in the form of loans from individuals (primarily in the framework of Israel Bonds), banks and governments. More than half of the required amount came from grants from friendly governments (first and foremost, the United States). Over the years, this imported capital – to cover the annual deficits in foreign currency – has totaled more than $120 billion (in nominal terms).
Growth of the National Product
Growth – producing more and more – is of great importance to any national economy, as, indeed, it is to every individual and family. This is because the more that is produced, the more resources the country as a whole and individuals have to use to satisfy their varied needs and wants. Since it is people that are behind production, the more people active in a private or national economy, the greater the product. However, more important than the number of people participating (the size of the economy’s work force), is the equipment available to them for performing their work. The more sophisticated this equipment, the more can be produced. This equipment can take the form of work tools, fields, animals, machines, or even education. What is common to all these is that they can be purchased with money. Thus, the more capital an individual (or an economy) has, the more and better equipment they will have, and, thus, the greater their product will be.
Those who referred to what was happening in the Israeli economy as an “economic miracle” were not amazed by the fact that it successfully met the challenges described above, nor by the ability to raise resources worldwide for this purpose. Most of these economists were not even aware of this. Rather, what amazed them were the statistics that Israel recorded: an unprecedented achievement of rapid growth of the national product over the period of a generation, with an average rate of 10% in the years 1948-1973. There have been economies with higher growth rates, just as there were economies that maintained long periods of growth. But there was no other country that was able to maintain such high growth rates over so long a period.
Thus, we can now appreciate the nature of the “miracle”: the rare combination that took place in Israel of rapid growth of the work force, as a result of mass immigration, and a massive influx of capital that the country succeeded in raising. Each wave of immigration, whose initial absorption represented an economic burden on the Israeli economy, turned into a blessing when these immigrants joined the circle of production – thereby contributing towards increasing the national product – in a relatively short period of time, thanks to the capital that could be made available for this purpose.
The rapid growth that characterized the country’s first twenty-five years came to an end with the Yom Kippur War in 1973, due, among other things, to the drop in the rate of growth of the population. The average annual number of immigrants to Israel fell from about 42,000 in the years 1970-1973 to about 22,500 in the remaining years of the decade, and to about 12,500 in the 80s. The growth rate of the national product dropped accordingly, falling to an average of 3.6% in the remaining years of the 70s and 3% in the 80s. Then, the collapse of the Soviet regime led to the opening of the gates of the former USSR for Jews who wished to emigrate and they came to Israel at a rate reminiscent of the early years of the state. Again, proof was provided for the Israeli link between immigration and economic growth, the latter doubling to an average rate of about 6% – the highest rate of growth in the Western world in the first half of the 90s.
The rapid growth of the national product allowed the Israeli economy to register another important achievement, an increase by a factor of many hundreds in the export of goods and services, from $41 million in 1949 to $31.3 billion in 1996 – reaching the highest per capita exports in the industrial world. Even after allowing for inflation’s effect on the American dollar (amounting to a fall of 7.874 times in the years 1948-1995), there is still a 97-fold real increase in Israeli exports over the years of its existence. Furthermore, it is clear that the national product could not have grown as fast as it did, had a large part of the increase in manufacturing not been earmarked for export.
The single firm strives to increase its exports in order to expand business and increase profits. But from the point of view of the economy as a whole, the importance of increasing the country’s exports lies in the desire to achieve economic “independence” or viability – a situation in which the foreign currency received for exports is sufficient to pay for all the goods and services that are imported. On this front, too, the Israeli economy has recorded significant achievements: While in 1950, income from exports financed only 14% of the country’s imports, this figure increased to 51% in 1960, 73% in 1980, and 78% in 1990.
The ills of unemployment are not limited to the economic and morale-related effects on the individual and his family. Unemployment also affects the economy as a whole. Non-involvement in production represents a total waste: the economy can never recover the product lost for every day of unemployment. It is a serious problem that the industrialized nations face, and an even greater problem in countries in the midst of a transition to industrialization. One almost always finds a clear correlation between high rates of unemployment and low rates of economic growth.
Obviously, waves of immigration bring with them a certain degree of unemployment – very few immigrants find work immediately after arriving in their new country. Thus, most of the immigrants who came to Israel had to endure periods of unemployment, some longer, some shorter, before finding work.
The situation of relatively rapid growth in periods of massive immigration indicates that most of the immigrants were unemployed for only a short time. Accelerated growth of the national product in itself indicates an increase in the number of people employed. The comparatively quick absorption of tens of thousands of immigrants into the labor force is another noteworthy achievement of the Israeli economy.
The unemployment rate in Israel rose from 7% in 1950 to a high of 11.3% in 1953. This was the only year in the history of Israel that the national product decreased. This is not surprising in light of the fact that in that year immigration to Israel reached an all-time low (11,500 people, less than half of the number of immigrants in 1952 and less than 7% of the number of immigrants in 1951). From this point on, the rate of unemployment dropped continuously, reaching a low of 3.3% in 1964. In the next two years (again correlating with a drop in immigration) the rate of growth of the national product dropped, and unemployment climbed to 10.5% in 1967.
In the following 18 years, unemployment rates ranged from 2.6% to 6% (an enviable level of unemployment relative to most Western countries) and to 6% to 11% in the following decade, after 1985. The highest rates were registered at the beginning of the 90s – a period that saw waves of immigration the likes of which had not been seen since the early 50s. In this case, it took an average of a year for the immigrants (the majority of whom were the most educated and professional in the history of immigration to Israel) to find appropriate employment. The economic support given to these immigrants today, above and beyond the unemployment insurance benefits to which all unemployed citizens are entitled by law (since the end of the 60s), allows them to search for employment relatively unpressured.
In 1996, the level of unemployment was 7.1%.
Like unemployment, rising prices are an obstacle to healthy economic development. This, because inflation limits the ability of any consumer, producer, investor, debtor, or government to plan economic steps for the near or distant future. As was the case with unemployment, the achievement of the Israeli economy lies in its success in overcoming these and associated difficulties.
This was done through the refinement of the tool of linkage. The Israeli economy turned this tool into an art, and used it in an impressive manner unmatched by any other country. At first, workers’ wages were linked to the Consumer Price Index (CPI) to ensure that inflation – large or small – would not hurt their purchasing power. Later, banks began linking their customers’ savings to the CPI or to foreign currencies (usually the U.S. dollar) so that these customers would not be tempted to spend their money before its value dropped. For the same reason, insurance companies followed the banks’ lead and began using linkage. Many with debts to collect, usually those who were selling goods or services on payment plans, also resorted to the linkage system to avoid losing on transactions as a result of the value of future payments dropping when prices rose. Linkage received formal approval when the government began linking its contractual payments to suppliers as well as its receipts from various taxes to the CPI. Even the income tax brackets are updated according to increases in the CPI.
Hence, while large and powerful economies worldwide were straining under the havoc caused by annual inflation of 2%-7%, Israelis went about their business almost undisturbed despite inflation rates dozens of times higher than this. For almost forty years, Israelis were completely protected by the linkage mechanism, something that can be seen as an impressive achievement in itself. Indeed, the standard of living (per capita private consumption) rose by an annual average rate of almost 4% during this period.
The Israeli economy has witnessed inflation for all 50 years of its existence. In the early years, when burning problems led the captains of the economy to disregard the need for a monetary policy, inflation was high, reaching 57.7% in 1952. The “new economic policy” introduced in that year brought, among other things, a halving of the rate of inflation, to a level of 28.1% in 1953. From that point on, for a period of eighteen years until 1970, inflation remained single-digit, with a 1.4% low in 1959 and a 9.4% high in 1962. The annual rate of price rises turned double-digit in the 1971-1979 period (increasing from 12% to 78%), and in the 80s, this became triple-digit inflation, which reached a peak of 445% in 1984, and threatened to reach four digits.
This is where the party ended. It became evident that under this type of hyperinflation, the linkage mechanism could not provide a sufficient solution. Too high a price was being paid, in terms of the national product, on the daily adjustments required to use (and attempts to improve) this mechanism. In addition, the linkage mechanism itself was adding fuel to the fire of inflation, something that had always been true, but with a negligible effect when inflation rates were at lower levels.
In July 1985, when it became clear that there was no other choice, the government decided to adopt an economic stabilization policy, taking extreme steps, some of which are considered “reactionary” in economic thought. Ordinances were issued compelling a total freeze of prices of all goods and services in the economy, including all wages, public budgets, exchange rates and linked prices specified in various agreements. This policy, in fact, was a temporary suspension of the linkage mechanism. Indeed, in 1986, the inflation rate dropped by more than half (to 185%), and in 1987 it dropped to about a tenth of this rate (19%). In the ten years since then, annual inflation has never surpassed 20%, and there were two years during this period in which inflation was even single-digit. The linkage mechanism was reinstated (with stricter monetary supervision by the central bank), and the waves of criticism and doubt expressed by many economists worldwide with regard to the steps taken in the summer of 1985 turned into applause.
The “economic stabilization policy” and the determination shown in implementing the policy won admiration as an extraordinary achievement of the Israeli economy and today they are studied in economic faculties worldwide, as is still the case with the linkage mechanisms.
Private Consumption and Savings
It would have been reasonable to assume that in a national economy such as that of Israel, which had to withstand the burdens described above and at the same time maintained one of the world’s highest rates of economic growth, there would be no resources left over for individuals to use to raise their standard of living, i.e., their private consumption. In fact, if the Israeli economy only had at its disposal the means resulting from its own product, the tremendous level of public consumption and the savings required to finance the investments necessary for continued product growth would have made this the case. However, as mentioned above, the economy benefited from a large capital import which allowed it to record its achievements. This left enough to allow private households to improve their standard of living.
Until 1970, per capita private consumption rose by an average annual rate of some 4.7%, and has risen by about 3.2% since then. While there were a few years in which this consumption dropped, most of these during the second period, there have been more than 40 years in which per capita private consumption increased (at levels ranging from 1 to 11 percent), a noteworthy achievement. In this context, it is no less noteworthy that during this period the citizens of Israel showed restraint and did not spend all of their personal income. Rather, they behaved economically, saving a significant part of it – thus contributing to the investment possibilities of the country and allowing the economy to become that much less reliant on imported capital.
The rate of private savings in Israel is one of the highest in the world. During the country’s first decade, the proportion of private disposable income that was set aside as savings never dropped below 29%. At the beginning of the 60s, this ratio fell to 21%, but it then climbed up to 38% in 1972. In the following decade, the savings rate dropped to 34%, then to 29% in 1985 and 25% in 1996.
Reduction of Economic Inequality
As in all Western countries, a progressive income tax system in Israel serves to reduce inequality of income between individuals in the economy. This is accomplished by taking about half of the income of the richest individuals (those belonging to the highest deciles on the basis of income) while granting an exemption from income tax to those in the lowest income deciles. Income inequality is further reduced through a system of social transfer payments to complement income of those in need, using a variety of criteria, by the National Insurance Institute and other sources.
In addition to this policy of reducing inequality by refraining from collecting taxes from those with low incomes and by providing them with financial assistance, the government also works to reduce inequality by directly providing services such as education, health and culture that, while benefiting the entire population, are of greater benefit to those with lower incomes. The amount spent on these social services, both in absolute terms and in terms of the proportion of the total public expenditure spent on these services, has risen over the years, especially in the past two decades, during which the defense burden, as a percentage of the national product, began to decline.
However, not only has the real value of the budget for these services more than doubled over the course of the past decade – with its weight in the average disposable income of households rising from 17% to 23% – but the contribution that these services make to the reduction of inequality has increased, especially with the recent introduction of national health insurance in Israel.
Thus, while the economic income of the lowest decile equals only 8% of the income of the highest decile (a slight improvement as compared with 6.6% 40 years ago), the payments that they receive and the fact that their income tax and national insurance payments equal less than 2% of that of the highest decile, raise their disposable income to 19% of that of the highest decile. When one also takes into account the services that are provided directly by the government, the inequality is reduced even further, raising the lowest decile’s actual income (financial plus the value of services provided) to 27% of that of the highest decile. This is 3.4 times more than before government intervention.
Of all the branches of the Israeli economy, industry has grown the most: its growth rate is higher than that of the total national product; industrial exports have increased more than total exports; the number of people employed in industry has risen more than in any other branch of the economy. Furthermore, the future development of the Israeli economy depends on the growth of the industrial sector. In recent times, this sector has accounted for about 65% of the total export of goods and services, has received about 25% of the total investments in the economy, has produced 23% of the total national product and has employed about 22% of the total number of workers.
These achievements in the manufacturing industry stand out, not just considering the fact that its product actually shrunk in the first three years of statehood (when public and economic attention was focused on the physical absorption of the new immigrants), but also in view of the pre-statehood Zionist policymakers’ “ideological” disregard of industry during the first decades of renewed Jewish settlement in the Land of Israel. These leaders saw agricultural settlements as the highest priority and gave this area of activity whatever financial support could be raised. In those years, industry was thought of, at best, as essential in order to serve agriculture. The status awarded to industry only improved during WWII when it made a significant contribution to the war effort of the Allies.
Between 1950 and 1996, industrial exports rose from $13 million to $17.1 billion, a 167-fold increase (in real terms). The number of people employed in industry rose by four times, from 95,000 to 388,000. In the period 1952-1973, total industrial output grew at an average of about 12% per year, whereas during 1974-1996 it grew by an average of about 4% annually.
The growth of the hi-tech section of industry is even more remarkable: 30 years ago it was 37% of the industrial output, compared to 56% a decade ago and 66% today. In 1970 hi-tech exports amounted to $540 million, or 20% of total industrial exports, whereas in 1996 they were 20 times larger – exceeding $10 billion, or 60% of total industrial exports. Much of the fast growth of this section of industry may be attributed to the influx of highly skilled manpower arriving in Israel with the 90s wave of immigration. Also, hi-tech industry in Israel enjoys generous R&D public budget allocations and high rates of return on investments. It is no wonder that stock exchanges around the world show keen interest in Israeli hi-tech shares traded there.
As agricultural settlement was at the focus of the Zionist movement’s concepts, this branch of the economy received significant public assistance in the two or three generations preceding the establishment of the state (and even more afterwards). This led to its becoming extremely sophisticated, especially in the past thirty years. Nonetheless, the weight of this economic activity in the national product, in exports and in employment, has dropped over the years – partly due to the fact that the large investment made in agriculture led to very efficient production processes. Today, 4% of the work force in Israel (one-third of the proportion in 1950) is enough to meet all of the country’s food needs (except for seeds) and still yield more than $600 million of agricultural exports annually.
The main achievement of agriculture in Israel lies in the fact that it is one of the most advanced agricultural systems in the world, both in terms of efficiency and in terms of sophistication. In addition to varied agricultural produce, the country exports advanced agricultural know-how and machinery (the fruit of Israeli scientific development).
Yet another achievement is the annual number of tourists arriving in Israel – which has recently passed the 2.5 million mark, 76 times the 33,000 who visited the country in 1950. The value of exporting tourist services (i.e., the foreign currency income) now exceeds $2.8 billion. Israel has invested considerably in an infrastructure allowing tourists to enjoy the country’s geographical diversity, archeological and religious sites, almost unlimited sunshine and modern resort facilities at the beaches of the Mediterranean, the Sea of Galilee, and the Dead and Red Seas. The potential of all this is much greater and the further and faster growth in the number of tourists now depends – first and foremost – on peace in the region.
Naturally, it is impossible to list all the areas in which clear indications of Israel’s outstanding economic achievements may be noted. Many of these can not even be measured quantitatively. One example is the fact that Hebrew, not French, Spanish or Japanese, is the second language after English heard at international trade fairs of the hi-tech industry, indicating Israel’s momentous role in this field.
In addition, Israel has managed to rise above the losses caused by the tri-level Arab economic boycott. The boycott not only forbade firms in Arab countries to trade with Israel, but also blacklisted all firms in the world which do so (thereby preventing them from doing business with any Arab country) and furthermore blacklisted any company that dealt with any of the aforementioned firms.
The amount of business lost by Israel as a result of the secondary and tertiary boycotts is immeasurable. Still, this was limited both by anti-boycott laws passed, through Israeli pressure, in most Western countries, and by the realization, by many firms, that the small Israeli market was larger, for many industrial products, than all the Arab countries combined.
In summary, the leading measurable economic achievements of Israel are:
- Becoming one of the world leaders in economic growth rate – averaging 5% annually in the 1990s.
- Joining the list of the 20 highest per capita income countries in the world.
- Attaining the highest exports per capita in the world.
- Overcoming the ill effects of inflation by creating a sophisticated “linkage” (of prices) mechanism, and reverting to a stern stabilization policy with the advent of hyperinflation.
- Maintaining, in most years, close to full employment, while absorbing 2.6 million immigrants, four times the population at the establishment of the state.
- Making the manufacturing industry, especially the hi-tech sector, the main factor in the Israeli economy, with a growth rate higher than that of the total national product.
- Developing the most advanced agriculture in the world, in terms of, e.g., yield per acre, use of sophisticated irrigation systems and application of innovative research and technology in agriculture.
As Israel’s economy looks towards the 21st century, it expects to continue to prosper as an active partner in the world economy.