With Annexation Looming: The Vulnerability of the Israeli Economy During Hostilities with the Palestinians

A one-sided annexation to Israel of Palestinian territories runs the risk of a confrontation between Israelis and Palestinians. Such a confrontation may further exacerbate the economic crisis caused by the corona epidemic

Download the full report View previous publications

A one-sided annexation to Israel of Palestinian territories runs the risk of a confrontation between Israelis and Palestinians. Such a confrontation may further exacerbate the economic crisis caused by the corona epidemic, just as the second intifadah exacerbated the crisis that accompanied the bursting of the hi-tech bubble in 2000,” according to Shlomo Swirski and Noga Dagan-Buzaglo of the Adva Center, in a position paper published today.

Annexation may deepen the already extant economic crisis and adversely affect both Israelis and Palestinians. Against the background of uncertainty regarding the nature of the annexation, the authors would like to point out the vulnerability of the Israeli economy during confrontations with the Palestinians.

The second intifadah was the last major confrontation. It led to an economic recession that the Bank of Israel described as the most prolonged in Israel’s history. It should be remembered that due to Israel’s occupation of the Palestinian territories, it has for years been vulnerable to double crises: those resulting from worldwide developments and those particular to Israel. The “double jeopardy” creates a roller coaster economy.

The corona crisis threatens Israel’s credit rating, just as it threatens that of many other countries, but in the case of Israel, annexation will add another threat: that of security:  “You would have received a higher credit rating if it were not for the security issue,” stated the representative of Standard and Poor’s when it raised Israel’s rating to AA-, the highest rating Israel has ever received.

Economic recession results in unemployment. At the time of the corona outbreak, Israel’s unemployment rate was very low – 3.4%. This low figure was achieved thanks to years of economic growth, even though the growth rate itself was low.  The corona epidemic resulted in more than a million women and men suddenly finding themselves without a job, whether they were defined as unemployed or as persons sent home on leave of absence without pay. The economic crisis resulting from the second intifadah also up-jumped unemployment. Should a violent conflict break out over annexation, it will be even more difficult than it is today to lower the unemployment rate. Even without annexation, the Ministry of Finance found itself extending the period of entitlement to unemployment benefits a number of times.

One economic sector that is especially sensitive to instability is tourism. During the second intifadah, the number of tourists entering Israel declined to fewer than a million. It took years to get to the point where Israel hosted as many as three million tourists. This plateau continued for about a decade, until 2017, 2018 and 2019, during which tourism steadily increased, reaching 4.6 million entries in 2019.  In order to regain the loss caused by the corona epidemic, Israel needs not only to beat the Covid-19 virus but also to remain free of conflict.

Following the second intifadah, Israel embarked on a policy of fiscal austerity in order to reduce the national debt as well as the budget deficit. The policy succeeded in reducing both to a low European level. However, following the corona outbreak, the Bank of Israel forecasts that the national debt will be 74% of GDP in 2020 (as opposed to 60% in 2019) and the budget deficit will be 11.5% GDP, compared to 3.7% in 2019.

Fiscal austerity resulted in a reduction of social expenditures. While in 2001, Israel’s social expenditures stood at 17.5% of GDP – equal to the average in OECD countries, in 2007 they amounted to only 14.6% of GDP. The figure did increase with time, but less than the increase in OECD countries. A double crisis – corona and an Israeli-Palestinian confrontation – may magnify the threat to social expenditures. We need to keep in mind that these expenses include the public health care system, which was caught inadequately funded at the time of the corona outbreak.

The social safety net, which is supposed to help lift families out of poverty, now fails in that mission. The safety net is extremely sensitive to situations of conflict.  If on the eve of the second intifadah, the safety net succeeded in lifting 47% of families out of poverty, fiscal austerity instituted following the second intifada brought that number down to 35% (2018).

And now for the international scene. It is no secret that the European Union has serious reservations about the settlements and is in favor of the establishment of a Palestinian state. Sanctions that the European Union is liable to impose will be harmful to the Israeli economy. In 2019, Europe was the single largest market for Israeli exports, with 43% of total exports.

European sanctions are especially threatening to scientific cooperation. A prime example is the “Horizon 2020” program, a research and development project. Israel contributes about one billion euro and gets back, in the form of supports for a variety of projects, some 1.5 billion euro. The program has become one of the growth engines of Israeli academic R & D and of basic research in academic institutions. Besides funding, the program provides opportunities for cooperation with European corporations and research institutions, as well as  direct connections with European markets for technological products. Annexation is liable to threaten both the funding and the international standing of Israeli science and research.