Israel's Rising Economy and its Drawbacks - Causes, Consequences and Remedies

Bachelor Thesis, 2008

63 Pages, Grade: 1.7


Table of contents

List of abbreviations and foreign words

List of illustrations

1. Scope of the topic

2. Israel - an insight into the young country
2.1. Contemporary history and conflict
2.2. Economy
2.3. Demographics
2.4. Poverty
2.5. Unemployment and low participation in the labour market

3. The Ultra – orthodox population in Israel and its effects on the economy
3.1. The Ultra-orthodox society
3.2. Religious education
3.3. Draft exemption
3.4. Subsidies, other income sources and unemployment
3.5. Social problems
3.6. Population growth and poverty

4. Economic consequences of the Israeli – Palestinian conflict
4.1. Current situation
4.2. Conflict consequences on the Israeli economy
4.3. Conflict consequences on the Palestinian economy

5. Policy Suggestions for the Ultra-orthodox question
5.1. Revaluation and renewal of the “Tal Law” and setting up of a civil service
5.2. Establishment of outsourcing centers and training programs
5.3. Supportive measures
5.4. Negative income tax
5.5. Implementation of the EITC system in Israel

6. Suggestions for the Israeli – Palestinian economic relations
6.1. Future economic agreement
6.2. Israeli – Palestinian trade throughout the conflict
6.3. Benefits of economic cooperation
6.4. Price of economic separation

7. Conclusion


List of Abbreviations and foreign words

illustration not visible in this excerpt

List of Illustrations

Illustration 1: Number of suicide terror attacks in Israel from 2000

Illustration 2: Percentage of families and children in Israel below the poverty line

Illustration 3: Rate of participation in the Israeli labor market in the age group 25-64

Illustration 4: Photograph of an Ultra-orthodox family

Illustration 5: Population projection for the Ultra-orthodox in Israel. (Page 31)

1. Scope of the topic

The Middle East has always been major center of the world affairs. Many cultures and civilizations have originated from this area of the world. It is the geographical birthplace of the world’s three most dominant religions - Christianity, Islam and Judaism. It has also seen its fair share of conflicts and wars in its long history. The area’s abundance in crude oil has also contributed to that fact.[1] Collisions over ideology, religion, oil and land are persisting to remain to this day and it is a religiously, politically, culturally, and economically sensitive area. Today’s Middle East has developed after WW1, at the time when the Ottoman Empire, which was allied with the Central Powers, was defeated. Other defining events in this transformation process included the departure of the Europeans, namely Britain and France, but were supplanted instead by the rising influence of the USA. The establishment of Israel in 1948 has played a significant role in the change of the dynamics of the region.[2]

It is Israel that is going to the focal point of this work, also taking into consideration the Palestinian objective. Economics of Israel and its economical ties with the Palestinian Authority have suffered greatly due to continuous conflicts between the two. The huge economical potential that lies within the cooperation between Israel and the Palestinian Authority is going to be discussed here, leaving aside all the other benefits that would result from a resolution. The potential is large for both sides, despite Israel’s economy being the dominant one and more independent than the Palestinian.[3] In many ways Israel still relies on the Palestinians and this is not going to change in the near future. The Palestinian reliance on Israel is larger by many extents, so sound efforts should be made in order to improve the economical cooperation and the grim economical situation in the Palestinian territories.

Economic welfare is the basis for prosperity and peace and the Israeli – Palestinian conflict is at the heart of this region’s unrest.[4] Although this work is not going to discuss any political issues, it is clear that economical cooperation is crucial for this region and of high importance to Israel’s market.

The conflict with the Palestinians and the resulting volatile security situation in Israel are by far the most serious drawbacks of the Israeli economy but also an Israeli internal situation is threatening to become a serious potential drawback and is already showing signs of doing so.[5]

The Ultra-orthodox religious group in Israel is completely on the other side of the spectrum, regarding some issues – unlike Palestinians they are Israeli citizens, they are Jewish, and not Muslim. From an economical point of view, however, there are some similarities. The lack of participation of the Ultra-orthodox in the labour market is damaging the economy just as much as the lack of participation of the Palestinian foreign workers caused by the conflict, perhaps more. The closed society that this religious group created, almost a separate “state” and somewhat separate economy are to some extent like the separation of the Israeli and the Palestinian economies. The fact the Palestinians heavily rely on the Israeli economy is also quite similar to the almost total reliance of the Ultra-orthodox on the Israeli government. Both Palestinians and the Ultra-orthodox are very far from being self-sufficient and in that way are posing a burden on the Israeli economy.[6]

The Ultra-orthodox are a minority in the Israeli society that is growing in a very fast pace and their effect on the economy is starting to become more and more significant. At the current birth rate they are about to become a quarter of the whole population of Israel in the next decades.[7] Much like the growing aging population of Europe is a worrying topic, the Ultra-orthodox pose a much more serious economic and social challenge. Unlike the retired population, that has contributed its share to the economy and the labour market, the Ultra-orthodox have very little to almost none contribution to the economy as a whole. The time – demanding religious studies that are conducted for decades, deprive of the chance for higher education and of the participation in the labour market, regardless if willingly or unwillingly. Due to this fact, the reliance on government support is inevitable.[8]

In order to investigate these two issues, Israel as a country will be introduced, its background and brief history, the development of the economy from the early days of working the land and to the high-tech boom of the recent decade, all in the course of defending itself in the frequent wars that have impaired the economy. One of these wars also being the conflict with the Palestinians, which is to some extent a continuous war although not being counted as one, due to having a different nature. However, like other wars, this conflict is violent with casualties from sides, much suffering and poverty caused and resources, being inefficiently allocated, jobs lost, welfare diminished leaving the economies damaged. As always though, some sectors benefit from the conflicts, like the weapons development industry, for example, which creates one of Israel’s important exports.[9]

Israel’s social structure will also be introduced, in order to understand better the role of the Ultra-orthodox in the society. This particular religious group will be discussed in depth in the chapter thereafter, due to its important (although not positive) role in the economy. The Ultra-orthodox originate in Eastern Europe dating back to after WW2 and they have formed an enclosed sub-society in Israel. Further topics, which will be discussed are their culture and customs that eventually lead to their exclusion from the labour market, exemption from military service and exceptionally high fertility rate. Being much higher than in the rest of Israel, it is the cause for this group’s size change from a minority into a worrying burden on the society as a whole.[10]

The role of the government is also important, being the main financial supporter of the Ultra-orthodox and being the one responsible for introducing generous child support programs that have increased even further the fertility rate within this group. As a growing minority, the Ultra-orthodox are also becoming more influential in the government and politics, thus, creating a vicious circle and difficulty for change in the status quo.[11]

The chapter thereafter is going to investigate the economic effects of the Israeli – Palestinian conflict. Consequences of the conflict will be presented – one of them being Israel’s extremely high expenditure on defence, among the highest in the world. This is a prime example of resources that could have been used otherwise more productively, but instead being inefficiently allocated and diminishing the GDP.[12] The outbursts of violence create recessions, scare off investments and seriously damage the potential for economic growth.

Israel’s image hasn’t improved much in the last years and numerous boycotts on Israeli products are being organised (although not always efficiently) by different consumer groups, most in the Arab world but also many in Europe.[13]

The terrorism is also reducing private consumption and lowering the overall optimism level of the suppliers. The tourism sector is perhaps the one most dramatically affected in the short run, throwing this whole industry into a standstill. The Palestinian economy is affected in a much worse way, being very dependant on the Israeli one. Just of being deprived of the possibility to work in Israel or being unable to export or import products on a regular basis, many of the Palestinians live below the poverty line and are unemployed. The conflict is separating further the two economies instead of integrating them and a huge potential remains unfulfilled.[14]

Finally, possible solutions and options will be presented, regarding both the Ultra-orthodox group and the conflict with the Palestinians. Is the option of separating almost completely the Israeli economy from the Palestinian one desirable or perhaps the creation of a framework for economic cooperation even during an ongoing conflict is possible? Some reforms regarding the Ultra-orthodox seem also inevitable. What is the best path for integration if not into the rest of the Israeli society, then at least into the economy. An analysis of these options will be given.

2. Israel - an insight into the young country

2.1. Contemporary history and conflict

Birth of Zionism

The will to return one day to Zion, the synonym for the Land of Israel and Jerusalem, has been emphasized in the Jewish life of the Diaspora for centuries. Zionism as a national movement arose in a response to the continuing persecution and oppression of Jews in Eastern Europe, while Western Europe, formally emancipated, was failing to put an end to the discrimination and to integrate the Jews into the societies of the places where they lived. Zionist movement has been constituted as a political organization at the First Zionist Congress in 1897 in Basel, Switzerland, calling on the return of all the Jewish people to Israel and on the revival of their national life in the homeland of their ancestors.[15]

Thousands of Jews, inspired by the Zionist ideology began to arrive to the Land, which at that time was a sparsely populated and mostly neglected corner of the Ottoman Empire. The pioneers reclaimed wastelands, drained swamps, afforested hillsides, built villages and towns and established industries. Community services and institutions were set up and the Hebrew language, which has been restricted for use in literature and liturgy for centuries, was revived, making it once again a day-to-day language.[16]

Recognizing the historical connection of Jews with Palestine and the grounds for reconstituting their home in that country, in 1922 Great Britain was granted a mandate over the Land by the League of Nations. Great Britain was given the task to place the country under suitable conditions in politics, economy and administration, that would secure the establishment of a national home for the Jewish people.[17] Only the part west of the Jordan River was to be developed for this purpose, still extremist Arab leaders were opposing to this establishment of Jewish home, even in such small area of land. Attacks have been incited against the Jewish community and against Arabs who embraced this idea of coexistence. Restrictions on immigration have been introduced by Britain and this situation continued until WW2.[18]

By the end of the WW2, the restrictions on immigration were still in place, despite the immediate need for refuge of the Nazi Holocaust survivors. A network of illegal immigration has been organized and brought around 85,000 refugees from Europe to Palestine.[19]

Creation of the State of Israel

The British, unable to reconcile the growing Arab opposition to settling the land by the Jews, and the mounting demands of the latter to lift the restrictions on immigration, have turned over this issue to the UN. The UN General Assembly, in turn, have voted for the establishment of two states, one Jewish and one Arab, in the area west of Jordan River in November 1947. The Jews have accepted this partition plan while the Arabs rejected it. When the British mandate has terminated in May 1948, the Jewish people have proclaimed the establishment of the State of Israel. Armies of no less than five Arab states have launched a war less than 24 hours after the declaration, invading the new state. This war has become Israel’s War of Independence. In July 1949, after more than a year of fighting, separate agreements have been signed with all the neighbouring Arab states.[20]

Arab terror attacks, with the encouragement and support of the Arab states, have continued, targeting Israel’s population centers, instituting diplomatic and economic boycotts, blocking international waterways accessing Israel and instigating full-scale wars. In the years 1956 and 1967 Israel has launched pre-emptive attacks as self-defence to prevent major threats and in 1973 has battled-off simultaneous full-scale attacks on two fronts initiated by the neighbouring Arab states. In 1982 Israel operated against terrorist bases of the Palestine Liberation Organization in southern Lebanon, which were launching attacks against the northern civilian population in Israel. In 2006, the Israeli Defence Forces had to return to the same area, responding to massive missile attacks in the north of the country.[21]

After some negotiations, the long awaited signing of the Egypt-Israel Peace Treaty has taken place in March 1979, finally breaking the cycle of rejection by the Arab countries. Yet another significant breakthrough has been achieved with the Declaration of Principles in September 1993, signed by Israel and the Palestine Liberation Organization. Consequently, self-governing bodies have been implemented in Gaza and later extended to areas in the West Bank. The following year, 1994 has seen the ending of a 46 yearlong state of war between Israel and Jordan and a signing of a peace treaty and establishment of diplomatic relations between the two. Numerous other treaties and protocols between Israel and the Palestinian Authority have been signed in the following years, concerning redeployments and releases of prisoners.[22]

Ongoing conflict

Palestinian and Arab terrorism throughout these decades have caused thousands of deaths. In September 2000, a new Intifada (uprising) has been initiated by the Palestinians. This campaign of terror and violence has caused heavy loss of life and much suffering to both sides. Attempts to renew the peace process and end the confrontation have failed due to escalating terrorism by the Palestinians, which was supported by the Palestinian Authority. 1,137 people have been killed by Palestinian violence and terrorism since September 2000.[23]

2005 has seen the implementation of the Disengagement Plan, the withdrawal of all Israeli military forces and Jewish settlements from the Gaza Strip. As some predicted, terrorism from the Strip, since then, has continued and escalated. While the Israeli army manages to control this terrorism mostly, still the western Negev area in Israel is a subject to daily rocket attacks from Gaza.[24]

Illustration 1: Number of suicide terror attacks in Israel from 2000.

illustration not visible in this excerpt

Source : Israel Ministry of foreign affairs. (2007): Victims of Palestinian Violence and Terrorism since September 2000.

This conflict has intensified in the recent years and became also economical. Both Israel and the Palestinians are employing a wide range of techniques, including an almost complete closure by Israel of the territories controlled by the Palestinian Authority and Palestinian efforts to boycott any commerce with Israel and advocating this boycott to the rest of the world.[25]

The years of the last uprising have seen a dramatic deterioration of the economy and the society of the Palestinians, including a deepening of their economic dependence on the neighbouring countries. This was more enhanced by the fact that the Palestinian economy is labour-exporting in its nature and relies on worker remittances and foreign demand of these labourers, coming mostly from Israel. Due to this fact, the Palestinian economy has become more and more dependent on the economy of Israel, shaping its economic activities in coherence with the relations with them, thus becoming extremely vulnerable to the business cycle of the Israeli economy. Palestinian low value-added production is largely oriented towards Israeli consumption and re-export, and specializes in low-productive sectors as agriculture and construction.[26]

2.2. Economy

Rapid economic growth

In spite of the shaky security situation, Israel has been enjoying one of the fastest growth rates of GDP of all world economies throughout the second half of the 20th century. Still, Israel’s most remarkable achievement in its 60 years of existence is its rapid pace of development, while dealing with several challenges at the same time – maintaining national security (that accounted for over 25 percent in the 1970s and currently accounts for eight percent of the GDP), absorbing huge number of immigrants (over three million since 1948), creating a modern infrastructure which is suitable for sustainable economic growth and also providing public services on a high level.[27]

There was a price attached to this rapid growth and until recently it has been a constant deficit in the balance of payments. 2006 was the first year in which exports exceeded imports, the foreign debt has been paid and Israel started to become a creditor in the recent years. In 2006 Israel has achieved the main macroeconomic objectives of a low rate of inflation (that has been 445 percent in 1984), quite a low budget deficit and some increase in public expenditure. Israel is also a popular location for foreign investments.[28]

Israel has managed to become one of the leading countries in high-yielding, quality agriculture with researchers and farmers working together and cooperating on developing sophisticated scientific methods in this area. Locally designed and produced machinery and equipment is widely used in the farming activities, from irrigation to milking. By using the scarce arable land and water supplies efficiently, Israel is self-sufficient with food and also exports large parts of it. Imports are mainly meat, grain, coffee, tea, sugar and rice, while exports are much larger, including roses, tomatoes, avocados and various fruits that are popular especially during the winter months in America and Europe.[29]

Structure of the economy

The sector of industry is diversified and dynamic. Industry exports in 2006 amounted to $39.4 billion, comparing with $52 million in 1955. Because there are almost no raw materials in Israel, the industry has concentrated on producing high value-added goods, based on research, innovation and a qualified labour force. More than four percent of the Israeli GDP is spent for the purpose of research and development. Telecommunications, food processing, fine-chemicals, computer hardware and software and solar energy are significant to Israel’s industry. The high-tech industry has reached 70 percent of the industrial product in 2006, with 80 percent of the products being exported. The industry of diamond cutting and polishing is also an important one, being the largest in the world, with $13 billion of diamonds exported in 2006.[30]

The defence industry has also done well at the wake of 9/11 and the technological sector comes third or second in the world in patents being filed, firms listed on the NASDAQ and start-up companies set up.[31]

The technology industry however, employs only a few tens of thousands of workers, and they are the ones who are the most educated and can easily move abroad if the security situation deteriorates. The productivity of the traditional sectors is falling and research and development in those sectors is not sufficient.[32]

Foreign trade is most important with Europe and the USA. 33 percent of exports and 49 percent of imports are with Europe. USA is Israel’s most important trade partner, with 38 percent of Israel’s exports going there and in turn, Israel’s imports from the USA account for twelve percent of all imports. Israel has a free-trade agreement both with the EU and the USA, .[33]

The tourism sector is important to the country but also vulnerable. Over 1.8 tourists have visited Israel’s fine beaches of the Mediterranean, Red and Dead Sea coasts, and also various religious and archaeological sights while using developed tourist facilities. Ca. 54 percent of these tourists came from Europe and 33 percent came from the Americas.[34]

2.3. Demographics

Israel’s 7.1 million population is comprised of 76.2 Jewish majority, 16.4 percent Muslims and small minorities of 2.1 percent Christians and 1.6 percent Druze. 3.7 percent are not classified with any religion.[35]

The Jewish population has grown from 650,000 at the establishment of the state in 1948 to over five million in 2007, fuelled by the mass immigration to Israel all along its existence. Jews have been arriving from countries of oppression and from the free world as well. Almost the entire Jewish community of Ethiopia was brought to Israel in two major efforts in 1984 and 1991. Large wave of immigration from the former Soviet Union that began in 1989 has seen over one million new citizens.[36]

A crucial divide that exists in Israel is over the place of one’s origin. About a half of the population in Israel are immigrants or descendants of such from the Middle East and North Africa, known as Sephardi Jews. They are usually poorer than the Jews from Europe, the Ashkenazi.[37] The Jewish and Arab communities live in Israel side by side and have contacts on the economic, political and municipal levels but very little on the social level.[38]

Apart from having ethnic divisions, Israel is increasingly suffering from disputes between Orthodox and non-Orthodox Jews, including secular and reform Jews. Around half of Jews in Israel are secular, not practicing their religion actively but identify themselves as Jewish, 30 percent are Orthodox and additional 18 percent are Ultra-Orthodox. Reform Jews are arguing that the Jewish law should be interpreted in a less strict manner, as opposed to the total strictness of the Ultra-orthodox. The largest source of anger that is directed towards the Ultra-orthodox comes from the critics that disagree with the fact that the Ultra-orthodox have rising demands from the country while being exempt from army service, which all other Israelis have to do.[39]

2.4. Poverty

Poverty is also an issue in Israel, and inequality is on the rise. The proportion of families living below the poverty line rose from 17 percent in 1998 to 20 percent in 2007. The rise in the proportion of children in the poverty group has increased much more dramatically during those years from 23 percent to 35 percent. This rise can be attributed to a large extent to the Ultra-orthodox population in Israel, with very big families and high unemployment. The taxpayers are facing a growing bill to cover the social benefits of this group.[40]

Illustration 2: Percentage of families and children in Israel below the poverty line

illustration not visible in this excerpt

Source: Israel ’s Prime Ministers Office. (2007): p.16.

High poverty rates have consequences on the economy as a whole, besides the distress of the ones living in it. The state has to spend a large part of its budget on transfers supporting the population in need. This part could otherwise be spent for other purposes. Poverty, over time, produces social problems in other areas, like health or crime. These problems will also draw many resources form the government. High and continuous level of poverty also damages the future growth potential of the economy.[41]

When more than one third of the children in Israel are growing up among poor families, it means that in 2020 many of the young workers entering the labour market will lack proper skills and education, thus their contribution to the society and economy will be substantially reduced. In other words, Israel’s future workforce will not use its full potential and the whole economy will be forced to pay the price.[42]

The poverty in Israel has a very skewed distribution. The Ultra-orthodox and the minorities comprise together about a quarter of the whole population but represent more than a half of the poor families. The main reasons for this high rate of poverty are high unemployment, very low rate of participation in the labour market by Ultra-orthodox men and the draft exemptions that are granted to them, cultural gaps and very high fertility rate.[43]

Israel is facing a number of obstacles in applying the needed economic policies to reduce this poverty. The heterogeneity of the Israeli society is making this process very difficult. Every population group, (like the Ultra-orthodox, immigrants or minorities) requires a unique solution and policy that would not function effectively on another group. The ongoing heavy burden of defence, which to a large extent, can be attributed to the conflict with the Palestinians, is narrowing down substantially the scope of the government to deal with social problems like poverty. The conflict is also significantly “distracting” the attention of the government from these socio-economical problems.[44]


[1] Cf. BBC News. (1998).

[2] Ibid.

[3] Cf. Vaknin, Sam. (2002).

[4] Cf. The Peres Center for Peace. (2006): p.17.

[5] Cf. The Peres Center for Peace. (2006): p.18.

[6] Cf. Berman, Eli. (1999): Subsidized Sacrifice: p. 14.

[7] Cf. Berman, Eli. (1999): Subsidized Sacrifice: p. 11.

[8] Cf. Berman, Eli. (1999): Subsidized Sacrifice: p. 14.

[9] Cf. The Economist. (2007): Israel’s economy, Vigorous but vulnerable.

[10] Cf. Berman, Eli. (1999): Subsidized Sacrifice: p.14.

[11] Cf. Berman, Eli. (2000): Sect, Subsidy, and Sacrifice: p.5.

[12] Cf. Ben-Porath, Yoram (1986): p. 174.

[13] Cf. The Economist. (2007): Boycotting Israel, New pariah on the block.

[14] Cf. Mitnick, Joshua. (2006).

[15] Cf. Israel Ministry of foreign affairs. (2007): Looking at Israel- History.

[16] Ibid.

[17] Ibid.

[18] Cf. Israel Ministry of foreign affairs. (2007): Looking at Israel- History.

[19] Ibid.

[20] Ibid.

[21] Cf. Israel Ministry of foreign affairs. (2007): Looking at Israel- History.

[22] Ibid.

[23] Ibid.

[24] Ibid.

[25] Cf. Imri, Tov. (2000): p.1.

[26] Cf. Gianni,Vaggi and Sara, Baroud. (2005): p.3.

[27] Cf. Israel Ministry of foreign affairs. (2007): Looking at Israel – Economy.

[28] Ibid.

[29] Ibid.

[30] Cf. Israel Ministry of foreign affairs. (2007): Looking at Israel – Economy.

[31] Cf. The Economist. (2007): Israel’s economy, Vigorous but vulnerable.

[32] Ibid.

[33] Cf. Israel Ministry of foreign affairs. (2007): Looking at Israel – Economy.

[34] Cf. Israel Ministry of foreign affairs. (2007): Looking at Israel – Economy.

[35] Cf. Israel Ministry of foreign affairs. (2007): Looking at Israel – People.

[36] Ibid.

[37] Cf. BBC News. (1998).

[38] Cf. Israel Ministry of foreign affairs. (2007): Looking at Israel – People.

[39] Cf. BBC News. (1998).

[40] Cf. The Economist. (2007): Israel’s economy, Vigorous but vulnerable.

[41] Cf. Israel’s Prime Ministers Office. (2007): p.16.

[42] Ibid.

[43] Cf. Israel’s Prime Ministers Office. (2007): p.6.

[44] Cf. Israel’s Prime Ministers Office. (2007): p.30.

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Israel's Rising Economy and its Drawbacks - Causes, Consequences and Remedies
University of Applied Sciences Osnabrück  (Osnabrueck University of Applied Sciences)
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Israel, Rising, Economy, Drawbacks, Causes, Consequences, Remedies
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Gregory Ler (Author), 2008, Israel's Rising Economy and its Drawbacks - Causes, Consequences and Remedies, Munich, GRIN Verlag,


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