A History of Israel’s Start-Up Nation
The Israeli Central Bureau of Statistics announced that the inflation rate for July 2022 rose to 5.2%, the fastest yearly rate in 14 years. Described as “one of the most difficult economic environments in recent years,” this dramatic swell in inflation and the corresponding rise in prices is but the latest episode in Israel’s 74-year economic history.
Marked by incredible lows and dizzying highs, the country’s economic history is the story of how one small state went from relying on food rationing and price controls to becoming an advanced economy and one of the world’s leading technology hubs.
In this piece, we will focus on this fascinating story by taking a look at the three eras that define the history of Israel’s economy: 1948-1973, 1973-1985, and 1985-present.
1948-1973: From Austerity to Growth
The early years were difficult ones economically, as Israel was slowly rebounding from the 1948-1949 War of Independence — which claimed the lives of 1% of the nascent state’s population — while also being inundated with hundreds of thousands of immigrants from Europe, the Middle East, and North Africa.
In order to ensure that all of Israel’s citizens were receiving their essential needs, while also seeking to keep the cost of living low, the Israeli government instituted a number of austerity policies, including food rationing and price controls.
During this period, which was marked by high unemployment and rising inflation, each Israeli adult was given food tickets to use at their local grocery store in order to obtain their daily allowance of 1,600 calories.
As the economy grew and there was less need for strict austerity policies, regulations began to loosen until the rationing regime was ultimately ended in 1959.
Between 1950 and 1965, the Israeli economy grew by 11% annually, as the Jewish state began to see an influx of capital from American loans, a rise in the sale of Israel Bonds to overseas Jewish communities, transfers to public institutions, and the payment of Holocaust reparations by the German government.
Aside from this influx of capital, one of the major engines of this economic growth was the Israeli government’s 1952 new economic policy, which gradually ended price controls, drastically devalued the Israeli currency, encouraged exports, and embraced fiscal restraint.
In addition, Israel’s protectionist policies allowed for the development of domestic industries, particularly textiles, which were then subsidized in order to expedite the exportation of these products outside of Israel.
In the 1960s, Israel began a process of economic liberalization that saw quantitative restrictions on imports removed in exchange for tariffs and that replaced protectionism with realistic exchange rates. This period also saw the signing of beneficial trade agreements between Israel and the European Economic Community (the precursor to the European Union).
1973-1985: ‘The Lost Decade’
Following the 1973 Yom Kippur War, the Israeli economy entered a period of malaise and stagnation that has become colloquially known as “the lost decade.” This period is defined by almost zero economic growth, spiraling inflation, as well as rising debt and deficit levels.
This “lost decade” has its roots in the Yom Kippur War, when most of the Israeli workforce was called up for reserve duty for an extended period of time (up to six months). This inevitably led to a downturn in economic activity. In order to offset the business losses from the war, the government artificially propped up salaries, which led to an increase in debt and a rise in taxation.
During this time period, both private businesses and the quasi-governmental sector suffered from mismanagement and inefficiency and were forced to become heavily dependent on the government, which led to even further expenditures.
Israel’s inflationary spiral, which began in the 1970s and continued into the 1980s, became exacerbated in 1983 by the Israel bank stock crisis, when artificially inflated bank stocks dropped precipitously and the government was forced to buy these stocks in order to prevent the collapse of the entire Israeli banking system.
This drove up inflation, and Israel actually reached a stage of hyperinflation, with the 1984 rate hitting an all-time high of 445%.
It was at this point that the Israeli government decided to take action in order to rescue the economy from impending catastrophe.
1985-1990s: Stabilization Plan Successfully Implemented
In 1985, the Israeli government adopted the stabilization plan, which saw a reduction in government spending, the abolition of subsidies, wage freezing, temporary price controls, and the devaluation of the Shekel (and ultimately replacing it with the New Israeli Shekel in 1986).
In addition, the US government agreed to perform a one-time conversion of defense loans into grants, easing the pressure on the Israeli financial system.
The stabilization plan was incredibly successful, reducing inflation over one year from over 400% to a manageable level of 20%.
As a result of the reduction in government spending, both the private and semi-governmental sectors, which had previously relied on government subsidies, had to become more efficient and productive. A reduction in the role of the unions also during this period meant that it was easier to fire unproductive workers and increase workplace efficiency.
The change to the Israeli economic landscape that occurred during the late 1980s and early 1990s laid the foundation for Israel to become the advanced economy and tech hub that we know today.
1990s-2000s: Rise of the Start-up Nation
In the 1990s and 2000s, Israel’s economy was able to take off due to a number of factors, including government initiatives, the changing face of international politics, and the rise of the Internet.
In the 1990s, the Israeli government privatized major industries and opened up its markets to international competition by further reducing tariff protection, encouraging exports, and liberalizing currency markets. During this period, Israel also began to open up to the Asian markets. Additionally, the separate peace treaties that Israel signed with its regional enemies Egypt and Jordan allowed the Israeli government to considerably reduce its defense spending.
The Israeli government founded the Yozma program in the early 1990s, which helped facilitate investments in developing Israeli technologies. With the collapse of the Soviet Union, Israel saw the arrival of almost a million new Russian-speaking immigrants, many of whom were engineers, academics, or scientists. This influx of human capital gave a much-needed boost to Israel’s growing technological sector.
Perhaps the most important factor that contributed to the evolution of Israel’s economy was the popularization of the Internet in the 1990s. With the rise of such digital technology, young Israeli entrepreneurs were able to break into a global market with few government barriers and relatively low overhead costs.
Even though Israel has evolved into an advanced economy, it is still susceptible to economic downturns and recessions.
Between 2000 and 2003, Israel experienced the worst recession in its history when it suffered from the global hi-tech crash of 2000, coupled with the severe economic repercussions of the Second Intifada.
The policies adopted by the government in 2003, including more privatization, encouragement of participation in the labor market, and decreasing welfare payments, helped lead to an almost five-year boom in the Israeli economy until the great global recession of 2008.
During that recession, Israel did not fare as badly as other countries due to its strong banking system, its high level of foreign reserves, its high level of employment, and budgetary surpluses in the years prior to the financial meltdown.
2020-2022: Coping With Covid
During the 2020 Covid crisis, Israel suffered along with other countries, but fared better than most. While Israel’s GDP dropped 2.2% in 2020, this was a far cry from the average of 4.7% among OECD countries. Similarly, Israel bounced back faster than other countries, with 8.2% growth in 2021 and a forecasted 5.5% in 2022.
Even though the Israeli economy today is relatively resilient, it is still a point of concern for many Israelis, with 44% of Israelis responding to a recent survey that the main factor influencing their vote in the upcoming elections is the economy and the rise in costs.
According to a recent report in Globes, the state of the Israeli economy is relatively good when compared with other countries undergoing rising levels of inflation. This is a far cry from the early days of Israel’s existence, when the standard of living was only 30% of the United States, or when the Jewish state suffered from hyperinflation in the early 1980s.
The fact that the Israeli economy has gone from food rationing and price controls to the second-largest market for technology startups in the span of 74 years is nothing short of miraculous.