Israel’s Fruits of War Now Seen Spoiling On the Vine

By Thomas R. Stauffer

Israel is now victim of a war of attrition—one of its own making. The intifada has become an expensive affair, sapping Israel’s resources at a time when its economy already has been hit by stagnation in the U.S. and Europe. Hanging on to the territories which Israel conquered so easily in 1967 is now costly and painful—unemployment is up, investment is down, tourism has all but evaporated, and the banking system, fragile at best, is increasingly at risk. Quasi-permanent mobilization saps both morale and industrial productivity. Defending the settlers’ growing demands and their ever-expanding boundaries now costs some 10 percent of the county’s GNP.

The conquests of 1967 had been very lucrative for Israel. Those profits, however—then an integral part of the planning for the war—have been eroded away and are long gone. In ‘67, though, they were very real. Then Israel had seized a profitable captive market in Gaza and the West Bank. Palestinians benefited from remittances from their own Diaspora, and after 1967 that hard currency had to be spent on high-priced Israeli goods. It preempted even the Holy Land tourist trade, a multi-billion dollar business. Its military victory enabled Israel to avail itself of a growing source of cheap labor for its construction industry, farms, and textile sweatshops. In 1967 Israel seized from Egypt oil fields in the Sinai which ultimately were worth some $1 billion a year. And, lastly, its capture of the West Bank and the Golan Heights secured an additional 50 percent of Israel’s water supply.

Today, because of the current intifada, Israel’s bottom line has reversed, and the costs of sustaining the occupation exceed the benefits. The oil fields reverted to Egypt in 1975, under pressure from President Gerald Ford. The greatest reversals, however, have taken place in the last 24 months. The contrast between the 1970s and 2002 is stark. The economic toll imposed by the Palestinian resistance has been notably apparent in three sectors: 1) tourism, 2) labor supply costs, and 3) the captive Palestinian market.

Tourism shows the most obvious scars from the collateral damage wrought by the intifada. In 2000—before the resistance erupted—it grossed over $4 billion in hard currency, a tidy sum to the small Israeli economy, because most of the money was spent on Israeli goods, rather than leaking abroad for imported soap or linens as is the case in “Club Med”-style tourism. Tourist-nights have fallen by 75 percent or more, and dollar revenues are down to possibly less than $1 billion per year, from a robust annual figure of $4 billion. These are “high-impact” dollars, so that their loss is acute.

Local tourism is holding up, but it brings in shekels, not dollars. It is the dollar trade which has been hit, and the industry is clamoring for help from a government already wracked by such demands from other ailing sectors and by a growing deficit. Restaurateurs and guides have added to the clamor. Local banks nervously point to possible loan defaults on NIS 4 to 6 billion in reportedly non-performing loans to the hoteliers, which would further weaken the banks’ anemic balance sheets. Signs of resuscitation are elusive; many Jewish organizations have canceled their own tours, citing concerns for potential liability.

The intifada’s second major impact is the disruption in labor patterns—truly ironic in the sense that Israel’s crackdown has produced a double whammy: it has lost the lucrative Palestinian market and, at the same time, the docile supply of cheap Palestinian labor. Just as the cheap Palestinian workers who built Israeli buildings and who worked the lands of moshavim and kibbutzimare gone, so is the Palestinian purchasing power which made the West Bank and Gaza so profitable to Israeli businessmen. Collaterally, also gone are the ateliers which produced duty-free “Made in Israel” goods for the U.S. market via the Free Trade Agreement.

The economic repercussions have proved to be unexpectedly profound and—no less surprisingly—reflect a partial Saudization of Israel’s economy. Unemployment among Jewish Israelis is very high—about 10 percent—and is maintained and financed by generous welfare payments and discounts which make non-work quite attractive. The welfare rolls are reinforced by the growing numbers of haredim who are exempt from work and are supported by the state, along with their growing broods, as long as they perpetuate their theological studies. Israel’s labor minister declared that 113,000 more families had been added already this year.

Hitherto, the labor gap had been filled by peripatetic Palestinians. But their numbers have dwindled away since 2000, and Israel now imports expatriate goyish labor from around the world—Thais, Romanians, Filipinos, etc. Although the ministries and ministers pontificate against this trend, and it is regularly announced that tens of thousands of non-persons must be deported, the number of legal and illegal expats seems to linger persistently at 250,000 to 350,000. Not only are these workers more expensive than the captive Palestinians, still worse, the replacement labor force hordes its savings and remits the dollars back home. The Palestinians, on the other hand, had no choice but to spend their earning on high-price goods via Israel.

The two effects represent serious drains on Israel’s precarious balance of payments. The net lost captive trade with the West Bank and Gaza is in the range of $1.5 billion per year—allowing for high markups by Israeli middlemen and the re-labeling of both agricultural and textile goods—and the comprehensive figure may be even larger. Israel had a virtual monopoly over imports and exports from the occupied territories, and thus control over prices. Nominally, some tax revenues were remitted to the Palestinian Authority, but the imbalance was overwhelmingly in Israel’s favor. That positive flow has been dissipated.

Labor shifts were even more costly. The Central Bank and the Central Bureau of Statistics report somewhat differently, but it appears that displacing labor from the Palestinian Bantustans has cost an additional $3 billion per year since 1999. The profits from that aspect of the 1967 conquest—a pool of cheap, captive labor—are indeed lost and gone—perhaps forever.

The macro-economic indicators reflect the malaise which is obvious at lower levels. The budget deficit is 4.5 percent of GDP and growing, as the direct costs of the intifada continue and grow as well. The GDP is actually declining: preliminary figures indicate that the real GDP per capita has eroded by at least 10 percent since the onset of the intifada. At least one subsector, however, reports clear signs of growth: security service. Diamond exports to the U.S. have jumped precipitately, too, but dark rumors circulate that the dealers are accelerating the exportation of inventory for safety’s sake.

Israelis and foreign investors alike are “voting with their shekels.” Inward investment, once largely in high-tech firms, especially start-ups, has dwindled from a multi-billion dollar annual flow to a trickle of a few hundred millions per year. As ominously noted in the Israeli press, capital outflows have started. Although hard data are not yet available, the anecdotal reports are convincing.

Overall, exports are down, and not just those tied to the intifada. Imports, too, have dropped, but not enough to forestall a worsening of the balance of payments. This is serious because Israel has exhausted its last block of “secret”—i.e., non-budgeted—aid from the U.S., and it is difficult to see how it can extract or extort more from the U.S., even in an election year, when the American economy itself is languishing. Between 1992 and 1998 Israel spent $10 billion in borrowed funds, fully guaranteed by the U.S. Treasury, to bolster its serious foreign account deficits. Since there has been no structural reform in the Israeli economy, given that the Jewish state has trusted in recourse to Washington and the U.S. taxpayer, it would require a massive rescue of that magnitude to offset the current problems. It should come as no surprise, then, that Israel is contemplating a request for $10 billion in additional U.S. aid in exchange for refraining from an eventual retaliation against Iraq.

Israelis and foreign investors alike are “voting with their shekels.”

The rating agencies, such as Moody’s and Fitch, have not yet downgraded Israel’s sovereign debt, which itself is of minimal significance. One recalls that none were able to sound a warning on Enron’s or Worldcom’s problems before they were already evident and being discussed in the popular press. The signs are there to be read, however. Israel holds some $23 billion in foreign exchange reserves—against which the Central Bank owes at least $27 billion in foreign liabilities, plus possibly $10 billion more in contingent liabilities which, according to the latest bond prospectus, are denominated in hard currencies.

Israel’s commercial banking system may be even more vulnerable. Its short-term foreign liabilities are also some $4 billion greater than its assets. More disturbing, however, is the high ratio of deposits by foreigners to assets of the banks. This often signals money-laundering activity, which suggests that the commercial banks might quickly find themselves insolvent. Some of the foreign exchange reserves may be double-counted, because of back-to-back accounts between the Central Bank and some of the commercial banks, although it is possible that the practice was discontinued after an earlier banking crisis.

Pressures from the European Union are a new concern, since it is no longer obvious that the EU will yield to Washington on Middle East issues. The Central Bank of Israel warned of the possibility of EU sanctions in its latest report, noting that such measures, if they materialized, could substantially affect the country’s economic outlook. Sporadic boycotts of Israeli goods already have been unofficially promoted in several European states, and the EU may have opened a broader campaign by demanding that Israel cease labeling goods from the occupied territories as being of Israeli origin. This would cut uncomfortably into the profits of the Israeli middlemen and—Israelis fear—represent the thin edge of a wedge.

The intifada now cuts both ways. The Palestinians have been economically devastated, but the Israelis are hemorrhaging as well. The burden upon Israel of keeping the occupied territories is higher in relative terms than the cost to the U.S. in maintaining the Vietnam War—and the carnage and costs certainly are closer to home. Subsidizing the life-style of the settlers has long been a sore point among many Israelis. The exponentially additional costs of defending them—possibly for a long period—adds to the discontent.

War, in short, no longer is profitable for the Israelis—disastrously so if no more extra aid is forthcoming from the U.S. The one bright blip on the dark clouds of war is the possibility that the Israelis may conclude that being a colonial power, even on a small scale, is not worth the candle. Even the water captured in 1967—once an unquestioned asset—has slowly become a liability, because the additional water forced Israel to pay out additional subsidies to its expensive, heavily subsidized agricultural sector. Giving back the captured water—45 percent of total use—actually would increase Israel’s GDP.

The grapes of wrath no longer are harvestable—peace may be the cheapest solution.

Thomas R. Stauffer is a Washington, DC-based engineer and economist who has taught the economics of energy and the Middle East at Harvard University and Georgetown University’s School of Foreign Service.