Israel: Economy Going Down, Prospects Going Up

By John T. Haldane

Israel's program for economic stabilization, announced with great fanfare in July 1985, is in serious trouble, with a sharp downswing in Israel's economy likely.

"There are new threats to price stability and to our foreign currency position this year," Israeli Minister for Economy and Planning Gad Yaacobi concedes. "We are looking at a $1.5 billion fall in foreign currency receipts in a country that exports $10.5 billion in goods and services."

Prof. Herbert Stein of the American Enterprise Institute in Washington, DC, an advisor to the Department of State on Israel, warned last December that the long-term durability of the Israeli economy is an "open question" and that budget cuts are absolutely essential.

A recent US Department of Commerce report states that although the Israeli program has achieved its primary goals of reducing inflation and Israel's balance of payments deficit, "Other developments during the first seven months of 1986 point to a potential erosion of the recovery process." Trends have begun which will increase pressures for devaluations and price hikes, as well as widening the trade gap, the Commerce Department warns.

Other economic commentators caution that while the Israeli government has reduced its budget deficit, it has not set in motion renewed economic growth or structural changes to sustain the progress already achieved.

Up to now, Israel's strenuous economic stabilization program has been blessed with a lot of good luck. The Israeli economy benefited from a decline in the value of the dollar against the European currencies, a decline in the price of oil, a drop in foreign interest rates, and the granting of an additional $1.5 billion over normal US assistance (half for 1985 and half for 1986).

"These, however, are occurrences which will most likely not be available to sustain the Israeli economy in the future," the Commerce Department report notes.

Despite rosy Israeli Government reports on the state of its economy, the US Embassy in Tel Aviv predicts that Israel will have an estimated $3.5 billion shortfall for 1986, not just the $1.5 billion that Minister Yaacobi mentioned. This must be met by increased Bank of Israel lending, more private and institutional remittances, and commercial borrowing.

Ironically, as Washington Post correspondent Jim Hoagland reported from Jerusalem February 22, "A return to runaway inflation and budgetary problems would tarnish one of the few clear successes abroad recorded by Secretary of State George Shultz, who has personally overseen American efforts to help Israel restructure its economy."

Israel's severe budget problem is exacerbated by speculation about early elections, triggered by arguments over Israeli participation in an international peace conference. Prime Minister Yitzhak Shamir of Israel's hard-line Likud bloc opposes such a conference, while Foreign Minister Shimon Peres of the Labor Coalition seems prepared to bring down the present Labor-Likud government over his own endorsement of peace negotiations. Israeli officials acknowledge that if a general election becomes necessary, it will be more difficult to maintain balanced economic and fiscal policies, particularly on wages and the austerity budget.

"Pleasant though it is, stability has not solved a single one of the very real problems that still beset the Israeli economy," the Wall Street Journal reported recently. "The government's budget is still almost as big as total GNP. The former isn't shrinking, although the government has been 'cutting' and 'slashing' it for as long as anyone can remember. GNP is barely growing, although 'growth' is on everyone's lips."

Unlike other countries struggling to make ends meet, however, Israel can always rely on the United States Congress to bail it out. All of Israel's $2.6 billion in regular US Government assistance in US Fiscal Year 1985 (FY 85), for example, was made interest-free for the first time. For FY 86, total regular assistance amounted to $2.9 billion. In addition, the US provided additional "one-time" aid in the amount of $1.5 billion, half of which was paid in each of those two years, to assist Israel in implementing its economic stabilization program.

This year, FY 87, in addition to the $3 billion already granted Israel in military and economic aid, even more American assistance is on the way. On December 9, 1986, President Reagan signed a memorandum reducing the interest rates on outstanding US military loans to Israel, Egypt and a few other countries. American economists predict that Israel will save about $200 million in interest payments to the United States during the 1987 fiscal year. In the next three fiscal years, they estimate that Israel will save some $300 million annually. This is a significant gift to Israel, since that nation owes the US about $5.5 billion from military loans made in earlier years. Principal and interest due on Israel's military and economic debts to the US this year alone has been estimated at $1 billion.

On August 19, 1985, at the time the US-Israel Free Trade Area Agreement was signed, Israelis expected to increase exports to the United States significantly. There also were visions of numerous cooperative research and development projects in the high-tech sectors of both countries. Few of these projects have materialized, however, and some Israeli subsidiaries of American firms are in deep financial trouble. A statement released in late 1986 by the American Investors in Israel, a subcommittee of the American-Israel Chamber of Commerce and Industry, said "It is likely that all exporters in dollars will soon be—if they have not already been—seriously hurt. Further, the advantages afforded by the protection given by the Free Trade Area Agreement with the United States will soon be dissipated as well."

The group warned that unless Israel allows exporters in dollars to make a profit, some US firms may close down their Israeli subsidiaries. American Electronic Laboratories, a Philadelphia-based high-tech firm, for example, is considering closing its Israeli subsidiary, Elisra, which employs 1,200 workers, because of heavy financial losses incurred during 1986.

The economic situation is so serious that the Israeli Government is considering the sale of El Al, the national airline. Reporting this possibility, the Christian Science Monitor noted on January 27: "It's name means 'skyward,' but El Al Israel Airlines' profits have generally moved anywhere but up."

What can Israel do to escape impending economic disaster? It is unable to generate sufficient export income to balance the budget and dares not increase already high income taxes. Nor does it dare press Congress too hard to increase annual US taxpayer grants to Israel above the current $3 billion level, since the United States in cutting its non-military expenditures to the bone. The answer clearly lies in the still-intact US military budget.

The Israelis have therefore maneuvered the Reagan administration into granting them not only active participation in the "Star Wars" program, but status as a "non-NATO ally." There is, potentially, big money for Israel in both of these US concessions. Virtually all of it, however, will be at the expense of American research and development firms and of similar companies in NATO countries.

The strategy came into the open when Israeli Defense Minister Yitzhak Rabin and Secretary of Defense Caspar Weinberger signed a memorandum of understanding on May 6, 1986 making Israel the first non-NATO country eligible to participate in the $26 billion American effort to devise a space-based defense against nuclear missiles. The agreement permits Israeli research establishments and companies to bid on SDI "star wars" research contracts.

"SDI is somewhat less controversial in Israel than in the US," the Washington Jewish Week observes tactfully. "From Jerusalem's point of view, Israel's participation is seen as a means of helping the economy as well as keeping Israeli scientists and technological personnel from emigrating."

Two such US contracts have been signed with Israeli organizations so far, one for an estimated $5.1 million. Three more are in the final stages of negotiation. Since the Pentagon is close-mouthed about SDI contracts, the dollar totals have not been revealed.

US designation of Israel as a "non-NATO ally," may be similarly rewarding. It gives Israel the right, along with South Korea, Japan, and Australia, to bid on US defense contracts and allows the US the right to use Israeli military bases. Although Prime Minister Shamir was informed of the US decision before his recent visit, that did not prevent him from asking, while in the US, that Israel be awarded an even more privileged status as a full-fledged NATO ally. At present Israel has no defense treaty with the United States, although Tel Aviv did sign a strategic cooperation agreement with Washington in 1983. The compromise decision, confirmed February 17 by the White House, will give Israel some of the economic advantages enjoyed by the NATO allies, but without any of the mutual defense obligations imposed by the 1949 NATO treaty.

US congressional sources say the Israelis are seeking the same status as NATO allies in order to raise their US financial and military aid well above present levels. Even status as a "non-NATO" ally will permit Israel to participate in US military research and development projects, purchase American military equipment at lower prices, and bid on maintenance work for certain US aircraft based in Europe.

"Israel's share of US foreign aid doled out by the State Department has leveled off at $3 billion a year—more than the US gives any other nation—with no increases in sight," the Wall Street Journal explains. "So Israel's supporters have come up with a new legislative strategy that reaches into the deep pockets of the Defense Department."

Critics contend that this potential bonanza for the Israelis will lead to considerable losses for US research and development firms. David Saad, executive director of the National Association of Arab Americans, explains: "Here we have a small, relatively minor country, not involved in the protection of Europe or other formal joint military undertakings with the United States, trying to find ways to finance its cash-short economy, and leaving disgruntled defense manufacturers here."

A former Defense Department official agrees that any comparison between Israel and NATO allies is a bogus one, since the NATO countries are pledged to go to war if one member is attacked; Israel has no such commitment.

The Wall Street Journal explains that in seeking to solve Israel's chronic financial problems with increased American military funding "Israel's supporters—lawmakers and lobbyists—have adopted a low-key approach in pushing the new strategy, preferring to work quietly with a small number of influential legislators and Reagan administration officials rather than launch an aggressive, public campaign."

Or, in the words of an Israeli diplomat, "It's a modest beginning."

John T. Haldane is a specialist in Middle East affairs who has served as a Foreign Service Officer in Baghdad, Cairo, and Beirut, and as an international economist for the Departments of Treasury and Commerce.