Fighting for our Home: The Economic Front

The ongoing war poses unprecedented challenges—military, civilian, geopolitical, and economic. Our focus is on providing necessary responses to the needs of the military, the needs of those directly affected in combat areas, mitigating the financial damage to businesses and employees, and rebuilding the communities destroyed on October 7.

Bezalel Smotrich, Minister of Finanace. Photo by Arie Leib Abrams/Flash90

The State of Israel is in the midst of a war that is posing unprecedented challenges—military, civilian, geopolitical, and economic. Our focus in this article is on the economic aspects of the conflict, with the aim of providing necessary responses to the needs of the military and the needs of those directly affected in combat areas, mitigating the financial damage to businesses and employees, and rebuilding the communities destroyed on October 7. The current circumstances make it impossible to carry on “business as usual” on the economic front.

The realities and needs of the country have changed, and thus Israel’s economic policy needs to be adjusted immediately. The state budget for 2024 must be fundamentally redrafted, as must the budgets for the next few years, based on a redrawing of our national priorities.

As a first and necessary step, the government must decide to immediately revoke the coalitionary funding arrangements and close down the superfluous and wasteful ministries that were created only to solve political problems and that cannot be justified in the current state of affairs. This will release huge sums of money that can be redirected to funding new and urgent needs.

The direct costs of the fighting (mainly armaments and reservist pay), the government grants to businesses affected by the war, and the cost of providing for tens of thousands of evacuees are expected to be vastly greater than the costs associated with the 2006 Second Lebanon War and the previous rounds of fighting in Gaza. For example, the budgetary cost of the Second Lebanon War, which lasted 34 days, was approximately NIS 9.5 billion, and that of Operation Protective Edge, which lasted 50 days and also included a limited ground incursion into Gaza, was around NIS 7 billion. This is without taking into account the possibility of the war expanding to the northern front, or lasting more than a few months. Should either (or both) of these scenarios come to pass, then the costs will of course be significantly higher.

In addition, considerable resources will be required to rebuild homes and infrastructure in communities in the Gaza border region which were destroyed in the murderous attack of October 7, and to improve protective measures for residents, along with the costs of compensation due to families of those killed in the attack.

Furthermore, a sharp drop in tax revenue is anticipated due to the reduction in economic activity. Moreover, increased defense spending will place a sizable burden on the budgetary basis (that is, on annual expenditure over time).

Thus, the average deficit for 2023 and 2024 is forecasted to grow significantly and to reach somewhere between around 3% of GDP according to the relatively optimistic forecast from the Bank of Israel, or as high as 5.25% (according to S&P). The differences between these forecasts are attributable to: different estimations of the scale of the impact of the war on economic activity (and thus in growth forecasts); different estimations of the costs of fighting, of compensation to victims, and of government support for business; and different estimations of the extent to which these costs will be funded by diverting funds from other budget items and altering budgetary priorities.

The expenditures stemming from the war will have to be funded at least in part by changing the priorities in the state budget, and first and foremost by immediately diverting funds allocated under the coalitionary agreements which do not contribute to the tasks that now lay before the State of Israel. An explicit government resolution to carry out such a redirection of funding, and its immediate implementation, along with the closure of all superfluous government ministries, will signal that the government understands and appreciates the size of the challenge it faces and that it is capable of making the necessary decisions to address this challenge.

So far, the private sector, non-profit organizations, volunteering organizations (such as Brothers in Arms, the High-Tech Forum, and the Business Forum), and thousands of regular citizens have shown initiative and demonstrated the remarkable solidarity and volunteering spirit of Israeli society, all with outstanding efficiency. Now, it is important that the government also improves its performance accordingly, and acts to reduce divisions and strengthen solidarity. To this end, the capabilities and quality of the management echelon in government ministries must also be significantly improved, while maintaining efficient and appropriate public administration and safeguarding the proper budgeting principles that apply to public expenditures.

Revisiting the 2024 budget, and realigning the priorities in the budget to address the new realities and needs created by the direct and indirect costs of the war, will make it possible to deal with the situation without losing control of the state budget and the national debt. Without the necessary dramatic change in these priorities to align with the new needs, the growth in government expenditures will lead to an uncontrollable rise in national debt. In turn, this will mean much higher debt servicing costs and lead to a further rise in the risk premium of the Israeli economy, accelerated devaluation of the shekel, higher inflation, and economic instability.

If the government of Israel does not make the significant changes to the budget that are demanded by the new circumstances, it will be signaling weakness in its ability to govern, and will thereby increase the risk of Israel’s credit rating being downgraded by the international credit rating agencies. This will lead to a significant increase in Israel’s financing costs in the global markets, and consequently to higher financing costs for the business sector and Israeli households, to reduced investment in the Israeli economy, to even greater damage to economic growth, and to delayed recovery.

Only a major and immediate change to the priorities in the budget will prevent this negative scenario and enable Israel to offer a fair and proper response to the challenges of supporting business activity during the war, compensating and treating bereaved families and the many casualties of the war (both physical and psychological), and supporting the engines of growth that will help the economy recover when the war is over.

Now is the time for the government to demonstrate leadership and responsibility by making decisions for the good of the entire country. This is the way to strengthen the financial infrastructure that is so important for bolstering national resilience.

 

This article was originally posted in the Jerusalem Post.