The Economic Cost of an Inconclusive Election
A constrained budget, reduced civilian spending and investment in drivers of growth, widening social disparities, and a decline in investment: An inconclusive election that leaves a caretaker government in office and prevents the passage of a state budget is likely to have far-reaching economic consequences.
Photo by Yonatan Sindel/Flash90
When an election fails to produce a clear outcome and the government remains in a caretaker capacity, it is likely that the state budget will not be approved. The implications extend beyond simply reducing government spending - it would also become difficult to adjust budgetary priorities to the changing needs of the economy. A political deadlock could come at the expense of civilian spending and investments that support economic growth, social welfare, healthcare, education, and efforts to reduce inequality. An inconclusive election also creates political uncertainty, which deters both domestic and foreign investors and threatens the stability of Israel's credit rating. At the same time, a short-term reduction of the deficit could present as a silver lining.
In the absence of an approved state budget, the government operates under a “continuation budget”, which limits monthly expenditure to one-twelfth of the previous year's base budget, adjusted for the rate of population growth over the preceding three years but without indexing to the Consumer Price Index. This restriction will erode the budgets of government ministries in real terms and limit their ability to expand services and investments. The result is a constrained budget that undermines public services, increases the costs borne by citizens for these services, deepens economic disparities, and might even deter investors.
A report published by the Knesset Research and Information Center provides an indication of the sums that would be missing from the state budget under the one-twelfth rule. According to the report, had the 2026 budget not been approved, the continuation budget would have been approximately NIS 93 billion lower than the budget actually approved for 2026—a shortfall equivalent to roughly 13.3% of the approved budget. Under the one-twelfth rule, the budget would have totaled NIS 606 billion, compared with the NIS 699 billion actually approved for 2026 (though part of the gap stems from unexpected increases to the defense budget).
Assuming, as seems reasonable under current circumstances, that defense spending remains at its current high level during the caretaker government's term (or even increases), most of the fiscal restraint will come at the expense of civilian spending, which is already approximately 10 percentage points of GDP below the median of high-income OECD member countries.
- Reductions in civilian spending budgets will translate into cuts to healthcare, education, and welfare services, or alternatively, a decline in the quality of public services provided to citizens. The impact will be concentrated primarily in the more flexible components of the budget, such as new contracts and projects.
- Lower-income deciles will be the first to suffer from reductions in civilian services, as they often lack the means to pay privately for these services. The middle class and upper-income deciles will face a further increase in the cost of living as they are forced to pay privately for more healthcare, education, and welfare services. The result will be wider economic and social disparities and a heavier cost-of-living burden.
At the same time, reductions or restrictions on civilian spending are also highly likely to undermine funding for growth-promoting activities. This could occur through across-the-board budget cuts from which the defense establishment is exempt, as we are seeing today, or through a freeze on new contracts and agreements. Such measures could adversely affect budgets that support economic growth, including funding for the Israel Innovation Authority, the Investment Authority, and contracts for new investment projects, among others.
The longer a continuation budget remains in place, the more restrictions will apply to new commitments and contracts, some of which will require special approval. New projects may be delayed, and the continuity of government operations may be disrupted, placing a particular burden on organizations that depend on state funding.
Nonprofits and social organizations are therefore among the first to be affected by a continuation budget. Their contribution to social and national resilience has proven invaluable in the aftermath of October 7. Any reduction in their budgets will, in turn, impact the vulnerable populations that rely on their services.
Infrastructure investments are not entirely immune to the effects of budgetary constraints, even though they are typically planned over multiple years. The impact may be felt primarily through delays in launching new projects, postponement of stages that have yet to receive approval, and slower implementation of existing projects. Reduced infrastructure investment could adversely affect productivity and the economy's long-term growth potential.
This runs counter to the OECD's recommendations. In a review published in December 2025, the organization emphasized the importance of protecting investments in education and infrastructure during periods of fiscal adjustment. In effect, the OECD warned against across-the-board spending restraint—precisely what would occur under a continuation budget during a caretaker government's term.
Instability and uncertainty are obstacles to economic growth that also affect the private sector. Credit rating agencies are concerned about instability for good reason. Numerous studies have shown that uncertainty leads to lower investment and higher financing costs (greater uncertainty = greater risk = higher interest rates to compensate for that risk).
An inconclusive election and the absence of an approved state budget signal to domestic and foreign investors that uncertainty in Israel persists. This could discourage businesspeople, delay decision-making, and even tip the balance in favor of investing in other countries that offer greater certainty and stability.
Credit rating agencies closely monitor the performance of the Israeli economy, the country's political stability, and the government's ability to pursue responsible fiscal policy.
Recently, Fitch affirmed Israel's credit rating at A with a negative outlook, pointing to the continued increase in public debt and the risk that political instability could make it difficult to implement necessary budgetary adjustments.
According to Fitch, an inconclusive election followed by another round of elections could increase the perceived risk associated with the Israeli economy and drive up financing costs. Under such circumstances, the budgetary cost of servicing the public debt would rise, forcing Israel to make further cuts to civilian spending. This, in turn, would inflict additional harm on citizens and economic growth.
One potential silver lining in such a scenario is that restraining the growth of public spending could help moderate the budget deficit in the short term (in 2027), compared with a scenario in which an approved budget allows for greater spending than a continuation budget.
However, this would not necessarily stabilize the debt-to-GDP ratio, which is also influenced by the pace of economic growth, government tax revenues, and interest costs—the latter of which are likely to rise amid political instability.
