C.E.S.

Project

C.E.S Project
Israel Economy
By
FL1 Fall Winter 07-09 Robin Kapoor

ECONOMY OF ISRAEL
At a glance:

GDP (2006 est.): $195 billion.

The country's GDP (Purchasing power parity) in 2006 reached $195 billion according to
the International Monetary Fund or $179 billion according to the World Bank. GDP per
capita has been $31,767 according to the International Monetary Fund in 2007 or $26,200
in 2006 according to the CIA World Fact book. $31,767 is on par with most Western
European countries like France or Italy, while $26,200 is lower than most Western
European countries except Greece, Spain and Portugal but higher than all Eastern
European countries and close to the average for the European Union. The economy grew
by 8% in the last quarter of 2006, the fastest growth of any Western nation.

Currency: Shekel, (4.58 shekels = 1 U.S. dollar; 2005 est.).

Natural resources: Copper, phosphate, bromide, potash, clay, sand, sulfur, bitumen,
manganese.
Agriculture: Products--citrus and other fruits, vegetables, beef, dairy, and poultry products.
Industry: Types--high-technology projects (including aviation, communications, computer-
aided design and manufactures, medical electronics, fiber optics), wood and paper
products, potash and phosphates, processed food, beverages, tobacco, caustic soda,
cement, construction, plastics, chemical products, transport equipments diamond cutting
and polishing, metal products, textiles, and footwear.

Trade: Exports (2005 est.)--$40.14 billion. Exports include polished diamonds, electronic
communication, medical and scientific equipment, chemicals and chemical products,
electronic components and computers, machinery and equipment, transport equipment,
rubber, plastics, and textiles. Imports (excluding defense imports, 2005 est.)--$43.19
billion: raw materials, diamonds, energy ships and airplanes, machinery, equipment, land
transportation equipment for investment, and consumer goods. Major partners--U.S.,
U.K., Germany; exports--U.S., Belgium, Hong Kong; imports--U.S., Belgium, Germany,
Switzerland, U.K. Israel is one of the world's major exporter of military equipment.

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Israel proclaimed Jerusalem as its capital in 1950. The United States, like nearly all other
countries, maintains its embassy in Tel Aviv

External trade

For 2006, Israeli exports grew by 11% to just over $29 billion; the hi-tech sector
accounted for $14 billion, a 20% increase from the previous year. Israel has the highest
average living standards in the Middle East, but a large portion of the population, often
Palestinians and immigrants, are not benefiting from the wealth of Israel. Costs of living
in Israel is high, and for many their wages never manage to cover more than just the basic
costs. Israel has a large portion of the population that lives under very modest conditions,
often surviving only on aid from the government's side.
Much of the growth in Israeli economy comes from a politics that has allowed high
deficits on state budgets and foreign trade balance. Israel has the most diversified
economy of the Middle East, and has a high level of modernization.
Israeli economy has in the recent years experienced an upswing, much due to less
need for transferring funds to the military.
Mining is an important activity for Israeli economy, of which much is extracted from
the Dead Sea. Petroleum extraction exists in Israel, but is very small scale.
Agriculture in Israel is very effective, as is able to covering about 75% of domestic
needs, despite the limited land available. Citrus fruits and eggs are exported. Yet,
agriculture contributes to only 3% of Israel's GNP.
Israel has large income from heavy tourism, as well as from donations from
individuals and organizations around the world. USA is aiding Israeli economy at the
level of US$ 3 billion annually, of which 1,8 billion is allocated to military expenses, the
remaining to the civil economy of Israel. Since Israeli economy still runs on heavy
deficits, the country cannot be without this help, even if the recent governments have
declared economic independence as of its main objectives.

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Israel has a diversified, technologically advanced economy with substantial but
decreasing government ownership and a strong high-tech sector. The major industrial
sectors include high-technology electronic and biomedical equipment, metal products,
processed foods, chemicals, and transport equipment. Israel possesses a substantial
service sector and is one of the world's centers for diamond cutting and polishing. It also
is a world leader in software development and, prior to the violence that began in
September 2000, was a major tourist destination.

Israel's strong commitment to economic development and its talented work force led to
economic growth rates during the nation's first two decades that frequently exceeded 10%
annually. The years after the 1973 Yom Kippur War were a lost decade economically, as
growth stalled and inflation reached triple-digit levels. The successful economic
stabilization plan implemented in 1985 and the subsequent introduction of market-
oriented structural reforms reinvigorated the economy and paved the way for rapid
growth in the 1990s.

A wave of Jewish immigration beginning in 1989, predominantly from the countries of

the former U.S.S.R., brought nearly a million new citizens to Israel. These new
immigrants, many of them highly educated, now constitute some 13% of Israel's 6.7
million inhabitants. Their successful absorption into Israeli society and its labor force
forms a remarkable chapter in Israeli history. The skills brought by the new immigrants
and their added demand as consumers gave the Israeli economy a strong upward push and
in the 1990’s, they played a key role in the ongoing development of Israel's high-tech
sector.

During the 1990s, progress in the Middle East peace process, beginning with the Madrid
Conference of 1991, helped to reduce Israel's economic isolation from its neighbors and
opened up new markets to Israeli exporters farther a field. The peace process stimulated
an unprecedented inflow of foreign investment in Israel, and provided a substantial boost
to economic growth in the region over the last decade. The onset of the intifada beginning
at the end of September of 2000, the downturn in the high-tech sector and Nasdaq crisis,
and the slowdown of the global economy have all significantly affected the Israeli

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economy. However, despite the recent conflicts in Gaza and Lebanon, the Israeli
economy grew during 2006.

Israeli companies, particularly in the high-tech area, have in the past enjoyed considerable
success raising money on Wall Street and other world financial markets; Israel ranks
second to Canada among foreign countries in the number of its companies listed on U.S.
stock exchanges. Israel’s tech market is very developed, and in spite of the pause in the
industry’s growth, the high-tech sector is likely to be the major driver of the Israeli
economy. Almost half of Israel’s exports are high tech. Most leading players, including
Intel, IBM, and Cisco have a presence in Israel.

Growth was an exceptional 6.2% in 2000, due in part to a number of one-time high tech
acquisitions and investments. This exceptional year was followed by two years of
negative growth of -0.9% and -1%, respectively, in 2001 and 2002. As a result of the
security situation and the associated downturn in the economy, there was a significant rise
in unemployment and wage erosion. This led to a decline in private consumption in 2002,
the first time that there had been negative private consumption since the early 1980s.
However, following growth rates of 1.7% in 2003 and 4.4% in 2004, the Israeli economy
entered into a period of stabilization and recovery after the deep recession of 2001 and
2002. Since then, the Israeli economy seems to have returned to a trend of consistent
growth. The Israeli economy grew by 5.2% in 2005 and GDP per capita (U.S. $17,800)
increased by 3.3%. The Israeli economy grew by an estimated 4.8% in 2006.

Exports of goods and services in Israel grew by 7% in 2005. Service and agricultural
exports each increased by more than 10% in 2005, whereas exports increased by 5.6%
and imports rose to 4.4%. Tourism revenues increased by 22.7% as a result of the
dramatic increase following the intifada’s subsidence.

Israel’s private consumption increased by 4% in 2005. The largest growth in private

consumption was in the purchase of clothing, footwear, and personal effects, which
increased by 10.2%, following an increase of 5.4% in 2004. Consumption of consumer
durables grew much more slowly than in 2004, with an increase of only 3.4%, compared

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with 14.3% the previous year.

In the Israeli business sector, business GDP grew by 6.6% in 2005. According to CBS
statistics, the transportation, storage, and communications industries grew by 9.2%,
following growth of 6.6% in 2004. The GDP of the wholesale, retail, restaurant, and hotel
sector increased by 8.1%, up from 6.1% in 2004. The GDP of the finance and business
services sector in 2005 increased by 6.4%, up from the previous year’s 6.1% growth rate.

The general consensus among economists is that Israel’s economy is very strong and that
its growth potential is in the 4% to 5% range.

The United States is Israel's largest trading partner. In 2005, two-way trade totaled some
$26.6 billion, up 12% from 2004. The U.S. trade deficit with Israel was $7.1 billion in
2005, up 33% from 2004, due largely to rising Israeli exports to the U.S. U.S. exports to
Israel rose 6.1% in 2005 to $9.7 billion, making Israel our 19th largest export market for
goods. The principal goods exported from the U.S. include civilian aircraft parts,
telecommunications equipment, semiconductors, civilian aircraft, electrical apparatus,
and computer accessories. Israel's chief exports to the U.S. include diamonds,
pharmaceutical preparations, telecommunications equipment, medicinal equipment,
electrical apparatus, and cotton apparel. The two countries signed a free trade agreement
(FTA) in 1985 that progressively eliminated tariffs on most goods traded between the two
countries over the following 10 years. An agricultural trade accord signed in November
1996 addressed the remaining goods not covered in the FTA but has not entirely erased
barriers to trade in the agricultural sector. Israel also has trade and cooperation
agreements in place with the European Union, Canada, Mexico, and other countries.

Best prospect industry sectors in Israel for U.S. exporters are electricity and gas
equipment, defense equipment, medical instruments and disposable products, industrial
chemicals, telecommunication equipment, electronic components, building
materials/construction industries (DIY and infrastructure), safety and security equipment
and services, non-prescription drugs, travel and tourism services, and computer software.

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Israel has a diversified economy with substantial government ownership and a rapidly
developing high-tech sector. Poor in natural resources, Israel depends on imports of
petroleum, coal, food, uncut diamonds, other production inputs, and military equipment.
It also has received substantial direct economic aid from the United States, including
approximately $1.2 billion per year since the mid-1970's, although that regular annual
amount has been being tapered off by $120 million per year beginning in 1998. In 2007,
direct economic aid from the US amounted to $120 million, or about 0.07% of Israel's
GDP. As regards overall net international transfers, Israel is a major recipient and has
ranked at or near the top ever since 1959; in 2006 Israel received net from abroad US$7.4
billion (of which $4.4 billion went to the government, and $3 billion was received by the
private sector). In May 2007, Israel was invited to join the OECD.

Israel possesses a substantial service sector and the Israel diamond industry is one of the
world's centers for diamond cutting and polishing. It is also a world leader in software
development and is a major tourist destination. In 1998, Tel Aviv was named by
Newsweek as one of the ten most technologically influential cities in the world. American
billionaires and business tycoons including Bill Gates, Warren Buffett, and Donald Trump
have each praised Israel’s economic environment, and the country was the destination for
Berkshire Hathaway's first investment outside of the USA when it purchased ISCAR
Metalworking, and the first R&D Centers outside the USA for companies including Intel
and Microsoft. The country has now become known as Silicon Wadi.

This is a chart of trend of gross domestic product of Israel at market prices estimated by
the International Monetary Fund and EconStats with figures in millions of Israeli Shekels.

Year Gross Domestic Product

1985 28,437
1990 106,475
1995 269,718
2000 470,732
2005 553,970

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IMF Report

Israel's strong commitment to economic development and its talented work force led to
economic growth rates during the nation's first two decades that frequently exceeded 10%
annually. The years after the 1973 Yom Kippur War were a lost decade economically, as
growth stalled, inflation soared and government expenditures rose significantly. Also
worthy of mention is the 1983 Bank stock crisis. By 1984 the economic situation became
almost catastrophic with inflation reaching an annual rate close to 450% and projected to
reach over 1000% by the end of the following year. However, the successful economic
stabilization plan implemented in 1985 and the subsequent introduction of market-
oriented structural reforms reinvigorated the economy and paved the way for its rapid
growth in the 1990s and became a model for other countries facing similar economic
crises.

Two developments have helped to transform Israel's economy since the beginning of the
1990s. The first is waves of Jewish immigration, predominantly from the countries of the
former USSR, that has brought over one million of new citizens to Israel. These new
immigrants, many of them highly educated, now constitute some 16% of Israel's 6.5
million population. The second development benefiting the Israeli economy is the peace
process begun at the Madrid conference of October 1991, which led to the signing of
accords led to a peace treaty between Israel and Jordan (1994). The Oslo Accords
between Israel and the Arabs led to the Second Intifada, which caused Israel to lose
billions of dollars in economic terms. Experts say that even had the peace process not
failed the Arab economies had little to offer Israel in terms of trade except for oil. In spite
of Israel's difficult security situation it managed to open up new markets to Israeli
exporters farther afield, such as in the rapidly growing countries of East Asia. In the past
few years there has been an unprecedented inflow of foreign investment in Israel, as
companies that formerly shunned the Israeli market now see its potential contribution to

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their global strategies. In 2006, foreign investment in Israel totaled $13 billion, according
to the Manufacturers Association of Israel. Thus, in Israeli terms, prosperity increases,
regardless of whether there is a de-facto peace or not. The Financial Times recently said
that 'bombs drop, yet Israel's economy grows', as a demarker to this fact.

Israeli companies, particularly in the high-tech area, have recently enjoyed considerable
success raising money on Wall Street and other world financial markets; Israel now ranks
second among foreign countries in the number of its companies listed on U.S. stock
exchanges.

Israeli exports in 2006

The United States is Israel's largest trading partner; two-way trade totaled some $12.6
billion in 1997. The principal U.S. exports to Israel include computers, integrated circuits,
aircraft parts and other defense equipment, wheat, and automobiles. Israel's chief exports
to the U.S. include cut diamonds, jewelry, integrated circuits, printing machinery, and
telecommunications equipment. The two countries signed a free trade agreement (FTA) in
1985 that progressively eliminated tariffs on most goods traded between the two countries
over the following ten years. An agricultural trade accord was signed in November 1996,
which addressed the remaining goods not covered in the FTA. Some non-tariff barriers
and tariffs on goods remain, however. Israel also has trade and cooperation agreements in
place with the European Union and Canada, and is seeking to conclude such agreements
with a number of other countries, including Turkey, Jordan and several countries in
Eastern Europe.

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Until the last decade, Israel's trade with the Arab world was minimal due to the Arab
League boycott. Beginning in 1945, Arab nations not only refused to have direct trade
with Israel (the primary boycott), but they also refused to do business with any
corporation that operated in Israel, or any corporation that did business with a corporation
that did business with Israel (the secondary and tertiary boycotts).

2.8% of the country's GDP is derived from Agricultural activity. While Israel imports
substantial quantities of grain, it is largely self-sufficient in other agricultural products
and food stuffs, due to the fact that food must be regulated Kashrut for sell in the Israeli
retail market, and hence imports almost no food products from other countries. For
centuries, farmers in Israel have grown varieties of citrus fruits such as grapefruit,
oranges and lemons. Citrus fruits are still Israel's major agricultural export.

Israel's Economy—Successes and Problems

Israel's economic history is varied: a series of major achievements accompanied by

serious problems. The 1950s, 1960s and early 1970s were highly successful in terms of
economic growth, with the exception of the 1966-67 recession. By the early 1960s the
economy had successfully absorbed the mass immigration of earlier years and labor
shortages had become the norm. However, balance of payments problems soon became
more severe and inflationary pressures grew, although Israel's labor shortages were
ameliorated after the 1967 Six Day War. The opening of the pre-war borders brought a
growing influx of Arab labor from the areas which came under Israeli control.

The Yom Kippur War of 1973 and the oil shock of 1973-74 greatly aggravated
inflationary pressures and balance of payments problems. The second oil shock (1979-80)
raised Israel's oil import bill to over $2 billion per annum, a value that exceeded the

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grants which Israel received from the United States. The oil shock and the huge revenues
acquired by the rich Arab states helped to stimulate the Middle East arms race, further
straining the Israeli economy. Hyperinflation, amounting to hundreds of per cent per
annum, became the norm, with all of its attendant evils. Economic growth slowed to a
crawl, dropping from 9-10% per annum between 1953 and 1973 to 3.2% per annum in
the decade from 1975-85, and barely exceeded the population growth rate.

In 1985, a national unity government came to power and adopted important economic
measures designed to reduce inflation drastically and to put greater stress on economic
efficiency. Increased US aid during a two-year transition period facilitated the
implementation of the new program. The results were excellent. Inflation, over 300% per
annum in 1984 and 1985, fell to 48% in 1986, and continued at a steady decline to less
than 20% per annum from 1987-91 and 10-12% from 1992-95. Initially economic grow
th rates lagged—as is usually the case when drastic anti-inflationary measures are taken
—but these policies laid the groundwork for the favorable economic performance of the
Israeli economy during the first half of the 1990s.

Based on an international comparison, since 1990 Israel has enjoyed a high rate of
economic growth, around 6% per annum. This is three years before the signing of the
Declaration of Principles. In fact, the growth rate of GDP, 5.7% per annum from 1993-9 5
was somewhat lower than in the previous three years, 6.4% per annum in 1990-92. The
business sector GDP (i.e., excluding government and non-profit institutions), shows a
more significant drop in the growth rate in the latter period, from an annual aver age 7.8%
in 1990-92, to 6.6% in 1993-95.

The high rate of economic growth since 1990 was stimulated, in part, by the large-scale
immigration from the former Soviet Union. During the period of mass immigration (200
thousand per annum in 1990 and in 1991) the rate of unemployment rose. But in su
bsequent years, when immigration was back to a more "normal" 75 thousand per annum,
the rate of unemployment steadily declined. The improving state of employment was
accompanied by moderating inflation, which by 1995 was down to 10%.

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But the good news was accompanied by bad news. In particular, since 1993 Israel
experienced a sharp deterioration in the balance on current account of the balance of
payments, which worsened in 1994, and even more so in 1995. The balance on current
acco unt is defined as exports of goods and services, plus unilateral transfers from abroad
(US grants, contributions from world Jewry, German restitution, immigrant and other
private transfers) minus imports of goods and services. In 1990-92, as a whole, the
balance on current account was positive at $154 million. In the following three years,
1993-95, there was a sharp deterioration with a total deficit of $7.8 billion, of which $4.1
billion was incurred in 1995 alone. This deficit was not the result of arms imports, which
actually declined. Estimates for the first quarter of 1996 show a continued deterioration
with the deficit in the balance on current account 25% higher than in the same period a
year earlier. These deficits were covered, for the most part, by loans and a growing
external debt.

If the budget submitted to parliament by the new government in mid-1996, which focuses
on cutbacks in government expenditures, is implemented, it should reverse the adverse
trends in the balance of payments and reverse the recent up-trend in inflation.

The data do not suggest that the Oslo agreements had any perceptible effect on the Israeli
economy. Nor can one "blame" the Oslo accords for the problems which arose since
1993/1994. Israel's recent economic woes are attributable mainly to unwise govern ment
economic policies. One example is the unusually large wage increases granted by the
government to public sector employees in 1993-96 (soon emulated by other sectors) that
stimulated very large increases in private consumption, imports and inflation. A second
example is the provision by the government of unusually large subventions to politically-
favored groups, aggravating the budgetary deficit and indirectly the deficit in the balance
of payments.

What all this tells us is that Israel's economic problems can be addressed only by the
adoption and implementation of appropriate economic policies. Israel adopted some
important new economic policies in the mid-1980s which fostered efficiency,
productivity, and profitability, and the favorable results became very visible in the early

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1990s. Wise economic policies underlay Israel's prosperity, and poor economic policies
explain the problems that arose in more recent years.

As the rest of this discussion will demonstrate, the same is true of the Arab states where
the problems are far more deep-rooted. Wise domestic policies hold out the promise of
prosperity. Only basic, fundamental economic changes can significantly improve the
performance of the Middle Eastern economies, and provide jobs and decent incomes for
the vast army of unemployed and under-employed, the poor and downtrodden—not
interstate politics.

Since independence in May 1948, Israel has fought six wars, two intifadas, a continuing
terrorism threat, an economic boycott, and intermittent diplomatic isolation. It is currently
in a formal state of war with two of its neighbors (Syria and Lebanon) and has only a cool
peace with the other two (Jordan and Egypt), despite peace treaties. In effect, all of its
land borders are relatively closed to trade. More generally, it is an outcast in the Middle
East, deprived of any opportunity to benefit from the commerce generated by regional oil
wealth but having to bear the costs of living in a neighborhood characterized by arms
races and instability.

Once a traditional economy based mainly on agriculture, light industry and labor
intensive production, Israel was until the 1990s described as the "most socialist economy
of any nation outside of the Eastern bloc". High growth, second only to Japan in the
period 1922-73, was achieved through a highly centralized, state-driven economic policy,
making Israel a world record-holder in high taxes, foreign debt, and finally inflation,
which reached triple digit levels from 1977 to 1984.

The Israeli economy has been lauded by some of the biggest names in the world of
finance. A chief economist and head of the Global Competitiveness Network at the World
Economic Forum, declared that Israel could “become one of the most prosperous
countries in the world”. Bill Gates, Warren Buffet and Donald Trump have all invested
significantly in Israel, with the latter declaring “Israel is one of my favorite places in the

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world.” This is made even more remarkable by the fact that Israel has no significant
natural resources.

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