Is Israel on the Brink of a Financial Crisis?

[A version of this was originally posted here]

Along with highly publicized remarks on the turnout of Arab Israeli voters and his support for a two-state solution, Israeli Prime Minister Benjamin Netanyahu frequently touted his respectable economic record during his electoral campaign last month in Israel. As with most political boasting, Netanyahu’s “achievements” were mainly attributable to economic forces beyond the leader’s control. He can however take credit for more or less staying out of the way of Israel’s successes.

Israel’s economic good fortune is largely thanks to the fact the country was spared by the 2008 global financial crisis and enjoys a declining unemployment rate. Israel is also considered the second-greatest hot spot for start-ups, second to Silicon Valley in the United States.

Up until recently, Israel has been able to rely on steady economic growth, reinforced by the 1999 discovery of important maritime reserves of natural gas. One of the fields, Tamar, began extraction in 2013 while larger reserves will be ready over the course of the next decade, promising steady returns from taxes and royalties revenues for a government that is seeking to increase spending and reduce state debts.

But there is a dark side to this rosy picture. A detailed study led by Global Entrepreneurship Monitor (GEM) in 2013 showed that Israel ranked very low in stimulating entrepreneurial ventures compared to other developed countries. Its main weaknesses are in government funding and subsidies, where it ranked 61 among 70 countries, followed by the efficiency of governmental regulation for business owners in obtaining business licenses or enjoying uniform policies in taxation and bureaucracy.

The research also highlighted the government’s failure to successfully promote the creation of new businesses. Incompetence of state employees assigned to assist entrepreneurs in their initial research on potential ventures is the main cause of this problem. The report specifically highlighted the “unprofessionalism of the government clerks” put in charge of providing such information.

While Israel has quite a successful higher-education system—with effective college and university training for the business market—its primary and secondary schools receive relatively low scores, leaving Israel 42 out of the GEM’s list of 70. Access to financial support and banking is also weak (56), as are ratings for market dynamism (57) and openness to new companies (62).

These rankings stem from the fact that Israel’s economy is dominated by a group of large companies who exercise control over the market to preserve their respective monopolies. Not only has the current government proven incompetent when it comes to dismantling such monopolies, but often success in business depends on business owners developing privileged relationships with government officials. Thus, GDP growth typically does not trickle down to the underprivileged segments of the population and new venture businesses, which are not part of the already existing system of companies. While Israel is commonly considered to be a hot spot for start-ups, opportunities are in fact mostly limited to a small part of the population.

This becomes more apparent when it comes to poverty rates and inequality gaps. Israel has the highest poverty rate of all developed countries, according to an 2014 report by the Organization for Economic Cooperation and Development (OECD). It also has one of the highest rates of income inequality, only surpassed by four other countries. The top 10 percent of Israelis earn on average 14 times what the bottom 10 percent earns, and, compared to the average of the countries reviewed, social spending is lower.

In 2011, this situation led the Israeli middle class to take to the streets to protest the rise of the cost of living in the country. Nearly four years later, the release of a report concerning housing prices showing that the average apartment’s price rose 55 percent between 2008 and 2013 created another national debate over the state of the economy.

Netanyahu’s strategy consisting of placing national security issues ahead of economic reforms on his agenda has proven successful, at least in taking attention away from the latter. But this ordering of priorities will most likely have a poor impact on Israel’s economy in the long-term. In addition to neglecting economic concerns, the roots of the problem run deep and necessitate a reshaping of the entire governmental system, measures that Mr. Netanyahu is unlikely to pursue.

Outside of the defense ministry, ministers are appointed not according to their domain of expertise, but according to their respective parties and political affiliations. To stay in power, they spend more time building support for their incumbency rather than launching bold reforms. Netanyahu’s decision to focus people’s attention on the nuclear talks with Iran, ensured national security would be prioritized over plans for economic reforms.

Although national obsession over the army has so far been an apparent advantage for the start-up scene (particularly the information and security industries), Netanyahu’s reelection will likely cost Israel a great deal over time. His unwillingness to address the increasingly successful Boycotts, Divestment, and Sanctions (BDS) Movement and his failure to promote a peace process—which will further sour EU-Israel relationships—could severely impact the economy.

Each war with Gaza means a slow down in Israeli business. Beyond this, the country’s growing international isolation and the subsequent difficulty in opening up to larger markets impairs Israel. It prevents Israel from becoming the tech-hub and “start-up nation” it envisions itself to be.

Deganit Perez

Deganit M. Perez is a Swiss-Israeli graduate of the University of Lausanne with an M.A in French and English Literature and Linguistics. She is currently pursuing an M.A in International Relations and Journalism at New York University.