The Exorbitant Costs of Israel's Wars and the Future Ahead

Israel's wars over the past year have not only resulted in painful human costs and widespread devastation but have also been financially burdensome, raising concerns about their impact on Israel's economy. Military expenditures in Israel have skyrocketed, and economic growth has stalled, particularly in dangerous border areas where residents have been evacuated. Economists believe that alongside the severe pressure of war costs on the public budget, Israel will face declining investments, rising tax rates, and difficult decisions between allocating budgets for military or social services. However, Israel's economy is still considered strong. This Associated Press report examines the financial costs of the war for Israel from various perspectives. According to the Stockholm International Peace Research Institute, Israel's military spending before the Hamas attack on October 6 last year was about $1.8 billion per month, but this figure increased to approximately $4.7 billion per month by the end of 2023. Both the U.S. and the European Union also classify Hamas as a terrorist organization. The Stockholm Peace Research Institute reports that Israel's military expenditures over the past year amounted to about $27.5 billion. In the global military budget table prepared by the Stockholm International Peace Research Institute, Israel ranks fifteenth, just after Poland, and above Canada and Spain, whose populations are at least several times larger than Israel's. Israel's military spending last year was equivalent to 5.3% of its GDP, while in the U.S. it was 3.4% and in Germany 1.5%. However, Israel's military spending is minimal compared to Ukraine, which allocates about 37% of its GDP and over half of its government budget to counter the Russian military invasion. The impact of the war on economic growth and labor supply has been significant. In the three months following the Hamas attack (from mid-October to mid-January 1402), Israel's economy shrank by 5.6%, the worst performance among the 38 member countries of the Organization for Economic Cooperation and Development, which consists of wealthy nations. Statistics show that in the first quarter of 2024, Israel's economy rebounded, with a growth rate of about 4%, but it fell to 0.2% in the second quarter. The consequences of the war for Gaza, which has always faced severe economic problems, have been much heavier. About 90% of the population in this strip is displaced, and a large portion of its workforce is unemployed. The economy of the West Bank has also been severely damaged. Tens of thousands of Palestinians who used to work in Israel before the Hamas attack have lost their jobs and sources of income, and Israeli military attacks in the area and the establishment of more checkpoints have severely restricted Palestinian movement. According to World Bank statistics, the economy of the West Bank shrank by 25% in the first quarter of this year. Within Israel, the war has imposed heavy economic costs. The extensive mobilization of reserve forces and the extension of their service period have jeopardized the labor supply necessary for economic activities. Security concerns have hindered investment in new businesses, and disruptions and periodic flight cancellations have significantly reduced the number of foreign tourists and, consequently, the income of the tourism industry. On the other hand, the government is covering the housing costs of tens of thousands of citizens who have been evacuated from areas near Gaza due to Hamas attacks and from northern Israel due to Hezbollah attacks. Hezbollah is a militia group and also a political party that controls much of southern Lebanon. The U.S. considers Hezbollah a terrorist organization, while the European Union has designated its military wing as terrorist. One of the major concerns is the uncertainty about when the wars in Israel, which began more than a year ago, will end. After the 2006 war with Hezbollah in southern Lebanon, Israel's economy quickly recovered, but that war lasted only 34 days. Moody's, a reputable international credit rating agency, downgraded Israel's credit rating by two notches in early October this year based on these factors. According to this agency, the 'Baa1' rating assigned to Israel is still considered an appropriate investment position but with medium risk. The Israeli economy is by no means collapsing. It is a highly advanced and diversified economy that includes a very strong sector in digital technology, which plays a significant role in tax revenue and funding military expenses. The unemployment rate in Israel is very low, and the country's stock market index has increased by 10.5% over the past year. According to the head of the Economic Policy Institute at Reichman University in Israel, even while the war continues, digital technology companies managed to attract $2.5 billion in investments in the third quarter of this year. Zvi Eckstein reminds us that Israel started the war in 'the best economic condition' in terms of public debt, with government debt around 60% of GDP, which is relatively low. He states, 'We have essentially financed the cost of the war through government borrowing, which has now reached 62% of GDP, significantly lower than France's approximately 111% and similar to Germany's public debt of 63.5%.' This research institute predicts that if the current wars do not escalate significantly and a ceasefire or end to the war is reached by the end of next year, Israel's government debt will rise to about 80% of GDP. In the budget plan of Bezalel Smotrich, Israel's finance minister, a deficit of less than 4% is anticipated for 2025, and it is promised that the volume of government debt will remain stable. Mr. Smotrich defended this budget by stating that the exchange rate of Israel's national currency is stable, stock prices are rising, the unemployment rate is low, government tax revenues are strong, and it has access to robust financial credits and a growing digital technology industry. However, Moody's has questioned the budget deficit figure and predicts it will increase to 6% next year. Karnit Flug, a former head of Israel's central bank and current vice president of the Israel Democracy Institute, believes that the downgrade of Israel's government credit rating by Moody's will increase borrowing costs, forcing the government to cut public service budgets and raise taxes. The increase in U.S. military aid and support for Israel has been significant. Before the war began, U.S. military aid to Israel, based on an agreement signed during Barack Obama's presidency, was $3.8 billion annually. This amount is nearly equivalent to 14% of Israel's military expenditures before the recent wars, with most of it going to American arms companies. According to the Brown University 'Costs of War' project, which was published on the anniversary of the Hamas attack (October 6 this year), after the onset of the war in Gaza and the escalation of tensions and conflicts in the region, the U.S. has provided at least $17.9 billion in military aid to Israel. In addition to purely military and arms assistance, the U.S. government has also provided financial aid to Israel during critical and crisis moments. In 2003, during the second Intifada (Palestinian uprising), when Israel faced serious economic problems, the U.S. Congress approved $9 billion to guarantee Israel's foreign borrowing, allowing it to obtain loans at low-interest rates. Some of these financial guarantees remain unused, and if the Israeli government faces heavy borrowing costs, it could theoretically utilize them. What does the future hold? The Israeli government has formed a special commission headed by Yakov Negel to examine the volume of military budgets in the future and the implications of increased military budgets on the country's economy. He is a former national security advisor to Israel and the head of the negotiating team for the latest package of U.S. aid. Zvi Eckstein, an Israeli economist, believes that to help revive the country's economy after the war and cover military costs that are likely to increase in the future, public service budgets should be reduced, and tax rates should be increased.