Half a century ago Israel was a poor new state hopelessly indebted to the outside world. Fifteen years later, it could be described as a rapidly growing developing country undergoing successful industrialization. By the early 1980s, it was an extreme case of an economically overburdened state incapable of stemming stagnation and spiraling inflation. But as the century comes to a close, the guardians of the “Washington consensus” laud Israel as a model of economic liberalization and successful adaptation to globalization and technological change.

In the course of the 1990s, the Israeli economy enjoyed a wave of growth comparable in pace to the Asian tiger economies that brought average living standards within reach of the rich OECD democracies. Between 1992, when mass immigration from the former Soviet Union peaked, and the 1996 elections, Israel’s real per capita GDP grew by a remarkable 4 percent per annum. Since then, however, the economy has moved into a deepening recession. Economic pundits attribute the recession to either policy errors or the deadlock in the peace process. [1] But from a longer historical perspective, the rhythm of the ongoing business cycle is not unusual. Ever since the onset of modern Jewish settlement in Palestine, geopolitics, immigration and capital inflow (assets brought by immigrants or foreign gifts) have driven the economy’s major episodes of boom and bust.

At the same time, the fundamental parameters of the state-economy relationship have remained remarkably stable. Neither wars nor political upheavals could alter the extensive scope of public employment and expenditure, the state’s generous subsidization (for Jews) of both businesses and households, or its dominant role in mobilizing and allocating capital. Periodic attempts to contract the state’s economic role and to create conditions for self-powering capitalist growth proved unsuccessful.

All that has now changed. Since the stabilization plan of July 1985, which stopped hyperinflation in its tracks, the state has adopted a string of structural reforms that have altered dramatically the traditional parameters. Preparations for war now claim a smaller proportion of manpower, national product and industrial activity. The private sector has experienced internationalization (inward and outward foreign investment and increased exposure to trade); dismantling of protective regulations and subsidies; the rise of high-tech industry at the expense of agriculture and traditional manufacturing; and significant changes in the structure of big business.

Does Israel’s new political economy represent a permanent transformation? Was this transformation responsible for high growth in the 1990s, or was this boom merely a passing episode powered by the usual exogenous dynamics? From a structural perspective, does Israel’s transformed political economy signify a diminished role for the state, or a superficial alteration of its economic activity? Finally, who are the winners and losers in these developments?

The Role of the State

The motors of Israel’s recent economic growth were threefold. [2] First, by making it possible (indeed, essential) for Jews wishing to leave the former Soviet Union to come to Israel, and by then subsidizing their absorption, the government provided a huge stimulus to the housing and labor markets. (Enlarged American aid and loan guarantees helped finance this stimulus. [3]) Second, the peace process that appeared to be heralded by the Oslo accords of 1993 enabled Israel to compete in an increasingly internationalized world economy. Third, the state’s educational and industrial policies, no less than its heavy past investments in Israel’s military-industrial complex, facilitated the high-tech takeoff of the 1990s.

These three catalysts of the 1990s growth spurt underline the state’s crucial role in Israel’s political economy, while also pointing to the specific character of this role. In settler societies, the state actively attracts people and capital from outside while managing internal conflicts with the indigenous population over territory and demography. Israel is unique in that, historically, a combination of unfavorable demography, lack of sovereignty, access to foreign gifts, the high price of land and the low wages accepted by Palestinian labor led the Zionist movement and its ally (later master), the Labor movement, to opt for collectivist economics. [4] Collectivism, most evident in truly communitarian projects such as the kibbutzim on the margins of the market economy, was far more important to the mainstream of workers and businesses who depended upon centralized political bodies to organize and subsidize Jewish colonization and oversee the development of the Jewish economy.

Israel’s attainment of sovereignty only intensified preexisting collectivist tendencies. The state’s multiple roles in external relations (e.g., military, manpower and fundraising requirements), along with the internal consolidation of its control over territory, legitimated activism in economic affairs. In addition to high defense, immigrant absorption and infrastructure expenditures, state activism in the 1980s exhibited several forms that deserve closer analysis.

The state underpinned the key institutional complexes of the Israeli economy, “big labor” and “big business.” Big labor was politically represented by the Histadrut labor organization, founded in the colonial era to perform the simultaneous functions of employment creation, labor representation, social protection and political mobilization. The most powerful sector of organized labor was the “bureaucratic sector,” state-owned or funded enterprises and services which sheltered Jewish-only internal labor markets. [5] Big business was dominated by giant conglomerates and the large banks that were their principal owners. [6] By virtue of government regulations and subsidies, the “big economy” enjoyed a high degree of monopoly power and protection from foreign competition.

Spurred on by periodic waves of protest by the underprivileged, the Israeli welfare state encouraged Jews to immigrate to and remain in Israel — especially if they were newcomers, impoverished or located in “strategic” (empty or Arab-dominated) spaces. The welfare state featured a substantial core of redistributive universal transfers (social security), alongside diverse practices that subsidized targeted population groups (new immigrants and “development town” residents) while completely neglecting Israel’s Arab citizens. [7]

To pay for all these subsidies, the state extracted high taxes and mobilized extensive “unilateral transfers” from abroad while also appropriating the bulk of household savings and controlling their allocation to public and private investment. The state prevented the free flow of capital into and out of the country, thus precluding the development of a domestic capital market. [8]


Under the stewardship of economists in the treasury, the central bank, and the universities, Israel underwent a string of liberalizing measures beginning in the mid-1980s. As a result, the state’s distributional role has contracted considerably but unevenly. As a percentage of national product between the early 1980s and the late 1990s, overall public expenditure fell from 75-80 percent to around 55 percent. The expenditure categories critical to the welfare of big business (debt service, subsidies and domestic defense procurement) experienced much sharper declines. [9] By comparison, in the 1990s social transfers and services claimed 27 percent of GNP, [10] even more than before.

Protective restraints have been removed. Long-standing restrictions on the import of goods and capital have been eliminated, the government’s former domination of savings and investment has greatly diminished and deregulation and anti-monopoly policies have encouraged competition in some sectors. Labor markets have also become more “flexible.” There is now far less economy-wide wage bargaining, greater use of temporary labor and individual contracts, and sizable imports of “temporary” foreign workers (although these innovations were the product of employer, rather than state, initiatives).

Privatization and reforms of the Histadrut have weakened the bureaucratic sector. Privatization is popular with both Labor and Likud governments, although plans to sell off government corporations and banks nationalized after the 1983 financial crisis have not been fully implemented. Several of the bastions of big labor — notably electricity and telecommunications — have actually grown. Still, the combined effect of privatizations, retrenchment of military industries and the armed forces, and the sale of the Koor conglomerate and other Histadrut-owned enterprises has been the reduction in size of the protected labor market and the elimination of some of its privileges. [11]

The implications of these far-reaching changes in Israel’s political economy are not immediately obvious from the facts reviewed above. While the scope of the state has declined, it has freed itself from obligations that limited political and bureaucratic discretion and brought state and society to the brink of a serious crisis in the early 1980s. [12] Rule changes and the dominance of free-market ideology in economic discourse have also favored a leaner, more autonomous state.

Although big business has been obliged to forgo massive subsidies, it has been compensated by tax cuts, various state-supported opportunities for profit making in the international economy and beneficial acquisitions of privatized government assets. The biggest banks have been forced to give up part of their vast portfolios of non-financial assets, but this has not hurt their profits.

The managerial elite now has to share or even yield its control of former public and Histadrut assets to the country’s richest families and some well-connected foreign magnates. Relationships among the big banks and the largest non-financial corporations are in a state of flux that has partially opened up the commanding heights of the economy to new players. Some of these players are foreign multinationals or businessmen whose “invasion” has been welcomed by key segments of local business. The state has aided and abetted this “invasion” through old-fashioned subsidies as well as by the adoption of a liberal policy stance.

Winners and Losers

In Israel as elsewhere, liberalization in a context of increasing globalization generates distributional “shocks.” The obvious winners are capitalists (new and old) and business executives, along with the foot soldiers of liberalization — the middlemen and women of the “professional,” “service,” or “new” classes. A common characteristic of these beneficiaries is their Ashkenazi (European origin) identity; most are also men. The biggest losses (in descending order of magnitude) have been suffered by Palestinian commuter laborers, [13] the Palestinian Arab minority inside the Green Line and those Mizrahi Jews (still Israel’s majority) who remain trapped on the geographic and economic periphery.

The potential for political backlash against liberalization’s uneven material consequences is difficult to gauge because distributional politics in Israel are filtered through idiosyncratic stratification and citizenship regimes. Although political inequalities and competing symbolic domains are part and parcel of these regimes, [14] political and media discourse separates status and identity politics from class politics. There is little likelihood that the state will limit the gains of the wealthy. Nevertheless, because Mizrahi Jews are the most salient floating voters for the two main parties and because their interests are also represented by potentially “king-making” smaller parties, the plight of peripheral “development towns” periodically becomes a major political issue. A similar dynamic also comes into play for parties representing new immigrants or Israel’s Palestinian Arab citizens.

These political dynamics partly explain the resilience of Israeli welfare state expenditures, the Achilles’ heel of economic liberalization. The most expensive components of the welfare state are entitlements to universal programs in health, education and income maintenance which are politically popular and actively defended by those who provide them. Another factor is the demise of the Histadrut as a representative of the trinity of labor, the quasi-welfare state and big business. Although this fusion of functions gave rise to vexing political contradictions, it rendered the Histadrut the most important axis of power and coherence in the pre-1990 political economy. [15] In the past, this axis was mobilized for and against state attempts at policy innovation, but without it, the new policy regime lacks a key legitimating component.

An additional difficulty is posed by the tension between Zionist ideology and economic and civil liberalism. Among the Jewish majority, those most vulnerable to the impact of liberalization — and to welfare state retrenchment — are particularly opposed to any dilution of the national and religious components of the Jewish identity of the state and its citizens. Moreover, while governments and their changing policy agendas come and go, the state itself must continually grapple with demographic, territorial and security issues that generate a bias toward social protection.

Not surprisingly, popular support for welfare state economics remains exceptionally strong in Israel, to the detriment of liberalization policies. [16] Binyamin Netanyahu’s aspirations to emulate the American model of political economy patently contradict his drive to defend Greater Israel and preserve the primordial foundations of Israel’s individual and collective identity. Liberals on the left of Israel’s political spectrum are caught in a bind of their own. Repulsed by Netanyahu’s brand of Zionism, let alone that of the religiously orthodox nationalists, their aspirations for a liberalized economy and a more pluralistic and less intrusive state are compromised by traditional Zionist convictions requiring a substantial role for the state in administering collective tasks.

The liberalization of Israel’s political economy is thus simultaneously far-reaching yet potentially fragile. The reformed state must confront the consequences of catering to a settler society whose most compelling discourse urges acceptance of collective responsibilities.

The economic benefits of peace for foreign trade and investment cannot far outlast the moribund peace process. Unless that process continues, costly confrontations with the Palestinians and neighboring Arab states remain a distinct probability. Add to these uncertainties the ups and downs of the current world economy, and it is evident that 
no one can guarantee that economic liberalization has anchored 
a stable growth — inducing political-economic regime in Israel.


[1] This debate is currently exemplified by the contrasting opinions of the two senior economic commentators of the Israeli daily, Ha’aretz, Abraham Tal and Nehemia Strasler.
[2] For further details, see Michael Shalev, “Zionism and Liberalization: Change and Continuity in Israel’s Political Economy,” Humboldt Journal of Social Relations 23/1-2 (forthcoming 1998). Two other recent surveys are Yair Aharoni, “The Changing Political Economy of Israel,” Annals of the American Academy of Political and Social Science 555 (1998), pp. 127-46 and Ephraim Kleiman, “The Waning of Israeli Etatism,” Israel Studies 2/2 (1998), pp. 146-171.
[3] Due to a sizable increase in US aid and declining purchases of imported US arms, Israel has enjoyed since 1985 an aid surplus averaging $1.25 billion annually. In addition, following the transition to a Labor government after the 1992 elections, Israel was able to obtain US guarantees for $10 billion worth of future commercial loans.
[4] See Gershon Shafir Land, Labor and the Origins of the Israeli Palestinian Conflict, 1882-1914 (Cambridge: Cambridge University Press, 1989).
[5] See Emmanuel Farjoun, “Class Divisions in Israeli Society,” Khamsin 10 (1983), pp. 29-39.
[6] Robin Rowley, Shimshon Bichler and Jonathan Nitzan, “Some Aspects of Aggregate Concentration in the Israeli Economy, 1964-1986,” Working Paper 7/88, Department of Economics, McGill University, 1988.
[7] See Avraham Doron and Ralph M. Kramer, The Welfare State in Israel: The Evolution of Social Security Policy and Practice (Boulder, CO: Westview Press, 1991); and Ze’ev Rosenhek, “Policy Paradigms and the Dynamics of the Welfare State: The Israeli Welfare State and the Zionist Colonial Project,” International Journal of Sociology and Social Policy, forthcoming.
[8] See Yair Aharoni, The Israeli Economy: Dreams and Reality (New York: Routledge, 1991).
[9] Shimshon Bichler and Jonathan Nitzan, “Military Spending and Differential Accumulation: A New Approach to the Political Economy of Armament — The Case of Israel,” Review of Radical Political Economics 28 (1996), pp. 51-95.
[10] Inter-period comparisons refer to the first five years of the 1980s versus the most recent five-year period (1993-1997). Data are from the statistical appendix of the annual report of the Bank of Israel for 1997, Tables 3 and 4.
[11] Research in progress by the author attempts to distinguish the effects of changes of ownership and changes in personnel policy from the impact of downsizing of military budgets and insufficient foreign arms sales.
[12] Shalev, op cit.
[13] The Palestinians have been hurt by Israel’s abandonment of one form of liberalization in favor of another. Israel refused on security grounds to honor its commitments to a free flow of labor from the Palestinian territories to Israel, and, in a radical departure from previous policy, it opened its gates to foreign labor.
[14] Gershon Shafir and Yoav Peled, “Citizenship and Stratification in an Ethnic Democracy” Ethnic and Racial Studies 21 (forthcoming 1998).
[15] See Lev Luis Grinberg, Split Corporatism in Israel (Albany NY: State University of New York Press, 1991) and The Histadrut Above All Else [Hebrew] (Jerusalem: Nevo, 1993).
[16] See Michael Shalev, “The Limits of Liberalization: Welfare State Retrenchment and Public Opinion in Israel and other Rich Democracies,” paper presented for presentation at a conference entitled “The Future of the Welfare State: International and Israeli Perspectives,” Jerusalem, June 8-10, 1998.

How to cite this article:

Michael Shalev "The Contradictions of Economic Reform in Israel," Middle East Report 207 (Summer 1998).

For 50 years, MERIP has published critical analysis of Middle Eastern politics, history, and social justice not available in other publications. Our articles have debunked pernicious myths, exposed the human costs of war and conflict, and highlighted the suppression of basic human rights. After many years behind a paywall, our content is now open-access and free to anyone, anywhere in the world. Your donation ensures that MERIP can continue to remain an invaluable resource for everyone.


Pin It on Pinterest

Share This