Transformations in the Israeli Economy
By Ben Winer
History of Comparative Capitalist Systems
The rise of the Jewish nation state from the ashes of the Holocaust is an impressive historical feat that has captured the attention of the world. Within this stunning story lies a subplot no less transformative in nature: the rise of the Israeli economy from heavily socialist, agrarian origins to a 21st century capitalist, high-tech powerhouse. Without a deep focus and exploration into the foundations and changes of the Israeli economy, the feats of this country and its people cannot be fully understood. A journey through key episodes in the history of Israel’s economy highlights radical transformations in ideology, practice, and the fundamental purpose of the State’s existence. Confronted with existential wars, mass influxes of immigrants, and a lack of natural resources, the country has overcome an array of unique challenges to achieve a level of economic success and prosperity that is remarkable within a span of 70 years. This paper explores the country’s heavily socialist origins through social institutions such as the Kibbutz commune and the Histadrut labor union and how the needs of the times shifted the ethos of the Israeli economy toward a more Westernized but still unique capitalist orientation. Governmental reforms in fiscal policy and privatization, a change in consumer mindset, and the harnessing of Israeli culture to embrace the riches of Israel’s human capital have transformed Israel into a modern, market-driven economy with emphasis on advanced technology creation. These developments have made Israel one of the most innovative and thriving economies of the 21st century, marking the transformation of Israel as a pioneering starter country to a pioneering start-up nation.
The economic history of Israel cannot be portrayed properly without taking immigration into account. Israel is a state inherently created, developed and sustained by immigrants throughout the generations of the State’s existence. Many waves of immigrants have contributed to this project. Perhaps most notable among these are those immigrants who arrived in British Mandate Palestine during the fifth Aliyah (“going up” or influx) in which nearly 250,0001 immigrants arrived from primarily central, eastern, and southern Europe in hopes to escape quickly rising fascist and Anti-Semitic attitudes in Europe. When these early-state immigrants arrived in their new Middle Eastern home, not only did they bring cultural and social norms from Europe but socio-economic leanings as well.
Many immigrants from Eastern Europe came with the influence of socialist and communist philosophies, owing to the geographical roots of those economic structures. These immigrants had largely been members of labor organizations that were trending in the early part of the 19th century in Europe. As the new immigrants arrived, their aspirations were realized in their new Jewish home through the formation of the Kibbutz movement and reached a national culmination in the form of substantial government involvement in the economy through many state-owned businesses as well as a quasi-governmental labor union that dominated Israeli society.
Socialist aspirations grew under the leadership of European theoreticians in the Labor Zionist movement such as Moses Hess, Aaron David Gordon, and most notably David Ben-Gurion, the first Prime Minister of Israel. These early Zionist leaders aspired to develop an agrarian-based economic infrastructure in the rural, agricultural regions of the state, with a Jewish proletariat in the urban settings. Established Zionist, socialist youth movements in Europe such as Hashomer Hatzair urged immigration to the land of Israel in the early part of the 20th century. The success of the ideology can be attributed to its eventual transformation into Israel’s largest ruling political party for the first thirty years of the state under its new name, Mapai, which translated from this Hebrew acronym, means the Workers Party of Israel. Moreover, its associated pre-state military wing, the Haganah, became the most prominent military organization amassing nearly 10,0002 Jewish soldiers which is credited with uprooting the ruling British presence and dominating right-wing Zionist military factions such as the Irgun, an organization then led by Menachem Begin who would later lead Israel toward its current capitalist form.
Mapai worked closely with the state’s largest labor federation known as the Histadrut, which employed nearly 75%3 of newly arriving immigrants. The Histadrut held great influence for the individual in the form of wages, and for the state with regard to the means of production and allocation of resources in Israel’s early years. The labor organization gradually gained dominance in nearly all sectors of the economy from “agricultural settlements, agricultural marketing, housing, construction, quarrying, cooperative groceries, industry, transportation, insurance, banking, exports and imports, social welfare, health services, and even education.”4 Coastal cities like Tel Aviv and Haifa became prominent centers for Histadrut activism due to their proximity to ports for trade, flat land for industrialization and manufacturing, and density of urban population from which to draw workers. The prominence of the Histadrut is still seen today as it employs nearly 5% of the Israeli population and controls 25%5 of the Israeli economy. With this vast reach into all sectors of the Israeli economy, the Histadrut considerably shaped the economic underpinnings of the State in its formative years. In recent years, its prominence has declined significantly in the face of vast free market successes, but its ideological influence and share in the economy are still material factors in Israeli society. At the same time that Histadrut gained its foothold in urban areas of Israel, a new movement for pioneering workers was gaining traction in the agricultural regions of the land. Most notably was the rise of the Kibbutzim, self-sustaining agrarian communes deeply rooted in the Zionist socialist dream.
The History of the Kibbutz
The Kibbutz which, in Hebrew means “gathering or clustering,” began as a tangible manifestation of the socialist, even communist, notion that workers could own and control the means of production in a single-class micro-society formed as an agricultural collective. While arguably utopian in conception, the Kibbutz movement nevertheless had quite tangible utility in developing Israel’s economy and striving to realize the full potential of the Zionist project. The movement was designed as a social, political, and economic strategy to harness the influx of immigrant labor backed by nationalist motivations to build the country. The first Kibbutz was founded in 19096 in the small town of Degania located on the southern side of Sea of Galilee in what is now north-eastern Israel.
When the first Halutzim (pioneers) came to the land of Israel, they faced severe challenges cultivating the land for agricultural growth. Conditions were harsh, as Halutzim were forced to battle malaria, hunger, and swampy land conditions. Immediate solutions included planting eucalyptus trees to drain the swamps, but a more collective and organized method needed to be realized to transform the desolate inland terrain. The land for Kibbutz Degania, as well as the land for many other Kibbutzim, was purchased with funds from the JNF, a worldwide Zionist non-profit organization that collected funds to acquire and develop land in Israel in the early 19th century. With its support, Kibbutz Degania was formed as a collective of immigrant laborers that lived communally and sustained themselves on their agricultural and farming output. Kibbutzim became increasingly popular for Zionist pioneers immigrating to the land who sought immediate employment as well as a new community to join. Kibbutzim offered new immigrants a community to rebuild themselves after leaving their countries of origin. One primary ideological aspiration of the Kibbutz movement was to reinvent the image of the “Jew” from being a largely urban, educated and commercial worker to a physically active, agrarian and collectively-minded laborer. This romantic, quasi-transcendentalist notion attracted younger Jews from Europe who wished to establish themselves anew in their new country.
In the decades leading up to Israel’s founding, the number of Kibbutzim increased from 12 in the 1920’s to 214 in 1950.7 The greatest influx occurred between the years 1940 and 1950 in the wake of the Holocaust, in which the number of Kibbutzim increased from 82 to 214. By the establishment of the state, nearly 67,000 Israelis lived on Kibbutzim, constituting 7.5%8 of the population. After Israel was founded, the numbers began to dwindle as the government facilitated new programs and opportunities for housing and employment. However, the impact of the Kibbutz movement on the socialist vision for the State remained integral to early state politics and socioeconomic culture. “Kibbutzniks” (people living on Kibbutzim) retained great political influence, constituting 15%9 of the legislators in the Israeli parliament during the late 1960’s despite their 4% makeup in the overall Israeli population. Today, the number of Kibbutzim has dropped from its maximum in the 1990’s of 270 to roughly 24010 in the modern State. Currently, only 2% of the Israeli public live on Kibbutzim where 66.7%11 of workers earn a personal salary and live a traditional independent life, facts contradictory to the visions of the founders of the Kibbutz movement.
All in all, the function of the Kibbutz movement was not restricted solely to an economic strategy to sustain the new working class in Israel, but also as a method to formulate an Israeli identity focused on the collective. As the Israeli public moved closer to international trends of consumerism, materialism, and individualism, the focus on the collective and Kibbutz lifestyle has become less appealing and outdated.
The Kibbutz: A Case Study in Israel’s Transformation Toward Capitalism
A closer look at the transformation of one Kibbutz in the Northern Galilee region can shed light on how ideological underpinnings have broken and forced the Kibbutz to cater to a privatized national economy. Conceived as a farming collective, many of these Kibbutzim now cater to the tourism industry and garner revenues from vacationers desiring to learn about the history of the Israeli commune and enjoy a different flavor of lodging than that in the big cities. More broadly, government privatization of Kibbutz land on top of efforts to maximize Kibbutz profit to survive in a capitalist environment show how the Kibbutzim of today have shifted from their collectivist ideological aspirations to merely trying to stay alive in a modern capitalist economy.
Illustrating this trend which began in the 1960’s, Kibbutz Gvanim looked to alternative economic models to keep the Kibbutz dream alive. Gvanim was one of the first kibbutzim to pursue tourism as a method of financial sustenance in the 1960s. Subsequently, the trend spread as financial difficulties increased for the Kibbutz movement, and kibbutz tourism developed into a burgeoning industry including pioneer settlement museums and quaint bed-and-breakfast cottages for rent. Again illustrative, tourism-related revenues accounted for over 60 percent12 of Kibbutz Gvanim’s income by the 1990’s.
Some Kibbutzim turned towards manufacturing and industrialization as new means of profitability, but most turned to the tourism industry to establish cash flows that would support the movement. In 1963, the construction of guest houses on Kibbutz property was undertaken to host tourists and visitors wishing to experience the Kibbutz lifestyle. Tourists visiting the Kibbutz came for short spans ranging from days to just over a week to experience a Kibbutz first-hand. Kibbutz members viewed the project as a way to boost revenue and share Zionist attitudes with foreigners. However, over time, the tourism project became a source of contention for many members as allocations of money, labor, and time were heavily shifted to this sector. Members who worked in the guest house were often looked down upon by other members who worked in agriculture, labor, and education since the latter were seen as embracing the Kibbutz ideology more. After all, guest house workers’ task was solely to support the larger project of sustaining the Kibbutz as a collectivist community. While scorned by ideologues within the community itself, the tourist project ultimately prevailed for practical considerations. Allocation of resources and funds gradually moved overwhelming to support the guest house, activities for the guests, and even more predominantly, tourist food. Tourists were served meals at similar times as members, but often the quality of the food was significantly better than the meals afforded to members. Members began to feel that the Kibbutz had lost its core identity of a self-sustaining, Zionist community and that it had transformed into a barely profitable business project for tourists wishing to experience the nostalgia of a bygone era. Nevertheless, the profits from this project were enough to keep the Kibbutz alive, but overarching existential questions remained for Gvanim as well as other Kibbutzim that have pursued similar experiments as to the purpose and point of the Kibbutz itself in a largely privatized economy.
Government Financial Plans of the 1980’s: Privatization
Consumed by wars with its immediate neighbors both in 1967 and 1973, the Israeli economy was forced to allocate much of its spending to defense. Moreover, in the years following the Yom Kippur War, government expenditures as a share of GDP reached 77% indicating the government’s heavy involvement and intervention in the national economy. To fund the government’s spending, the government increased the tax burden on Israelis, with taxes increasing from 28% to 44%13 as a share of GDP. However, these tax policies did not raise government revenues enough to keep up with spending, so the government resorted to increased borrowing. As public debt grew, interest rates increased, and prices spiraled out of control. By the mid-1980’s, the Israeli economy was experiencing the highest inflation rates it had since the founding of the State. Other factors played into this inflation, including devastation in the stock prices of Israel’s four largest banks. During this period, Israel’s inflation rate was reaching 450% with projections aimed at reaching 1000%14 in the near future. These factors led ominously to the shutdown of the Tel Aviv Stock Exchange for 18 days and the nationalization of these banks.
One of the cornerstones of the 1985 stabilization plan included a reduction in the government budget deficit in order to begin minimizing public debt. The indicators of a reduction in fiscal policy would point to an increase in tax revenue, increase in government borrowing, or a decrease in government spending. To stabilize the economy, only the latter was a real option. Hence, the government looked to sectors within spending to reduce expenditures. In the years between 1980 and 1990, public consumption dropped from 39% to 29%15, a drastic reduction which led to the privatization of certain firms previously owned by the government. Public consumption includes defense, education, health, welfare service, and administrative service spending. The greatest decrease came in the form of a reduction in defense spending which dropped from 21% to 12%16 accounting for the largest share of public consumption. Historically, the decrease in defense expenditure can be attributed to a peace negotiation between Israel and its significant military adversary, Egypt. The negotiation of the peace treaty allowed both countries to decrease their share of defense spending, enabling the countries to recuperate from a strenuous, tolling war that left both sides politically and economically weakened. Secondly, the defense decrease can be attributed to the cancellation of the expensive Lavi fighter jet project in 1987. Israel’s reliance on foreign military packages had left the country vulnerable during the 1973 war when international politics left the country vulnerable to a lack of military resupplying. To combat this vulnerability, the government pursued the development of a state-of-the-art Israeli made jet fighter. Mismanaged funding for the project led to its ultimate demise. The overall cost of the project amounted to $1.5 billion,17 a cost that hit the defense sector harshly. However, the failure of the project enabled Israel to reduce defense spending in the face of general concerns over excessive government spending.
Other fiscal policies contributing to the stabilization plan included increases in welfare transfer payments to households coinciding with decreases in business subsidies for investment. These welfare transfers helped stimulate consumer spending which boosted the economy and raised GDP and were a more immediate aid to the economy than the slower growth that might result from investment in the business sector. These factors on top of a significant decrease in defense spending in tandem with a reduction in tensions with neighboring enemies allowed for the Israeli economy to rejuvenate and enter periods of significant economic growth. These reforms in reduced public spending and emphasis on privatization paved the road for a new revolution in the private market for the sector of high tech.
Consumer Revolution: A Changed Israeli
Following the government privatization plans of the 1980’s, the Israeli consumer witnessed a radical change in economic perspective and opportunity. For the greater part of the country’s existence until this inflexion point, individuals saw themselves as economic players within the collective, each doing his part within the available resources and goods. However, a decrease in government spending coupled by tax burden relief meant a surge in economic growth and, more practically, a lining of more cash in the pockets of Israeli consumers. Between 1975 and 1995, the Israeli GDP grew sevenfold18 as Israeli consumers began to participate in a global consumerist movement, acquiring goods customized for the individual. Consumer wealth grow, with GDP per capita growing at a piece of nearly 4.5% yearly from the 1950’s until it reached $17,00019 by 1996, a fivefold increase from the State’s creation, rivaling other newly flourishing economies such as in the Far East. This growth and increase in national production meant that Israeli consumers had the wealth to command a stronger choice in their consumption and that Israelis had sufficient affluence to participate in the rising tide of consumerism sweeping the globe of capitalist economies. Other indicators of this transition can be highlighted by the movement away from elementary articles to more supplemental and luxurious commodities. While 51%20 of the consumer basket was made up of necessaries in the 1950’s, this number dropped to nearly 29% by the 2000s. Private vehicle ownership grew as well, from 33 per 1000 to 204 per 1000 over the period from 1966 to 1996.
The growth in consumer spending not only boosted overall GDP but reflected a propensity in the Israeli consumer to establish himself outside of the mind of the collective. The collective attitudes and aspirations of the early 20th century Zionist became obsolete, and a new individualist, secular, and materialist mindset took its place. Although a strong sense of Israeli nationalism still permeated society, the collectivist attitudes necessary to sustain and bolster mere national existence were no longer necessary, and the desires of the individual became paramount. With this, attitudes toward immigration and emigration began to change, too. Yirida (emigration) which literally means “to go down,” no longer held its previous stigma of abandonment of the State and its cause. Visas to exit the country rose from 154,000 in 1970 to 2.5 million in 199521, marking the willingness of Israelis to leave the country as well as a growth in affluence enabling them to do so. In 1990 alone, nearly 25,00022 Israelis left the country, marking its highest rate in the past thirty years. The rise in emigration marked the economic independence of Israelis and their confidence to be able to withstand the challenges of the global economy. Further, the increase in Israeli consumer spending and migration in the 1990’s were a testament to growing detachment from a collective consciousness and a propensity to act as individuals in a consumerist and market-based economy.
At the same time, Israelis who remained at home began to to participate in the rise of advanced technology. As Israel moved into the 21st century, its economy witnessed its largest transformation ever, into its current state as an information and knowledge-based economy focused on the development and success of high-tech start-up companies.
Start-Up Nation: Harnessing Human Capital for a High-Tech Economy
Many advanced countries around the world have made shifts from strictly manufacturing, industrialization, and service-based economic models to incorporate innovations in advanced technology. Israel is no exception. Due to a lack of natural resources and a set of geopolitical challenges that the country must confront, it has made great strides in its high-tech and start-up industries to support the country’s overall output and income. Unlike its Middle Eastern neighbors who have been able to tap into a lucrative oil industry to sustain their economies through exports of tangible petroleum-based products, Israel has comparatively scarce natural resources. This has required the country to invest in human capital and technological development to make-up for this natural deficiency. Most notably is the rise of the start-up.
Start-ups in Israel have been located primarily in the Tel-Aviv metropolitan area, a region that is often referred to in Israel and abroad as “Silicon Wadi,” a correlation to its counterpart in Northern California and a testament to the dominant commercial force in Israel. In terms of sheer numbers, Israel has increased the number of start-up companies from 650 to 115023 from 2006 to 2015. Specifically, Israeli start-ups have focused on developing technologies in the information and communications technologies (ICT). In the most recent evaluations, sales in the ICT business sector accounted for 11% of Israel’s GDP and 19.2%24 of exports. In addition, Israel has become one of the leading countries to invest in research and development as a natural outgrowth of the start-up focus. According to INSEAD, a leading European business school that puts out rankings for countries’ economic development, Israel ranks 6th in the world in knowledge creation, a determining factor indicating the country’s ability to turn ideas into profit.
The primary factor for Israel’s ascent in the start-up world can be associated with one unique national attribute — the Israeli army. At the age of 18, most Israeli citizens are drafted on compulsory basis to the nation’s military. Through a series of standardized tests, group workouts, and physical tryouts, candidates are examined and placed in units that match their capabilities and interests. As a result, the army represents the great melting pot of Israeli society. Regardless of economic background, cultural heritage, or geographic location, soldiers are placed in units and advance through their entire army experience as cohesive groups — from basic training, to guard duty, to military exercises and operations and missions. For example, one of the final steps in most soldiers’ basic training is 50-60 kilometer hike with all members of the unit, dressed in full gear. Soldiers take turns carrying each other on stretchers, determined to do what is necessary for the team. Leadership positions are assumed by commanders who tend to be only a few years older than the soldiers under their command, as the army has an automatic, self-running transitionary system. These tight-knit units that spend hours of time together training and planning create an environment of teamwork and collaboration, skills necessary for a small start-up company. In drills, soldiers are commended for establishing themselves as individuals advancing the interests of the larger group. A willingness to take risks and even disobey orders for the greater sake of the team are not punished but encouraged. Due to Israel’s geopolitical threats, units maintain operational readiness at all times, leading to efficient and responsive qualities critical to a well- organized team. These factors lead to a very functional small-group culture that permeates Israeli society. Every combat and intelligence unit soldier has been through this, experiencing the difficulties of dealing with teammates, leaders, response time, collaboration, orders, and hierarchy. The skills established in these small unit settings transition perfectly for the climate of a burgeoning tech start-up where creativity, a willingness to take risks, and collaboration are the most contributing factors to a well-organized new company.
Some of the units in the Israeli army directly lead into a tech job, units such as Unit 8200, a cyber intelligence unit, which inculcates the engineering and problem-solving skills that support successful start-up and tech companies. Soldiers from these units command lucrative job offers in the tech sector, while others decide to move into high tech on their own seizing on the technical and organizational skills developed during army service. Currently, 89%25 of high tech workers in Israel held operational roles in the army. Coding and engineering skills, while advantageous, are not prerequisites to participating in a start-up. The breakdown between intelligence soldiers and combat soldiers in start-ups in Israel is shockingly comparable. Recent studies show that 31% of high tech workers served in technical intelligence units, while 29%26 served in traditional combat roles. This comes to show that, while direct tech skills do lead well into a tech job, many young Israelis can seek employment in high tech without the technical background due to the strong team and collaboration skills inculcated in Israeli soldiers generally.
Between 2009 and 2016, salaries for cybersecurity technologies — skills established in units like Unit 8200 — have risen 37.5%.27 This wealth serves as a great stimulus to the general Israeli economy. Further, a notable feature of the typical Israeli start-ups is the absence of foreign workers. Current Israeli law makes it difficult to hire foreign employees, driving the employment of domestic works and creating a further stimulus to wealth creation and general consumption in Israel. To hire a foreign worker, the sponsoring Israeli employer needs to prove that the candidate’s salary will be double the market value and that his/her expertise cannot be replicated by an Israeli. Yet, the lack of foreign talent might not work to Israel’s comparative disadvantage. The intrinsic Israeli cultural norms, most prominently forged in the army, create the conditions for a uniquely Israeli start-up, with its own competitive advances in a global economy that does not boast these features. While Silicon Valley can employee the best and the brightest from around the world, Silicon Wadi harnesses its own talent, ingenuity, and culture.
However, Israeli technology and start-up companies have had trouble entering markets besides ICT and other intangibles because they lack the investment necessary to compete with American conglomerates in e-commerce, finance, health care services, or media entertainment. Much of the reason why Israel has invested in intangible products and services is that the skills necessary for this entrepreneurial capacity are rooted in knowledge and relationships, building blocks that do not require a traditional economic infrastructure. At the same time, winning over foreign contacts in technology has been a struggle since overseas governments are cautious of sourcing foreign technology due to the state’s high standard for the types of military technologies that are allowed to be sold overseas in a private market. This remains a challenge to the Israeli start-up industry, resulting in innovations that support other countries’ commercial infrastructure, a service economy of a different sort, helping other companies abroad innovating with high-tech.
Thus, while Israel has a high-tech industry draws almost exclusively from its own domestic human capital, the intangible products and services emerging from this work force tap into industries that have global appeal, particularly in the advanced economies of the West. For example, there were close to 150 automotive start-ups that worked on vehicle communications, basic self-driving car technology and security for interconnected vehicles accumulating nearly $820 million28 in 2014-2015 alone despite the fact that Israel has never had an automobile industry. Overall, the developments in research and development primarily through the sales of information and communications technology have placed Israel among the leading countries in high-tech development. A unique harnessing of its own human capital has fostered economic growth and partnership with other tech industries around the world.
Conclusion: The Transformation of Israel’s Economy Bodes Well For Its Future
Over the course of its 75 year history, the Israeli economy has witnessed a substantial transformation from heavily socialist leanings to a vibrant and diverse free market economy. The shift toward a more capitalist economy, with an emphasis on high-tech entrepreneurship, has enabled the country to successfully compete in an increasingly global market economy. Government privatization plans in the 1980’s through fiscal reforms introduced a necessary shock of realism to Israeli markets, and at the same time changes in consumer mindset and spending choices helped bolster a previously stagnant economy. These changes have created substantial wealth for its people, further fueling a more robust economy. At the same time, the legacy of Israel’s socialist past remains present in Israeli society with numerous state-owned businesses uncharacteristic of most Western economies. Currently, the State owns 159 companies employing 65,00029 people in some of the largest industries in Israel ranging from El Al (Israel’s only commercial airline), Bezek (communications), Israel Refineries (petroleum) and Israel Aircraft Industries (defense). Still, nearly all Israelis now work in the private sector. As Israel continues its trend toward a more capitalist and consumerist society, with growing strength in advanced technology, it is positioned to thrive among the leaders of the global economy.
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Ben Winer is a freshman studying Business and International Studies at the Huntsman Program at the University of Pennsylvania.