Israel's Economic Intifada

By: Sam Vaknin, Ph.D.

Also published by United Press International (UPI)

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Written April 2002

Updated March 2005

A Danish firm, SID, as it was canceling an order with an Israeli supplier, dispatched to it this unusually blunt message: "When the soldiers of the Israeli army brutalize the areas of the Palestinians ... we do not feel it is the time to do business with your country. We hope this ugly war will end soon." Consumer boycotts of Israeli products are being touted - often through the Internet - from Belgrade to Moscow and from Copenhagen to Brussels.

Alarmed by this unprecedented erosion in their international image, Israeli industrialists donated food, clothing, and medicines to the inhabitants of the still-smoldering refugee camp in Jenin. The Israeli Electricity Company has contributed 4 transformers to the East Jerusalem Electricity Company, intended to help mend the ravaged grid in Tul-Karem. These gestures are aimed at ameliorating the EU's wrath as it convened in Luxembourg in April 2002 - together with Russia - to debate possible trade sanctions against Israel.

The European Parliament and the Belgian ministry of foreign affairs have already recommended to the Council of Ministers to suspend the EU's Association Agreement with the beleaguered state. It provides Israel with favorable terms and privileged access to its largest trading partner. The country exported c. $8 billion of goods to the EU in 2000.

An effective, though unofficial, arms embargo is already in place. Israel complained that Germany withheld shipment of spare parts for the Merkava tank. Other EU countries banned the export to Israel of all military gear that can be used against civilians.

Belgium denied rumors regarding a unilateral boycott of Israeli goods, including diamonds. It will act, it muttered ominously, only in tandem with all other EU members. Belgium exports c. $4 billion of rough diamonds annually to Israel's diamond industry.

The EU is unlikely to revoke the agreement - but it is likely to invoke its human rights provisions in bilateral "consultations" with the Jewish state. Despite its warm endorsement of deeper American involvement in the region, the EU is competing with the ubiquitous USA for clout - mainly of the economic sort - in the Middle East. A joint EU-US-Russian statement, issued in Madrid in April 2002, was followed by then US Secretary of State Colin Powell's trip and a re-assertion of America's (reluctant) dominance. In a desperate effort to remain relevant, Germany has floated its own peace plan.

The April 2002 and subsequent rounds of the Barcelona Process of co-operation between the EU and 12 countries of the Mediterranean Basin were an awkward affair. Israel was invited, as well as all its Arab adversaries, including the tattered Palestinian Authority. But it is difficult to envision a free trade pact between all the participants by 2010 - the end goal of the Process.

Still, EU sanctions may be the least of Israel's concerns. Its economy seems to be imploding. Small business debts, worth some $5 billion (out of $15 billion outstanding), may have gone sour. Bank Hapoalim, Israel's largest, has consistently undershot Bank of Israel's (the Central Bank) capital adequacy ratio of 9 percent - and misreported it in 2002. Small businesses constitute one fifth of the asset portfolio and two fifths of the operating profit of Bank Leumi - Israel's second largest bank. In 2001, bad debt allowances in the banking sector almost doubled to $1 billion.

Israel's Minister of Finance, a life-long political activist, wavers between levying a compulsory war "loan" and drastic cuts in budget spending. The Director General of the Ministry in 2002, Ohad Marani, was less ambiguous. Cuts in government spending would have to amount to c. $2.1-2.5 billion to offset the gaping hole left by the fighting.

No one bothers to explain how could expenditures be so pervasively cut in mid-fiscal year. The Treasury talks about freezing "populist" laws which cost the budget c. $200 million annually. But even if political hurdles to such an unpopular move are overcome - this is less than one tenth of the cuts needed in order to constrain the deficit to 3 percent of Israel's fast contracting GDP.

In the year to January 2002, Israel's industrial production dived by 10 percent and its GDP by 3.5 percent. The budget deficit in FY 2001 reached 4.6 percent of GDP. The trade deficit topped $5 billion in 2002 - compared to $3.7 billion in 2001 - and proved to be the beginning of a worrisome trend.

More likely, taxes - including VAT - will have to continue to be raised after climbing steeply in 2001. In a speech to the Israeli Venture Association Conference in Tel-Aviv, on April 14, 2002 Marani gloomily warned of a "financial collapse" and an "economic crisis".

Dan Gillerman, the affable then president of the Federation of Israel's Chambers of Commerce, warned against raising taxes:

"Such a move would give a final blow to the economy’s backbone, especially as the same population that pays taxes also does reserve duty, and is economically productive."

The government's chief economic advisor by law, the Governor of Bank of Israel, (David Klein at the time), is usually a much-respected economist and technocrat. Yet, typically, he is on the verge of resigning. He bitterly complains of being isolated by Treasury officials. Klein, for instance, was was quoted in "The Jerusalem Post" as saying:

"There is a total lack of communication between the Finance Ministry and Bank of Israel. The Treasury has not included me in any discussions over the economic package. I am not a partner in debate on the deficit target or discussions over new taxes."

The Minister of Finance periodically promises to present an economic plan to the Knesset. In 2002, while he procrastinated, a survey of 575 businesses, conducted by the central bank, documented a sixth consecutive quarter of economic slowdown.

Domestic orders were sharply reduced - though exports held stable. Surprisingly both the hi-tech sector (including telecommunications) and traditional industries fared better than mid-tech manufacturing. Perhaps because they were battered senseless in 2000-2001 and had nowhere to go but up. For the first time since 1998, Israeli firms also expect higher inflation and accelerated depreciation. The New Israeli Shekel has depreciated by almost 15 percent in the last few years.

This - and a sharp reduction in inventories - are the two lonely sprouts in this economic wasteland. The devaluation has rendered many Israeli products competitive exactly when a global recovery has commenced. A massive inventory builddown may translate into a sharp upswing once the economy recovers.

Still, Dun and Bradstreet's index of purchasing managers plunged below the 50 percent line in March 2002, indicating a contraction in the activities of manufacturers. Domestic demand shrank by 3.5 percent and exports have yet to pick up the slack. The employment component of the index stood at a dismal 45 percent.

Klein, then Governor of Bank of Israel, warned, at the time, that further depreciation might result in additional interest rate hikes, following a recent dizzying shift from easing to tightening. But he had little choice. The March 2002 CPI figure was a low 0.5 percent (2.4 percent in the 12 months to March 2002) - but future figures were higher than the 0.3-0.4 percent forecast by pundits and government alike.

In March 2002, inflation was already catapulted by depreciation cum deficit spending to an annual 4% on a quarterly basis, up from 1.4 percent in 2001 and an average of 2.7 percent in 1999-2002. As the fighting escalated, Israel ended up in the familiar 7-11 percent inflation range.

The IMF urges the Israeli authorities to tighten fiscal and ease monetary policy. Hitherto - the December 2001 economic package notwithstanding - they have done exactly the opposite. The IMF blames the shekel's precipitous depreciation on Bank of Israel's sudden departure from gradualist policies when it hastily shaved 2 percentage points off interest rates in 2001.

Small wonder that S&P revised Israel's outlook from "stable" to "negative". Only the country's $24 billion in foreign exchange reserves prevented the downgrading of its long-term foreign currency debts from the "A minus" rating they currently enjoy.

The desperation of Israeli businessmen can be gauged from an interview granted in April 2002 by Dov Nardimon, general manager of Israel W&S management consultancy to Israel's leading paper "Yedioth Aharonot". Nardimon pinned his hopes on a recovery led by surging demand for old-fashioned military products, such as munitions and gas masks. This will revive the moribund metallurgic, chemical, and electrical industries in 2002-3, he predicted. Growing global security awareness will enhance Israeli defense exports.

Regrettably, he proved to have been right. Foreign direct investment in February 2002 amounted to c. $300 million (compared to $200 million in January). The bulk of this amount went to defense-related hi-tech firms. The American Department of Defense invested c. $3 million in Atox - an Israeli R&D firm which is in the throes of developing molecules that suppress the activity of biological weapons.

But with all its woes, Israel is still the undisputed regional economic Gulliver. Its cumulative net capital inflow, in excess of $110 billion, outweighs its GDP. It has more foreign exchange reserves per capita than Japan. Its GDP per capita is a European $16,000.

The real victims of the Intifada are its instigators, the Palestinians. According to the World Bank, the Palestinian economy lost $2.4 billion by December 2001. Israeli economists add another $1-2 billion in triturated infrastructure and lost earnings since then.

The bulk of the damage is the result of Israeli closures - a manifestly inefficacious defensive measure against proliferating suicide bombers as well as a punitive reflex. Between 120-150,000 Palestinians used to work inside the "green line" separating Israel from the occupied territories - mainly as day laborers in construction workers, in tourism and in restaurants. Yet another 50,000 found employment illegally. Officially the number - and with it remittances - have now dropped to zero. In reality, about 50-70,000 Palestinians still cross the line daily.

The IMF estimates that Israel withholds c. $400 million in revenues - mostly VAT and tax receipts - owed to the Authority. As a result, Palestinian tax collection dropped to one fifth its pre-Intifada level. The Authority owes half a billion dollars in arrears. Household savings are utterly depleted and PA GDP dropped 12 percent in 2001 alone, according to the World Bank.

The Palestinian Authority - whose Web site now re-directs to "Electronic Intifada", a counter-spin news page - puts the unemployment rate at 25 percent. The real figure is at least 40 percent. Half the population subsists on less than $2 a day - the official poverty line.

The United Nations Office of the Special Coordinator in the Occupied Territories mostly concurs with these findings.

Had it not been for $1 billion annually doled out by donors as diverse as the EU, USA, Iraq, and Saudi-Arabia - 120,000 civil servants would have joined the ranks of the pulverized private sector and the destitute unemployed.

Israel's trade with the PA - c. $3 billion annually - has all but vanished. It was forced to open its gates to unwanted and unskilled African and Asian migrant labour to compensate for the disastrous deficiency in Palestinian semi-skilled labour. This, perhaps, would be the most lasting lesson of this sorry episode: that the PA is economically dependent on Israel and that no complete separation is a feasible solution. The parties are doomed to swim together or sink together. Up until now, they both seemed to prefer sinking.

Also Read:

Israel's Hi, Tech - Bye, Tech

God's Diplomacy and Human Conflicts

The Economies of the Middle East

Turkey's Jewish Friend

Israel - The Next Target

Sanctioning Sharon

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