Israel — literally — cannot afford to retaliate against Iran
The Israeli economy, normally quite resilient, has taken a beating over the months of war and protests
A flight information board displays cancellations in the arrival terminal of Ben Gurion airport the morning after a drone and missile attack from Iran, near Tel Aviv, Israel, April 14, 2024. Photo by Kobi Wolf/Bloomberg via Getty Images
Contributing Columnist Dany Bahar April 16, 2024
After an incredibly tense night this past weekend full of drones and cruise and ballistic missiles launched at Israel by the Islamic Republic of Iran, the big question on the world’s minds is: Will Israel retaliate?
A crucial aspect that Israeli policymakers should take seriously into consideration when answering this question is whether the Israeli economy can tolerate opening a new military front. A serious look at the numbers says: It is probably a bad idea.
Already, the six-month-long war with Hamas in Gaza is creating many pressures on the Israeli economy. It is estimated that it will cost in total nearly $60 billion, which is over 10% of Israel’s gross domestic product, costing over $6,000 per person. This is a very large amount of money, especially when Israel’s yearly defense expenditure relative to GDP prior to 2023 was at about 5%, less than half its current amount.
To cover this increase in expenditures, Israel — like any other country — must do it through a combination of raising taxes, cutting other costs and borrowing. For Israel, raising taxes right now is not a great move, given that the economy contracted by 5% in the last quarter of 2023, driven by a drop in consumption and investment due to the war. This economic contraction sent 2023’s annual growth plunging to 2 percent, a huge drop down from 6.5 percent in 2022.
This economic shrinkage is not just expressed in the numbers, but felt on the streets of Israel. With about 300,000 Israelis called to reserve duty for the first few months after Oct. 7, many businesses found themselves with a shortage of workers and unable to function properly. There are also the 135,000 people displaced from their homes in the Gaza envelope and near the northern border, meaning that all business activity in those regions (nearly a third of the country) has been almost entirely shut down. The ban on Palestinian workers in Israel has also resulted in a significant slowdown in sectors like agriculture and construction. All of these factors add up to less production, which means less income for regular Israelis, and in turn, less taxes.
To cover this war Israel cut costs wherever possible, but for the most part, it chose to borrow. The budget deficit went up to 5.6 percent of GDP, way more than the traditional target of 2.25% in “normal” years. Combined with the months of turmoil regarding the judicial overhaul before the war, international credit agencies have already downgraded Israel’s credit rating. A downgrade in Israel’s credit rating means that borrowing from the international financial markets becomes harder and more expensive to repay, putting additional pressure on Israeli taxpayers in the years to come.
This is the grim economic context upon which Israel must now decide how and when, if at all, to respond to the Iranian regime’s unprecedented attack early Sunday morning. A former economic adviser to the Israel Defense Forces chief of staff estimated that the cost of the incredible interception of 99% of the drones and missiles launched by Iran this past weekend was about $1.1 to $1.4 billion in only one night. If the conflict with Iran escalates, there could be many, many more Iranian attacks of this sort, forcing Israel (and its allies) to finance dozens of billions of dollars more.
Under a scenario of a multifront war involving Iran, the very generous and widely expected $14 billion package of military aid to Israel from the United States — which I’ve claimed is critical for Israel this time around — won’t be nearly enough. While the incredible success of the missile defense system the world saw last weekend is a case in point for both the U.S. and Israel to invest more in these defensive technologies in the long term, it is unlikely that the U.S. will do so in the short term. With pressure for conditioning and even reducing aid to Israel mounting, it has been challenging enough for Congress to pass the current package, let alone to consider expanding it.
Israeli policymakers should think smartly about this, and consider all angles — including the economic one — when calculating its retaliatory response. Part of Israel’s military edge comes from its vast investment in technologies to deal with the type of threats seen this weekend, which come directly from a healthy and growing economy. As long as the conflict with Hamas in Gaza continues, the Israeli economy, despite its incredible resilience, will need time to heal, too.
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