How resilient is the Israeli economy? ... The cost of war versus the Return
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Abstract
The war in Gaza is emerging as a structural factor reshaping the Israeli economy, transforming it from an innovation- and technology-driven economy into a war economy burdened by a defense budget of 107 billion shekels in 2025, most of which goes towards weapons purchases, compensation, and logistical supplies. This cost has pushed the projected deficit to over 6% of GDP, with debt likely to exceed 70% by 2026, while growth has declined and key sectors such as tourism, construction, agriculture, and technology have suffered. Despite US support, which alleviates financial pressure through aid and loans, it reinforces Israel's growing dependence on foreign powers and restricts its policy autonomy. Internally, the increased defense spending has impacted government legitimacy through rising prices, declining services, and a strained labor market due to conscription, potentially leading to electoral shifts and a reshaping of the political landscape. In conclusion, Israel is not facing immediate collapse, but it is on a path of long-term erosion, with its ability to sustain itself contingent on the war's duration, the level of external support, and the effectiveness of its crisis management.
Introduction
Since the outbreak of the war in Gaza in late 2023, the Israeli economy has entered a new phase of mounting pressures, as security and military challenges have intertwined with domestic and international economic slowdowns. While the Israeli economy has historically been known for its resilience in absorbing shocks, thanks to its reliance on advanced technology sectors, a strong financial infrastructure, and exceptional external support from the United States, the length of the war and its expansion horizontally (with fronts in Iran and Lebanon) and vertically (with repeated reserve calls, the absence of Palestinian workers, and internal unrest) have made the situation more complex. The equation is no longer solely about the direct cost of the war to the budget or growth, but also includes structural impacts on the production structure, a gradual erosion of confidence among local and foreign investors, and growing internal social tensions, which in turn put pressure on the government's ability to maneuver.
Preliminary data from the Bank of Israel and the Ministry of Finance indicate that economic forecasts have been revised downwards, with the projected growth rate for 2025 lowered to between 3.1% and 3.3%, down from previous estimates of around 3.5%. Although these figures may seem acceptable at first glance compared to other wartime scenarios, they actually reflect the financial system's ability to postpone collapse through borrowing and expanding the public debt, rather than reflecting genuine growth dynamics. The war bill, estimated at between $60 and $120 billion by mid-2025, includes not only direct defense spending but also losses in vital sectors such as tourism, construction, and agriculture, as well as a decline in tax revenue due to the closure of tens of thousands of small and medium-sized businesses. This comes alongside a significant decline in passenger traffic, ranging between 34% and 43% compared to the previous year, reflecting the collapse of the tourism sector as a major source of foreign currency revenue.
More importantly, this war has occurred at a time when the Israeli economy is facing unfavorable geopolitical and diplomatic developments. European and international pressure on arms deals and industrial cooperation is increasing, while some Western sovereign wealth funds have begun to divest from their investments in Israeli companies, foreshadowing higher borrowing costs and a weakening of the investment climate in the medium term. Internally, these pressures coincide with growing public unrest, manifested in large-scale demonstrations and threats of a general strike, transforming the cost of the war into a factor that threatens not only public finances but also the political legitimacy of the government itself.
Therefore, the central question is no longer merely about the Israeli economy's ability to "withstand" the war in a narrow sense, but rather about the extent to which this economy can absorb the exorbitant cost of the war without the resulting burden evolving into a structural crisis that undermines its core strengths: technology, finance, and social stability.
First – The Macroeconomic Impacts on Growth, Debt, and the Deficit
Since late 2023, the Israeli economy has entered a complex cycle of macroeconomic pressures, primarily reflected in three key indicators: growth rates, public debt, and the fiscal deficit. These indicators did not deteriorate abruptly, but rather through a gradual, accelerating process, influenced by the ongoing war in Gaza and broader regional military confrontations, most notably the conflict with Iran in June 2025.
1. Economic Growth:
The actual growth rate in the first half of 2025 fell below expectations. Data from the Israeli Central Bureau of Statistics showed a year-on-year contraction of 3.5% in the second quarter, following widespread business closures during the 12-day conflict with Iran. This result directly reflects the paralysis that gripped non-military sectors, particularly construction, agriculture, and tourism. The Bank of Israel continued to lower its growth forecast to 3.3%, while the Ministry of Finance projected that growth would not exceed 3.1% for the entire year. The severity of this decline lies in the fact that it goes beyond a mere "temporary recession" and reflects a structural imbalance. Even the traditional engine of the economy – the high-tech sector – has begun to be affected by the outflow of investments and the relocation of some start-up operations abroad, thus threatening the foundation for future growth.
2. Public Debt:
Public debt has risen sharply as a result of financing the war through extensive borrowing. The government has been forced to borrow approximately 190 billion shekels (around 50 billion US dollars) over the past two years to fund the military and cover the budget deficit. According to Moody's, the debt-to-GDP ratio has risen to 75%, instead of the previously projected 70%, while the fiscal deficit is projected at 8.1% of GDP, the highest level Israel has seen since the 2008 global financial crisis. Despite the government's attempts to control the deficit through tax increases and the implementation of the so-called "war bill" of $11 billion (which included raising VAT to 18%, imposing additional customs duties, and cutting ministerial budgets), these measures have only reduced consumer purchasing power and increased inflationary pressures, weakening domestic demand and burdening small and medium-sized businesses.
3. Military and Financial Spending:
The government allocated 107 billion shekels (approximately $29 billion) to the 2025 defense budget, a 65% increase from pre-war levels, and approved a plan to increase defense spending by approximately 20 billion shekels annually over the next decade. This trend reflects the complete integration of the "military economy" into the state's financial structure, at the expense of civilian sectors, and indicates that the war bill will not remain a temporary measure but will become a long-term structural burden.
This interplay between declining growth, rising debt, and the deficit places the Israeli economy in a double bind: on the one hand, it relies on US and international support to maintain its monetary and financial stability, and on the other hand, it finds itself compelled to implement austerity measures that exacerbate internal social tensions. The seriousness of this problem lies in the fact that it is not merely a temporary financial crisis, but rather a trend that could lead to a gradual erosion of the competitive advantages that have made Israel a “leading emerging economy” in the Middle East.
Second – The Israeli Currency and Monetary Policy
1. The Shekel in the Face of Shock: Currency Depreciation as the First Line of Defense
The stability of Israel's national currency – the shekel – represents the first line of defense against economic shocks resulting from the war, especially given the nature of the Israeli economy, which heavily relies on external financial flows, whether in the form of foreign direct investment, US military and economic aid, or high-tech exports. Since the outbreak of the recent war in Gaza, the shekel has seen a significant decline against the dollar, exceeding the 3.95–4.05 shekel per dollar level during some critical periods (compared to pre-war stability levels around 3.4–3.5). This decline reflects the escalation of geopolitical risks and increased capital outflows, as well as the rising cost of insurance on Israeli bonds (CDS), reflecting negative global market expectations regarding the Israeli economy.
2. Central Bank Intervention: Depletion of Reserves as a National Security Issue
In response, the Bank of Israel implemented a comprehensive intervention package; most notably, in October, it announced an exceptional program to sell up to $30 billion of its foreign currency reserves to curb the shekel's decline and contain market panic. It also injected an additional $15 billion through currency swap operations to boost dollar liquidity and ease pressure on local banks. This unprecedented move reflects the monetary authorities' understanding that currency stability is no longer merely a technical issue, but a national security matter linked to the state's ability to finance the war and maintain investor and creditor confidence.
3. The Inflation-Stagnation Dilemma: The War's Impact on Prices and Growth
From an inflation perspective, the war has triggered a new wave of price pressures. The cost of living has risen due to disruptions in domestic supply chains, labor shortages (particularly of Palestinian workers, who are a key component of the construction, agricultural, and service sectors), and higher energy and transportation costs resulting from regional tensions. Annual inflation is projected to reach around 3.3–3.5% by mid-2025, slightly above the target range (1–3%). However, the central bank has chosen to keep interest rates relatively high (around 4.5–4.75%) in an attempt to contain these pressures, despite the clear risks to growth. This dilemma reflects what can be described as the "inflation versus stagnation trade-off": if the central bank tightens monetary policy further, it risks stifling an economy already struggling due to the war; if it eases, it risks losing control over both price and currency stability.
4. Declining Asset Attractiveness and Foreign Investment Flight
Furthermore, the political and military uncertainty has reduced the attractiveness of assets denominated in shekels, making it more difficult for Israeli banks to maintain external financing flows. For example, data from mid-2025 showed that foreign direct investment declined by more than 25% compared to the previous year, while the cost of borrowing for Israeli companies in international markets increased by more than 200 basis points. These indicators confirm that the pressure on the shekel stems not only from the war itself, but also from global markets' perception of increased sovereign and financial risks.
In summary, Israeli monetary policy has become primarily a defensive tool: the Bank of Israel is depleting its foreign currency reserves at a relatively unsustainable rate, attempting to balance the need to stabilize the currency and control inflation on the one hand, with the need to prevent a collapse in economic growth on the other. This strategy provides a temporary "safety net," but it raises a fundamental question about how long Israel can sustain this approach, especially if the war drags on or expands geographically to include other fronts (Lebanon, Yemen, and perhaps even Iran), thus exacerbating both currency and inflationary pressures.
Third – Sectoral Implications
1. The Construction and Real Estate Sector: A Structural Weak Point and Rapid Loss of Production Capacity
The construction sector in the Israeli economy represents a sensitive production structure: on the one hand, it contributes approximately 6.5% of GDP, and on the other hand, it is a major driver for various sub-sectors (building materials, labor, financial services, and insurance). With the outbreak of ongoing hostilities, the mobilization of tens of thousands of reserve soldiers, and the ban on the entry of some 100,000 Palestinian workers, construction output declined by almost a third during the first two months of the war—a disruption that extends beyond the mere halt of projects, encompassing liquidity shortages for developers, disruptions in supply chains (raw materials and bank liquidity), and rising financing costs within an environment of escalating deficits.
This decline has three main repercussions: first, a direct loss in production value and capital investment, contributing to a widening output gap; second, a deterioration in the labor market, with millions of workers left unemployed or with reduced working hours, thus lowering disposable income and weakening domestic demand; and third, a wave of slowdown in housing and infrastructure projects, increasing the risk of a subsequent decline in real estate asset prices, with the potential for bad debts accumulating on the balance sheets of banks and project financiers.
From a policy perspective, the recovery of this sector depends on three interrelated elements: (a) restoring the flow of labor (a temporary solution involving either the recruitment of replacement workers or expanded labor arrangements); (b) targeted liquidity packages for small and medium-sized developers to prevent a chain reaction of bankruptcies; and (c) targeted credit guarantees to encourage the relaunch of vital projects. The absence of these policies risks turning the construction downturn into a secondary credit crisis, which could exacerbate the dynamics of the budget deficit and public debt.
2. Agriculture: Local Food Supply Impacts and Disruptions to Value Chains
Israeli agriculture, while not the largest contributor to GDP, is vital for local employment, regional food security, and export networks for certain crops. A productivity decline of up to 25% in some crops, linked to labor shortages and transport and supply constraints, directly impacts agricultural revenues and increases the cost of substitution (foreign currency expenditure or imports of alternative food products).
This contraction has a multiplier effect: lower incomes in rural areas exacerbate local political pressures and increase reliance on government subsidies, while also disrupting supply chains for agricultural processing industries. If these constraints persist for several seasons, structural damage will emerge: reduced investment in irrigation and technology, investor reluctance to commit to long-term agricultural projects, and a decline in the competitiveness of agricultural exports. Temporary policies (subsidies, recruitment of replacement workers, flexible movement exemptions) reduce immediate costs, but they do not address long-term investment losses without a medium-term stimulus plan.
3. Tourism and Hospitality: Collapse of Foreign Currency Revenues
Tourism is one of the most affected sectors, with visitor traffic plummeting—group tours canceled, hotels closed, and seasonal bookings declining—resulting in a drop in tourism revenues of more than 70-75% at the peak of the crisis. This collapse is not merely a temporary decline in revenue, but rather impacts the ability of local businesses (hotels, restaurants, transportation services, and cultural tourism) to survive, and undermines the skilled human capital and expertise in this sector.
The broader impact is the loss of hard currency that used to flow into the economy through tourism, increasing the need to draw on reserves to cover the current account deficit and support the currency. Furthermore, the long-term damage to the destination's reputation could lead to a decline in demand for years to come, requiring international marketing campaigns and investments in tourist safety and destination stability to compensate for the losses. Without a comprehensive rescue and strategic reform package for the tourism sector, these temporary losses will turn into permanent structural damage, diminishing the sector's contribution to economic recovery.
4. The High-Tech Sector: Relative Resilience and Strategic Risks
The technology sector is a vital engine of Israel's future growth: it contributes about 20% of GDP, accounts for more than half of technology exports, and employs a significant portion of the skilled workforce. This strength has given the economy some ability to absorb the shock, as large tech companies and startups have access to liquidity or international markets. In fact, some of the capital flow has shifted towards defense and cybersecurity projects related to the war effort, resulting in a decline in investment in certain civilian sectors.
However, some worrying trends have emerged: more than 30% of startups have relocated parts of their operations abroad, funding rounds have slowed down, and work arrangements have been disrupted due to employees being called up for reserve duty. If these trends continue, they will weaken Israel's "innovation ecosystem": companies will migrate to less risky environments, and the local market will lose human and institutional resources that are difficult to replace quickly.
The paradox is that the sector also possesses a defensive element: the increased demand for cybersecurity technologies and security solutions during the war may offer some partial compensation. However, relying solely on defense-related sectors alters the structure of the economy and reduces its attractiveness for long-term civilian investments. To preserve the sector's strengths, a public-private program to stabilize startups, tax incentives, and retention plans for employees and R&D offices located within Israel, rather than abroad, are needed.
5. Aviation and Airports Sector: Disruptions to the Logistics Infrastructure
The 40% drop in passenger traffic at Ben Gurion Airport over nine months (a decline in both flights and passengers) is more than just a statistic; it reflects the disruption of a key route for the flow of people, goods, and tourism, impacting several areas: loss of tax revenue and foreign currency earnings, reduced activity in airport-related logistics services, and weakening of the international connectivity network that benefits technology and export companies.
Restoring passenger traffic requires long-term security confidence and tangible signals demonstrating the state's ability to protect travelers and infrastructure, along with marketing packages and incentives for airlines. Without these measures, the losses in this sector will continue to contribute to the external deficit and raise import and export costs for the economy.
6. Small and Micro Businesses: Liquidity Shock and Widespread Social Impact
Small and medium-sized enterprises (SMEs) form the backbone of the local labor market and the tax base. Estimates suggest that up to 60,000 businesses may have closed during peak periods, which has two significant implications: first, an immediate loss of jobs and a rise in unemployment rates not captured in traditional statistics; second, a shrinking tax base and increased pressure on government budgets to provide compensation or social safety nets.
These businesses typically lack sufficient financial reserves to withstand a prolonged drop in demand, and the cost of borrowing for this sector has increased due to the overall risk rating and its impact on local interest rates. Temporary support programs may mitigate the impact of the collapse, but they are no substitute for an operational recovery plan that includes credit facilities, temporary liquidity support, and training packages to re-deploy labor to sectors that still have demand.
7. Sectoral Interdependencies and Amplifying Effects
It is important to emphasize that the damage is not confined to a single sector: a decline in construction reduces demand for materials and lowers revenues for small businesses; the collapse of tourism affects transportation, hospitality, and catering; a labor shortage in agriculture raises food prices and impacts inflation; a slowdown in technology affects export revenues and reduces foreign currency reserves. This network of interdependencies produces a multiplier effect: each sectoral shock increases the cost of initiating recovery and prolongs the time needed to return to pre-war levels.
In other words, the sectoral analysis shows that the Israeli economy has elements of resilience (a sophisticated technology sector, a deep local bond market, and external support), but these are insufficient to compensate for the deterioration of labor-intensive sectors that are crucial for social and political stability (construction, agriculture, tourism, and small businesses). Continued conflict, or a resurgence of regional tensions, will transform these temporary damages into long-term structural costs: partial migration of capital and skills, a shrinking tax base, and a rising deficit that necessitates austerity measures that disproportionately burden vulnerable social groups.
Fourth – Analysis of the Defense Budget and its Financial Implications:
Defense spending in Israel is the central pillar that shapes the financial landscape during the war, as evidenced by the 2025 budget, which allocated approximately 107 billion shekels (around $29 billion) directly for defense purposes related to the war in Gaza and the parallel fronts. This figure represents an exceptional increase of approximately 30-35% compared to previous years, demonstrating that security is no longer just a line item in the budget, but rather the budget itself, with resources being redirected at the expense of essential civilian sectors.
1. Military Purchases and Equipment:
Military purchases – whether from the United States or through the local defense industry – constitute the largest component of the defense budget. Estimates indicate that between 43 and 48 billion shekels (approximately $12-13 billion) will be allocated to finance deals for weapons, ammunition, spare parts, and interceptor missiles for systems such as the Iron Dome and David's Sling. This item depends directly on US support, which provides an additional $14 billion in annual military aid, but it remains a burden on the treasury in terms of local funding (salaries, transportation, maintenance). The danger with this item is that it is inherently growing: as the fronts expand (south in Gaza, north with Hezbollah, and at sea with the Houthis), it becomes difficult to reduce it without compromising the army's ability to continue operations.
2. Compensation and Internal Support:
An estimated 27–32 billion shekels is allocated for compensating those affected by the war—whether through direct aid to families displaced from the Gaza perimeter and the north, compensation for the agricultural and industrial sectors, or support for small businesses forced to cease operations due to manpower shortages or disrupted supply chains. This item carries significant political and social sensitivity, as the government uses it to mitigate public anger and prevent the economic costs from escalating into a social crisis that could destabilize the political situation. However, this compensation is financed through increased deficits and domestic borrowing, thus representing a deferred burden on the public debt.
3. Logistics and Ongoing Support:
Approximately 22–26 billion shekels are earmarked for logistical operations: fuel, military transport, supplies, field maintenance, and temporary military infrastructure in the south and north. This daily cost is often underreported in the media, but it represents a continuous drain on resources. The Israeli army spends an estimated 400–500 million shekels daily on the various fronts, making sustaining these operations a significant financial challenge in itself.
4. Medium-Term Implications
This breakdown reveals that more than 70% of the defense budget is allocated to items that are difficult to reduce or streamline, meaning that any continuation of the war will lead to a chronic fiscal deficit. The Israeli Ministry of Finance has already indicated that the overall deficit for 2025 could exceed 6–6.5% of GDP, compared to less than 3% before the war. Public debt is projected to rise from approximately 61% of GDP to nearly 70% by 2026 if current spending levels continue, especially given the projected slowdown in growth.
Overall, the budget structure itself has become unbalanced; instead of funding productive sectors and public services (education, healthcare, infrastructure), the bulk of the budget is being channeled into military spending and short-term relief measures. This pattern creates a kind of "war economy" that could keep Israel increasingly dependent on US aid and foreign borrowing, limiting its economic decision-making autonomy and making any future negotiations with international institutions contingent on political agreements.
Fifth – The Impact of Protests and Strikes on Output and Revenue:
1. The Direct Economic Cost of the Protests:
The ongoing protests and the threat of a general strike—including the closure of the Ayalon Highway and widespread disruptions to logistics and commerce—have transcended their purely symbolic nature and have become an economic force with an immediate and direct impact on macroeconomic indicators. Operationally, the intermittent shutdowns of ports, the closure of shops and offices, and the abstention from work by hundreds of thousands of people create an immediate loss of production, reflected in a daily/weekly decline in GDP; Preliminary studies and regional reports indicate that the direct costs of the ongoing protests from October 2023 to early 2025 could amount to billions of dollars (an independent study estimated the direct cost of international pro- and anti-Israel protests at approximately $1.51 billion until early 2025), while local estimates for major lockdown episodes suggest far broader impacts if a general strike were to extend for one day or more.
2. Key Economic Impact Channels:
Economically, the impacts arise through three main channels: (1) the immediate production shock—business shutdowns lead to a decline in current revenues and measurable lost working hours; (2) the impact on intermediate goods and services—where supply chains (especially for construction, manufacturing, and logistics) are disrupted, amplifying the effect beyond the daily loss; and (3) consumer and investor confidence—eroded by political turmoil and heightened operational risks, generating a prolonged decline in production and investment even after the strike itself ends. This cumulative effect translates into losses in tax revenue (income tax, corporate tax, VAT)—meaning the strike not only consumes government funds but also reduces the government's ability to finance current spending, including the defense budget. Budget reports have shown deficits reaching 6.9–8.1% of GDP at peak periods, and any widespread general strike scenario could temporarily raise the deficit by several percentage points due to revenue losses and increased emergency spending.
3. Political Impact as a Pressure Tool:
Politically, the most significant impact is that a strike represents an effective pressure tool that transcends purely economic considerations: it can force decision-makers to review spending priorities or expedite political settlements in order to restart the economy. Therefore, even if the economy is temporarily stabilized through external financing channels, a general strike has the practical ability to "freeze" domestic economic activity and create a state of government paralysis—which accelerates the erosion of legitimacy and increases the likelihood of changes in military or diplomatic policies. In summary: protests and strikes are not a minor issue on the economic front; they are a game-changer that can accelerate or deepen the deterioration of macroeconomic indicators if not managed politically and with a proactive plan to mitigate their impact on production and revenue.
Sixth – Implications of Defense Spending:
A review of the 2025 budget and a breakdown of the defense spending item, which amounted to approximately 107 billion shekels, shows that since 2023, Israel has entered a deep financing cycle based on three pillars: external support (most notably from the US), an active domestic and international debt market, and monetary reserves and interventionist monetary policies. This three-pronged structure has enabled Israel to continue military operations for a longer period than its limited resources alone would allow, but it has also brought about fundamental changes in the state's relationship with global markets and in the limits of its economic policy maneuvering space. The following provides a detailed and comprehensive analysis of this impact from two complementary perspectives: (a) the relationship with the United States and strategic dependence, and (b) external financing: bond market behavior, borrowing costs, and investor confidence risks.
1. The Relationship with the United States: A Strategic Financial Umbrella
Operationally, the United States has been the primary source of military equipment and emergency funding since October 2023: the regular annual aid (FMF) of approximately $3.8 billion remains a stable base, along with emergency military sales programs and major deals that have been proposed or discussed to expedite the supply of ammunition and combat systems—providing Israel with operational flexibility without straining the government's finances. This US support has allowed a significant portion of the 107 billion shekel budget to be allocated to equipment and ammunition, and enabled the government to maintain operations while the bond market absorbed some of the treasury borrowing. The international market's willingness to finance Israel's needs (successful international bond issues worth billions of dollars in 2024–2025) reflects investor confidence in an effective international "umbrella" of government support.
However, this US support does not address two critical economic realities: first, the aid does not compensate for actual production losses (lost labor, bankrupt small businesses, collapsed tourism), and therefore does not revive economic activity in civilian sectors; second, any long-term reliance on external financing weakens the "independence" of economic and political options, meaning that continued Washington support becomes contingent on political dynamics within Congress and the US-Israeli alliance. Contemporary political history shows that support may be subject to parliamentary conditions or diplomatic pressure if the humanitarian or political costs escalate to a point that affects public opinion in the United States. Similarly, the state cannot avoid the need for a robust domestic financing market and sound internal debt management, as any changes in US policy (slowing down emergency aid, imposing new conditions) will quickly expose the fragility of Israeli financing if there is no balanced domestic fiscal policy in place.
In short, US support may "buy time and military funding," but it does not eliminate the "internal cost" of the war. The productivity and structural losses (in employment, small businesses, and tourism) cannot be compensated by military aid. Relying on this external umbrella without a national strategy to restart the economy and reform public finances merely postpones the burden to a later stage, when political options will be more costly and difficult.
2. External Financing: Bond Markets and the Cost of Borrowing
Despite the crisis, the Israeli Ministry of Finance succeeded in issuing large international bonds (e.g., a $5 billion issue maturing in 2025, which attracted strong demand at a spread of 120–135 basis points above US Treasuries), indicating that global capital markets still recognize the Israeli credit model and the availability of international political support. Domestic bonds also absorbed borrowing needs, fueling an internal financing cycle that enabled the state to meet short-term obligations. This market flexibility is supported by the depth of the domestic debt market and the reputation of Israeli financial institutions.
However, this flexibility comes with warning signs: the yield spreads on Israeli international bonds have risen compared to pre-war levels, and the cost of insurance through CDS contracts has also increased, meaning that markets are pricing in additional risks; During periods of renewed tension (such as the potential confrontation with Iran in June 2025), markets experience sharp and rapid fluctuations—the shekel moves, and hedge funds react by withdrawing or adjusting their positions. Foreign currency reserves were also partially depleted by selling up to $30 billion in late 2023 to stabilize the markets, an exceptional measure that limits the central bank's ability to intervene in future similar crises without incurring further costs or depleting reserves.
3. Medium-Term Confidence Risks:
Actions such as the Norwegian Sovereign Wealth Fund's divestment from several Israeli companies and international measures to suspend military export licenses (Germany and others) carry two intertwined elements: political symbolism and practical economic consequences. Initially, these measures may be symbolic or limited in scope, as long as debt issuance continues. However, if divestments and export restrictions accumulate, and institutional investors adopt a cautious approach to buying bonds or shares, their cumulative effect will be to raise interest rates for Israel and narrow the issuance window with less favorable terms and maturities. As rating agencies have noted, some rating agencies have maintained their ratings but with a negative outlook, expecting debt to reach ~75% of GDP if the pressure persists; this is a practical indicator that the debt market is beginning to reassess the risks.
On the other hand, the sale of a large amount of foreign currency reserves (a program to sell up to $30 billion in 2023) and other swap operations gave the Bank of Israel temporary capacity to absorb currency shocks, but they deplete the "defense stockpile" of foreign currency. With defense spending remaining high and the debt continuing to rise, the central bank will find itself facing a difficult dilemma: either deplete its reserves further, leaving it vulnerable to future shocks, or tighten monetary policy and raise interest rates, which would negatively impact growth. Markets are closely monitoring this situation; any further erosion of reserves could trigger a rapid increase in borrowing costs as investors reassess the country's risk profile.
Seventh – The Domestic Socio-Political Context:
The exceptional defense spending allocated by the Israeli government (approximately 107 billion shekels in 2025) cannot be viewed solely as a financial variable; it is a direct political and social variable that alters the structure of relations between the state and society, reshuffles the interests of social groups, and opens new channels for public pressure—from ongoing demonstrations to threats of a general strike—which are no longer merely symbolic expressions but have an impact on economic performance and political decision-making. The following analysis is based on field indicators, opinion polls, and reserve mobilization figures (impact on the labor market and the status of compulsory military service), and it proceeds from the premise that large-scale defense spending is not separate from the legitimacy of the government, the dynamics of the labor market, or patterns of voting and protest.
1. Government Legitimacy: Temporary Boost and Structural Erosion
The substantial defense spending gave the government immediate capacity to sustain military operations and absorb logistical challenges; but at the same time, it raised a central question in the public's mind: For how long can security spending continue at the expense of social services, jobs, and purchasing power? Recent opinion polls reveal a clear erosion of public trust in the governing institutions: a national survey indicated that more than 60% of the population believes the government has lost public trust, and there is a growing desire for a prisoner exchange deal or a ceasefire to end the paralysis and social pressure—in response to the pressing demands of families affected by the war. This dynamic creates a worrying cycle of governance: the longer the conflict lasts and the more defense spending increases, coupled with a perception of diminished credibility in civilian services (education, healthcare, infrastructure), the higher the political costs of continuation become, thus raising the question of the political viability of prolonging military operations if they lead to a widespread loss of domestic legitimacy.
2. The Labor Market: Mobilizing the Reserves
The call-up of tens of thousands—and more recently, larger waves of up to 60,000 reservists—creates an immediate shock to the labor market. The deployment of reservists to their military duties reduces working hours in the private sector and generates operational gaps in critical sectors (construction, agriculture, logistics). A high percentage of women are also among the reservists, leading to more complex operational difficulties in sectors where women constitute a significant portion of the workforce. Data from central agencies and research institutions indicate a tangible impact: cumulative daily productivity losses, increased childcare burdens and costs for families, and rising wage pressures when replacements are needed, all of which increase operating costs for small and medium-sized businesses. This shock is not merely short-term: if reserve mobilizations continue frequently or continuously, they can cause structural distortions in the labor market, including the migration of skilled and talented individuals (particularly from the tech sector) to more stable markets.
3. The Streets and Protests: Disrupting Economic Activity
What happens in the streets of Israel is no longer merely a form of criticism; it is a tool of political and economic pressure. Partial strikes or calls for a general shutdown (such as the closure of the Ayalon Highway or local strikes by municipalities and businesses) translate immediately into operational and revenue losses. Preliminary estimates of the cost of these shutdowns suggest billions of dollars when accumulated over weeks or months; more importantly, a general strike, even if short-lived, has a greater psychological and political impact than its direct economic effect, as it reveals divisions within broad segments of society and intensifies pressure on parliament and the government to compromise or abandon military or economic options. As protests escalate and spread, decision-making mechanisms become more fragile, and the likelihood of an "impromptu political decision" to avert a complete collapse of civilian activity increases.
4. Electoral Representation: Reshaping the Political Landscape:
Defense spending and the associated social costs undermine the resilience of traditional parties; a public that feels it is bearing the true cost of the war may reorder its electoral preferences: the growing popularity of protest movements, the emergence of new political lists that embody opposition to security policy or the demand for social change, could lead to a reshaping of the coalition map in the next elections. Opinion polls show a decline in public trust in the highest governing institutions and erosion of support for the current government's policies, foreshadowing a shift from viewing security as an unassailable government priority to a matter with tangible political costs that undermines traditional foundations of legitimacy.
5. Social Dynamics: Geographical and Class-Based Disparities
The social impacts are not distributed evenly: areas adjacent to Gaza, the north, rural and agricultural sectors, and urban neighborhoods dependent on tourism are the most vulnerable. In these regions, economic collapse quickly translates into social disintegration: high unemployment, lack of essential services, and erosion of social safety nets. Families who have suffered human losses (prisoners, casualties, wounded) become a powerful political and social pressure group, demanding compensation and immediate solutions, thus increasing the social component of the defense budget—a move that could accelerate spending and exacerbate the public debt. This cycle is self-perpetuating: more spending to address the crisis leads to greater deficits, and deficits generate pressure to cut spending through austerity measures that disproportionately harm vulnerable groups.
Conclusion
By tracking and analyzing the course of the war in Gaza and its economic repercussions, we find that Israel is engaged in a conflict that transcends its military and security dimensions, shaping a structural transformation in its economy, society, and politics. The economy, once presented globally as a dynamic model based on innovation, technology, and integration into global markets, has now transformed into a war economy, dominated by defense budgets, compensation payments, and mounting deficits. While US financial and military support mitigates the severity of the economic collapse, it places Israel in a position of increasing dependence on external powers, thus limiting its economic and political freedom of action in the medium term.
Macro economically, this translates into a decline in growth, rising debt, and deficits, posing long-term challenges to fiscal sustainability. At the sectoral level, vital pillars such as tourism, construction, agriculture, and technology have been disrupted, threatening the competitiveness of the Israeli economy globally and making the recovery of growth contingent on the cessation of military operations and the stabilization of the security situation.
Socially and politically, the economic consequences of the war reveal a gradual erosion of internal legitimacy, as Israeli citizens face the daily costs of the war through inflation, rising unemployment, and declining public services. This scenario is likely to reshape the political landscape and reopen debates about the priority of security versus the well-being of the domestic population. Thus, the question is no longer solely about the army's ability to win the battle on the ground, but rather a broader one: to what extent can Israeli society and the economy continue to bear the cost of the war without fracturing its internal cohesion or undermining the foundations of its strategic growth?
In this sense, the Israeli economy may not collapse overnight, but it faces a path of long-term erosion; a path that depends on three factors: the duration of the war, the level of US and Western support, and the government's ability to maintain a balance between security and the economy. The longer the conflict continues without a political resolution, the closer Israel will come to a point where the war transforms from a tool for legitimizing its security posture into an existential threat to its economic and social stability.
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