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.