The Israeli government’s response to the economic impacts of the Israel-Hamas war has not been appropriate or sufficient, former Bank of Israel governor Karnit Flug told The Jerusalem Post on Tuesday.
The measures proposed, some of which have passed in the Knesset, while others have been delayed or are planned for the future, are not enough to tackle the situation Israel currently finds itself in, Flug, who serves as the vice president of research at the Israel Democracy Institute, said.
The measures, which include increased taxation and some budgetary cuts “only very partially offset the very large increase of spending related to military needs and to civilian needs associated with the war,” she explained.
Economic and political turmoil
Flug pointed to two possible factors behind the Israeli government’s insufficient response to the economic turmoil caused by the war: political pressures, and the possibility that the government does not fully appreciate the economic situation it is facing.
“The fact that they decided to delay the tax measures [meant to address increased spending] indicated that they have not completely internalized the severity of the situation,” explained Flug.
That political and sectoral interests are driving this government’s budgetary decisions is not new. The original 2023-2024 budget, before it was changed to address increased spending, was “political in terms of the priorities expressed by the government,” Flug explained.
“We found in this budget, that to a much larger extent than in previous coalition agreements, coalition resources were very sectorial,” said Flug, describing a finding from a study that will be presented at the IDI’s Eli Hurvitz Conference on Monday.
She explained that in this budget, not only were coalition funds not driven by professional recommendations about how to meet Israel’s national goals, but, at times, the allocation of funds contradict these goals.
One example, she said, is employment in the ultra-Orthodox sector. Flug explained that increased funding for educational frameworks that don’t teach common core subjects will have the opposite effect of meeting the national goal of increasing ultra-Orthodox labor market participation.
“What was really very disappointing was the fact that when there was a realization that [the government needed] to change the budget and meet all the needs that are related to the war, they only cut those [coalition] funds very partially,” Flug added.
There has been around a NIS 70 billion increase in spending, and so far, the government measures to address this have resulted in a NIS 17 billion package of cuts and revenue measures, not all of which have been approved, said Flug.
The composition of the cuts is as important as their size. “The fact that they didn’t cut coalition expenditures that are very sectoral and are not based on professional work substantially undermines the trust in the government. This will make it much harder to come to the public and say ‘look, there is an additional burden that you will have to incur,’” explained Flug.
The government’s response is critical, because it is one of two main factors that will determine where the economy is headed. Beyond the government’s macroeconomic policy, the other factor that will influence Israel’s future is whether or not the Gaza war will expand and if full-fledged war breaks out in the North.
These two things “will determine whether we will see the kind of recovery and sustained recovery that we have seen in the past, or if we are heading into a much longer-term economic slowdown or even crisis.
“The fact that we recovered in a very remarkable way from past crises, and in spite of the basic traits that make the [Israeli] economy resilient, there are still questions about if this will be enough to lead us to a sustainable path of growth following the current crisis,” Flug explained.
Many are confused about where Israel stands economically today: Dropped credit ratings from major agencies, coupled with politicians lauding Israel’s foreign bond offering as a roaring success, alongside price hikes in the supermarket that Israelis are told aren’t really the result of inflation but of corporate greed paint a confusing picture.
“In terms of the very basic data on growth we see a contraction of the GDP in annualized terms in the last quarter of 2023 of 20% and a recovery, again in annualized terms of 14% in the first quarter of 2024,” said Flug, commenting on where Israel’s economy is now.
This situation is similar to what we have seen after previous security events, said Flug.
The bigger question according to her, however, is where Israel’s economy is heading. There are many characteristics of Israel’s economy that make it resilient, she said, but the future of the war could have drastic impacts on Israel’s economy.
“If the war expands and the war in the north expands into a full-fledged war we might see another contraction in the economy.”
“That means that instead of a growth rate of between 1.5 and 2% which is currently projected this year, we might see a contraction of 2 or 3%,” she explained.
This could mean rising unemployment and a lowered standard of living, Flug explained. In this case, the deficit would also be much higher because tax revenue would decrease and government spending would increase as a result of the costs of the war.
Asked how the government should be handling the economic aspect, Flug said that it must first define its goals, which must include facing old economic challenges, such as increasing ultra-Orthodox labor market participation, while also investing in rehabilitation and rebuilding what has been damaged by the war. The government will also need to bring back the debt to GDP ratio to around 60% of GDP.
It will also need to determine the long-term defense budget based on the new security outlook, said Flug.
We will need to “find the kind of balance that will take into account not only that we need to defend ourselves, but also that we have a society and economy that can bear the burden of the defense,” she said.
In the longer term, Israel will need to increase tax revenue but it will need to do this by expanding the tax base and reexamining the social and economic justification of some of the existing tax exemptions, said Flug. This will need to be done gradually and while maintaining Israel’s competitiveness, she added.
It’s time for Israel’s government to address economic trends and challenges it has been kicking down the road, said Flug.