Exercise 7

Presentation 7: Recent Developments &
Current Challenges for the Israeli Economy
Haifa
(View from
Bahai gardens)
1
1
Required reading: 11-13+Conclusion
Inequality: Chapter 12 (Momi Dahan) in the Israeli Economy 1995-2017
Yuval Heller, UCSD Fall 2022
ECON 168: The Israeli Economy
Introduction
• First 6 presentations focused on (1) Israel past, and (2)
Positive aspects of the Israeli economy
• This presentation (and most of the special talks) will focus on:
(1) Israel present/future, and (2) dilemmas and challenges:
– New-liberal economic policy 1980-Today: Growth vs. Inequality
– Declining labor share of GDP in Israel
– Gender wage gap in Israel
– Jewish-Arab wage gap in Israel
– Discrimination of Arab workers
– Can the hi-tech continue to grow?
• Important general Economic issues:
– How to explain wage gaps?
– How to measure and classify discrimination?
• We start from an introduction to each of the 6 special talks
2
Special Talks
• 5 of the talks are Zoom/hybrid
• Mandatory attendance to at-least 4 of them (Zoom
or FTF)
– Login with your full name (or email me if you use a
different name), or
– Fill attendance sheet in class
– Login/come in time!
• Permanent Zoom link in Canvas
3
Prof. Prof. Eytan Sheshinski (Nov. 1st, Hybrid)
• Hebrew University of Jerusalem (Ph.D., 1966 MIT)
• World-renown expert on macroeconomics,
taxation and natural resources
• Published 100 papers and 5 books
• Headed various important expert governmental committees on
taxation and natural resources in the 2000s and 2010s
• Shaped the Israeli taxation policy to natural resources
• Talk: Israel’s tax policy viz-a-viz private firms that received exclusive
extraction rights from the state. This applies mainly to deep sea deposits
of gas (and oil) and minerals from the Dead Sea (e.g., Potash). Current
turmoil in natural resource markets due mainly to Russian-Ukraine war
makes this discussion highly relevant. International and regional
4
strategic aspects will be covered.
Prof. Ron Berman (Nov. 8th, FTF)
• Wharton Buisness School (Ph.D., 2014 Berkeley)
• World-renown expert on marketing analytics
and experimentation, online marketing, startups and
entrepreneurship
• Comprehensive knowledge on the Israeli hi-tech sector
(both academically, and as a consultant to various startups)
• Talk: Israeli Hi-Tech sector, and Israeli strat-ups
5
Prof. Omer Moav (Nov. 10th, Hybrid)
• U. of Warwick + Reichman U. (Ph.D., 1999, Hebrew U.)
• World-renown expert on Economic Growth,
Development, and the Israeli Economy
• 2009-10: Head of economic advisory board for the minister of finance
(+committee member in previous years)
• Talk: The public debate in Israel on economic issues and their effect on
government economic policy. Omer will discuss and illustrate how beliefs in
groundless economic theories guide policies adopted by the government,
and often serve a small powerful group on the account of the welfare of the
Israeli public.
6
Prof. Aamer Abu Qarn (Nov. 15th, Hybrid)
• U. of Ben-Gurion (Ph.D., Northeastern U., 2002)
• World-renown expert on development economics,
economic growth, and economic aspects of the Israeli-Arab conflict.
• Talk: Economic aspects of the Israel-Arab conflict:
– The growth-defense nexus for Israel and its adversaries;
– Costs of the conflict;
– Possible peace dividends;
– The role of the military industries in forming the startup-nation;
– How the Arab minority in Israel is affected by the conflict and how it could
serve as a growth engine for the economy
7
Prof. Avi Simhon (Nov. 17th, Hybrid)
• Hebrew University (Ph.D. U. of Minnesota, 1992)
• World-renown expert on family economics,
macroeconomics, Israeli economy.
• Chairman of the National Economic Council 2015-2021
(Chief economic advisor to prime minister Benjamin Netanyahu)
• Chief economic advisor to the finance minister 2010-2012
• Members in various expert committees
• Talk: The lecture will examine Israel: an economy that went from largely
nonexistent 150 years ago to its current form as a relatively free, market
economy. The lecture will discuss how Israel’s economy was originally designed
by several ‘architects’ in the early 1900s, reconstructed during the 1950s, and
then transformed between 1985 and 2005. It will conclude with a brief
8
description of Israel current makeup.
Prof. Joseph Zeira (Nov. 22th, Zoom-only)
• Hebrew University (Ph.D., Hebrew U., 1984)
• World-renown expert on macroeconomics,
economic growth, income distribution, money
and Inflation and the Economy of Israel.
• Author of the course’s textbook
• Steering committee member of Aix-group: Athink tank of Israelis,
Palestinians and Internationals, that studies the economics of the
Israeli-Palestinian conflict and its Two States Solution.
• Talk: The Israeli economy in the 2020s: four decisions and two
dilemmas
9
Neoliberal Economic Approach
• Prevailing in Israel since ~1980
• Main components: Eliminating price controls
deregulating capital markets, lowering trade
barriers, and reducing state influence in the
economy
• Famous examples in the world:
Reagan/Tatcher’s administrations in US/UK in
the 1980s
10
Neoliberalism in Israel Since 1980
• Substantially reducing import barriers
• Liberalization of capital market
• Privatization of government’s owned firms
• Gradual weakening of the labor union since early
1990s
• Reducing public expenditure (and taxation):
– 1980: public expenditure is 75% of GDP
– Reduced to 40% in 2010 (and remain 40% since then;
temporary spike in COVIS crisis)
– Supported by both large parties in Israel, and by many
Israeli economists
– Criticized by Prof. Zeira
11
Taxes on Imports (Fig. 11.1, Revenue from
Taxes on Imports as a Share of Total Imports)
imports
in percent
Temporary
Imports in
the 1950s
controlled
by quotas
and
controlling
currency
exchange
rate
12
liberalization
in 1962-7
Fast Liberalization (new
Likud administration)
Re-increasing some import
taxes due to economic crisis,
stopping government’s deficit,
and inflation stabilization
~5% average import
taxation since 2000
Subsidies on Exports (Fig. 11.2, Export
Subsidies Expenses as a Share of Total Exports)
Fast Liberalization (new
Likud administration)
Temporary
liberalization
in 1962-7
Temporary Reincreasing some
subsidies due to
economic crisis
~0% average import
taxation since 1995
13
Liberalization in Capital Market
• Capital market (people’s savings) were controlled
by the government till 1980s:
– Subsidized government bonds (5% real interest), which
allow the government’s budget deficit in the 1970s and
early 1980s
– Severe restrictions on buying foreign
currency/bonds/stocks
• Since late 1980s:
– Gradually stopping subsidized government bonds
– Moving to free trade/investment in foreign
currency/stocks/bond
14
Public Expenditure in OECD Countries
(Percent of GDP, 2019, Last Pre-COVID OECD Data)
15
1995: Israel’s
public
expenditure
(55%) similar to
Ger/Fra, much
higher than
UK/US, lower
only from
Scandinavia
Public Expenditure in OECD Countries
(Percent of GDP, 1995-2019, OECD Data)
States
2019: Israel’s public expenditure
(40%) similar to US/UK, much
smaller than most European
countries
16
Reduction in Taxation
17
Why Reduce Public Expenditure – Netanyahu’s Fat-Man
Proverb (https://www.youtube.com/watch?v=Sq82pVlNTww)
18
Impacts of Reducing Public
Expenditure (& Taxation)
• Reducing taxation can encourage growth
(less distortionary effects on taxes, e.g., income tax)
– Main advocate: Benjamin Netanyahu (minister of finance 20032005, prime minister 2009-2020): Fat-man proverb
– Supported by most ministers from both large parties
– Israel’s average growth (DGP per capita) remain roughly the
same since 1985 (~2% per year), though taxation has
substantially decreased
– growth relative to high-income economies substantially
improved since 2005 (0-1% growth in other countries)
• Reducing public expenditure typically increases
(disposable income) inequality
19
20
Income Inequality in Israel 1979-2015 (Israel
National Insurance Data)
21
Disposable (Net) Income Inequality:
OECD Data, 2019
• Israel has somewhat lower inequality than UK and US, but
22
somewhat higher inequality than most high-income countries
Disposable (Net) Income Inequality:
OECD Data, 2011-2019
• Gini index have slowly decreased from 37% to
34% in the last decade
23
Market (Gross) Income Inequality
(2013 OECD Data, Dahan, 2021)
24
Income Inequality – Summary
• Mixed (positive and negative) results regarding
inequality
– Somewhat more positive since 2005
• Inequality increases till ~2005, and is decreasing since
then
• Market income inequality is decreasing faster than
disposable income inequality
• Comparison with OECD average:
– Market income inequality is somewhat lower in Israel
– Disposable income inequality is somewhat higher in Israel
25
Stagnation in Real Wages Since 2000
High
Inflation
26
Large
Immigration
Wave
Labor Share of GDP in Israel Lower Than In
Other High-Income Countries
https://ourworldindata.org
27
Labor Share of GDP in Israel Lower Than In
Other High-Income Countries
https://ourworldindata.org
28
Possible Explanations to Wage
Stagnation Since 2001
• Decreasing power of labor union: Share of unionized
worked declined from 80% in 1980 to 20% today
• Limited competition among employees (in many of
the non-hi-tech sectors)
• Allowing entrance of more foreign workers (workers
coming for few years from low-income countries for
agriculture (Thailand), construction (China) and
nursing (Philippines)).
29
Share of Foreign Workers Employment
30
Gender Wage Gap In Israel
31
Monthly Gender Wage Gap
(OECD 2019 Data, Difference between median earnings of men and
women relative to median earnings of men)
32
Monthly Gender Wage Gap
(OECD 2019 Data, Difference between median earnings of men and
women relative to median earnings of men)
OECD Average
• Wage gap is almost the largest in the high-income world, and, moreover, is
increasing in the recent decade
33
Hourly Gender
Wage Gap
• 57% of the gap is due
to women in Israel
working less hours than
men
• Hourly wage gap is
similar to OECD
average
• 14% due to different
occupations/industries
• 29% remaining gap
(discrimination?)
• Figure 1, Taub Center
(2016 Analysis, Hadas
Fuchs)
34
Fertility Rate (OECD Data)
35
Fertility Rate (OECD Data)
36
37
Taub Center (2016 Analysis, Hadas Fuchs)
38
39
Gender Wage Gap – Summary
• Very large (25%) monthly wage gap
• Mostly explained by Israeli women preferences
to work less hours (and have more children)
– Gap begins at age 30
• Hourly wage gap (15%) – similar to OECD
average
– About half of hourly wage gap due to different
choice of occupations/industries
– Remaining half – unexplained gap
(possibly, discrimination)
40
Jewish-Arab Pay Gap and Discrimination
41
Labor Participation rate – Men
(Katzir & Yashiv, 2013, Hebrew)
Jews
Arab
42
Labor Participation rate – Women
(Katzir & Yashiv, 2013, Hebrew)
Jews
Arab Jews
Arab
43
Jewish-Arab Monthly Wage for Men
(Shekel=0.3 dollar, Ministry of Finance
report (Hebrew, 2019)
38% gap between Arab men and
Jewish (non-ultra-orthodox) men
44
Jews (excl.
Christian Arab
Ultra-orthodox)
Druze
All Arab
Muslims
Econometric Decomposition of the Jewish-Arab Men
Pay Gap (Amria et. Al, Ministry of Finance, 2015, in Hebrew)
45
Possible Causes for the “Unexplained”
Pay Gap Jewish-Arab (14%)
• Hebrew Proficiency
• High crime rate.
– Homicide Rate: 6 per 100,000 among Arab (10 times as high as
among the Jews, 2-5 times as in most other Arab countries, similar to
the US)
• Lack of mobility: 91% live (and work) in the same area as the
parents (63% for Jews)
• Different Occupational Distribution
• Arab are substantially underrepresented in Israeli Hi-The
sector (partially due to lack of army service)
• Discrimination
46
Different Occupational Distributions
(Kasir & Yashiv, 2021)
47
Education
• Segregation in towns/neighborhood and in schools
• 4 different types of schools in Israel:
– Public (mostly attended by secular Jews)
– Public religious Jewish (modern religious Jews)
– Arab
– Ultra-orthodox Jews
– Similar budget per student in all schools
• The 3 minorities are happy with having separate schools,
and with their autonomy with regard to the curriculum
• Data suggests that the academic achievements in Arab (and
Ultra-orthodox Jewish) schools are poor, in particular, in
maths and GMAT
48
Large, persistent Underperformance in PISA
Low-Stake Middle-School Exam (Kasir & Yashiv, 2021)
• 100 points = 1 standard deviation
• Rate of students who learn advanced math is
substentially lower in Arab high schools
49
Large, persistent Underperformance in Psychometric
High-Stake GMAT-Like Exam (Epstein et al., 2015)
• Data for all first degree graduates in 1995-2008
• 100 points = 1 standard deviation
50
Average Labor Income
(Shekel, Kasir & Yashiv, 2021; CBS Data from 2017)
Men
Women
Jews
Arab
Dif. %
Jews
Arab
Dif. %
High School
Diploma
10,080
7,025
-20%
5,665
3,812
-33%
Bachelor’s
degree
17,720
10,910
-38%
10,462
7,778
-26%
Dif. %
76%
55%
85%
104%
• Low returns for education for Arab Men
• Epstein et al., (2021): Half of the gap in returns for
education disappears when controlling for the
psychometric (GMAT-like) exam grades
51
Arab Discrimination in the Labor Market
• It is difficult to estimate from the empirical data the
extent and type of discrimination and its impact on the
Arab-Jewish pay gap, and how much it depends on
considerations of violence / personal safety
• In the next slide I describe a clever experiment (survey)
that aims to answer some of these important questions
• Bar & Zussman, 2017, Journal of Labor Economics,
“Customer Discrimination: Evidence from Israel”
52
Arab Discrimination in the Labor Market
(Bar & Zussman, 2017)
• Labor-market discrimination in Israel is largely influenced by
customer preferences
• Theoretical model – Becker (1957)
– Homogenous service, all workers have the same ability
– Sufficiently large share of customers have discriminatory tastes
against minority workers
– Profit-maximizing firms
• Theoretical Results:
– Some firms employ low-wage minority-group workers and charge
low-service prices from non-discriminatory customers
– Remaining firms employ high-wage majority-group workers and
charge high prices from discriminatory customers
53
Customer Survey (Bar & Zussman, 2017)
• Israeli market for labor-intensive services
(e.g., painting an apartment)
• Customer survey among Jewish customers (Aug-Dec 2015):
– 2*1000 people in telephone survey with Jewish names (29% response rate)
• Impact of late-2015 outbreak of Palestinian violence (“knife
intifada) vs. calm period till sep 2015:
– 3 violent attacks/attempts per day (30 Israeli killed)
• Supplemental survey in 2016: Eliciting reasons for the customers
preferences with an open ended question
– 71% mentioned personal safety
54
55
Customer Survey Results (Bar & Zussman, 2017)
• Only 3% refuse to answer the question on willingness to pay a premium to have
their apartment painted by a Jewish worker (vs. 13% refusal for relative income)
• Premium is highly correlated with belief on potential threat for personal safety
from Arab workers
56
Customer Survey Results (Bar & Zussman, 2017)
57
Firm Survey (Bar & Zussman, 2017)
• Survey among 400 small Jewish-owned firms (typically,
single owner, 2-20 workers) listed in the 2 popular Yelp-like
sites in Israel (Midrag and Mikzoanim)
– Each firm has an average customer’s rating
– 13% of customers who reported using these sites have similar
distribution of answers to the survey as the remaining customers
• 2 independent surveys to firm owners:
1. Getting a quote for a detailed routine task (e.g., painting a 2bedroom apartment), and then asking if the owner employs Arab
workers
2. Asking for the owner’s perception of Arab and Jewish workers,
and preferences of Jewish customers
58
Firm Survey Results (Bar & Zussman, 2017)
• Jewish workers are:
– more efficient than Arab workers: 34%
– More trustworthy: 60%
– Pose lower threat to the employer: 55%
– Prefer not to work with Arab workers: 33%
• 80%: Jewish customers prefer to receive services
from Jewish workers
59
Firm Survey Results (Bar & Zussman, 2017)
• Jewish workers are:
60
Firm Survey Results (Bar & Zussman, 2017)
61
Firm Survey Results (Bar & Zussman, 2017)
62
Labor Discrimination Against Arab Workers:
Conclusions from Bar & Zussman (2017)
• Discrimination in labor-intensive services is induced
by customer’s discrimination
• Personal safety considerations are a central reason
for the customers’ discrimination
• It is difficult to divide the customer’s discrimination
between taste-based discrimination and statical
discrimination
63
Jewish-Arab Pay Gap – Summary
• Arab men get 38% lower average salary than Jewish (non-ultraorthodox) men
• Gap can be divided to 3 roughly equal parts:
– Differences in the level of education
– Other observables (mainly, parents’ income, GMAT grade)
– Unexplained
• Segregated schools, although preferred by both Jewish and Arab,
induce subperformance in maths and GMAT
• Clever experiment suggests that customer discrimination is a main
reason for the unexplained pay gap
– Personal safety considerations are a main drive of this discrimination
– It is difficult to decide whether it is taste discrimination or statistical
discrimination
64
Can the Israeli Hi-Tech Sector Continue to Grow?
(Brand, 2018, Taub Center)
• Israel already has a
large share of workers
in hi-tech
65
Can the Israeli Hi-Tech Sector Continue to Grow?(Brand, 2018, Taub Center)
PIAAC (survey of adults skills)
suggest:
• Jewish skills are close
to OECD average
• Arab skills are 1
standard deviation worse
High variance in Israel:
• Top skills decile in Israel
similar to top decile
in OECD
• Wide gaps for low skill deciles
66
• Improvement in
the young generation
(except for Haredi)
• Improvement for the
Arabs is still slow:
90 years to reach
OECD/Jewish level
67
68
69
70
71
72
73
74
p •
• Limited Potential to increase the hi-tech sector due to the limited skills.
• Probably most of these workers prefer not work in hi-tech.
• Current potential among Arab is very small.
75
Summary – Potential for the Hi-Tech Sector
• The high-skilled quantile in Israel is very good
– Many of them already employed in the hi-tech sector
• The low-skilled quantiles in Israel are much worse than the
OECD average
• It will be very difficult to further increase Israeli hi-tech sector
(without significantly improve the skills)
• The current education system does not provide Arabs with
adequate skills (both in Math and English)
• Gradual improvement for Arab population (1% of STD per
year), is significant, but slow
76
Assignment 6
• Submission deadline: Monday Nov 14th
• Choose an important advantage of the Israeli economy and an
important disadvantage/weakness of the Israeli economy, and
present a one-paragraph discussion of each: why Israel differs
from most other high-income economies in this aspect, why it
is an advantage/disadvantage, what should Israel do to better
exploit this advantage / overcome this disadvantage.
77
Assignment 7
• Submission deadline: Monday, Nov 21th
• Choose 2 ideas/arguments/stylized facts that you heard in
one of the various guest lectures so far in the course: one that
you agree with (preferably, one that you haven’t thought
about before the lecture), and one that you disagree.
Present a one-paragraph discussion for each. In particular,
discuss:
1. why the first idea is important in your opinion, and how it
should affect Israeli economic policy, and
2. why you disagree with the second idea, and which counter
argument/evidence you have about it.
78
Conclusion of Presentation 7
• Neoliberal economic policies have probably helped to the economic
growth, but decreased labor share of GDP, and might increase inequality
• Hourly gender pay gap similar to OECD average
– Larger monthly gender pay gap due to Israeli women preference to work less
(and have more children)
• Substantial Jewish-Ara pay gap for the Arab population
– Segregated environments induce shortage of skills
– Significant, yet too-slow, gradual improvement
– Customer’s discrimination, which is influenced by personal safety concerns, is a
major reason
• Hi-tech sector is very close to its maximal capacity, unless the skill
distribution is substantially improved
• Difficult challenges, yet Israel has successfully faced more difficult
situations in the past
• David Ben-Gurion (Israel’s founding father): “In Israel, in order to be a
realist, you must believe in miracles.”
79
Conclusion of the Course
• Israeli economy, despite its small size, is very interesting
• Economic success story, although facing difficult challenges
• Excellent data and various opportunities for natural experiments, allow to
gain important general economic insights,
and test various theories and models:
– How low-income countries can grow into high-income countries?
• What is the contribution of capital flow? Public education?
– What is the economic impact of immigration?
– What are the economic costs of conflict?
– How to deal with lack of natural resources? And with newly-found natural
resources?
– How to develop a successful startup sector? How to sustain growth as a highincome country in the 2000s?
– How to measure and classify discrimination?
• I hope you enjoyed the course
• Next quarter I teach a somewhat more mathematical course with focus
on Israel: Game Theory: Israel is a Case Study (ECON 182)
80
My Courses in the Remaining Quarters
• Winter 2022-3 – ECON 182 – Game Theory
Applications to Israel:
– More mathematical course
– Course Prerequisites: ECON 100C
– Shapley value and Israeli parliament, stable
matching and Israeli medical residents, game’s
nucleoli and Talmudic bankruptcy law…
• Spring 2023: teaching again the Israeli
economy (ECON 168)
81
THE ISRAELI ECONOMY
The Princeton Economic History of the Western World
Joel Mokyr, Series Editor
A list of titles in this series appears in the back of the book.
The Israeli Economy
A Story of Success and Costs
Joseph Zeira
PRINCETON UNIVERSITY PRESS
PRINCETON AND OXFORD
Copyright © 2021 by Princeton University Press
Princeton University Press is committed to the protection of copyright and the intellectual property our authors entrust to us.
Copyright promotes the progress and integrity of knowledge. Thank you for supporting free speech and the global exchange of
ideas by purchasing an authorized edition of this book. If you wish to reproduce or distribute any part of it in any form, please
obtain permission.
Requests for permission to reproduce material from this work should be sent to [email protected]
Published by Princeton University Press
41 William Street, Princeton, New Jersey 08540
6 Oxford Street, Woodstock, Oxfordshire OX20 1TR
press.princeton.edu
All Rights Reserved
ISBN 978-0-691-19945-0
ISBN (e-book) 978-0-691-22970-6
Version 1.0
British Library Cataloging-in-Publication Data is available
Editorial: Joe Jackson and Josh Drake
Production Editorial: Jenny Wolkowicki
Jacket design: Pamela L. Schnitter
Production: Danielle Amatucci
Publicity: James Schneider and Kathryn Stevens
Copyeditor: Cyd Westmoreland
Jacket credit: Fruit and vegetable stalls at Mahane Yehuda market, Jerusalem, Israel / Yadid Levy / Alamy Stock Photo
To my wife Anat Zeira and to my daughters,
Noa and Yuli Zeira
With love and gratitude
CONTENTS
Preface xiii
Acknowledgments
1
xix
Historical Background 1
Jewish Immigration: Description 2
Jewish Immigration: Characteristics 8
The Israeli-Arab Conflict: The Beginning 11
The Main Eruptions of the Conflict 12
Changes in the Type and Intensity of the Conflict 17
Building a New Nation 19
Success and Its Costs 29
PART I. THE ISRAELI GROWTH MIRACLE 31
2
Catching Up: The Rapid Growth of 1922–1972 33
What Is Economic Growth and How Do We Measure It? 33
Global Economic Growth 36
Economic Growth in Israel over the Years 37
Comparing Economic Growth in Israel to Growth in Other Countries
Structural Changes 41
Growth of Factors of Production 43
Summary 51
3
Explaining Israeli Economic Growth 53
How Do We Explain Economic Growth? 53
Labor Growth and Capital Deepening 54
The Solow Residual 55
Total Factor Productivity and Its Effects 57
Human Capital 61
Adding the Kuznets Effect to Human Capital 65
Technical Progress 67
Summary: Productivity, Human Capital, and Technical Progress
4
High-Tech, High Fertility, and Missing Capital 74
71
39
Recent Developments 74
The High-Tech Sector: Progress and Scale 75
The High-Tech Sector: A Miracle or Public Education? 80
Discovering Gas in the Mediterranean 84
High Fertility in Israel 86
Why Is Labor Productivity in Israel So Low? 89
The Good News and the Bad News 94
Lessons from Part I 97
PART II. THE ISRAELI-ARAB CONFLICT 101
5
The Conflict and the Fiscal Roller Coaster 105
Direct Military Expenditures over the Years 105
The Fiscal Roller Coaster 108
The Fiscal Crisis and the Rise of Defense Costs 110
The Rise of Other Expenditures 111
It’s the Conflict … 115
Peace with Egypt and the End of the Fiscal Crisis 117
Summary: The Wide Conflict and Its Fiscal Cost 120
6
Additional Costs of the Conflict 123
The Conflict between Outbreaks 123
Conscription and Loss of Human Capital 124
Summary of Costs 128
Costs of the Conflict That Are Hard to Estimate 134
Are There Economic Benefits to the Conflict? 139
War and Peace: An Economic View 144
Lessons from Part II 147
PART III. ECONOMIC LESSONS FROM A TURBULENT HISTORY 149
7
Business Cycles in Israel 153
Business Cycles and Their Causes 153
First Identification by GDP Growth and Unemployment 156
A Closer Look at Each Recession 160
Idiosyncratic Business Cycles 168
Peace with Egypt and the Change in Business Cycles 170
The Dynamics of Unemployment 171
Fiscal Policy: Counter- or Pro-Cyclical? 174
Why Israel Had Fewer and Milder Recessions than Other Countries?
8
The Balance of Payments: From Deficit to Surplus
177
175
International Trade and the Balance of Payments 177
The Balance of Payments in Israel over the Years 179
The Intertemporal Approach to the Balance of Payments 183
The Trade Deficit and Its Causes: Growth, War, Immigration, and Transfers
Some Comments on Applying the Theory to Israel 190
Immigration from the Ex-Soviet Union and the Trade Deficit 191
The Composition of International Trade 194
Reality and Economic Theory Can Match 197
9
High Inflation in Israel 199
Inflation as a Tax 199
The Rise and Decline of Inflation in Israel 201
The Theory of Inflation Tax 203
Explaining the First Step of Inflation 207
Explaining the Second Step of Inflation 210
Explaining the Third Step of Inflation 211
Stabilization in 1985 215
Summary 221
10 Monetary Policy and Its Costs
223
The Long Disinflation 223
The Phillips Curve 224
Two Episodes of Unemployment 226
Inflation Targeting in Israel 228
The Independence of the Central Bank 233
Commercial Banks and Financial Intermediation in Israel 236
The Role of Monetary Policy in Israel 240
Lessons from Part III 243
PART IV. NEOLIBERALISM AND ITS IMPACTS 245
11 Between Intervention and Markets
247
Left and Right, Socialism and Capitalism 247
Public and Private Ownership in the 1950s 249
Public and Private Ownership after 1960 254
Privatizing Public Companies 257
Protection versus Openness 260
Israel’s Trade Policies 262
Liberalizing Other Markets 265
The Tragedy of the Labor Movement 268
12 The Public Sector since 1985
271
187
The Measure of Public Expenditures 271
The Global Rise of Public Sectors in the Twentieth Century 272
The Decline of Public Spending since 1980 277
The Decline of the Public Sector: The Policy and the Rule 280
The Reduction of Taxes 282
More on the Public Sector 285
The Diet of the Fat Man 288
Privatization of Public Services 291
Economists or Politicians? 294
13 Inequality
297
Inequality: Between the Labor Market and the Government 297
The Factor Distribution of Income 301
Why Has the Share of Labor Declined? 303
Income Gaps between Workers: Education 308
Women, Arabs, Mizrahi Jews, and the Ultra-Orthodox 310
Market and Disposable Income: The Effect of Government 316
The Two Hands of the Government 322
Lessons from Part IV 325
Conclusion: Four Decisions, Two Dilemmas, and One Pandemic 327
Appendixes
333
1. Labor-Augmenting Total Factor Productivity 333
2. Human Capital 336
3. Capital-Output Ratio and Labor Productivity 337
4. Dynamic Tests of Rates of Unemployment 340
5. Empirical Tests of the Balance of Payments in Israel 342
6. Inflation Tax 344
7. The Phillips Curve 345
8. The Dynamics of Public Debt-to-GDP Ratio 346
9. Wage Regressions 347
References 353
Index 365
PREFACE
This book tells the story of the economy of Israel. It is a small country of only 9 million people,
but I strongly believe that its story should be of interest to people from other countries as well.
One reason for this interest is that Israel has experienced large shocks during its short history,
such as large immigration waves, intense wars, the negotiation and implementation of peace
treaties, and more. These shocks hit the small economy strongly and thus enable us to isolate
their economic effects and to analyze them. In other words, Israel has been a unique laboratory,
with many natural experiments, which enable us to examine economic mechanisms in a
fascinating way.
A second reason the Israeli economy should be interesting to non-Israelis is that Israel is
located in the heart of the Middle East, an area of great importance to the world. First, it is
important geographically, as it connects three major continents, Asia, Africa, and Europe.
Second, it is rich with oil, which adds to its significance politically and economically. Third, it is
the birthplace of the three major monotheistic religions, of which two, Judaism and Christianity,
where born in the country of Israel. As a result of this importance, the country and the region
have always attracted foreign conquerors and rulers, like Egypt, Assyria, Babylon, Greece and
Rome in ancient times; the Arabs, Crusaders, and Ottomans in the Middle Ages; Britain and
France in the twentieth century; and now the United States.
Today, Israel plays an important role in the Middle East. Unlike other countries in the region,
its population is largely not indigenous but consists mostly of immigrants and their descendants.
Many came from Europe, but many others came from other areas of the region itself: these are
the Jews from the Middle East and North Africa. More importantly, the immigration to and
colonization of the country gained much support from the big powers, Britain first and the
United States later. To this day, many view Israel as alien to the Middle East.1 Today Israel is a
major power in the Middle East, militarily, economically, and politically, so it is impossible to
understand the region without understanding Israel and its phenomenal success.
The book has four main parts, which follow a historical background. History is highly
important for understanding any economy, because if we wish to apply economic theory to any
country, we cannot do so blindly. We need to thoroughly understand the specific circumstances
in which the economy develops and operates in order to use economic theory properly to
understand it.
Part I of the book analyzes the rapid economic growth of Israel. Within 100 years, Israel grew
from a small and poor country on the periphery of the Ottoman Empire to become one of the
thirty richest countries in the world. Many observers call it a miracle of economic growth. This
part consists of three chapters. Chapter 2 shows that the main period of fast economic growth
lasted 50 years, from the early 1920s to the early 1970s, and it was a period of “catching up”
with the global frontier. This chapter also shows that this economic growth was unique,
especially relative to the neighboring countries, which are much poorer. Chapter 3 shows that
Israeli economic growth was not a miracle and that standard economic theory, together with the
unique history of Israel, can fully account for it.
Chapter 4, the last chapter in this part, discusses additional aspects of economic growth in
Israel. It analyzes the huge success of the high-tech sector but raises some questions about how
much this sector has contributed to aggregate economic growth in the country. The chapter also
studies the rate of fertility in Israel, which is very high by international comparisons. The chapter
then raises the question of why Israel did not fully catch up with the frontier and why its labor
productivity is still significantly below that of the most economically advanced countries in the
world. It shows that a large part of this missing productivity is due to missing capital, caused by
the risks of the Israeli-Arab conflict.
Part II of the book focuses on the economic effects of the Israeli-Arab conflict. Israel is
unique in living in a conflict continuously, even prior to its establishment. Hence, we can learn
much about the effect of such a conflict on the economy. In 1948, the Israeli-Palestinian conflict
expanded to become a widespread conflict between Israel and the Arab states that surrounded it.
It became a conflict between conventional armies, which is very costly. Chapter 5 in this part
describes these costs and shows how they led to a severe fiscal crisis and almost to bankruptcy.
In 1979, Israel reached a peace agreement with Egypt, which ended de facto the wide conflict
between Israel and its neighboring Arab states. The conflict returned to its Israeli-Palestinian
stage. The narrow conflict has much lower direct costs, but it has many other indirect costs, as
described in chapter 6.
Part III of the book is of high interest to economists, as it uses the unique history of Israel, of
powerful external shocks, to test some important economic theories. Chapter 7 describes Israeli
business cycles and shows that due to the large shocks that hit Israel, we can identify the shock
that began each recession and the shock that ended it. Interestingly, except for one recession, all
reflect domestic shocks. Hence, business cycles of Israel did not correspond to global cycles. A
second lesson from this chapter is that all business cycles in Israel were demand driven. A third
lesson is that returning to the narrow Israeli-Palestinian conflict in the 1980s increased the
country’s vulnerability to business cycles.
Chapter 8 examines the balance of payments in Israel, which was in a deep deficit in the past
and is now balanced. The chapter shows that the trade deficit in Israel was high whenever people
expected gaps in income between the future and the present, as in periods of high growth,
immigration waves, wars, and temporary transfers from abroad. This finding fits very well the
predictions of the intertemporal approach to the balance of payments, the leading theory in the
area. Chapter 9 examines the period of high inflation in Israel, between 1973 and 1985, and
shows that it fits very well the monetary theory of inflation with rational expectations. Chapter
10 analyzes the long process of disinflation that followed the 1985 stabilization program. It
shows that this long process fits well the theory of the Phillips Curve.
Part IV of the book deals with socioeconomic policies and more specifically, with the Israeli
experiment in neoliberal economic policies. Chapter 11 examines the degree of public
intervention in the economy over the years. It shows that the private sector was always dominant,
even in the initial years of the state, when the labor movement led the country. This was a result
of the importance of the national goals in times of crisis, which were top goals for the labor
movement, which was the leader of the Zionist project. Chapter 12 describes how the
government reduced its expenditures drastically after the peace with Egypt and used this
reduction to lower the tax burden. Interestingly, economic growth did not change much during
this entire period and has remained quite stable since 1973. This stability of growth is therefore
strong empirical evidence against the claim that neoliberal policies encourage economic growth.
Chapter 13 examines the high level of inequality in Israel. It shows that the neoliberal policies,
especially the reduction of direct taxes and of welfare subsidies, increased inequality
significantly.
Forty-two years ago, I switched from the study of mathematics to economics. One of the
reasons for this transition was my growing interest in social and political questions. I was hoping
that understanding economics could help me answer these questions better. Since then, I have
studied, taught, and done research in economics. Gradually I realized that the connection
between economic understanding and solving social and political problems is not so simple. On
one hand, understanding economics has enabled me to examine critically many political claims
and to tell when they are fact based, when they rely on illusions, and when they are based on
deception. On the other hand, I have learned that understanding economics does not always
provide clear answers to important political questions, as these questions also depend on
worldview and on social values, which can differ from one person to another, even if the
individuals share the same economic knowledge.
An important and wise economist, Frank Hahn, once said that economics does not solve the
major disputes between us, but it helps us understand better our differences. I believe that this is
a great truth. The way I understand it is that economics should open options instead of closing
them. Namely, there is no such animal as “the right economic policy.” There are many possible
economic policies, and economists can study the costs and benefits of each policy to different
groups in society. However, the choice among different economic policies is a political decision.
Hence, this book is not trying to prescribe what economic policies Israel should follow, as many
books in the past have done, but rather to better understand the different options and their
implications.
However, this book is not only about economic policies, but mostly about the unique story of
the Israeli economy and what can we learn from it. One of the main lessons from this book is
how well economic theory can explain many of the developments of the Israeli economy. The
book shows that the rapid economic growth in the 1950s and 1960s, the high inflation in the
1970s and 1980s, the current account deficit in the early years and its decline to zero in later
years, and much more, fit very well neoclassical economic theories. To do this, the book needs to
remind us of these theories. I describe them intuitively in the main text, to make it accessible to
nonprofessional readers, while I defer the technical presentations to appendixes at the end of the
book.
Naturally, this book contains large amounts of economic data, in tables, graphs, and in the
text itself. Data play a major role in the book for many reasons, but perhaps the most important
one is that data help us demolish many “accepted truths” and show that they are actually myths.
For example, many in Israel believe that our tax burden is high, while the data show otherwise.
Many believe that the fiscal crisis of the 1970s and 1980s was a result of wasteful welfare
policies, while the data show that the main reason was the intensification of the Israeli-Arab
conflict after 1967. The data are therefore the factual basis for the book.
Where do the data come from? Mostly from two sources. One is the Israeli Central Bureau of
Statistics, especially the Statistical Abstracts it publishes annually. The other source of data are
the Statistical Appendixes of the annual Bank of Israel Reports. Both of these institutions, the
Central Bureau of Statistics and the Bank of Israel, helped me significantly and provided data in
addition to their publications. However, most of the data are from the open publications of these
two institutes and are fully available on the Internet. As with all such institutions, they revise the
data every year. Hence, some of the data in the book may not fully fit future publications of these
two institutions. However, such revisions are relatively small and do not affect the overall picture
that emerges from them. The book also uses data from other sources, like the research center of
the Knesset, the Israeli Parliament, and even publications of the US Congress.
No single book can fully cover all the issues of a broad topic like the Israeli economy, and
this book leaves out many such issues as well. It reflects my intention to focus on some
important issues and deepen their analysis, rather than covering too many details. Some issues,
like the black economy, are missing for lack of satisfactory data. I should also admit that the
book reflects my own specialization in macroeconomics, the area that studies general economic
phenomena, such as economic growth, business cycles, inflation, balance of payments, and
inequality. Therefore, although the book deals extensively with the Israeli economy, it has an
emphasis on Israeli macroeconomics. This is not only due to my own expertise, but also because
the unique and interesting aspects of the Israeli economy are macroeconomic.
The book gains much from my own research on the Israeli economy. My main work in this
area, three papers written jointly with Michel Strawczynski from the Bank of Israel, is on fiscal
policy in Israel over time. Another research project that influenced this book is my joint paper
with Thomas Sargent on the jump in inflation in Israel in October 1983, described extensively in
chapter 9. We published this paper in 2011, which shows how often we understand things quite
late. Time lets the dust settle, allows us to think more clearly about the issues, and enables a
broader outlook. This is why understanding economics and economic history are so strongly
related.
Hence, this book is about the Israeli economy and about the economic history of Israel at the
same time. Economics is not just a description of the current situation, but an understanding of
processes and economic mechanisms. Such an understanding requires a detailed historical
analysis, for three main reasons. First, the roots of current economic issues lie in the near and
sometimes even the far past. Second, economic mechanisms operate over time, so the only way
to study them properly is by using a historical perspective. Third, gathering data over long
periods enables us to improve the tests of many economic theories. The time this book covers
begins with 1950, when most Israeli statistics began, although some issues that the book
addresses use data from the Mandatory period as well. The book ends with 2018, which is the
last year with available data at the time of writing.
I finished writing the first draft of the book in January 2020. There was some early news on a
new mysterious virus in China, but it seemed far away and irrelevant. Within a short time, we
were in the midst of the coronavirus global pandemic and in a deep economic recession. I did not
include this development in the main analysis of the book. First, it is too early to analyze it
properly, as the events keep unfolding. Second, this event is global and similar in many
countries, so it might not add much to include it in a book that analyzes special lessons from the
Israeli experience. However, in various places in the book, I have added references to this current
dramatic development.
The book deals at length with the Israeli-Arab conflict and its economic effects. It shows that
the conflict has a huge impact on the Israeli economy—on its output, budget, business cycles,
inflation, balance of payments, and much more. This is not surprising, as the conflict has been
central to life in Israel for more than 100 years. What is sometimes surprising is how little
attention most Israeli economists have given to the conflict. However, despite the wide
discussion of the economic costs of the conflict, we should always remember that the main cost
is lost human life. While I do not emphasize it enough in the book, I wish to stress this point
here. It is important to me personally, as I participated in both the Yom Kippur War and the
Lebanon War and lost friends in these wars.
This book is an English version of a book in Hebrew, with a similar title, published in
February 2018. The two books have much in common, but there are also big differences in
structure and in topics covered. The main difference between them is the audience that each
version of the book targets. The Hebrew book tries to explain to Israelis the economy they live
in. The English book tries to inform those readers who live far from Israel what they can learn
from the experience of this country. I believe that they can learn quite a lot.
1. Even many Israelis share this view. One of Israel’s prime ministers, Ehud Barak, described it once as “a Villa in the
Jungle.”
ACKNOWLEDGMENTS
I thank many people who helped me and contributed to this book. First are coauthors of my
studies on the Israeli economy, Olivier Blanchard, Thomas Sargent, Michel Strawczynski, and
Tal Wolfson. I also thank my coauthors on inequality, Michele Battisti and Oded Galor. My
research on the economics of the conflict gained much from my work in the Aix Group, and I
thank all its members and especially Arie Arnon, Saeb Bamya, Gilbert Benhayoun, Samir
Hazboun, and the late Ron Pundak.
The book gained much from my course on the Israeli economy, and I thank all my students at
the Hebrew University and at Northwestern University. Special thanks go to Avishai BenSasson, Matti Israel, and Michael Wiesen. I am especially grateful to those research assistants
who helped me collect data and process it, Michael Ritov, Sarit Weisburd, Anna Zaposechini,
and especially Dina Dizengof, who assisted me in the main stage of writing the book. Many
people helped by reading parts of the book, among them Gadi Barlevy, Yaron Ben-Naeh, Hillel
Ben-Sasson, Arik Ben-Shachar, Michal Corcos, Momi Dahan, Moshe Efrati, Hagai Forschner,
Oren Heller, Frank Hespeller, Yagil Levy, Jacob Metzer, Uzi Rebhun, Adi Shani, Shmuel
Shtrauss, and David Weil.
The book received financial support from the Israel Science Foundation and from the Falk
Institute for Economic Research in Israel. I received much help from the Bank of Israel and the
Central Bureau of Statistics. The publisher, Princeton University Press, has been very helpful. I
thank Joe Jackson, who led the project steadily, Josh Drake, Cyd Westmoreland, Jenny
Wolkowicki, three anonymous reviewers and especially the scientific editor of the series, Joel
Mokyr, for his invaluable comments. I also thank my academic home, the Department of
Economics in the Hebrew University, which gave me time to research, make contacts with
students, and facilitated significant scientific interaction.
On a more personal note, I am grateful to my late parents, Asher and Yocheved Frieda Zeira,
who nurtured my interest in learning and in science, to whom I dedicated the Hebrew version of
the book. Finally, I am extremely grateful to my wife, Anat Zeira, who supported me throughout
this project, and my daughters Noa and Yuli, who accompanied the writing of the book with
much love and enthusiasm. I dedicate this book to them.
THE ISRAELI ECONOMY
Map of Israel
1
Historical Background
This chapter describes the historical background to the economy of Israel. Clearly, this is not a
full history of Israel, as it focuses only on the main historical processes that are crucial for
understanding the Israeli economy. These processes are the Jewish-Zionist immigration to the
country, the Israeli-Arab conflict, and nation building. These three processes intertwine strongly
with one another. The Israeli-Arab conflict would not have erupted without the waves of Jewish
immigration that posed a growing threat to the local Arab community. Similarly, the Jewish
immigration was not an act of individuals, as most immigrations are. It was part of a political
project, Zionism, whose goal was to renew Jewish nationalism in the country. This strongly
linked the building of national institutions to Jewish immigration.
The history of Israel reflects a country that has changed dramatically over the years. In the
nineteenth century, it was a collection of districts in the Ottoman Empire. During World War I,
the British Army conquered it and the rest of the Middle East. Following their victory over the
Ottomans, Britain and France divided the Middle East between them according to the SykesPicot Agreement.1 Palestine became a British Mandate in 1922.2 In 1947, the United Nations
reached a resolution on the partition of Palestine into two states, one Jewish and one Arab.3
Following the rejection of the resolution by the Arab states and the Palestinians, a war broke out.
In the middle of that war, on May 15, 1948, the British Mandate ended, and the State of Israel
was established. After the 1949 Armistice Agreements between Israel and the Arab countries,
which ended its War of Independence, the State of Israel controlled 78 percent of the territory of
the country. This changed again in June 1967, when Israel occupied all of Western Palestine, the
Golan Heights, and the Sinai Peninsula. Israel withdrew from Sinai in the Peace Agreement of
1979 with Egypt, but the remaining territories (the West Bank, the Gaza Strip, and the Golan
Heights) are still under occupation, and their permanent status has yet to be determined.4
Jewish Immigration: Description
The main process behind the development of Israel has been the rapid growth of the Jewish
population in the country since 1882 by means of immigration. Prior to that year, Jewish
immigration was relatively small. In 1881, on the eve of the Zionist immigration, the Jewish
population, called the “Old Yishuv,” numbered only 24,000.5 These Jews lived mainly in the
four holy cities of Jerusalem, Hebron, Safed, and Tiberias, where Jewish communities had
existed for hundreds of years. In the nineteenth century, Jews began to settle also in Jaffa, Akko,
and Haifa.6 Many of them lived on religious donations, but some, mainly Sephardim, lived by
engaging in retail, trade, and crafts. There were some early attempts at modernization in the Old
Yishuv, in production, education, and even the foundation of an agricultural settlement (Petah
Tikva, established in 1878). However, these attempts were minor and did not significantly
change the Jewish community.7
Change began in 1882, after the pogroms in Russia in 1881, which were triggered by the
murder of Tsar Alexander II. These pogroms, together with the dire economic conditions of
Jewish life in Russia and Poland, led to a massive emigration from Eastern Europe. Most of the
Jews went to the United States, numbering 3.7 million Jews between 1880 and 1929.8 Some
emigrated to Europe, and only a handful of idealists went to Palestine. They belonged to a
movement called Hovevei Zion (Lovers of Zion), and they formed the first wave of immigration.
This movement soon became part of a wider national movement, Zionism, founded by Theodor
Herzl in 1897. From then on, Jewish immigration to the country was the result not only of the
terrible hardships of Jewish life in Eastern Europe but also of strong national aspirations,
influenced by the general rise of national movements in Europe at the time and supported by the
Zionist movement.9
Over the years, more waves of Jewish immigration to Palestine followed, becoming larger
over time, and within a few decades, they changed the country beyond recognition
demographically, geographically, politically, and economically.
Table 1.1 shows how the country’s demography changed dramatically over the years. While
at the beginning of the period, in 1880, Jews constituted less than 5 percent of the population, in
1947, toward the end of the British Mandate, they were already close to a third of the population.
This enabled them to declare independence and to win the war of 1947–1949.10 In the following
three years, 1948–1950, the Jewish population doubled with the large immigration of the
Holocaust survivors from Europe and entire Jewish communities from Syria, Yemen, and Iraq.
At the same time, the Arab population declined drastically, both because Israel did not include
the West Bank and Gaza, and because most Palestinians who had previously lived in the Israeli
area became refugees.11 After 1950, Jewish immigration to Israel continued, and the population
grew quickly. From 1950 to 2018, total population grew 6.5-fold, and the Jewish population
grew 5.5-fold.
Like all migrations, the Jewish immigration was driven by both push and pull forces. The
push factors in the countries of origin were persecutions, wars, and economic hardship. The pull
factors were religious; strong sentiments for the Jewish homeland; national aspirations; security;
and more recently, Israel’s economic prosperity. The push forces explain why immigrations
usually come in waves, when troubles hit countries of origin, and it was true for the Jewish
immigration to Israel as well. This is important for the economic analysis in this book, because
the variation in immigration over time helps us identify the economic effects of immigration. I
next describe briefly the immigration waves since 1882.12
TABLE 1.1. Population in Palestine and in Israel, selected years, 1890–2018 (thousands at end of year)
Year
Population
Jews
Non-Jews
1880
549
24
525
1914
683
85
595
1922
768
84
683
1931
1,036
175
861
1939
1,505
449
1,056
1947
1,970
630
1,340
Comments
First British census
1948
1,015
759
156
1950
1,370
1,203
167
Only in the State of Israel
1960
2,150
1,911
239
1970
3,022
2,582
440
1980
3,922
3,283
639
1989
4,560
3,717
843
Eve of ex-Soviet Union immigration
2000
6,369
4,955
1,414
225 thousands non-Jews and non-Arabs
2010
7,695
5,802
1,895
320 thousands non-Jews and non-Arabs
2018
8,968
6,664
2,303
425 thousands non-Jews and non-Arabs
Arabs of East Jerusalem added in 1967
Source: Data for the Ottoman period are from Gorny (1987); for the British Mandate from Metzer (1998, table A.1). Data after 1948 to the present
are from Central Bureau of Statistics (2019, table 2.1).
THE FIRST ALIYAH, 1882–1903
The first immigration wave was mainly from Russia, but it coincided with the arrival of a small
group of Jews from Yemen as well.13 This first wave of 20,000–30,000 immigrants was already
part of the great Jewish migration from Eastern Europe. While previous Jewish immigrants to the
Holy Land settled among the Arab population in existing towns and communities, the new
immigrants established separate Jewish settlements. These were the early moshavot.14 Among
them were Rishon LeZion, Zikhron Ya’akov, Rosh Pinna, Ekron, Yesud HaMa’ala, Ness Ziona,
Gedera, Rehovot, and Hadera. The establishment of separate settlements was the beginning of a
geographic separation between Jews and Arabs, which remains a dominant pattern in Israel
today.
THE SECOND ALIYAH, 1904–1914
This immigration followed the failed Russian Revolution of 1903, and most immigrants were
young Zionist-Socialists from Russia who belonged to the movements Poalei Zion and Hapo’el
Hatza’ir. Between 30,000 to 40,000 immigrants arrived, although many left, especially during
the difficult years of World War I. This immigration put the labor movement in a leadership
position in the Zionist movement. Its most prominent leaders were David Ben-Gurion, A. D.
Gordon, Berl Katzenelson, Yitzhak Ben-Zvi, and Levi Eshkol. This immigration continued to
establish separate Jewish settlements. They built the first kibbutzim (agricultural collective
settlements), but they also laid the foundations for the first Jewish city, Tel Aviv (1909).
THE THIRD ALIYAH, 1919–1923
These 35,000 immigrants had two main motives. The pushing motive was the Russian
Revolution of 1917, and the pulling motive was the new British rule in Palestine and its promise,
expressed in the Balfour Declaration, to promote a “national home” for the Jewish people in
Palestine.15 Despite the high hopes that followed this declaration, this immigration was still small
and consisted mainly of young idealists from Eastern and Central Europe. The Jewish masses
continued to go to the United States. The immigration to Palestine continued to establish separate
Jewish settlements, mainly kibbutzim and moshavim.16
THE FOURTH ALIYAH, 1924–1932
This was the first Jewish mass immigration to Palestine, of 82,000 immigrants, mainly from
Poland. They escaped its dire economic conditions and the growing anti-Semitism in the country,
also reflected in the policies of the Minister of Finance Wladislaw Grabski. It was mass
immigration not only by number but also by composition, as entire families arrived, whereas
previous immigrations had many young idealist pioneers.
The beginning of mass immigration of Jews to Palestine in 1924 was not incidental. That year
the United States passed the Johnson-Reed Act, which greatly reduced immigration quotas of
ethnic groups from outside the Western Hemisphere. Among these groups were East European
Jews, and the act greatly reduced their ability to enter the United States.17 Thus, many Jews in
Poland, at the time the largest Jewish community with 3.5 million, chose Palestine instead. This
had a dramatic effect on the Zionist project. After three small immigration waves came the first
mass immigration, which has since become the main type of Jewish immigration to the country.
Actually, in 1925 the number of Jewish immigrants to Palestine exceeded the number of Jewish
immigrants to the United States.18
The Fourth Aliyah continued the pattern of separate Jewish settlements, this time mainly
urban. Many came to Tel Aviv, which more than doubled in population during these years. The
newcomers also built other towns, such as Herzliya, Bnei Brak, Kiryat Ata, Bat Yam, and
Netanya. The professional skills of the immigrants and the money they brought with them made
them pioneers in industry, trade, and crafts.
THE FIFTH ALIYAH, 1933–1938
Mass immigration resumed in 1933, after the rise of the Nazis to power in Germany. It spread
fear in central and Eastern Europe, and 197,000 Jews arrived mainly from Germany and Poland.
The immigrants from Germany were highly educated, which contributed much to building the
education system in the country. The Fifth Aliyah expanded the map of Jewish settlements to
new towns like Holon and Nahariya, and also to many kibbutzim and moshavim.
THE SIXTH ALIYAH, 1939–1948
During World War II, Jewish immigration to Palestine declined, as Jews were trapped in Europe
under German occupation, and the Mediterranean was almost closed to seafaring. In addition, the
British “White Paper” of 1939 imposed restrictions on Jewish immigration, as a reaction to the
Arab Revolt of 1936–1939. Still, 138,000 immigrants arrived during this period, a fifth of them
from Arab and Muslim countries, a larger share than before. After World War II, in 1945–1948,
many immigrants arrived illegally to challenge the British restrictions. They were mainly
Holocaust survivors, who were desperate to leave the refugee camps in Europe and go to
Palestine.
THE GREAT ALIYAH, 1948–1951
Following the establishment of the State of Israel on May 15, 1948, a wave of 688,000
immigrants arrived, doubling the population of the country in 3 years. Half were Holocaust
survivors from the refugee camps in Europe, who could now come freely. The other half were
Jews from Arab countries, who found themselves in a dangerous situation with their countries
fighting their own people and facing growing animosity from their Arab neighbors. Many such
communities chose to immigrate to Israel, initially from Syria, Iraq, and Yemen.19 This large
immigration created desperate needs for housing and jobs in the young state. Most immigrants
landed in temporary camps of tents and sheds, called “maabarot,” where living conditions were
harsh. Some camps were in the center, but many immigrants had to settle in the periphery, to
solidify the new borders of Israel.20
IMMIGRATION FROM NORTH AFRICA, 1956–1965
Following Gamal Abdel Nasser’s rise to power in Egypt and the Sinai (Suez) Campaign of 1956,
the Jews left Egypt, followed by Jewish migration from other North African countries.21 The
main drivers of this migration were the Israeli-Arab conflict and the end of French colonial rule
in North Africa. Some 465,000 Jews arrived during these years, of which 209,000 were from
North Africa. The others came from East European Communist countries, mainly Romania and
Poland.
IMMIGRATION AFTER THE 1967 WAR, 1969–1973
The victorious war triggered high enthusiasm in the Jewish world, and a new wave of
immigration came to Israel, mainly from developed countries. The total number of immigrants
was 228,000, of which 184,000 came from Europe and America. Some came from affluent
countries; others came from the Soviet Union, being able to leave it for the first time, although in
small numbers. Still others were young Latin Americans who were fleeing totalitarian regimes.
IMMIGRATION FROM THE FORMER SOVIET UNION AND ETHIOPIA, 1990–2000
In 1989–1990, the Soviet Union collapsed. One of the results of this dramatic event was the
opening of its gates to allow Jewish emigration. Some went to Germany, the United States, and
Canada, but most immigrated to Israel.22 During the 1990s, about 1 million Jews immigrated to
Israel, of which 376,000 came in 1990–1991. The immigration continued, though at a lower rate,
until 2000. In addition to the former Soviet Union immigrants, 47,000 came from Ethiopia
during these years.
Jewish Immigration: Characteristics
Figure 1.1 gives further support to the claim that Jewish immigration to the country was not a
smooth process but took place in waves. The figure shows the numbers of immigrants in each
year relative to the existing population at the beginning of the year (which is the Jewish
population during the British Mandate and total population of Israel during the State years).
Figure 1.1 is informative on how large the effect of immigration was and on the difficulty of
absorbing it. In relative size, the largest wave was the Fourth Aliyah. In 1924, immigrants
increased the Jewish population by more than 35 percent. The Fifth Aliyah also stands out: In
each of the years 1935–1939, immigrants increased the Jewish population by 20 percent. A third
large wave is the Great Aliyah in 1948–1951, when immigrants increased the population by an
annual average of 18 percent. The fourth significant wave is the immigration from the ex-Soviet
countries in the 1990s. Its annual relative size was lower, since in 1989 Israeli population was
already large, at 4.5 million. However, the million immigrants increased the population of Israel
by 20 percent over 10 years.
Figure 1.1 also reinforces the importance of 1924, when mass immigration began. From 1882
to 1923, 40 years and three immigration waves increased the Jewish population from 24,000 to
only 90,000. However, in the 23 years from 1924 to 1947, 428,000 immigrants came and
significantly changed the demographic balance in Palestine. This further highlights the
contribution of the Johnson-Reed Act of 1924 in the United States to the success of Zionism in
the twentieth century. What the Zionist movement could not achieve until then, despite all its
efforts, became possible once the American gates closed for Jewish immigration. The Jews of
Eastern Europe, who felt the ground shaking under their feet, came in growing numbers to
Palestine. The immigration of pioneers and idealists finally became mass immigration.
FIGURE 1.1 Annual immigration relative to beginning-of-year population, 1920–2018 (percent).
Data from Mandatory period are from Metzer (1998, table A.3) and after 1948 from Central Bureau of Statistics (2019, table
2.53).
The Jewish immigration changed the country beyond recognition in several respects:
Demography: Jewish immigration increased the Jewish presence in the country from a
negligible minority in the beginning of the British Mandate to one-third toward its end. After
1948, immigration increased the Jewish population of Israel by ten times and made the Jewish
State a solid fact.
Geography: Most Jewish immigrants did not settle among Arabs but established separate
Jewish settlements. They settled mainly in the coastal plain and in the valleys, but some also
settled in the Galilee and in the Negev. Some of these settlements became large cities. Hence,
immigration significantly changed the physical map of the country.
Politics: The Jewish immigration led to a violent conflict with the Palestinians, which
expanded in 1948 to a wider conflict with the entire Arab world. The immigration also increased
Jewish population to a point of being able to demand self-determination and to establish the State
of Israel, significantly changing the political map of the Middle East.23
Economics: The Jewish immigrants built a thriving economy based on agriculture (in which
they had no previous experience), industry, high-quality education, and services. The economic
development of the Yishuv, and later of Israel, transformed within 50 years a poor country into
one of the thirty most developed countries in the world.
Institutions: The Jewish immigration was not only an act of individuals but also part of a
political project, Zionism. The Zionist movement encouraged immigration and created the
necessary conditions for successful absorption of the immigrants. It did so by promoting
economic growth, which provided housing, jobs, and institutions that improved the lives of
immigrants.
Finally, it is useful to compare the Jewish immigration to Palestine and Israel to other
migrations in modern history. One similarity is that all migrations are not continuous, but come
in waves, since they respond to bad conditions in the countries of origin, like the great Irish
famine in the mid-nineteenth century. The immigration waves to Palestine and Israel followed a
similar pattern. The waves of immigration followed the terrible conditions in Poland between the
two World Wars; the rise of Nazism; the Holocaust; the wars between Israel and the Arab
countries; and more recently, the collapse of the Soviet Union.
Another similarity between the Jewish immigration to Israel and other migrations is that good
economic conditions in the receiving country are required for immigration. This has been the
case for the United States almost throughout its history, and in Europe in this century. Similarly,
Jewish immigration to Palestine and Israel declined during the economic crisis of 1927–1928,
during the recessions of 1952–1953 and 1966–1967, and during fiscal crisis and high inflation in
1973–1985. Ben-Porath (1986a) also confirms that good economic conditions in Israel
encouraged immigration.
However, the Jewish immigration to Palestine and Israel differed from most other migrations
in two main aspects. First, most of the immigrants had middle-class backgrounds, education, and
moderate financial means far above those of immigrants in other modern episodes. The reason is
that while most immigrants leave due to economic hardships, Jewish immigrants left mainly for
national and religious reasons. Part I in this book shows that this was relevant to Israel’s
economic success. A second difference from other immigrations is that the Jewish immigration
was part of a national movement. Zionism, the political movement that encouraged and
supported this immigration, was instrumental to its success.
The Israeli-Arab Conflict: The Beginning
As shown above, Jewish immigration to Palestine increased Jewish presence in the country
beginning in 1882 and especially since 1924. The immigrants, who came under the umbrella of
Zionism, built villages and towns and established institutions like schools, journals, universities,
companies, and even defense organizations. The indigenous Arab population soon understood
the significance of this development and viewed it as a serious threat.
This was the background to the Jewish-Arab conflict. However, it took time to brew. Some
local clashes between Jews and Arabs took place at the beginning of the Zionist settlement, but
these were rather random and rare. The clashes evolved into a national conflict only after the
British occupation in 1917.24 The Ottomans, who had ruled the country before, established a
stable regime that lasted more than 400 years, under which many ethnic and religious groups
lived in mostly peaceful coexistence. As many believed that this situation would last forever,
they viewed local national aspirations as unrealistic and hesitated to follow them. Only toward
the end of the nineteenth century did a general Arab national consciousness begin to develop.
The British occupation of Palestine ended this status quo for several reasons. First, the sudden
disappearance of the Ottomans made national aspirations seem more realistic. Second, the British
arrived with two conflicting national promises. On one hand, they promised the Arabs
independence, in return for their help in winning the war in the Middle East.25 The promise was
vague, and it did not refer directly to Palestine; nevertheless, it encouraged the Palestinians to
exert pressure on the new British government in their favor. On the other hand, the British
delivered to the Zionists the Balfour Declaration in 1917, which promised support of a Jewish
national home in Palestine. With Palestine under their rule, they could fulfill the promise. These
two conflicting promises caused both sides to hope that with enough political pressure, they
could tilt the scales in their favor. This explains the first major outbreak of the conflict in 1921.26
Despite the importance of the British promises to both sides, the main motivation behind the
escalation of the conflict was Jewish immigration, as shown by the correlation between
outbreaks of the conflict and waves of immigration. The events of 1921 happened after the
arrival of the Third Aliyah in 1919, and the events of 1929 erupted after the Fourth Aliyah.
Interestingly, H. Cohen (2015) describes the events of 1929 as the true beginning of the JewishArab conflict and indeed, the fighting broke out after the beginning of mass immigration in 1924.
The Arabs realized that the Jewish presence in the country was no longer negligible but
significant and growing fast, due to large influxes of Jews. Similarly, the Arab Revolt of 1936–
1939 broke out at the peak of the Fifth Aliyah.
From early on, the Palestinians focused on one main demand from the British: to stop the
flow of Jewish immigration. For a long time, the British refused to comply with this demand,
which contradicted the Balfour Declaration and the mandate by the League of Nations. However,
under Palestinian pressure, mainly due to the Arab Revolt, eventually the British changed their
position. The famous White Paper of 1939 imposed severe restrictions on Jewish immigration.
Jewish immigration contributed to the conflict not only by raising Palestinian resentment but
also by increasing Jewish self-confidence. As their number increased to a third of the population
in the 1940s, and being much better organized than the Arabs, their willingness to fight for
independence increased, and their demands became more daring. In the 1940s, the Biltmore Plan
already demanded a Jewish state. The Zionists also put significant pressure on the British
Mandate by increasing the illegal immigration of ships that arrived by night on the beaches.
These developments helped bring the Mandate to its end and expedited the onset of the war of
1947–1949.27
The Main Eruptions of the Conflict
The history of the Israeli-Arab conflict reveals two patterns, which are of great importance to the
economic analysis of the conflict. One is that violence is not continuous over time but erupts
every few years. The second is that the conflict has changed its scope and character several times
over the years. Recognizing these two types of variation in the conflict can help researchers
study and identify the effects of the conflict on the economy.
The following list of eruptions demonstrates the first phenomenon that violence breaks out
only once in a few years, while between these eruptions, the conflict is contained.28
THE EVENTS OF 1921
The events29 broke out in Jerusalem following the Nebi Musa celebrations but expanded to other
areas, such as Jaffa (among those murdered was the famous writer Y. H. Brenner).
THE EVENTS OF 1929
These events followed clashes over the prayer arrangements at the Western Wall in Jerusalem,
and quickly spread to other places. The most deadly attack was in Hebron, where Arabs killed
dozens of Jews, and Jewish life ceased to exist there afterward.
THE EVENTS OF 1936–1939
These were more intense and longer than earlier events, and indeed, the Palestinians call it “the
Arab Revolt.” The Palestinians fought not only against the Jews but also against the British,
demanding that Jewish immigration be stopped. The British brutally suppressed the revolt, but
the publication of the British “White Paper” in 1939 shows, that despite its military failure, the
revolt achieved its main political goal.
THE WAR OF INDEPENDENCE, 1947–1949
The war began immediately after the UN resolution on the partition of Palestine in November
1947. Its first stage was limited to a war between the Jewish and Arab communities. In April
1948, it became clear that the Jews were winning, and most Palestinians from the area intended
for the Jewish state left their homes or were expelled by force. That started the problem of
Palestinian refugees, and it is why the Palestinians call this war “Nakba” (“disaster”). As the
British left and the Yishuv declared the State of Israel in May 1948, Arab armies from Egypt,
Jordan, Syria, Iraq, and Lebanon invaded the country and joined the war. At its end in 1949,
Israel controlled 78 percent of the territory of Palestine, more than it got under the UN plan. The
Armistice Agreements with the neighboring Arab countries set the temporary border of this
territory, the “Green Line,” which survived for 19 years. The number of Israelis who died in the
war was about 6,000, close to 1 percent of the population.
THE SINAI CAMPAIGN, OCTOBER 1956
In this war, also called the Suez Campaign, Israel attacked Egypt after a long period of border
clashes due to infiltration of Palestinians into Israel and to Israeli retaliations. The attack was
coordinated with Britain and France, who planned to conquer the Suez Canal and return it to
their control after Egypt had nationalized it. Israel conquered the Sinai Peninsula within a week,
but it had to withdraw back to its previous borders within a few months, due to joint pressure by
the United States and the Soviet Union. Israel lost 172 soldiers in the war.
THE SIX-DAY WAR, JUNE 1967
In May 1967, Egypt sent army forces to Sinai in violation of the demilitarization agreements,
removed the UN forces from the border, and closed the Red Sea to Israeli ships. These moves
created great tension between the sides; after a few weeks, Israel attacked Egypt and conquered
the Gaza Strip and the Sinai Peninsula up to the Suez Canal. As Jordan and Syria joined the
fighting, Israel captured the West Bank from Jordan and the Golan Heights from Syria as well.
Israel lost 776 soldiers in the war. Unlike the Sinai Campaign, Israel remained in the occupied
territories without much pressure to withdraw, partly due to growing US support. This led to two
important results. First, Israel now controlled, for the first time, all of Palestine and the
Palestinians who lived there, which changed dramatically their role in the Israeli-Arab conflict.
Second, remaining in the territories after the war increased the tension between Israel and its
neighbors, which led to an escalation in the Israeli-Arab conflict.
WAR OF ATTRITION, 1968–1970
As the Arab world did not accept the results of the 1967 war, the War of Attrition began soon
after. This was a static war, mainly with Egypt along the Suez Canal, but also with Syria on the
Golan Heights and along the Jordan River against the new Palestinian organization, Fatah, which
was part of the Palestinian Liberation Organization (PLO). In the War of Attrition, Israel
suffered 1,424 fatalities, twice as many as in the Six-Day War.
YOM KIPPUR WAR, OCTOBER 1973
This war, also called the “October War” or the “Ramadan War,” began when Egypt and Syria
attacked the Suez Canal and the Golan Heights, respectively. The attack was part of the Arab
effort to force Israel to withdraw from the territories occupied in 1967. The war was fierce. It
lasted three weeks, and Israel suffered a great loss of life, 2,297 soldiers. It also lost much
equipment and ammunition, so the economic cost of the war was heavy as well. In retrospect, we
can say that this war paved the way to the 1979 Peace Agreement with Egypt, where Israel
withdrew from Sinai in return for full peace, mutual recognition, and diplomatic relations.
THE 1982 LEBANON WAR
Israel began the war with two main goals. The explicit goal was to push the PLO forces from
southern Lebanon, from which they could fire rockets on Israeli towns and villages in the north.
The PLO forces settled in Lebanon, after they escaped Jordan in the “Black September” of 1970.
An additional implicit goal of the war was to intervene in the Lebanese civil war, which began in
1975, in support of the Maronite Christians. Israel achieved the explicit goal within a few
months, when the PLO forces left Beirut and Lebanon, mainly to Tunisia. The other goal of the
war failed completely. Not only did Israel fail to impose the Maronite militias on Lebanon, but it
also created a new enemy. The Shiites in southern Lebanon formed a strong militia, Hezbollah,
which began a guerrilla war against Israeli forces in Lebanon. In 2000, 18 years after it invaded,
Israel withdrew completely from Lebanon, after suffering 1,216 fatalities in this war.
THE FIRST INTIFADA, 1987–1993
This was the first widespread Palestinian uprising since the Israeli occupation of the Palestinian
territory in 1967, and in fact the first direct Palestinian-Israeli confrontation since 1948. The
Intifada began with demonstrations, stone throwing, strikes, and boycotts of Israeli goods, but
later deteriorated to the use of arms. The PLO directed the Intifada from abroad, but soon a new
force emerged, Hamas, the Palestinian branch of the Islamic Brotherhood. Some 200 Israelis and
1,200 Palestinians died in the First Intifada. In 1988, the PLO agreed to partition into two states,
thus paving the way for peace talks with Israel. The negotiations between Israel and the PLO
began after the election of Yitzhak Rabin to be the Israeli prime minister in 1992 and led to the
Oslo Agreements in 1993. The agreements included mutual recognition, establishment of
temporary Palestinian Autonomy in the territories, and promised to reach a Final Status
Agreement within five years. The Oslo agreement also enabled the peace agreement between
Israel and Jordan in 1994.
THE GULF WAR, 1991
Following the occupation of Kuwait by Iraq, the United States led a large coalition of countries
to fight Iraq in “Operation Desert Storm.” Israel was not part of the coalition, but Iraq fired many
conventional missiles at Israel. Israel held back and did not respond, so its part in the war was
passive, and it suffered very few casualties.
THE SECOND INTIFADA, 2000–2005
In July 2000, negotiations on the Final Status Agreement between Israel and the PLO at Camp
David failed. Tensions between the sides increased, and in September, the intifada began (the
Palestinians call it the “Al Aksa Intifada”). The Second Intifada was more intense than the first,
with greater use of firearms, and hence it caused more fatalities: 1,100 on the Israeli side and
close to 5,000 on the Palestinian side. Israel suppressed the intifada by the use of large military
campaigns. The Second Intifada ended in 2005 with the Disengagement from the Gaza Strip.
This was a unilateral withdrawal from the Gaza Strip, including demolition of the settlements
there.
THE SECOND LEBANON WAR, 2006
This was a relatively minor war between Israel and Hezbollah. It erupted mainly due to unsettled
issues from the previous war in Lebanon, such as the status of the remaining Lebanese prisoners
in Israel and border issues. Israel suffered 170 fatalities in this war.
THE OPERATIONS IN GAZA, 2006–PRESENT
Israel left the Gaza Strip in 2005 but continued to control its borders by land, sea, and air. In fact,
Israel put Gaza under a siege, which intensified after Hamas’ victory in the Palestinian Authority
elections in 2006, and further after Hamas took over the security forces in Gaza in 2007. The
Gazan answer to the siege was the development of “Qassam” rockets that enabled Hamas to
harm routine life in Israel around the Gaza Strip. The tension along the border between Israel and
Gaza is high and has led to several eruptions in 2006, 2008, 2012, and 2014. The heaviest
fighting took place in 2014, killing 73 Israelis and more than 2,000 Palestinians.
Figure 1.2 presents the annual number of Israeli military fatalities. It demonstrates the pattern of
eruptions in the Israeli-Arab conflict and between them years of relative calm. Note that figure
1.2 also shows a trend of rising fatalities over time in calm periods, as the number of fatalities
includes not only soldiers killed in action but also in accidents. This leads to an upward trend, as
the population and the size of army grow. Figure 1.2 also shows a marked rise in the number of
fatalities in the years 1967–1977, when the Israeli-Arab conflict intensified significantly.
Changes in the Type and Intensity of the Conflict
Until 1948, the conflict was between two ethnic communities in the same country. Militarily, it
was a conflict between militias, because neither side could build a real army, as it was illegal
under the British rule. Thus, until 1948, it was a narrow conflict, only between Israelis and
Palestinians, with low costs, in terms both of human life and of arms and ammunition. In 1948,
with the invasion of Arab armies, the conflict expanded from a narrow to a wide conflict between
Israel and all Arab countries.
It is hard to explain this expansion of the conflict. The Arab countries claimed that they
invaded Palestine to help the Palestinians, but they may also have hoped to grab some Palestinian
territories, as Jordan captured the West Bank and Egypt the Gaza Strip. Another explanation is
that the establishment of Israel, in its exceptional location, divided the Arab world into two
separate areas, thus harming it significantly. A fourth explanation is that Palestine was holy and
had been important to Islam for more than 1,300 years. Whatever the explanation, the change in
the conflict in 1948 was not only political but also military and economic. From a militia
conflict, it upgraded to a conventional military conflict. Thus, it became much more costly in
human life, arms, and ammunition, as fighting involved not only infantry, but also tanks,
artillery, air forces, and navies.
FIGURE 1.2. Annual military fatalities, 1910–2018.
Data are from the Ministry of Defense. See Freedom of Information (2018).
The Israeli-Arab conflict remained wide for more than 30 years, until the 1979 peace with
Egypt. This was peace with one country only, but it was with the strongest Arab country
militarily. Since forming an Arab fighting coalition against Israel became impossible without
Egypt, the wide Israeli-Arab conflict ended de facto. Chapter 5 supplies additional evidence that
the wide conflict indeed ended in the 1980s.30
The Palestinians were early to recognize that the wide conflict with the Arab countries ended
and that no one would fight for them any more. This realization triggered the First Intifada in
1987. Since then, the conflict has returned to its pre-1948 shape, as a narrow Israeli-Palestinian
conflict. The type of fighting changed as well, from conventional warfare to militia fighting.
Although it is the army that fights on the Israeli side, it uses mainly infantry, which is similar to
using a militia. On the Palestinian side, there are two major militias since the First Intifada, Fatah
and Hamas. A conflict between militias is much less costly than the conventional wars of the
past.
The list of eruptions together with figure 1.2 show that even during the period of the wide
conflict, there were large variations in military activity. The 10 years after 1967 were years of a
significant rise in the intensity of the conflict. Instead of one eruption in a decade, as before
1967, this decade saw three wars: the Six-Day War, the War of Attrition, and the Yom Kippur
War, and all three were costly. A plausible cause for the rise in intensity of the conflict after
1967 is that Israel did not withdraw from the territories it had conquered in the war, unlike after
the 1956 Sinai campaign. As a result, Egypt, Jordan, and Syria continued to apply military
pressure on Israel to withdraw from these territories. The high intensity of the conflict after 1967
had many economic consequences, as shown in chapter 5.
Building a New Nation
The new nation of Israel built many institutions: economic, governmental, social, and cultural.
Over the past 100 years, Israelis have invested a huge creative effort in these institutions to
support the Zionist goal of absorption of the immigrants and their integration into a nation. The
history of these institutions is important not only in itself but also helps to understand the present
as well, since institutions have strong inertia and change slowly over time. Thus, understanding
many current Israeli institutions, like the Histadrut (General Union of Workers in Israel), the
Labor Party, or the Jewish Agency, requires knowledge of how these institutions began and what
their original purposes were. The conditions in which these institutions were born have long
changed, but the institutions themselves have changed too little and too slowly since then. In
general, institutions are of great importance for the functioning of the economy.31
The brief discussion in this chapter cannot cover all aspects of Israeli institutions, so it
focuses on four issues only. The first is that the institutions established by the Zionist movement
were for Jews only. The second is the great role of the political parties in Israel. The third issue is
how the labor movement dealt with the tension between its two ideologies, Zionism and
Socialism. The fourth issue is the gaps between European Jews and Jews from Arab and Muslim
countries.
ZIONIST INSTITUTIONS
The Zionist movement made great efforts to absorb the immigrants successfully, hoping that it
would encourage immigration of more Jews. To achieve this goal, it built institutions that were
by nature for Jews only. An example of such institutions were the Zionist political parties, which
helped absorb new members on arrival in the country. These were clearly Jewish parties. After
the establishment of the State of Israel, these parties remained the leading political parties, and
they kept their Zionist character. As a result, only few Israeli Arabs could join these parties,
which remains the situation today.32
Another example of institutions for Jews only is the Jewish Agency and its related
institutions. The Jewish Agency was the representative of the Yishuv before the British
authorities, and it actually functioned as a government of the Yishuv. After the establishment of
the State of Israel, the Jewish Agency remained active, with two main goals. One was to promote
Jewish immigration to Israel, and the second was to build new settlements. Naturally, these
settlements were for Jews only. A related institution was the Jewish National Fund, which
purchased land for Jewish settlement during the Mandatory period. After 1948, this institution
controlled a large share of the land in Israel. As such, it contributed to discrimination against
Israeli Arabs in land use.33
The discrimination was much worse in the early years of Israel, especially due to the military
rule imposed on Arab towns and villages, which lasted until 1966. Discrimination declined over
time, but it has never fully ended. One channel is through labor markets, as described in chapter
13, where Arabs find it hard to find jobs in firms that work with the defense establishment.
However, the toughest discrimination is in the area of land development and housing, as
described above.
The Yishuv also established educational institutions: primary schools, high schools, and even
two institutions of higher learning (the Hebrew University of Jerusalem and the Technion, a
technology institute in Haifa). All schools taught in Hebrew and were open to Jews only during
the Mandatory period. With the establishment of the state, these schools became a public
education system that consists of three separate systems: state, state-religious, and Arab, while
only universities are open to all. Hence, to understand why Israel has separate educational
systems for Jews and Arabs, it is necessary to keep in mind the Mandatory period and the
separate settlements of Jews that began very early.
The Zionist movement established many more institutions. A major one was the general labor
union, the Histadrut, which also created additional institutes that supplied jobs; housing; pension
funds; and health care, such as Kupat Holim and its hospitals.34 The Histadrut organized only
Jewish workers during the Mandatory years. After 1948, it accepted Arabs in a separate “Arab
department.” Only after 1966 did Arab workers become full members of the Histadrut. The
Zionist movement created additional health-care and housing institutes outside the Histadrut as
well, like the housing company Rassco (Rural and Suburban Settlement Company), the Hadassah
hospitals and other health funds. It also created institutes to promote science, such as the
Weizmann Institute, the Academy of the Hebrew Language, and the National Library. Other
institutions, like publishing houses, newspapers, and theaters, promoted culture and the arts.
Most of these institutions continued to operate after 1948, and many remain exclusively for Jews
to this day.
Hence, the story of how separate institutions for Jews began is not just history but is part of
the explanation of how Israel operates today. The separation was understandable under the
British Mandate, in a period of immigration absorption and national consolidation. As
institutions are highly inertial, many still remain separate. Nevertheless, the separation is also a
longstanding policy of the Israeli government and not only a result of the inertia of institutions.
There are many examples of this policy, like the widespread land confiscations in 1976 and the
recent attempts to evacuate Bedouin settlements from their land. These policies reflect how the
continuing conflict between Israel and the Arab world affects the relations between Jews and
Arabs in Israel. Part of this policy operates by keeping the separating institutions active.
THE STRONG PARTIES
Among the institutions built in Palestine, the Zionist parties were uniquely strong, far more so
than political parties in other countries. These parties used to own and operate school systems,
health funds, newspapers, publishing houses, banks, and even militias.35 How did the Zionist
parties acquire such organizational and economic power? One explanation is that since Zionism
was a national-political project, parties played an important role in it. The Zionist movement
formed in 1897 and soon became a coalition of Zionist parties, which covered the full political
spectrum: left, center, right, and religious.
To understand better the strength of the Zionist parties, it is important to consider their mode
of operation. Each of them functioned on a dual basis, in Palestine and in the Diaspora. This
enabled them to encourage and organize their supporters abroad to immigrate to Palestine. Even
the British Mandate officially recognized this role of the Zionist parties as recruiters of
immigrants. The British, who issued immigration permits (called “Certificates”), granted these to
the Jewish Agency, which divided them among the various parties.
Hence, the parties acted as importers of the two main factors of production in every modern
economy: labor and capital. Most of the immigrants became workers in Palestine, and they came
mainly through the parties of the labor movement. However, many immigrants brought with
them some wealth, though mostly modest. They arrived mainly from Poland and Germany and
belonged to the centrist Zionist parties. These immigrants invested in domestic projects and thus
imported capital. They invested in industry, commerce, citrus growing, and other economic
areas. During the Mandatory period, immigrants’ money funded these investments. In
agriculture, the labor movement built the settlements, kibbutzim, and moshavim, and supplied
the labor, but the financing came from Zionist donations, organized by all Zionist parties. Hence,
being importers of labor and capital to the growing economy gave these parties a lot of strength.
Of all the Zionist parties, the most powerful and energetic were the Zionist-Socialist parties,
which formed the labor movement. In their center was Mapai (the Party of Workers of the Land
of Israel), led by David Ben-Gurion. To their left was mainly Hashomer Hatzair, which later
became Mapam. From the early 1920s, the labor movement became the leader of the Yishuv and
of the Zionist movement in general. They led the process of nation building, all the way to the
establishment of the state in 1948, and then through shaping the young country, until 1977. The
leadership of the labor movement was widely supported, and they presided over a broad coalition
of parties. This coalition included the two liberal parties, the General Zionists at the center-right
and the Progressives at the center-left. The coalition also included the religious-Zionist party,
Hamizrahi and even a Zionist-Socialist branch of the Ultra-Orthodox party, Poalei Agudat
Yisrael. The main opposition to the labor movement during the Mandatory period was the
Revisionist party of Ze’ev Jabotinsky on the far right, which even left the World Zionist
Organization. After the establishment of the state, the revisionist party became Herut, under
Menachem Begin. Later, it joined forces with the General Zionists, who left the coalition with
the labor movement, to form the Likud Party. In 1977, they won the elections, formed a
government, and ended 60 years of leadership of the labor movement.36
THE LABOR MOVEMENT BETWEEN ZIONISM AND SOCIALISM
What explains the rise to power of the labor movement? What enabled it to reach leadership so
quickly, even though the movement was far from the center? Without pretending to give a full
answer to this question, I would like to offer one explanation, which also connects to later
economic policies of the labor movement. It focuses on the movement’s flexibility and its ability
to adapt to the changing conditions in Palestine.
Workers’ movements elsewhere responded mostly to the distress of workers in their
workplaces, and hence, struggled mainly for better labor conditions, shorter workdays, and
unionization. However, the situation in Palestine was very different. The main problem of
workers was not how to cope with the employer in the workplace but rather to find a job. This
difference is due to two main reasons. The first was the rapid flow of immigrants, which required
a rapid buildup of new jobs. The second was competition for the few existing jobs with the
domestic Arab workers, who were willing to work for less and were more experienced,
especially in agriculture, which was a large sector at the time. The labor movement developed
two main ways to cope with the lack of jobs, which drew a sharp difference between it and
typical Socialist parties. The first was to create jobs by itself, by becoming an employer, and the
second was to launch a campaign against hiring Arabs, termed “Avoda Ivrit” (Hebrew Labor).
In agriculture, the labor movement created jobs by establishing cooperative settlements,
known as kibbutzim and moshavim. This was the preferred solution for Jewish agricultural
workers, because once they owned the settlement, they could ensure that only Jews worked
there, while the older moshavot, which were privately managed, often employed Arabs. Hence,
the cooperative settlements were not only the outcome of labor ideology but also of the desperate
need to create jobs for immigrants. However, building settlements required funding for purchase
of land and for construction. The funding came from donations, which arrived mainly from
centrist Zionists. This cooperation between Socialists and centrists led the labor movement to
inevitably compromise on its socialist principles, since it had to convince its partners that the
cooperative settlements were not part of a socialist revolution but rather of a national revolution
—Zionism.
The labor movement created jobs not only in agriculture but also in other sectors. The
Histadrut, the general labor union of Jewish workers in Palestine, founded in 1920, built a
network of companies called “Chevrat Haovdim,” namely, the “company of workers.” It
included construction companies like “Shikun Ovdim,” an infrastructure company “Solel
Boneh,” a financial institute “Bank Hapoalim,” a produce distribution company “Tnuva,” and
many more. By willing to build jobs and by becoming an employer, the labor movement
demonstrated its flexibility in adapting to the conditions in the new country. This brought it
broad support, not only of the workers but also of others, who realized that the labor movement
was working for national rather than for class interests, as it gave Zionism top priority.
The labor movement not only created new jobs but also struggled against hiring Arabs in
Jewish workplaces, under the slogan of “Avoda Ivrit.” They demanded that Jewish employers
should not employ Arabs but Jews, even if it harmed their profits. The wide Jewish public
viewed this struggle as support of Zionism and not as an act of narrow class interests. It thus
gave the labor movement further popularity, despite its cruelty. In 1929, David Ben-Gurion, then
secretary general of the Histadrut, wrote the following, insisting on 100 percent of Jewish labor
not only in Tel Aviv but in the moshavot as well:
The situation of the Jewish worker who immigrates to the country is the opposite of that of
any migrant worker in other countries, such as N…
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