The Multinational Monitor


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War Costs Bring Judgement Day For Israel's Economy

by Joe Stork

Against the background of the intensifying war in Lebanon, President Reagan and Israeli Prime Minister Yitzhak Shamir met in Washington for two days at the end of November. In an agreement announced on November 30, the two leaders spelled out a new strategic relationship between the two countries that will mean increased cooperation in military planning and maneuvers, the stockpiling of American weapons in the country, and the use of U.S. military aid to pay for weapons made in Israel. In addition, the U.S. agreed to negotiate with Israel on reaching a joint free trade agreement, similar to the Caribbean Basin Initiative, designed to increase Israeli exports, stimulate production, and reduce inflation, which is now hovering at the 170 percent level.

The economic agreement, thought to be among the most generous aid packages offered to a U.S. ally, is part of a new U.S. policy to assist the deteriorating Israeli economy. In this report, Joe Stork, editor of MERIP Reports and a recent visitor to the Middle East, reports on the background to the current crisis and the relationship of Israel's economic troubles to its burgeoning expenditures on the military and in the West Bank and Lebanon.

On October 11, the new government of Yitzhak Shamir, hours after it was approved by the Knesset, went into an allnight session and emerged to announce a 23 percent devaluation of the shekel, an increase of 50 percent in the price of subsidized essentials such as bread and milk, and promises of imminent price hikes for transportation, water, and electricity.

A day later, the media revealed Finance Minister Yoram Aridor's plan to "dollarize" the economy and standardize the widespread informal linking of Israeli economic transaction to U.S. currency. The immediate political uproar forced Aridor to resign on October 11, and he was replaced by Yigal Cohen-Orgad, a proponent of free-market theories. Cohen-Orgad immediately reversed the "dollarization" policy and declared his intention to reduce the Israeli standard of living and to cut government expenditures.

The events leading to this government crisis have their roots in the government's inability to deal with two major problems which have plagued Israel over the past few years: a serious balance of payments deficit and extremely high rates of inflation. These, in turn, are related to two longer-term problems: the country's overdependence on U.S. aid, and its heavy military expenditures. How the problems are solved carry enormous implications for Israel's domestic political future and for the direction of U.S.-Israeli relations.

Until the end of 1982, a steady and low level of unemployment (about five percent), and a slow rise in consumption despite declines in real wages, precluded popular opposition to the government of Menachem Begin on economic grounds. But this tranquility was delusory, purchased by government spending and private borrowing on the international market.

In 1982, the country's GNP remained absolutely stagnant and by all indications declined in 1983. Imports sharply increased to fill the production gap, equalling 60 percent of Israel's GNP by spring 1983. The 1982 trade deficit was $5 billion, up 12 percent from the year before, and increased another 10 to 11 percent in the first nine months of 1983. The country's published foreign debt amounted to $27.1 billion in July. During October, Israel's cost of living rose by over 20 percent-a sign that inflation might reach 175 percent in 1983. ,

During the year, the rising inflation and steady drop in industrial exports began to force some layoffs. Although a successful December 1982 strike of hundreds of thousands of workers in the public sector (which employs one third of the Israeli work force) for a 12 percent wage hike indicated that workers were not ready to trade wage increases for job security, industrialists were warning that massive unemployment may lay ahead.

All of these factors eventually came to a head with a crunch in the country's capital markets. A January 1983 announcement of changes in investment rules triggered a four-day panic that wiped out a year's worth of rising stock prices. By the fall, only investments in bank stocks remained high, and even these began to be unloaded as the economy deteriorated sharply, causing banks and government to invest millions in bank shares to shore up prices. The result was aggravated inflation and capital losses of $3 billion in October alone.

It was at this point that the Israeli cabinet took its austerity measures and devalued the Israeli currency.

The drastic moves by the Shamir government were prompted by both domestic concerns and pressures from the country's chief backer, the U.S. Soaring debt and inflation rates in Israel have caused alarm within the U.S. government, which is worried that Israel may not be able to pay its debts without a large increase in U.S. aid. A report by Financial Times correspondent David Lennon, stated that, during their summer visit to Washington, Shamir and Defense Secretary Arens "were told in the bluntest terms by Mr. George Schultz, the Secretary of State, that Israel must adopt a more realistic economic policy." Schultz's "lecture," Lennon concluded, "clearly had an impact."

Today, as in the past Israel's deficit is covered by official loans and grants, chiefly from the U.S. government and by Israeli government and private bank borrowings from the international banks.

The U.S. aid package for 1984 passed by the House of Representatives on November 10 was a record $2.6 billion, more than two-thirds in direct grants or "forgiven" credits. In addition, the U.S. provides several hundred million dollars worth of military contracts and ExportImport Bank loans. Another $1.5 billion comes from private donations and investments, including the sale of Israel Bonds. U.S federal and state laws grant Israel Bonds a special status that allows them to be sold more easily than other foreign bonds.

U.S. assistance is an essential underpinning of Israel's ability to borrow from banks abroad. The U.S. Embassy in TelAviv argues that ever higher levels of aid are necessary to "show an undiminished U.S. support to Israel's creditors," while the IMF now considers Israel to be among the poorest credit risks worldwide. U.S. official aid is by far the most crucial element in Israel's immediate economic future, making the country far more dependent today on the indulgence of U.S. taxpayers than at any point in its history. Until now, this one factor has allowed the Israel government and its citizens to put off the day of economic reckoning.

The country's worsening economic plight is partially attributable to the large proportion of Israeli resources-30 percent of the GNP-devoted to the military. The direct costs of the Lebanon invasion were over $20 billion, according to opposition Labor Party member Gad Yaacobi, and the continuing occupation of southern Lebanon is costing roughly $1 million per day. Another significant and controversial expenditure is the cost of settlements in the occupied West Bank and Gaza. The price tag for the current program of incentives to induce 100,000 Israeli Jews to move to the West Bank by the end of 1985 is estimated at $2 billion.

The Lebanon invasion has been capitalized through about $1 billion raised internally from "compulsory war loans" and special levies decreed during the invasion in July 1982. But military expenditures have been somewhat offset by weapons exports, which have become an important source of foreign exchange over the last decade. (Israel is a major arms supplier to Guatemala, Honduras, and El Salvador.) Annual sales have risen from around $10 million per year in the late 1960s to $1.3 billion in 1981-with greater increases expected in the future. A September 1982 U.S. government report noted that "the market for Israeliproduced equipment will be enhanced because its effectiveness was demonstrated in Lebanon." (In recent discussions between Prime Minister Shamir and President Reagan, however, the U.S. rejected an Israeli proposal to allow U.S. military credits to be used by third countries, such as the Philippines, to buy weapons in Israel.)

The Israeli government's handling of the current economic crisis could spark widespread political discontent. Yigal Cohen-Orgad, the new finance minister and a settler on the West Bank, opposed Menachem Begin's negotiation of the Camp David treaty with Egypt. His ultranationalist politics and his advocacy of free-market economic policies lie behind his strong concern to reduce Israel's already great economic dependence on the U.S., for fear it will lead to political concessions (such as, in his opinion, Camp David). Cohen-Orgad's public warnings that Israelis should expect a drop in their standard of living, and his program of sharp cutbacks in government services and increased taxes and fees are guaranteed to lead to increased disenchantment with the Shamir government. According to a November public opinion poll, no less than 80 percent of Israelis believe that the government would be unable to control the crisis, and only two percent believe that Cohen-Orgad might improve the situation.

Trade unions or consumer groups might chafe at the new austerity measures as well. A recent U.S. Government Accounting Office report on U.S. aid to Israel stated that "Israel believes that substantial austerity measures could tempt emigration from Israel and promote labor unrest." This possibility represents "the bounds which Israeli democracy imposes on measures restricting private consumption," the report noted.

The link between Israel's domestic economic course and its U.S.-backed military and strategic policies in the area may be the crucial factor in domestic support for the government's programs. The price of Israel's military policies in the region and occupied territories-namely, a lowered standard of living-may reduce Israel's ability to attract and retain immigrants needed to assure Jewish demographic dominance and provide a skilled workforce for the country's hightech export industries.

As Amos Elon, a well-known Israeli author, wrote in the daily Ha'aretz on October 14, "Israelis had never before been asked to pay the economic price for their country's policies. Those who applaud [former chief of staff] Rafael Eitan or shout 'Arik [Sharon], King of Israel' in the market place were never asked to give up their color television set for a new settlement in Nablus, or to do without a new car so that we might bomb Baghdad. . .Nobody was expected to forego their spring vacation in Europe so that we could establish a 'new order' in Lebanon."

Joe Stork is editor of MERIP Reports, the monthly publication of the Middle East Research and Information Project, P.O. Box 43445, Washington, D.C. 20010.

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