By Bill Montague

WHEN ISRAELI Gen. Ariel Sharon arrived in Washington for a brief visit last October, his mission was a strictly non-military one at least on the surface.

Sharon, the hawkish former defense minister who masterminded his country's 1982 invasion of Lebanon, came to the U.S. capital in the unlikely role of travelling salesman, touting Israel's profit potential to a gathering of businesspeople and investors at the Washington Sheraton Hotel.

But the role change was actually less drastic than it might seem. Sharon, now Israel's minister of trade and industry, was actually promoting one of his country's basic strategic goals-- freedom of action.

By boosting investment and trade, the Israelis hope to revive their lagging economy and reduce their dependence on U.S. economic aid--winning them a measure of leeway to pursue their own military and diplomatic objectives around the world.

Sharon hinted at this in his Washington appearance. "The day may come," he predicted, "when the U.S. will stop civilian aid, and Israel should be looking towards that day. Our relationship should be based on equality."

For the Israelis, one key to achieving that equality is the sweeping free trade agreement it negotiated with the United States in 1985. Sharon's visit was only part of a campaign to translate that pact into tangible economic results.

The agreement, long sought by the Israelis, will gradually remove nearly all trade barriers by 1995, allowing most goods to move between the two countries without quotas, tariffs or restrictive red tape.

Israel's hopes for the treaty rest on the nation's unique status as an "associate" member of the European Economic Community (EEC), which allows Israel to export all but agricultural products into the EEC countries duty-free. With the U.S. trade pact in hand, the Israelis hope to become a "trade bridge"--a way station between the world's two largest markets. Components from the United States could be assembled into finished products and then sold in Europe, or vice versa.

Tantalized by this possibility, Israel has gone to great lengths to publicize the U.S. pact. Shortly after it was signed, Israel bought a nine-page supplement in Forbes magazine to promote itself as a "new base for world trade." Major Israeli firms, such as Koor, the giant union-owned industrial conglomerate, advertised their eagerness to enter into joint ventures with American companies.

Selling Israel
With help from the U.S. government, major trade conferences-- like the one that brought Sharon to Washington last October-- have been organized in Israel and the United States. In fact, the U.S. has been almost as active as Israel in selling the agreement. The Commerce Department has set up an Israel Information Bureau, and U.S. officials have travelled the country briefing interested investors.

For the United States, the benefits of the deal are largely political, not economic. Increased trade offers a way to help Israel without adding to the federal budget deficit. And even at a time of heightened protectionist feelings at home, Congress has looked upon Israeli trade with special favor. Both the House and Senate specifically exempted Israel from various import restrictions in the major trade-reform bills they approved last year.

Israeli officials say the treaty now is beginning to show dramatic results, after a disappointing start in its first two years. According to David Litwach, the Israeli trade commissioner in New York, exports to the United States increased by more than 15 percent in 1987.

Most of the increase, Litwach claimed, has been in sophisticated products--like medical instruments and defense electronics-- where Israel hopes to carve out a specialized niche in the world market. Having emerged as a major player in the global arms industry during the 1970s, Israel hopes to repeat that success in other high-tech fields.

While Israeli officials prefer to highlight the possibilities in the civilian market, U.S. officials privately agree that defense-related sales are likely to account for most of the treaty's benefits. For example, Israel recently signed an agreement with General Dynamics that is expected to lead to at least $800 million in sales for Israeli Aircraft Corp. over the next few years.

Getting Off the Dole
Increasing exports has long been a key objective for Israel, which has run a trade deficit every year since the state was founded in 1948. For years Israeli politicians have preached the need for economic autonomy--to end the country's humiliating dependence on U.S. aid, West German war reparations and other sources of outside assistance.

As former Israeli finance minister Yigal Hurvitz put it in a 1985 interview with the Israeli monthly New Outlook: "Independence does not consist of waving the flag or declarations. It is economic strength. It is being able to disagree with an ally and not be dictated to."

That message has taken on added economic urgency in recent years, as Israel has evolved into an affluent Western-style consumer society, with an ever-increasing appetite for automobiles, video cassette recorders and other imported trappings of the good life.

Indeed, the U.S. trade agreement came at a critical moment for Israel, whose already weak economy was ravaged by chronic mismanagement under the conservative government of Likud bloc leader Menachem Begin.

Begin, who came into office promising to challenge the power of the unions and unleash the capitalist sector, ended up pursuing a reckless course of deficit spending in a cynical effort to buy the allegiances of Israel's poor but hawkish Sephardic community.

While the economy grew by only 17 percent between 1978 and 1983, government spending rose by 45 percent. The trade deficit skyrocketed, increasing by more than two-thirds in the first two years after Begin took office.

This consumption orgy continued throughout the early 1980s, despite the heavy drain of the war in Lebanon, the costly settlements in the occupied territories and the rising price of imported oil. In 1983 the Israeli stock market collapsed, and inflation began to spiral into the stratosphere, eventually nearing 500 percent, but the party went on, reaching its peak in mid-1984 as Begin's successors prepared for general elections.

Ironically, it was Begin's arch-rivals in the Labor Party who came to the rescue. Pushed by Labor prime minister Shimon Peres- -nominally a socialist--Israel's shaky coalition cabinet approved an austerity plan that cut subsidies, restrained wages and committed the government to sell off inefficient state-owned industries.

Since that time, the government has moved--despite considerable domestic opposition--to deregulate, privatize and open Israeli markets to foreign competition. As part of the free trade treaty, Israel lifted restrictions on foreign investment, and eased a requirement that U.S. firms "offset" their sales to the public sector by purchasing Israeli goods in return.

In return for these liberalizations, Israel now has unrestricted access to the U.S. market--the largest in the world--a privilege no other country currently enjoys, although a similar treaty with Canada awaits ratification.

Courting Investors
With economic barriers coming down, the Israelis especially hope to attract U.S. investment in the nation's basic industries. While more than 135 U.S. firms currently do business in Israel, (see list, page 24 - omitted here) only a relative few have made significant direct investments in productive enterprises outside of the defense sector.

The Israelis hope to change that, taking advantage of opportunities as they arise. Right now, for example, Israel is going after the semiconductor market, spurred by U.S. restrictions on Japanese dumping. Those sanctions have driven U.S. computer chip prices up sharply, and National Semiconductor, Motorola and Intel are all expanding their Israeli plants, according to Litwach.

Israel has had some other successes in attracting big-name investors. W.R. Grace, the giant conglomerate, recently bought a sizable stake in Teva, Israel's largest pharmaceutical company. News magnate Rupert Murdoch has announced a joint project with a leading Israeli research institute to develop computer security products. An American firm, Isramco Inc., has raised capital in U.S. markets for Israel's unsuccessful oil exploration efforts.

But these individual deals, while widely publicized, have not reversed the continuing stagnation in most sectors of the Israeli economy.

Government statistics show that business confidence in Israel remains weak, with the country suffering a net disinvestment in 1986. According to the American Embassy, direct U.S. investment fell from $855 million in 1985 to $710 million in 1986. And while exports to the United States grew last year, imports grew even more, Litwach conceded. The Agency for International Development estimates that Israel's overall trade deficit widened sharply in 1987, by about $1.7 billion.

U.S. policymakers are watching these trends with growing unease, and have expressed their dissatisfaction with the slow pace of Israel's promised liberalization. At last October's trade conference, conservative economist Herbert Stein, a top advisor to a joint U.S.-Israeli commission set up in 1985 to monitor the reforms, warned the Israelis that painful steps still have to be taken to reassure private investors that Israel has permanently forsaken its socialist leanings.

"You are going to have to tackle some of the big, structural reforms," Stein said. "You have to free the capital markets, keep your deficits down, and privatize."

A Wall Street analyst put it even more bluntly: "You aren't going to go very far if you don't safeguard the rights of investors, including the right to maximize profits."

But such steps are controversial at the best of times in the world of Israeli politics, and even more unlikely now that the Israeli government is immersed in a violent debate over the Palestinian uprising in the occupied territories.

All of which bodes ill for Israel's economic future. If Israel continues its expensive war of occupation in the West Bank and Gaza, U.S. and European firms that have shown an interest in Israel may reconsider. Already, there are signs of trouble. Disturbed by the events in the territories, the 12 EEC nations recently refused to ratify trade agreements that would have extended Israel's privileges to agricultural products and provided a $77 million loan from the European Investment Bank.

A decline in trade and investment would eventually prove disastrous for the Israelis, despite the continuing infusion of U.S. aid. Even more than South Africa, Israel is highly vulnerable to economic forces beyond its control. A go-it-alone strategy is almost sure to fail.

Israel's domestic market, Litwach noted, has "25 percent of the total customers who visit Manhattan every day. We have no choice but to base our economy on international trade."