Israel has been fighting not one, not two, but three expensive wars. It was spurring thousands of reservists into the military, shutting out Palestinian construction workers, evacuating thousands from the country’s north, and this combined with huge drops in foreign investment and tourism Israel was already putting a massive strain on its economy. This is causing government debt to go through the roof.), which in turn prompted the former chief economist of Israel’s own finance ministry to write that
“Israel faces a looming financial crisis if it fails to act”
So could it be that, despite not completely crushing Hezbollah in Lebanon, Netanyahua former security advisor was right when he recently said about the ceasefire that:
“Israel cannot afford another year of war” at its current scale in the north.
That question can only be answered if we understand the concept of
1 The war economy
In contrast to a ‘normal’ civilian economy, which should be about making civilians more wealthy, a war economy is about how to best mobilize a country’s resources to aid the war effort.
For me the best way to think about these two concepts is to see them as two extremes on a scale. On the left, you’ll find a country without an army like Bermuda. And, on the right, you’ll find countries that are fighting for their very survival, or for total conquest, like Ukraine or Russia. Most other economies, which do support standing armies in case a war breaks out, are somewhere in between.
This framework can help answer the question what level of fighting a country can actually ‘afford’ by thinking about three distinct variables needed to fight a war: resources, money & political capital.
So, to find out what Israel can and cannot afford, let’s first talk about its
2 Resources
After all, a war economy is about mobilizing RESOURCES to fight a war. Resources could roughly be divided into three categories: manpower, military technology, and raw materials.
Does Israel have enough of each of these resources to afford to keep fighting?
First, when it comes to manpower, Israel’s position looks really good on paper. It is the only rich country in the world right now that has a relatively young population. On top of that, its population is still rapidly growing thanks to high fertility and lot’s of Jews all over the world still migrating to Israel.
However, even a growing population may potentially not be enough to fight these three wars all at once, as there are lot’s of reports that both the army and civilian sectors of the economy cannot find enough skilled workers. The reasons for Israel’s shortage of manpower are threefold. First, Israel’s civilian economy was already near full employment when the war started.
Therefore, every reservist employed to fight in Gaza and now Lebanon is a productive worker lost in the civilian economy. This shortage is already causing wages and prices to shoot back up after the Covid inflation spike.
The second reason is that Israel’s economy depended for a large part on Palestinian migrant workers, both from Gaza and the West Bank. These workers have increasingly been denied access to Israel due to security concerns, adding to worker shortages, especially in the construction sector. Thirdly, while Israel’s demography looks amazing on paper, it is actually much worse in practice given that 12.9% of it consists of ultra-orthodox Haredim Jews. A segment that, despite a recent ruling, still doesn’t serve in the army much AND works much less than the general population because they get a stipend from the government to study religious texts. Thus, you could argue that the ultra-orthodox in Israel are like the elderly in other economies. They mostly collect benefits without being productive. So, despite looking good on paper, Israel’s economy, in its current position on the war economy scale, is already struggling to support the war effort, at least when it comes to manpower resources.
For military technology and raw materials the story is completely reversed in the sense that here Israel looks weak on paper while being strong in practice. Being a small country, Israel only has limited access to raw materials and, even for military technology, where Israel’s firms are really strong, the tiny country still relies a lot on US and other Western technologies.
However, in a modern economy you don’t need to have all of these resources yourself. What matters is that you have access to international markets to complement your own resources with foreign resources. But, to asses whether Israel can do that, we need to talk about the second variable that determines whether Israel can afford to keep fighting which is
3 Money
In a modern economy, money is about whether or not you can actually MOBILIZE the resources you need to fight.
Here, I think it is crucial to make the distinction between mobilizing national and international resources. To mobilize international resources, you need the global reserve currency: the US Dollar. US Dollars can be obtained in three ways. The first is by exporting more than you import. The second is by borrowing. And the third, which just so happens to be very important to Israel, given that it is the biggest recipient of US aid ever, is by getting Dollars gifted to you, preferably by a sugar daddy that just so happens to issue the global reserve currency.
But, even if it wasn’t for US aid, Israel is currently just not constrained by access to US Dollars. It has relatively low international debt and can borrow at relatively low costs. But, right now, it doesn’t even need to because it exports way more than it imports thanks to its massive tech sector.
As a consequence, Israel has a massive war chest filled to the brim with US Dollars. This means it still has plenty of room to buy additional raw materials and technology if it wants to keep fighting.
Similarly, with low government debt, and, globally speaking still pretty low inflation, mobilizing local resources by borrowing or issuing currency may not seem like a constraint either. However, to me, reports of manpower shortages everywhere combined with rapidly rising inflation in Israel, while it is falling everywhere else, shows that, while Israel has enough money, it arguably already cannot afford to fight 3 wars on the scale that it is currently doing.
Sure, Israel can attempt to mobilize more people to fight its war. But, given that it has already roughly reached full employment this will only increase inflation.
Therefore, I’d argue that, if we want to know whether Israel can actually afford to keep fighting, we should be asking:
4 Does Israel have the political capital to keep fighting?
In fact, I’d argue that in most wars, whether a country can afford to keep fighting is ultimately not about resources and money, it is about whether a country is willing to bear the economic consequences of depleting some of its money and resources.
For example, the U.S. had more than enough resources and money to keep fighting in Vietnam. But, many economists have argued that excessive Vietnam war spending ultimately caused inflation to get out of control and governments spending to be diverted from social programs for the poor in America to the war in Vietnam. These two economic consequences —increased inflation and lost prosperity— were politically so costly that it likely contributed to making the war unpopular enough for politicians to finally pull the country out of Vietnam, losing the war.
On the other side of the spectrum, in 2022, many analysts predicted Russia’s sanctioned economy would not be able to support a long war. Indeed, while Russia was still somewhat in ‘civilian economy mode’ at the start of the war, the Russian Ruble collapsed and inflation shot through the roof. However, the Russian government responded by militarizing the economy. This involved, amongst other things, taking away people’s freedom to transfer money across borders and raising interest rates to quell inflation. But, because people cared less about transferring money across borders than inflation, Russia’s actions reduced the political cost of the war, allowing it to keep fighting much longer. Of course, Russia did much more than that, such as subsidizing interest rates for ordinary people, and increasing the oppression of political dissent. But, the point remains that by moving on the scale towards a militarized economy, Russia could afford to keep fighting much longer than many had expected.
So, how can Israel militarize its economy further to overcome its manpower constraint? There are at least three solutions to solve this problem. All of them come at a political cost.
First, Israel could spend more on military salaries, compelling more Israeli’s to join the army. If nothing else is done, this would increase inflation, which is politically costly. However, if Israel combines increased spending with inflation fighting measures, such as higher interest rates, capital controls, price controls or a combination of these. The economic cost could come in the form of reduced freedom and wealth for Israeli’s instead, which may be politically less costly.
A second option would be for Israel to cut government spending on social programs while forcing people to join the army through expanded conscription. In this case, spending cuts would limit inflation. But, similar to the option of increased spending with very high interest rates, this option would damage Israel’s economy quite severely, which may also be politically unpopular.
Finally, in this specific case, I believe there is also a third option. An option in where the economy does not suffer in terms of inflation or lost GDP. Instead, Israel could take away benefits and exceptions for the ultra-orthodox completely. This option could leave Israel’s economy largely untouched, and would reduce inflation. However, of course, there will still be a political cost, as it will anger the ultra-orthodox community, which are an important voting block.
So, armed with this final lens of evaluating Israel’s war economy, we have arrived at a
5 Conclusion
Could Israel afford to keep fighting? Or was the economic reality simply that a ceasefire was the only option? If we apply the concept of the war economy, we see that, because Israel’s economy was under massive strain due to manpower constraints, it could only afford to keep fighting by turning it’s economy more and more into a war economy. This could take many forms. But, all of them would have had major political costs.
Could Israeli society have tolerate these costs? Nobody knows for sure. But, given that recent opinion polling showed that only 53% of Israeli’s believed the government was doing a good job, I think it is plausible that Netanyahu wagered that the political costs to keep fighting were just too big, taking into account how much manpower would be needed to control Lebanon compared to Gaza.
This concludes my economic analysis of a deeply controversial topic. While this war is about so much more than economics, I’ve approached it from an academic economic perspective, rooted in facts first and not expanding the analysis to areas that I am not trained in—an approach many of you said in a recent survey that you value.
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