Israel's Defense Industry Fears Fallout From Increased U.S. Aid

Washington conditioning more assistance on eliminating allocations for Israeli firms.

Alon Ron

Israel’s defense industry is bracing for hundreds of millions of lost revenues as part of the price the government is prepared to pay for getting an enlarged package of U.S. defense aid.

Executives warn that the terms being discussed right now between American and Israeli officials could mean a loss of at least $800 million in sales to the Defense Ministry, now paid with U.S. aid money, and could reduce funding local companies get for joint projects like the Arrow missile, which has a budget of $500 million annually.

It could also force companies to shut down production lines in Israel and move them to the U.S. where they would qualify as American companies entitled to a share of the U.S. largesse. Research and development teams might follow, warned defense industry sources, who asked not to be identified.

That could render Israel short of arms-manufacturing capabilities in time of war when air and sea routes are shut or a country imposes an embargo on weapons shipments.

“The Defense Ministry doesn’t understand the needs of the economy, just the imperatives of national security,” said one source. “It sees itself getting another $500 million for the budget and nothing else interests it, but we in the defense industry stand to lose $1.2 billion to $1.3 billion a year, including the $500 million Congress has allocated for special projects.”

At issue is an American offer to boost annual military aid to Israel to between $3.8 billion and $4 billion annually for 10 years, starting in 2017, from the $3.1 billion it provides now. Under the current aid package, Israel can convert up to 26% of the aid to shekels and spend it with domestic defense contractors.

American negotiators, however, are conditioning the increase on the shekel allocation being eliminated. Sources said Washington is offering either a seven-year grace period before the shekel allocation ends or a phased in reduction that would start earlier.

Israel would have the right to award contracts with the aid as it sees fit in the United States, so that Israeli companies that incorporated subsidiaries’ in America could qualify. In fact, many, like Elbit Systems, already have extensive U.S. operations in order to qualify for defense procurement contracts from the U.S. government, but they would have to expand those operations at the cost of local production and employment.

As it is, Israel’s budding defense trade with India has forced Israeli companies to move production to India as a condition for winning contracts, which has cost hundreds of local jobs.

The impact of eliminating the shekel allocation could be exacerbated if the U.S. insists, as many in the defense industry fear, on trying to end another practice: Until now, Israeli contracts to American defense companies are conditioned on the U.S. company buying goods in Israel valued at as much as half the cost of the contract.

Ending this practice could cost hundreds of millions of dollars more in lost revenues, Israeli sources said.

“If Lockheed Martin or General Dynamics doesn’t buy in Israel, that could be very significant,” said another defense source. “We’re talking about hundreds of millions of dollars, most of which goes to the defense industry.”

He pointed to the history of the Merkava armored personal carrier, much of whose production has moved to the United States in recent years, hurting some 200 Israeli contractors and subcontractors. “While it didn’t lead to any factory closing, it did shrink production lines and that led to layoffs,” he said.

Industry sources said the biggest losers from loss of American aid money would be the state-owned defense companies Israel Aerospace Industries, Rafael and Israel Military Industries. But other warned that 100 smaller companies would be hurt the worst and that many of them would have to shut down.

One industry source said he is hoping that Israel will agree to take a smaller enlarged aid package of $3.75 billion in exchange for Washington backing off on eliminating the shekel allocation. Officials have told a worried industry that, even if Israel agrees to it, the terms can be renegotiated later.

“The source said Israeli officials had told him in effect: “In another five years there will be a change in the administration and we can come to the Americans to propose amending the section on Israeli procurement, which in any case isn’t supposed to go into effect for another seven years.’” But, added the defense ministry source, “I don’t think we can count on that.”