The Gaza War: An 'External Shock’ That Wrecks Israel’s Economy, Too

If Operation Protective Edge morphs into a war of attrition, Jerusalem may have to take special steps to get people spending.

Gil Cohen-Magen

Even without knowing much about economics, the typical Israeli understands what happened to the economy during the four weeks of Operation Protective Edge. In the south, and later in the entire country, people stopped going to stores and restaurants. Tourists fled.

Large companies stopped advertising and offering deals. Amid the heightened uncertainties and fears, people postponed large purchases especially. Sales of cars and luxury goods — actually just about anything that costs a lot — stopped happening.

This was the case with real estate too, but also because of the wait for Finance Minister Yair Lapid’s zero-VAT plan on inexpensive new apartments. And with the drop in revenues, the treasury has suffered a drop in tax collections.

In economics textbooks, Israel is undergoing an “external shock,” though this time it’s not a financial crisis, a jump in oil prices or the bursting of an asset bubble. But the result is the same: a sudden plunge in aggregate demand.

During the U.S. financial crisis of 2008, for example, the shock was caused by collapsing housing prices and the many mortgages “underwater” — the value of the home was less than the debt on the rest of the mortgage. All this ruined the savings and equity of millions of American households — especially of the less well off.

The result was similar to that in Israel now: People stopped spending and the economy froze. That’s also what happened at the beginning of this year in the United States, though that external shock was much smaller. The particularly cold winter was marked by blackouts that kept people at home and out of the malls.

So what are the damages from the external shock of Operation Protective Edge? So far economists have refused to provide estimates, as the operation is still under way, even if appears to be winding down. The Finance Ministry’s only serious numbers are on the Gaza offensive of the winter of 2008-09 and the Second Lebanon War in 2006. But of course those were different campaigns; this time the fighting might not end entirely.

Preliminary estimates by the State Revenue Administration point to a 4.5-billion-shekel ($1.3 billion) drop in gross domestic product during Operation Protective Edge — up to the end of July only. As a result, tax revenues are expected to fall by hundreds of millions of shekels in the coming months. But such estimates are conservative by nature; no one will be surprised if the actual numbers for lost production are much higher.

True, in previous military operations the economy returned to speed within a quarter or two, but the current external shock is particularly shocking. Official pronouncements like “the economy will overcome the war with no problem” are largely attempts to calm people down.

Plenty of handy tools

So what can Jerusalem do about the steep drop in consumer demand? In general, the immediate response of governments and central banks is to release the monetary brakes — to inject cheap money into the economy. The idea is that if people have cash in hand, or access to low-cost credit, they’ll be more willing to spend again and restart the economic engine.

This is the reason the Bank of Israel lowered interest rates last week. But in doing so the central bank shot its next-to-last bullet, since its main interest rate is now only 0.5%. The Bank of Israel can lower rates once more, by another quarter of a percent, but that’s it. After that Israeli interest rates will be in line with those in the United States, Europe and Japan, where rates are zero to 0.25%.

Then what can be done if demand still refuses to awaken? Governments have a further series of tools. One is the program that harks back to 2008, still the days of U.S. President George W. Bush: tax benefits for low- and middle-income earners, as well as breaks on mortgages. The total cost was around $160 billion for 2008.

In 2009, Barack Obama signed a much larger program with the declared goal of creating jobs and providing temporary help to those hurt worst by the recession. The total investment for Obama’s program is expected to reach $831 billion over 10 years. It included direct spending on projects in areas such as infrastructure, health care, education and energy, along with the expanding of unemployment insurance and the social safety net.

Did it work? At least among leading American economists there’s no doubt it did. In a recent survey of economists, all 37 but one said the program reduced unemployment and spurred the economy. The ratio of economists was 25:2 on whether the program’s high price was justified.

The other major tool that the United States has used to spur demand is the famous one: printing money. In a series of monetary actions known as quantitative easing, the U.S. Federal Reserve bought trillions of dollars worth of bonds in the open market — using money it conjured out of thin air. But the goal was the same: to lower yields on bonds and make keeping money in the bank unprofitable — and in doing so get people shopping and businesses investing.

The Europeans, including the British, have done similar things — though with their own variations. For example, the European Central Bank favored investment and has still not massively bought bonds, but many think the ECB will be forced to use this tool sooner or later. Japan and Britain already have.

The American way

As of today, at least based on the consensus of economists, the efforts in the United States appear to have worked. There is broad agreement that the steps taken by the government and the Federal Reserve have saved the United States from another Great Depression. Unemployment has fallen significantly, the economy grew in the last quarter by a healthy rate, and the Fed is gradually tapering its bond buying.

All these steps have a very high price — a rise in national debt, bubbles in financial markets and worsening inequality are only a few. Still, the consensus is that these costs are justified when compared to the alternative of a long depression.

In light of Israel’s external shock and the drop in demand, the Bank of Israel and Finance Ministry are probably thinking what to do if Israelis continue to keep their wallets closed. If Operation Protective Edge ends in the not too distant future and the security situation quiets down — at least if it seems that way — the government will wait. It will hope the economic scenarios from after Operation Cast Lead and the Second Lebanon War repeat.

It’s already clear that the figures for 2014 will be disappointing, with no improvement over 2013. But it’s still possible to hope that 2015 will be rosier, especially amid forecasts that next year will be better for the global economy.

Still, if the current operation turns into a war of attrition and consumers don’t feel secure, and if Ben-Gurion International Airport has to shut down occasionally, the external shock and the drops in aggregate demand and consumption will require different treatment. We’ll start to hear about government plans to stimulate the economy, print money in various and sundry ways and raise funds from Jewish communities overseas. And we’ll see those ad campaigns to buy Israeli-made goods.

We should hope we never reach that stage. It could be proof that the economy has entered a crisis that can’t be solved in the short term. Or it could provide a golden opportunity for the ruling elites and other interest groups to sweep away Israel’s social reforms that threaten them — and their control of the economy.