Israel Must Invest More in Its Periphery

Without integrating regional centers in the north and south into the core economic dynamics of knowledge-based capital exports and growth, the costs of neglecting regional development will only worsen.

Seven years after the Second Lebanon War, the regional economic inequalities that made the Galilee look like an easy target have not changed.

The litany of unsustainable regional gaps have widened since 2006:  unemployment and poverty run are nearly double in the Galilee compared with the center of the country; average income runs about 40% behind the center; and lower income communities are almost twice as concentrated throughout the region as elsewhere.

With all the billions of emergency funds raised in the war’s aftermath, precious few of those dollars made their way into sustainable economic development projects that might have strengthened the north.

Most of the philanthropic emergency funds raised by Jewish communities abroad, as the state comptroller later reported, simply found their way into bridging the budget deficits of local authorities perpetuating the existing fiscal dysfunction and lackluster growth of the north compared to the overall economy.

In short, Israel’s economic growth remains inadequate and unequal to bridge widening regional gaps that marginalize millions of Israelis in a country that cannot afford to have a “periphery.”

The price of that regional inequality reduces aggregate growth and threatens Israel’s global competitiveness. The national security consequences, even if ignored within Israel, are not missed by others.

The Second Lebanon War with Hezbollah in 2006 was followed by similar rounds of missile wars with Hamas in 2008-2009 (Cast Lead) and most recently last November (Pillar of Defense) that temporarily shut down large parts of southern Israel. While cheap as far as wars go (a 0.7% loss in GDP in 2006 and a 1.5% loss in 2009, according to the Bank of Israel - with those losses made up in later quarters), this pattern of attacks signal an increasingly serious structural threat to Israel’s economy and national security. This threat, first demonstrated in the Second Lebanon War, related directly to the lack of economic participation and regional integration by a third of the country’s geography and 20% of its population.

Without integrating regional centers in the north and south into the core economic dynamics of knowledge-based capital exports and growth, the opportunity costs of neglecting regional development will only worsen. Josephus Flavius, writing about the difficulties faced in mounting a defense against the Romans in the Galilee in the 1st century B.C., noted the regional gaps between “wealthy cities” and “poor towns and villages” - the earliest recognition of center-periphery gaps in the Ancient Judean province. Apparently regional disparities have never worked out very well for maintaining a unified nation in Israel.

The context is unsettling - Israel finds itself increasingly surrounded by failed or semi-failed states with increasing numbers of rockets that over the past seven years have been launched with alarming frequency through a multilateral war of attrition on Israel’s northern and southern regions. The targeting abilities and range of these missiles is not getting worse. Meanwhile, underinvestment in those regions increases their economic and ultimately political vulnerability, resulting in outmigration and creating a spiraling cycle of decline. While there have been positive increases in public infrastructural investments for much needed transportation links, enormous challenges for economic development in the Galilee remain unaddressed.

Choke holds on capital access exist in Israel’s regions, cutting down on sources of new growth in technology clusters, environmental projects, tourism development, and manufacturing.

Overall, bank credit has declined steadily since 2006. Institutional credit is increasing as a share of the overall credit market, but regional projects have no access to that market. Small and medium-sized businesses also have no channels of capital access to institutional investors in Israel for long-term capital needs. A generation of Israeli economists from Daniel Felsenstein at Hebrew University to Dafna Schwartz at Ben-Gurion University has demonstrated how decision-rules of financial institutions discriminate against small-scale entrepreneurship in peripheral regions of the country. Without locationally targeted programs, the information asymmetries about risk profiles of regional projects and firms make them unattractive to investors, and the potential economic growth is aborted.

Regional economic development projects have limited access to long-term, competitively priced credit. Funding is fragmented and limited from government and philanthropic sources. How do we bridge these capital gaps? We need to carve channels of capital from local and global institutional investors and leverage government and philanthropic capital to provide long-term financing for a full range of small and mediums sized business, environmental, tourism and new industrial projects.

We’ve identified an array of technology, manufacturing, environmental infrastructure and tourism/cultural development projects that will benefit from this public-private (both for-profit and philanthropic) partnership that can be launched that will provide enormous returns both financially and socially to these underserved regions. Only by weaving together new regional centers in the north and south will Israel’s core economy strengthen. Without a platform to finance the future of Israel’s regions, the centrifugal forces of outmigration, capital flight, and declining competitiveness will ultimately confirm the economic principle that Yeats poetically warned of: “things fall apart; the center will not hold.”

Glenn Yago (senior director) and Steve Zecher (director of project finance and regional development) are at the Milken Institute’s Israel Center, which will soon release its report and model for a regional development finance initiative for Israel regions.

Yaron Kaminsky