The Pitfalls of Netanyahu's Idea of Tying Defense Spending to Israel's GDP

Government spending, including expenditures of local governments, has shrunk from 49.9% of GDP in 1995 to 39.1% in 2015, says treasury

Israeli soldiers in the northern Gaza strip, October, 2004.
Uriel Sinai/Getty Images

An idea that Prime Minister Benjamin Netanyahu is considering that would link the country’s defense spending to Israel’s gross domestic product has horrified many of those who have heard about it, as similar ideas have in the past. Israel’s defense spending does in fact take on a life of its own, but with all due respect, one may ask what the connection is between the defense budget and the size of the country’s economy, as measured by its gross domestic product.

Israel’s GDP has been growing at a nice clip in recent years – faster than in many other developed countries. And it should be noted that GDP factors in government spending among other things, so every shekel spent on defense increases the gross domestic product, whether it funds a sophisticated missile interception system that saves lives or is a shekel spent on changing the color of the beret of an army unit.

The demands on the country’s defenses are also growing at a fair clip, at least that’s what the Defense Ministry claims, but still, there is no real connection between these needs and the growth in the GDP. Even when the economy grows at an annual pace of 3.3%, as it did last year, the country’s borders have not gotten longer or shorter, and it has no bearing on the number of planes that the Israel Air Force needs. It also doesn’t affect the range or accuracy of Iran’s Shahab missiles or the stockpiles of the Hezbollah militia’s rockets in Lebanon. Israel may be facing improved versions of these weapons, but not at a pace linked to the growth in our gross domestic product.

Linking defense spending to the GDP would threaten a trend that Israeli governments have pursued for the past 20 years involving a shrinking of government spending as a percentage of the gross domestic product. There are, admittedly, those who argue that Israel has taken the process too far, but it has helped the Israeli economy grow more than twofold between 1995 and 2015 after adjusting for inflation.

Government spending, including the expenditures of local governments in Israel, has shrunk from 49.9% of GDP in 1995 to 39.1% in 2015, the Finance Ministry says. (Since then it has increased by about one percentage point). The dramatic decline was made possible by the steep drop in interest paid on public debt, from 6% in 1995 to 2.3% last year – and by a reduction in defense spending during the same period as a percentage of GDP, from 8.4% to 5.5%. Civilian sector government expenditures, including education, healthcare and social welfare spending, also declined somewhat as a percentage of GDP, from 35.4% to 32.2%.

But the shift in government spending made it possible to devote a greater proportion of the government budget to civilian needs. Between 2007 and 2017, civilian sector public expenditure went from just under 73% of spending to 79%. In 2017, when expenditures were about 500 billion shekels ($137 billion), that increase translated into an additional 30 billion shekels diverted from defense and debt service to civilian expenditures.

The shift in spending helped Israel address problems in the civilian sector, but that era might be behind us. It will be a challenge to continue to reduce the cost of government interest payments in the next few years as interest rates around the world begin to rise and in the face of political pressures to increase the budget deficit.

And when it comes to defense spending, the Finance Ministry, in state budget documents for 2019, said its fiscal restraint depends to a great extent on “government willingness” to meet the constraints of the five-year spending plan worked out between then-Defense Minister Moshe Ya’alon and Finance Minister Moshe Kahlon.

In an interview with TheMarker about two months ago, Yoel Naveh, the Finance Ministry’s former chief economist said civilian sector spending is 32% of GDP. “That’s the right place. We tried to get there for many years,” he said. Increasing civilian sector spending should be shifted from the defense budget and from debt service expenditures, he added. “From 2009 to now, we have managed to reduce defense spending by 0.5% of GDP -- all told, and in recent years it only occurred by virtue of the Kahlon-Ya’alon agreement. Defense spending has remained nearly stable as a proportion of GDP, and there’s no reason in the world for that to happen.”

Naveh said he isn’t calling for a cut to the defense budget in nominal terms, but is calling for the rate of increase to be slowed and for its percentage of the country’s GDP to be cut.

Curbing poverty and inequality, increasing disability benefits, public housing needs, improvements to the educational system, addressing the aging of the population and improving workforce skills all require billions of shekels in civilian spending. Granted that funding for some of these needs can come from future economic growth, but it will be harder to ensure that it is available if a fixed slice of the pie goes to defense spending.