Israel’s economy is struggling. Economists say ending the war would help

JERUSALEM (AP) — In Jerusalem’s Old City, nearly all souvenir shops are closed. In Haifa’s flea market, forlorn merchants polish their wares on empty streets. Airlines are canceling flights, businesses are failing and luxury hotels are half empty.

Nearly 11 months into the war with Hamas, Israel’s economy is struggling as the country’s leaders grind ahead with an offensive in Gaza that shows no signs of ending and threatens to escalate into a wider conflict.

Prime Minister Benjamin Netanyahu has tried to allay concerns by saying the economic damage is only temporary. But the bloodiest, most destructive war ever between Israel and Hamas has hurt thousands of small businesses and compromised international trust in an economy once thought of as an entrepreneurial dynamo. Some leading economists say a cease-fire is the best way to stop the damage.

“The economy right now is under huge uncertainty, and it’s related to the security situation — how long the war will go on, what the intensity will be and the question of whether there will be further escalation,” said Karnit Flug, Israel’s former central bank chief who is now the vice president of research at the Israel Democracy Institute, a Jerusalem think tank.

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The war has inflicted a far heavier toll on Gaza’s already broken economy, displacing 90% of the population and leaving the vast majority of the workforce unemployed. All banks in the territory have shut. The fighting has killed more than 40,000 people, according to Palestinian health officials in the Hamas-run territory. Their count does not distinguish between civilians and combatants.

The fighting in Gaza and daily attacks from Hezbollah militants in Lebanon have also driven tens of thousands of people from their homes along Israel’s northern and southern borders and caused large-scale damage.

The Israeli economy has recovered from previous shocks, including shorter wars with Hamas. But this longer conflict has created a bigger strain, including the cost of rebuilding, compensating families of victims and reserve soldiers, and vast military spending.

The drawn-out nature of the fighting and the threat of further escalation with Iran and its Lebanese proxy, Hezbollah, have an especially harsh impact on tourism. Though tourism is not a major driver of the economy, the damage has hurt thousands of workers and small businesses.

“The hardest thing is that we don’t know when the war will end,” said Israeli tour guide Daniel Jacob, whose family is living off savings. “We need to finish the war before this year’s end. If it’s another half a year, I don’t know how long we’re going to make it.”

Jacob, 45, returned in April from six months of duty as a reserve soldier to find out that business had dried up. He was forced to shutter the tourism company he spent two decades developing. His only income is aid from the government, which pays him half his prewar salary every few months.

Meir Sabag, a Haifa antiques dealer whose shop sat empty, said business is worse now than during the COVID-19 pandemic.

On a recent weekday, the formerly bustling port of Haifa, a major hub of Israeli import-export where massive container ships would often stop, was still.

With Yemen’s Houthi rebel group endangering ships passing through Egypt’s Suez Canal, many long-haul ships have stopped using Israeli ports as hubs, said a port official who spoke on the condition of anonymity because he was sharing internal information.

He said Israeli ports saw a 16% percent drop in shipping in the first half of the year, compared with the same period in 2023.

The war began on Oct. 7, when Hamas militants killed some 1,200 people and took 250 people hostage.

Renewed U.S.-led cease-fire efforts appear to be sputtering, and Iran and Hezbollah have threatened to avenge the recent assassinations of top militant leaders, raising the threat of a wider regional war. These fears have prompted major airlines, including Delta, United and Lufthansa, to suspend flights in and out of Israel.

Yacov Sheinin, an Israeli economist with decades of experience advising Israeli premiers and government ministries, said the total cost of the war could amount to $120 billion, or 20% of the country’s gross domestic product, a broad measure of economic activity.

Of all 38 member countries in the Organization for Economic Cooperation and Development, Israel’s economy underwent the biggest slowdown from April to June, the organization reported Thursday. The Israeli GDP was projected to grow 3% in 2024. The Bank of Israel now predicts a growth rate of 1.5% — and that’s if the war ends this year.

Fitch downgraded Israel’s rating from A-plus to A earlier this month, following similar downgrades by S&P and Moody’s. The downgrading could raise the government’s borrowing costs.

“In our view, the conflict in Gaza could last well into 2025,” Fitch warned in its rating note, which cited the possibility of “significant additional military spending, destruction of infrastructure and more sustained damage to economic activity and investment.”

In another worrying sign, the Finance Ministry this month said the country’s deficit over the last 12 months has risen to over 8% of GDP, far exceeding the 6.6% deficit-to-GDP ratio the ministry projected for 2024. In 2023, Israel ’s budget deficit was roughly 4% of its GDP.

The downgrade and the deficit have increased pressure on the Israeli government to end the war and reduce the deficit — something that would require unpopular decisions such as raising taxes or cutting spending.

But Netanyahu needs to keep his coalition afloat, and his hard-line finance minister, Bezalel Smotrich, wants the war to continue until Hamas is decimated.

Flug, the former central bank chief, said the situation is unsustainable and that the coalition will have to cut back on spending, such as unpopular subsidies to ultra-Orthodox schools that are perceived by the broader public as wasteful.

“The public will have hard time accepting it if the government does not show that the severity of the situation forces them to give up some of the things that are dear to them,” Flug said.

Smotrich said Israel’s economy “is strong” and vowed to pass a “responsible budget that will continue to support all the needs of the war, while maintaining fiscal frameworks and promoting growth engines.”

The unemployment rate has dipped below pre-war levels, Sheinin said, to 3.4% in July compared with 3.6% in July of last year. But when taking into account Israelis forced out of the labor market, the figure rises to 4.8%, a figure that would still be considered low in most countries.

Meanwhile, many small businesses have closed because their owners and employees were called up for reserve military duty. Others are struggling amid the broader slowdown.

Israeli business information company CofaceBDI reports that some 46,000 businesses have closed since the start of the war — 75% of them small businesses.

Even Jerusalem’s iconic American Colony hotel, a popular stop for politicians, diplomats and movie stars, has laid off workers and is mulling pay cuts, said Jeremy Berkovitz, who represents the owners.

“We did consider at one point closing for a few months,” said Berkovitz “but of course that would mean sacking all the staff. It would have meant letting the gardens, which we’ve developed over 120 years, go fallow.”

Sheinin said the best way to help the economy bounce back would be to end the war.

“But,” he cautioned. “If we are stubborn and continue this war, we will not recover.”

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This story corrects the name of the economist to Yacov Sheinin instead of Jacob Sheinin.

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