"Israel’s economy is at a highly sensitive point," the Taub Center for Social Policy Studies in Israel’s State of the Nation Report 2025 declares. The reason for that, according to the Taub Center, is the high expenditure on the war that raised the fiscal deficit, the debt:GDP ratio, and the debt servicing burden, and also hit productivity, investment, and private consumption. These factors combine with the structural problems of the Israeli economy that depress the country’s standard of living. The report says that, in order to return to growth, "more than ever a policy is required that supports general growth that particularly includes investment in physical infrastructure and in improving human capital."
The Taub Center researchers, Benjamin Bental and Labib Shami, fear that the high defense expenditure will squeeze civilian expenditure, and thus create a vicious circle. "A lack of growth will worsen the shortage of resources, hurt the necessary public investment, and lower the rate of GDP growth even more. Such a process is even liable to put at risk Israel’s ability to finance necessary spending on defense. Policy setters must be alert to these risks and to the dilemmas they pose."
The report notes that in the decade preceding the war there was a consistent decline in the debt burden, and the impact of the state budget on the economy fell. The recent dramatic growth in defense spending has led to deficits that immediately affect the State of Israel’s debt. The debt:GDP ratio has thus reached 70% this year, ten percentage points above the level before the war, and Israel’s debt burden has grown by NIS 8 billion in a year.
Working more, producing less
In the coming decade, defense spending budget will remain higher than it was before the war and will weigh on the state budget. Up to now, the government has made civilian expenditure keep pace with the growth of the population, but given the expected rise in defense spending, "only accelerated economic growth will allow this trend to continue and prevent severe harm to civilian services."
One way to achieve this, according to the researchers, is to improve Israel’s human capital. Although Israel’s unemployment rate is stable at a low level of around 3%, work productivity is lower than in countries similar in population size and economic structure (such as Austria, Denmark, the Netherlands, Finland, and Sweden). The gaps have narrowed over the years: "between 2015 and 2023 the gap in value added per worker across the entire economy fell from 20% to 12%," the report states, thanks mainly to the complete closing of the gap in information and communications technology.
The researchers stress that technology is the Israeli economy’s engine, accounting for 60% of the country’s exports. They quote figures from the Israel Innovation Authority according to which the technology sector has accounted for 20% of GDP and 40% of economic growth since 2018. Exports of technology services rose from $15 billion in 2013 to $55 billion in 2024.
In the economy as a whole, however, in worker productivity per hour the gap versus peer countries remains wide. "Across the economy, the gap narrowed over those years (between 2015 and 2023) from 36% to 30%; in services it fell by 8 percentage points to 28%; and in industry it remained stable at around 40%. These gaps are explained, among other things, by the fact that employed people in Israel work, on average, about 25% more hours per year than in the reference countries - a ratio that has remained fairly constant over time," the report states
The report also points to the shortfall in capital per worker. "In Israel, capital per worker in the economy as a whole and in services stands at about half the level in the reference countries. According to standard economic calculations, aligning Israel’s capital per worker with that of the reference countries would eliminate the GDP-per-worker gap and about half of the GDP-per-hour-worked gap," it states.
Soaring cost of living
Meanwhile, the researchers note that the cost of living in Israel is soaring. They attribute this to structural problems, and to the strengthening shekel. A basket of consumer products in Israel was about 13% dearer in Israel in 2023 than in five reference countries.
" The study found a long-run gap of about 29% in Israel’s price level relative to the OECD average, stemming from structural characteristics of the Israeli economy. Prominent factors affecting the price level include low competition in parts of the services sector, high operating costs, import restrictions, regulations that make it difficult for new firms to enter the market, and the absence of economies of scale typical of a small and remote economy. Together, these create a higher cost starting point for the Israeli consumer even before exchange-rate effects, and, therefore, Israel’s cost of living has been relatively high compared to other countries for many years," the report states.
Prof. Bental, the co-author of the report who is the principal researcher and economics policy program chair at the Taub Center, said, "If the best scenario materializes, the economy will be able to meet the defense challenge without harm to the civilian services that the government provides. But to ensure growth, the government has to introduce supportive policies, and in particular it has to invest in developing the country’s physical infrastructure and in human capital in Arab and haredi society in order to raise productivity in the economy"
Last week, a report was released by the Aaron Institute for Economic Policy at Reichman University that predicts that, after growth in 2026, Israel will dip below the trend line for economic growth to just 2.5% annually unless the government adopts growth-supporting reforms. That report too mentions physical infrastructure and human capital in the Arab and haredi populations, as well as strengthening of the technology sector, reducing the cost of living, and other reforms.
Published by Globes, Israel business news - en.globes.co.il - on December 29, 2025.
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