Israel's Economic Challenges Intensify Amid Postwar Recovery

The economic landscape post-October 7, 2023, represents a shift from prior conditions, with the economy managing military disruptions without suffering a financial crisis, though the government's fiscal flexibility is significantly limited. Persistent structural issues exacerbate the scenario, such as low productivity in some sectors, educational disparities, and low labor force participation in specific communities.

The Bank of Israel estimates that fiscal costs associated with the war will reach approximately 350 billion shekels by 2026, with about half funded through borrowing. Furthermore, the public debt is expected to increase from 60.5% to 68.5% of GDP, while the government deficit stands at 4.7%. A separate analysis by the central bank indicated a shortfall in production amounting to about 177 billion shekels due to the conflict.

Prof. Elise S. Brezis, a macroeconomist at Bar-Ilan University, advises caution regarding the rising debt levels. She noted that compared to many OECD countries, Israel's debt situation is manageable and pointed to stable exchange rates as a sign of market confidence. Brezis posits that immediate action concerning the debt may not be the top priority for the new government.

Recent indicators from the Bank of Israel support this view, showing the risk premium had returned to pre-war levels in September, alongside a tight labor market. Economic activity also rebounded in the second quarter of 2026, although it was partly a recovery from previous disruptions.

Conversely, Adrian Filut, chief economic commentator at Calcalist, presents a more cautious stance. He stresses that the forthcoming government will likely have “very little fiscal room.” His concerns stem from Israel’s geopolitical risks, which require larger fiscal reserves compared to other nations.

Filut emphasizes that the current 70% debt ratio is significant and warns that soaring defense expenditures complicate recovery efforts. Before the war, military spending accounted for about 4.5% of GDP, soaring to approximately 8% by 2025 and expected to remain near 6% into 2026. Even if wartime expenses plateau, defense will still take a larger slice of the economy than prior to the conflict.

The Bank of Israel projects a 2026 deficit of 4.9% of GDP, with possibilities that increased defense spending might elevate it further to about 5.5%, limiting fiscal options. Filut suggests strategies such as increasing tax revenues or re-evaluating sectoral spending to address these challenges, highlighting that tax hikes could adversely affect consumption.

In contrast, Brezis stresses the critical need for investment in education and human capital. She warns that the growing demographic challenges require more than merely increasing employment numbers; workers must possess the skills for higher productivity roles. She supports uniform education across different communities while allowing for local cultural curricula.

Brezis recommends prioritizing education reform and improving public transportation while reallocating budget funds for efficiency. She estimates that changing sector-based funding could yield savings of roughly 20 billion shekels.

Filut concurs that the productivity of the workforce is paramount. He argues that enhancing the skills of workers, particularly in high-demand sectors like technology, is essential for Israel's economic sustained growth.

Both economists agree on the necessity for structural reforms to avert long-term economic issues but diverge on the sequence of policy implementation. Brezis suggests a focus on education and resource allocation, while Filut advocates for a fiscal plan aimed at addressing the debt situation before turning to broader reforms.