A Gloomy Forecast: The Negative Impact of the Gaza War on the Economy Has Become Clear
Medium-range forecasts of Israel's growth – i.e., the next five years – have become gloomier as the negative impact of the Gaza war on the economy has become clearer. Official bodies have cut their forecasts for gross domestic product growth from 2027 to 2030 to between 3 and 3.5 percent a year, compared to an average of 4 percent over the previous decade.
Nevertheless, growth in 2026 is expected to be fairly high – 4.7 percent according to the Bank of Israel and 5.2 percent according to the Finance Ministry – because in 2026 the economy is expected to make up for the decline in activity over two years of war.
According to the Finance Ministry's medium-range forecast, growth of 3.5 to 3.7 percent is expected from 2027 through 2029. But it's quite likely that this forecast will be revised downward.
The Bank of Israel doesn't release medium-range forecasts. But its last annual report predicted that "the war is expected to have significant medium-term implications ('scars') on the Israeli economy.
"Defense expenditures are expected to increase relative to their prewar levels; the military will expand; it will be necessary to reduce the debt-to-GDP ratio – which has risen – to once again create fiscal space; the risk premium may remain high; the economy will have a lower international credit rating than before the war and [there will be] extensive expenditures on rehabilitating conflict areas and ongoing care for the many war casualties. All these are expected to have a negative impact on the economy's growth potential."
A long-term impact
A drop in Israel's growth potential from 4 percent a year to between 3 and 3.5 percent, that is, a permanent loss of 0.5 to 1 percentage points in growth potential, will have a dramatic cumulative impact over the long term. If Israel remains at this moderate rate of growth for a decade, then at the end of the decade, its GDP will be 5 to 10 percent lower than it would have been if there had not been a war.
In terms of shekels, this means a GDP loss of between 100 billion and 250 billion shekels within a decade ($30.5 billion to $76.1 billion). In terms of per capita GDP, this means that every person in Israel will produce or earn between 8,000 and 16,000 shekels less every year.
This gloomy forecasts bring to mind the impact of the 1973 Yom Kippur War on Israel's economy. That war gave birth to what is known as the "lost decade" – a decade of low growth, heavy debts and raging inflation. At the end of that decade, Israel was on the brink of bankruptcy, and only the Economic Stabilization Plan of 1985, coupled with the tailwind produced by the peace agreement with Egypt, enabled it to extricate itself.
Now, too, there are serious fears of long-term negative economic effects of the war that began on October 7, 2023, though on a far smaller scale than after the Yom Kippur War. The biggest negative effect stems from the absence of the roughly 2,000 people who were killed. The vast majority of them were young people who would have been expected to contribute to Israel's growth over the course of their lives.
Alongside the dead, there are 20,000 wounded under the care of the Defense Ministry's rehabilitation department, the vast majority of whom are also young, plus another 80,000 wounded under the auspices of the National Insurance Institute. That adds up to 100,000 currently, but the rehabilitation department predicts that by 2028, that number will have risen to 120,000, mainly because of people whose mental health will have suffered over the long term.
The contribution made by the wounded to the GDP will naturally be significantly lower than their potential. Moreover, one person's injury often reduces his family's earning capabilities.
Due to all of the above, the economy is estimated to have lost roughly 1 percent of its work force due to the war. And on top of that, outlays on medical treatment and benefit payments are likely to soar by about 6 billion shekels a year for the rehabilitation department and 2 billion shekels a year for the NII.
Conditional optimism
Another negative effect of the war is the increase in defense spending, which isn't expected to subside even though the war has ended. The defense establishment wants its share of the 2026 budget to be 6.3 percent of GDP, up from 4.2 percent in 2022. And in the years following that, it believes its budget should not drop below 5 percent of the GDP.
This means that over the medium term, defense spending as a proportion of the GDP will be 1 to 2 percentage points higher than it was before the war. And that increase will come at the expense of investments that contribute to economic growth.
But even a defense budget of 5 to 6 percent of the GDP is immeasurably lower than defense spending during the "lost decade," when it soared to between 25 and 30 percent of the GDP, according to Prof. Joseph Zeira, an economist at Hebrew University. From this standpoint, the economic impact of the war in Gaza will be far more modest than that of the Yom Kippur War.
Nevertheless, all of the above is conditional on the optimistic assessment that the war has ended and that there will be no additional flare-ups on any of the fronts – Gaza, Lebanon, Iran or the West Bank. An escalation in the West Bank, for instance, would require calling up a huge number of reservists, which would once again increase defense spending and reduce GDP because of their absence from the labor market.
Another negative impact of the war on Israel's growth potential is the reputational harmthe country has suffered overseas, which shows no sign of ending even though the war is over. Over the past month, there have been continued reports of shows of contempt for Israel around the world. One manifestation of this is the meme "spiritually Israeli," which is being attached to anything negative, hypocritical or embarrassing on social media.
It's necessary to qualify here, that it's difficult to quantify the impact of reputational harm on Israel's economy. This isn't just because that harm has so far had almost no impact on export data, but also because it isn't clear whether Israel's negative reputation will remain or subside. The increase in Israel's risk premium on capital markets due to the war, for instance, has already almost vanished.
Another danger mentioned in recent weeks is what appears to be an escalating wave of emigration from Israel, primarily by people with academic degrees – or in other words, human capital that is valuable to the economy. But even though emigration has surged over the last two years, its impact still seems negligible.
The Bank of Israel estimated that 4.7 percent of Israeli productivity has been lost due to the war – a loss of over a year of growth. Although with the end of the war there's hope for recovery it estimates that not all of the deficit accumulated by Israel will be made up. And if the growth rate falls below its prewar level, a large part of the loss of productivity won't be replaced.
The blow to the economy due to the war is compounded by obstacles that undermined growth even earlier. The three main issues weighting down the economy are the low employment rates in ultra-Orthodox society, and the low productivity of the Haredim who do work (an issue compounded by the fact that this population has the highest growth rate in Israel); the Israeli school system's poor achievements, as reflected in international exams; and Israel's major infrastructure deficiencies.
On the other hand there's the great hope of artificial intelligence. If Israel can recreate its success in data communication and cybersecurity in AI as well, the gloomy forecasts regarding growth in the medium term could be wrong.
Despite the hope that AI brings, the price the economy will pay because of the war is unavoidable. At the moment, the economy is headed toward a substantial decline in the growth rate. But that level of decline isn't predestined.
It's impossible to bring back the dead or to make the wounds disappear, but it is possible to offset the negative effect by dealing with the problems weighing down the economy. Reforming the school system, a huge investment in infrastructure, and mainly integrating the Haredim into the job market – all these would restart the economy's growth engines, and enable it to renew the trajectories of its historic growth and even to exceed them.
All these require a government with an ability to act, and mainly with a willingness to confront Haredi society, and the refusal of Haredi men to study the core curriculum or to work.