After weeks of deadly bombings and naval bombardments in response to Hamas’ offensive on October 7, the Israeli army began a military campaign in Gaza.

In keeping with its pledge to demolish Hamas, Israel has murdered at least 13,000 Palestinians, including more than 5,500 children, and damaged or destroyed up to 51.4% of the buildings in northern Gaza.

Yet, the devastating response and the probably protracted nature of the military operations have had a drastic economic impact, raising the possibility of a systemic risk to Israel as a result of the disruption of businesses, the slowdown of commerce, the cancellation of flights to the nation, and the cessation of tourism.

There is a great deal of political and economic uncertainty ahead, given the fact that the outcome and duration of the conflict remain undetermined and that Israel is losing $260 million every day to the war in Gaza.

“The army has summoned 360,000 additional reservists, around 8% of Israel’s workforce, for the war on Gaza”

Shortages of labour

The labour market has experienced a significant supply shock in Israel’s industrial sector, primarily as a result of tightening limitations on staff availability and mobility.

In addition to its 150,000-strong active military force, the army has mobilised an extra 360,000 reservists, or around 8% of Israel’s workforce, for the battle in Gaza. This is one of the biggest military mobilisations in the history of the region.

Since Israelis over the age of 18 are still required to serve in the military, hundreds of workers are quitting their regular employment to join the front lines. One such division is the 252nd Sinai Division, where the Israeli army reports a 120% reservist turnout rate.

The opportunity cost of workers’ direct contribution to production and declining labour productivity remains equivalent to the employers’ charge, even in the event that the National Insurance Institute reimburses businesses for the benefits paid to employees called up to the reserves.

Additionally, as a result of Israel’s war, some 520,000 working parents are no longer able to work remotely due to inefficiency, the educational system has been closed entirely or in part, and 144,000 workers who were living in evacuated or cleared areas—mostly in Israel’s north and south—have left the country.

Thus, during the first five weeks of the Gaza conflict, the Bank of Israel calculated that the weekly cost of employee absences would equal 6% of the weekly Gross Domestic Product (GDP).

However, as this figure only includes Israeli workers and excludes costs associated with the absence of Palestinian and foreign workers, it does not accurately represent the entire negative impact on the supply side of the labour market.

Indeed, the exclusion of almost 164,000 Palestinian workers from Israel and Israeli settlements is projected to lower productivity in a number of industries, including construction and agriculture.

For example, due to the exclusion or ban of Palestinian labourers, the Israeli agriculture sector lacks at least 15,000 Palestinian and foreign workers. In addition, a large number of immigrants and foreign workers—16.2% of the labour force—have left Israel in large numbers.

The duration and scope of war activities will determine how severe and long-lasting these labour shortages are, but Israel’s economy is now and will remain below its potential real GDP.

Decrease in consumption and demand

An external shock is negatively affecting the absorption of both domestic and imported production in terms of aggregate demand. This has led to a decline in household disposable income and a slump in private consumption of goods and services.

Persistent inflationary pressures in Israel have contributed to this drop in spending, which has been further worsened by the extraordinary acceleration of the Shekel/US Dollar exchange rate devaluation since October 9.

Late October reports said the shekel had fallen to a 14-year low. Simultaneously, Fitch Ratings, Moody’s Investors Service, and S&P issued warnings that Israel’s national debt rating would be reduced in the event that the conflict escalated.

Furthermore, the uncertainty that permeates the area is starting to be reflected in the risk premiums built into bond market interest rates. Due to rising capital costs, declining productivity, and disruptions in the supply chain, this may cause investment to stagnate.

Apart from a decrease in services and consumption and a scarcity of manpower, Israel’s technology industry has been especially affected.

Economists estimate that 10% of Israeli workers are employed in the high-tech industry, which accounts for 50% of the nation’s exports. Numerous youthful, well-educated, and industrious reservists have been called up for duty.

According to this theory, a rise in public spending would make up for the decline in private demand. Depending on how long the war lasts, a fiscal stimulus package might help Israel’s macroeconomic balances.

Bezalel Smotrich, the minister of finance in Israel, published an economic plan last month that called for giving $1 billion in grants to impacted companies. However, there have also been requests to divert money from pro-settler and ultra-Orthodox groups. Smotrich is scheduled to unveil a revised budget.

Discretionary funding of over $4 billion were given to pro-settler and ultra-Orthodox parties in the May budget this year for 2023 and 2024. This included higher stipends for ultra-Orthodox men who choose to pursue their studies over employment or military service.

Additionally, the impact of a projected rise in the military budget needs to be analysed in light of how existing operational expenses and investment expenses for equipment and weaponry procurement are divided.

This is on top of the money the government spends on aid, rehabilitation, and subsidies for businesses and households in general. Given that Israel’s war is expected to get financial support, Israel’s public debt may be comparatively large.

According to some Israeli experts, if the conflict continues for a year, the combined costs might amount to 10% of the country’s GDP, indicating that the dual economic shock on supply and demand could cause an unprecedented macroeconomic disaster for Israel.

The head of Israel’s central bank stated earlier this month that the conflict was more costly than anticipated and a “major shock” to the economy.

The political authorities in Israel remain unsure about their goals and the duration of the conflict, which might have significant short- and long-term effects on the economy.

(Adapted from NewsArab.com)