Israel's Economy Shows Resilience Amid War But Faces Long-Term Challenges

Three years after the October 7, 2023, events and subsequent conflicts, Israel's economy has demonstrated a remarkable capacity to withstand the burdens of war, enabling sustained military operations. This resilience, however, has come at a significant cost, including a sharp rise in security spending, increased public debt, and a widening budget deficit, limiting the government's financial maneuverability. The growing allocation to defense has gradually shifted budget priorities, diverting resources from civilian sectors and long-term investments toward military needs.

Despite these challenges, the Israeli economy has adapted, with its military, security, and high-tech industries playing a crucial role through exports, economic activity, job creation, and tax contributions. Israel has long viewed its economy as integral to its national security and strategic resilience, aligning its structure and policies accordingly. The expansion of technology, services, advanced industries, and military sectors has enhanced its ability to maintain economic activity during prolonged conflicts and extensive military mobilization, albeit with substantial financial and economic costs.

This assessment is highlighted in the National Security Index, October 2026 report by the Institute for National Security Studies (INSS). The report's chapter on "Economic Strength: Remarkable Resilience and Future Challenges" positions the economy as a cornerstone of national security. It notes that the economy's ability to continue functioning and maintain financial stability during the extended, multi-front war has been vital in funding the war effort over the past three years, while emphasizing that this resilience was achieved at a steep cumulative price.

The INSS report identifies a paradox in the Israeli economy's performance since October 7, 2023. While it has shown exceptional resilience, avoiding a prolonged recession and maintaining the capacity to fund high war expenditures, this has been accompanied by negative structural changes. These include a continuous surge in military spending, a reduced fiscal margin for the government, and stagnant living standards for the population. Consequently, the central question has shifted from whether the economy has "survived" the war to the price paid and its future impact on economic strength and national security.

Prior to the war, Israel's economy was relatively robust, with annual growth near 3%, a public debt-to-GDP ratio around 60%, and disciplined fiscal policy. Military spending, though high compared to OECD averages, was about 4% of GDP. The war triggered an initial economic contraction, but the economy subsequently recovered and avoided a technical recession, underscoring its underlying strength. Israel also maintained access to capital markets, enabling government financing of increased military needs without a broader financial crisis.

However, the war has resulted in a cumulative loss of approximately 175 billion shekels (about 8.5% of annual GDP) according to the Bank of Israel. A significant economic cost is the stagnation of per capita GDP, with population growth offsetting most economic gains, leading to a virtual standstill in living standards for nearly three years. This translates to an estimated cumulative loss of 35,000 shekels per citizen compared to pre-war projections.

Public finances have also deteriorated, with the debt-to-GDP ratio increasing by about nine percentage points and deficit targets being repeatedly missed. Credit rating downgrades have raised borrowing costs, and the increased debt and its financing costs diminish future governments' fiscal flexibility. This represents an erosion of the financial resilience that was a key economic strength before the war.

The most significant shift is the near doubling of military spending, from about 4% of GDP before the war to over 8% during it. The INSS suggests this may indicate a permanent shift to a higher defense budget share, potentially at the expense of long-term civilian investments in education, health, infrastructure, and innovation. While meeting immediate security needs, this could weaken the long-term economic resources that fund military power.

In conclusion, the Israeli economy's resilience exceeded expectations, maintaining stability and financing a prolonged war without a full-scale crisis. However, this came at a high price: stagnant living standards, increased debt, reduced fiscal flexibility, and a near-doubled defense burden. The report warns that the erosion of foundations for future growth and prosperity, driven by the shift of resources from productive investments to security spending, poses a significant long-term risk. The INSS distinguishes between resilience and the capacity for future growth and prosperity, stressing that sustained future growth is not guaranteed. The report calls for an economic policy shift post-war to rebalance security requirements with the preservation of growth engines, civilian services, and financial stability.