The Israeli economy is showing signs of a return to normality despite the strain the war against Hamas has put on it.

Although official economic data for the first three months of 2024 has yet to be released by the government, recent labor market data from the Central Bureau of Statistics and credit card transaction data from the Bank of Israel suggest the country's economy is rebounding from the shock of the October 7 terror attacks and the war that has followed.

Israel's economy suffered a major contraction in the final quarter of 2023, following the terrorist attacks. Its economy shrank by 5.2% compared with the previous quarter. Much was related to the labor force disruption which resulted when around 300,000 reservists were called up to the country's armed forces.

However, Benjamin Bental, professor of economics at the University of Haifa, says the labor market is finally recovering from the sudden departure of so many workers and small business owners from the economy.

"The labor market is really stabilizing quite rapidly," he told DW. "It's not yet at its pre-war level but formal unemployment is actually 1% lower than it was in September 2023."

The ongoing return of some reservists has improved the labor situation while the strong credit card data suggests returning consumer optimism after a big slump in late 2023.

However, Bental said certain sectors remain severely affected by labor shortages, particularly construction. That is largely because the industry was heavily dependent on Palestinian workers coming from the Israeli-occupied West Bank who are now unable to travel to their jobs in Israel due to the security situation.

Around 75,000 Palestinians used to commute daily to Israel for construction work from the West Bank. Their absence brought building work to an almost complete halt, as residential construction fell by 95% in late 2023.

The sector has recovered somewhat since Israel brought in thousands of workers from India, Sri Lanka and Uzbekistan to resume construction work, but the full picture won't be clear until first-quarter data is released.

Israel's budget deficit

The war forced the Israeli government to dramatically ramp up spending, with a surge in defense expenditure as well as reconstruction costs associated with the Hamas attacks and the cost of re-housing tens of thousands of Israelis displaced in the north and south of the country.

Israel announced an amended state budget for 2024 last month of 584 billion shekels ($160 billion, €144 billion). The budget was initially reported as setting a deficit of 6.6% of gross domestic product (GDP) in 2024, up from a pre-war level of 2.25%. However, Benjamin Bental says it's already clear that this is a significant underestimate and that a deficit of 8% looks more realistic.

"This is what looks more or less reasonable, assuming that there is no further deterioration of the security situation," he said, referring to current tensions with Iran.

There is obvious pressure on government finances. It plans to raise about $60 billion (€56 billion) in debt this year, as well as increasing taxes, but it insists it has the capacity.

"The economic fundamentals are there," Yali Rothenberg, the finance ministry's accountant general, told the Financial Times ahead of the amended budget announcement. "If you look at the high-tech sector, it's there. If you look at the infrastructure investment, it's there. If you look at the private consumption, it's there."

Learning from past conflicts

Before the attacks on October 7 by the militant Islamist Hamas group, Israel's economy was in good shape. "The economy was performing remarkably well," said Bental. "Inflation was coming down and the entire monetary situation was under very good control."

He pointed out that Israel was headed for growth of 3.5% before the attacks in 2023, and that it still managed growth of 2% for the year despite the final quarter shock.

He stressed that on the streets of cities such as Tel Aviv or Haifa, there is little evidence of a war economy or any sense of shortage or deprivation. However, he cautioned that Israel's experience of how previous wars and security crises impacted the economy should guide the current leadership.

Bental is worried about excessive spending on defense, for example. During the Yom Kippur War of 1973, Israel had dramatically ramped up defense expenditure to the point where it reached a "totally unsustainable" 30% of GDP. Combined with the oil crisis and wider global economic crisis of the time, the conflict "led to a real disaster economically" for Israel, where "you have very high inflation and basically no growth for almost 10 years."

According to Bental, the Second Intifada of the Palestinians, which took place between 2000 and 2005, had more similarities to the present conflict in that it involved civilians.

"You can learn a little bit about the damage that is caused by the loss of confidence of the civilian population and the loss of the sense of security during that particular episode," he said. "And there are estimates that over these years, let's say three, four years, the Israeli GDP lost about 10% just because of that"

Another example he gave is the 2006 conflict with Hezbollah and Lebanon — a conflict that showed how quickly the economy can recover once the fighting stops.

"We're talking about a situation where for basically a month, the northern region of Israel was not functioning," he noted. "But when you look at the data and you look for any traces of this, you won't find it. This is really amazing. The economy, once this was over, recuperated in no time."

Bental hopes that this will be the case when the current conflict ends and suggests the recent signs of recovery point toward that very situation.

Edited by: Uwe Hessler