THE COSTS OF THE INTIFADA TO THE ISRAELI ECONOMY

C O N F I D E N T I A L SECTION 01 OF 03 TEL AVIV 001708

SIPDIS

E.O. 12958: DECL: 03/09/2014
TAGS: ECON EFIN PREL KWBG IS ISRAELI PALESTINIAN AFFAIRS ECONOMY AND FINANCE
SUBJECT: THE COSTS OF THE INTIFADA TO THE ISRAELI ECONOMY


Classified By: Economic Counselor Ted Mann for Reasons 1.4 (b,d)


1. (C) Summary. More than three years into the Intifada, a
lively debate has ensued about its costs to the Israeli
economy, both past and future. A fair degree of unanimity
exists among experts that past costs were huge, with Bank of
Israel and Ministry of Finance estimates falling somewhere
between 9 to 13 billion dollars in lost GDP. Opinions on
future costs are strongly divided, however. The Ministry of
Finance argues that the economy has adjusted to the Intifada
and that it no longer has a major impact on the current
growth rate. Bank of Israel analysts say it continues to be
a drag on the economy and point to continued problems with
consumption and investment, saying these reflect the
continuing security concerns of the average Israeli. End
Summary.

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A Little Bit of History
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2. (C) Israeli economists may not agree on the current and
future impact of the Intifada, but they generally agree on
its past economic effects. According to the Ministry of
Finance and the Bank of Israel, the Intifada impacted the
Israeli economy through a series of ever-widening ripple
effects. Immediately after the violence broke out in
September 2000, the violence hit a small number of economic
sectors intensely, particularly tourism, exports to the
occupied territories, construction and agriculture. The
GOI's decision to reduce access of Palestinian laborers into
Israel directly and negatively influenced growth rates in the
latter two sectors. MoF estimates indicate that the violence
led to a 3% drop in annual GDP in 2001 based on an analysis
of statistics relating to tourism, trade with the PA, and
transport. A large part of this decline was due to the fall
in tourism receipts from $4.4 billion in the year ending
September 2000 to an estimated $2.1 billion in 2002.


3. (C) The MoF quantified initial damage to construction and
agriculture at the onset of the Intifada by assessing the
seasonally-adjusted decrease in activity in these areas in
the fourth quarter of 2000 compared with the level during the
previous quarter. For example, in construction the
difference came to NIS 1.2 billion in 2000 prices, or about
0.3 percent of GDP for 2000 alone.


4. (C) As the Intifada continued into 2001 and 2002,
Israelis realized that it was going to affect their lives
over the longer term. The resulting negative wealth effect
exerted a powerful influence on investment and private
consumption. Per-capita spending on private consumption
decreased by an estimated 2.3 percent in 2002 after rising
for many years, a figure that includes a sharp drop of 11
percent in per-capita consumption of durable goods.


5. (C) Another direct effect of the Intifada was the
reallocation of budgetary funds to increased Israeli defense
expenditures, which rose from 8.4 percent of GDP in 2000 to
an estimated 10.2 percent in 2002. The reallocation had
wider effects: As the MoF notes in a January 2003 MoF
report, "the primary downside of the hike in defense
expenditure is that it necessitates cuts in other budgets,
impairing the level of services and citizens' standard of
living, and/or an increase in the tax burden, which harms the
business sector and is liable to affect the potential for
future growth."

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Parsing a Triple Whammy
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6. (C) The MoF's chief economist, Michael Sarel, readily
admits that his ministry's calculations on the Intifada's
impact are speculative. The main difficulty any analysis of
the Intifada's costs encounters is disaggregating the causes
of Israel's 2001-2002 recession, in which the country faced
three separate challenges: the Intifada; the world recession;
and the collapse of the NASDAQ (the level of which correlates
highly with Israeli high-tech exports). According to the
MoF, the recession as a whole reduced GDP by 5.0 percent in
2001, and by another 4.6 percent in 2002 compared to a
baseline level projecting growth at the average level of the
1990s.


7. (U) The January MoF 2003 report says that "several
studies have tried to assess the relative impacts of the
various shocks on the level of economic activity. The
standard assessment is that the impact of Palestinian
terrorism on activity in 2001 was approximately equal to the
impact of the other shocks ... and was responsible for about
half the disparity in GDP. It is harder to come up with an
estimate for 2002 and 2003, but presumably terrorism is
responsible for more than half of the total damage to GDP.
Therefore, it can be said that the harm done by Palestinian
terrorism to Israeli GDP in 2001-2003 totals at least $14
billion. This does not include direct harm to persons,
property and to the well-being of individuals." As this
report was written prior to the recovery in 2003 GDP, Sarel
told us he now believes that it overestimates the cost of the
Intifada by at least USD one billion.

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BOI Estimates
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8. (SBU) In its 2002 and 2003 annual reports, the Bank of
Israel also provides an estimate of the Intifada's costs.
The BOI estimates the loss of GDP in 2002 alone due to the
continuation of the Intifada, comparing the actual situation
with what it could have been had the unrest concluded at the
end of 2001. This estimate yields a cost range between 3.1
and 3.8 percent of GDP. The BOI notes, "this approach is not
the same as comparing the situation with what would have
happened had the Intifada not erupted at all; an estimate ...
using that approach yields a far greater loss as it
incorporates in its base the unmaterialized growth in 2001 as
a result of the Intifada." (Comment. The latter approach is
essentially that taken by the MoF in its estimates, which are
considerably higher. End Comment.)


9. (C) The BOI has provided the Embassy a pre-publication
copy of its 2003 Annual Report, which estimates the cost of
the Intifada in 2003. The report outlines two scenaria
according to which the Intifada affected the economy to
different degrees resulting in a cost of between 0.7 percent
to 1.8 percent of GDP. The BOI breaks its data down into the
two scenaria presented in the following chart, in which the
column headings are:


A. Actual Figures for 2003

B. Projected Figures without the Intifada, Higher Impact
Scenario

C. Projected Figures without the Intifada, Lower Impact
Scenario


Category of Impact A B C

Gross Domestic Investment -14.0 1.8 -1.4

Residential Building Investment -3.7 5.0 3.0

Private Consumption 1.8 3.8 2.9
- w/o Consumer Durables 1.9 3.2 2.7
- Consumer Durables Only 0.1 10.0 5.0

Public Consumption -1.0 -1.9 -2.2

Domestic Defense Consumption -1.5 -11.4 -10.0

Exports 6.2 8.9 7.4

- Tourist Services Only 26.9 50.0 35.0

GDP 1.3 3.1 2.0



10. (C) It is worth taking a closer look at the
sub-components of investment numbers from 2002-2003, since
these show divergent trends. While gross domestic investment
(which the BoI uses in its estimates) fell from 89.457
billion shekels in 2002 to 77.342 billion shekels in 2003,
foreign direct investment increased from USD 1.647 billion to
3.748 billion. Michael Sarel told us he had asked the
Central Bureau of Statistics (CBS) for a detailed breakdown
of FDI utilization in order to explain this discrepancy.
Unfortunately, the CBS was unable to provide this
information. Sarel theorized that the increase in FDI was
the result of a number of factors: the end of worries about
Iraq; the increased stability of the Israeli economy as the
result of the U.S. loan guarantees and the Netanyahu economic
plan; the expansion of the U.S. economy in 2003, which
brought funds from U.S. investors looking for overseas
opportunities; and lastly a major change in how certain
investments were entered into Israeli FDI figures.


11. (SBU) Bank of Israel Estimates of Year-by-Year Intifada
Costs
(constant 2000 prices, amounts in billions)

Year Fall in GDP Loss in: Shekels Dollars

2001 2% 9.28 billion 2.28

2002 3.1%-3.8% 14.3 - 17.5 3.5 - 4.3

2003 0.8%-1.9% 3.7 - 8.8 .92 - 2.2

Total 27.3 - 35.6 6.7 - 8.7

According to Flug, the BOI believes its numbers underestimate
the overall, cumulative cost of the Intifada, as they do not
account for the effect of each year's reduced growth on the
growth of subsequent years. "I would say the overall cost is
at least USD 9 billion," she told us.

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The Future Costs: MoF and BoI Present Different Analyses
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12. (C) Although the differences in the BOI's and MOF's
estimates are not insignificant, they are mainly
methodological in character and are generally comparable.
These two institutions' views diverge regarding future costs,
however. Michael Sarel thinks that, economically speaking,
the Intifada has run its course. In his view, the violence
has reduced the annual level of Israeli GDP by approximately
6 percent below what it would have been otherwise. He
realizes this is not an insignificant cost and accepts that
the drop will not be made up until a peace track has been
established. But for him, the key issue is how future growth
rates have been affected. "If our potential growth rate is
4% per year, and population growth is 2% per year, Israelis
should be able to expect their average economic level to
increase gradually over time." If, however, the Intifada has
seriously affected prospects for future growth, these
expectations will increasingly not be met. Sarel says the
difference is between a stagnant economy where the best minds
move elsewhere and immigration tapers off and an economy that
not only keeps its talent and innovation but adds to it. "At
stake is the future of the country."


13. (C) Sarel pointed to a number of factors that support
his analysis that Israel is back on track towards meeting its
economic growth potential, and which are part of a model the
ministry is working on that preliminarily supports his
hypothesis. First of all, the IDF is doing its job
protecting Israelis from terror. Whereas 450 Israelis died
from terror attacks in 2002, that number had fallen to 211 in
2003 and is likely to fall even further this year, he
believes. Average monthly tourist arrivals increased to
eighty-eight thousand in 2003 from seventy-two thousand in
2002, an increase that became particularly pronounced
following the war in Iraq. Private consumption is also
gradually improving.


14. (C) Flug, on the other hand, believes the growth rate
has been seriously dampened by the intifada, and points to
problems with investment. "How could the Intifada not impact
our growth rate?" she asked. Flug noted that Israel is an
open economy competing for world capital. Although it has
tremendous strengths in human capital, these are offset by
regional instability. Although some courageous investors
might be willing to take a chance in Israel, she believes
that at least a significant portion of other investors would
not be willing to do so. As for recent increases in
consumption, she again believes logic dictates the figures
would be better without the Intifada. She insists growth
will not return to its potential until a peace process "with
results" is established.

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Comment
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15. (C) Although we respect Sarel's economic credentials and
insights, we tend to support Flug's analysis. Decreased
levels of domestic investment in 2003 compared to 2002 are
just one reflection of the effect of "Intifada insecurity".
As for the Israeli "recovery," in per-capita terms the
economy continued to decline in 2003 for the third year in a
row and will show only a very small increase in 2004, in
spite of the recovery in global growth and particularly in
technology spending. To put it another way, we believe that
if the Israelis and the Palestinians were engaged in a
credible peace process, growth rates would be significantly
higher than they are now. That is the real cost of the
Intifada, and one that only grows larger every year the
violence continues.

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