Don’t let the war distract you from the looming threat to Israel’s economy

While Israel’s ongoing war with Hamas has taken a legitimate toll on Israel’s economy, Israelis must remain vigilantly aware of a deeper underlying threat to the nation’s economy: the current government’s controversial judicial reform, which has fallen to the wayside in recent months but has by no means disappeared.

For more than a year, economists, executives, and experts throughout Israel and around the world have raised red flags and warned about the potentially crippling impact that the reform poses to foreign investment.

This could have severe consequences, particularly given the pivotal role of the hi-tech sector in the economy: Israel's hi-tech industry accounted for 18.1% of the GDP in 2022, making it a primary contributor to the economy.

Critics argue that by undermining the legal authority of the country’s High Court, the government threatens to destabilize Israel’s relationship with foreign investors — a warning that has already begun to come to fruition.

As of 2024, Fitch, Citi, Moody’s, Morgan Stanley, and S&P — all of which are leading international credit rating agencies — have warned investors of the risk that investing in a post-reform Israel would pose. Several agencies have lowered Israel’s investment rating.

Immediately before the war, and for many months preceding it, reports highlighted that Israel’s foreign investment was on a downward trend in the wake of the controversial moves that the government has made toward neutering the Supreme Court’s legal authority.

A decrease in investments and deals

A September report from the Start-Up Nation Policy Institute (SPNI) highlighted a 20% decrease in investments and a 50% drop in deals during the second and third quarters of 2023. The decline can be attributed to a decrease in active investors, both local and foreign, with Israeli funds decreasing by a third and foreign ones by more than 40% during the same period.

The slowdown is also reflected in the reduced emergence of unicorn companies and mega-funding rounds in 2023, with only one unicorn and a handful of mega rounds originating from Israeli headquarters.

Even the Bank of Israel warned against the negative impact of the reform in a report released earlier this year, saying the uncertainty surrounding the legal reform’s legislation had increased the risk premium of the economy.

Dan Ben-David, head of the Shoresh Institution for Socioeconomic Research and an economist at Tel Aviv University, as well as a long-standing opponent of the reform, warned about the need for vigilance regarding the government’s activity expands beyond the continued interest in judicial reform.

“As if all of the uncertainty caused by the attempted judicial coup, the addition of the still ongoing war with Hamas, and the as-yet unresolved border war with Hezbollah were not enough, we have a government that is not content with simply being disconnected with the facts that need to be dealt with,” he said.

“It is as though the government is actively searching for ways to exacerbate the uncertainty of the days ahead,” Ben-David said. “It refuses to stop increasing sectoral and personal budgetary allocations that need to be diverted to fund national needs, such as the war and rebuilding efforts. It refuses to decide on the day after in Gaza. It actively antagonizes Israel’s declining circle of international supporters, while its ministers dance at a conference that spits in the face of The Hague court by advocating the transfer of Gazans and settlement of Jews in their place.”

The Knesset’s current economic priority is, and should be, managing the economy in an efficient and strategic manner during the ongoing war. If and when that priority can be shifted, however, addressing the damage that the judicial reform has already done to the economy – and preventing it from doing more – must be moved to the top of Israel’s to-do list.