Is the Israeli Economy Recovering?

State of the Nation Report 2025 – Chapter: Macroeconomic Trends

Israel’s economy is at a highly sensitive point. The high costs of the war have increased the government budget deficit, the level of debt relative to GDP, and the burden of interest payments, and the prolonged war has impaired productivity, investment, private consumption, and economic growth. The easing of the security situation and the prospect of new political agreements create an opportunity for correction and for returning the economy to a path of rapid growth.

Taub Center researchers Prof. Benjamin Bental and Dr. Labib Shami analyze Israel’s economy in 2025 against the backdrop of a complex security period. The chapter reviews the immediate implications of the sharp rise in defense spending, alongside structural problems and long-term trends in the Israeli economy that do not stem from the war alone — chief among them low labor productivity and high price levels. The researchers warn that high defense spending may come at the expense of essential civilian expenditures and harm public investment. Such a situation could create a vicious cycle; whereby slower growth reduces budgetary resources and undermines the ability to finance security needs in the long run.

The increase in defense spending and debt accentuates the dependence of civilian spending on the economy’s growth rate

Over the decade preceding the war, the debt burden declined steadily, reducing its impact on the state budget. The recent dramatic increase in defense spending has led to deficits with an immediate impact on Israel’s public debt.

With the outbreak of the war, the state budget was increased in 2023 by NIS 23 billion, a little more than 1% of GDP. The 2024 state budget was increased relative to its original version by about NIS 107 billion, more than 5% of GDP. In March 2025, the Knesset approved a defense budget of NIS 136 billion, and following the war with Iran the government increased the defense budget by an additional NIS 31 billion. As a result, the deficit ceiling was raised to 5.2% of GDP, but due to high tax revenues it appears that 2025 will end with a lower deficit, of about 4.5% of GDP.

According to Bank of Israel estimates, the debt-to-GDP ratio will stabilize this year at 70% and next year at 71%, provided that the fighting does not resume. Compared with 2024, the debt-to-GDP ratio has risen by 10 percentage points. This increase, which stemmed from the need to finance the war, raises Israel’s debt burden by about NIS 8 billion per year. The expected increase in defense spending over the coming decade adds a further burden to the state budget. Until now, the government has kept civilian spending in line with population growth. However, in view of the expected rise in defense spending, only accelerated economic growth will allow this trend to continue and prevent severe harm to civilian services.

Defense spending

Labor market: the unemployment rate remains stable, but productivity gaps are still high relative to European countries

Since 2022, the unemployment rate in Israel has been stable, hovering around 3%. Labor productivity continues to be relatively low in international comparisons, although the gap has been narrowing. A comparison the researchers conducted between Israel and several European countries similar to it in population size and economic structure (Austria, Denmark, Finland, the Netherlands, and Sweden) shows that between 2015 and 2023 the gap in value added per worker across the entire economy fell from 20% to 12%. By sector, the gap in services narrowed from 19% to 7%, and in industry it remained stable at around 12%. The productivity gap in information and communications technology (ICT), which stood at about 15% in 2015, was fully closed by 2020.

In value added per hour worked, by contrast, the gaps remained large. Across the economy, the gap narrowed over those years from 36% to 30%; in services it fell by 8 percentage points to 28%; and in industry it remained stable at around 40%. These gaps are explained, among other things, by the fact that employed people in Israel work, on average, about 25% more hours per year than in the reference countries — a ratio that has remained fairly constant over time.

Another key factor behind the labor productivity gap is the level of capital per worker. In Israel, capital per worker in the economy as a whole and in services stands at about half the level in the reference countries. According to standard economic calculations, aligning Israel’s capital per worker with that of the reference countries would eliminate the GDP-per-worker gap and about half of the GDP-per-hour-worked gap.

The cost of living in Israel is soaring — due to structural problems and high sensitivity to exchange-rate changes

In 2023, the consumer basket in Israel was about 13% more expensive than the average in the aforementioned five European countries. Prices of goods and services in healthcare were higher in 2023 in Israel than in the reference countries by about 40%, and in housing — the main expenditure item for Israeli households — Israel was about 20% more expensive. In contrast, prices in the communications area were about 22% cheaper in Israel than in the reference countries. Prices of clothing and footwear, recreation and culture in Israel were similar to those in the reference countries.

The study found a long-run gap of about 29% in Israel’s price level relative to the OECD average, stemming from structural characteristics of the Israeli economy. Prominent factors affecting the price level include low competition in parts of the services sector, high operating costs, import restrictions, regulations that make it difficult for new firms to enter the market, and the absence of economies of scale typical of a small and remote economy. Together, these create a higher-

cost starting point for the Israeli consumer even before exchange-rate effects, and, therefore, Israel’s cost of living has been relatively high compared to other countries for many years.

At the same time, changes in exchange rates have led to shifts in Israel’s relative cost of living. For most of the first decade of the century Israel’s price level was relatively low compared with the United States and the Eurozone, but, since then, as the Israeli shekel strengthened, the price level in Israel rose steadily, exceeding that in the Eurozone by more than 40%, and that in the US by about 20%. In recent years, as a result of global exchange-rate changes, there has been some reversal: in 2023, Israel was about 30% more expensive than the Eurozone, while the gap vis-à-vis the US nearly closed.

The high-tech sector accounts for about 20% of GDP and 40% of economic growth since 2018

Israel’s high-tech sector employs about 10% of the workforce and is responsible for about 60% of exports. According to the Israel Innovation Authority, the sector accounts for about 20% of GDP and 40% of economic growth since 2018. The high labor productivity in high-tech is reflected in the fact that average wages in high-tech are almost three times the average wage in the economy excluding high-tech.

Exports of high-tech services jumped from $15 billion in 2013 to about $55 billion in 2024, and as a share of total exports increased from about 21% to 44%. These data point to a substantial contribution to state revenues and to Israel’s standing in global markets.

Exports by technological intensity, USD Billions