Israel: Bad Combo: Global Slowdown, Local Violence

When Israeli Prime Minister Ariel Sharon took office on Mar. 7, he found an economy mired in a rapid slowdown.

True, growth for 2000 soared to 6%, but the figure was deceiving. After three quarters of strong economic activity, real gross domestic product fell at a 9.8% annual rate in the fourth quarter (chart). In 2001, real GDP may struggle to grow 2.5%.

Israel's problems are the result of its clash with the Palestinians as well as the worldwide slowdown, which has hurt the important high-tech sector. The Israeli-Palestinian violence, which erupted at the end of September, has led to a steep drop in tourism. In addition, the construction and agricultural sectors are dependent on Palestinian workers who have been unable to make it to their jobs because of the closure imposed by Israel on the West Bank and Gaza Strip.

The global slowdown, led by the weakness in the U.S., only makes matters worse. Two-thirds of last year's growth was attributed to Israel's tech sector. Total exports rose last year by 24%, but high-tech exports surged 58%.

In the past few months, though, dozens of local startups have closed down. And those that remain are finding it harder to raise money or go public on the Nasdaq market, where the shares of over 100 Israeli high-tech companies are traded. Even many well-established companies have issued earnings warnings, and thousands of workers have been laid off.

Economists expect the 2001 economy to expand by 2% to 2.5%. That will lead to a steady rise in unemployment, which is likely to hit 9.5% by yearend.

To counter the sharp economic decline, Sharon is already talking about cutting Israel's tax rates and substantially increasing investment in infrastructure projects in transportation and telecommunications. This will lead to a significant rise in the budget deficit. But Israel's return to rapid growth will largely depend on an improvement in the Palestinian situation and a recovery in the world's high-tech field.

By Neal Sandler in Jerusalem

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