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$Unique_ID{bob00272}
$Pretitle{}
$Title{Israel
Chapter 4D.   Industrial Policy and Development}
$Subtitle{}
$Author{Richard F. Nyrop}
$Affiliation{HQ, Department of the Army}
$Subject{exports
israeli
foreign
imports
billion
government
industrial
defense
percent
equipment}
$Date{1979}
$Log{}
Title:       Israel
Book:        Israel, A Country Study
Author:      Richard F. Nyrop
Affiliation: HQ, Department of the Army
Date:        1979

Chapter 4D.   Industrial Policy and Development

     The War of Independence destroyed any possibility for Israel to become a
regional manufacturing center with markets in nearby Arab areas. The Arab
boycott, which was still active in 1978, went further than just refusing to
buy Israeli goods. Sanctions were also applied to firms doing business with
Israel that wanted to trade with Arab countries. Arab sanctions had varying
effectiveness, but they created problems for marketing arrangements,
production licenses as a means of acquiring foreign technology, and direct
investment relationships between Israeli firms and international companies.
The Arab boycott increased the difficulties of overcoming the constraint of
Israel's small domestic market.

     The small size of the domestic market affected Israeli industrial
development in several ways. The most obvious and perhaps most important
impact involved economies of scale; many modern industrial processes require
a high level of production to achieve low unit costs-often a production level
considerably higher than could be sold in Israel. Thus investment in modern
technology frequently meant that investors had to build a plant large enough
to achieve economies of scale but with part of production to be marketed
abroad, thereby facing the competition from established, international
companies and the risks of penetrating foreign markets largely in
industrialized Western Europe. Less obvious were the small firms' inability
to maintain marketing and research staffs, the effect of small-scale
production on allocation of resources in Israel, and the difficulty of
finding appropriate government policies to achieve rapid and rational
industrialization.

     In the years immediately after independence the flow of immigrants was
extremely high, and a shortage of goods existed. The government therefore
intervened directly to foster rapid development of manufacturing. Many
inducements were introduced, but commercial policy was very important. Local
manufacturing was completely protected from foreign competition by high
tariffs and quantitative restrictions on foreign imports, resulting in rapid
growth primarily among numerous small industrial concerns. Production was on a
small scale, managerial and skilled labor were spread thin, and costs tended
to be high.

     By the mid-1950s government officials recognized that this excessive
level of protection was causing distortions in the economy. Quantitative
restrictions on imports were removed, and a commitment was made to gradually
reduce import duties. Liberalization of commercial policy was slow. By 1978
domestic manufacturing still enjoyed substantial protection although an
Israeli agreement with the European Common Market countries, signed in 1975,
committed the government to continual, gradual reduction of tariff duties on
industrial products in return for duty-free entry of Israeli manufactured
exports to Common Market countries starting in July 1977; free trade in
industrial products between the two areas was scheduled for the late 1980s. In
the late 1970s some foreign firms were interested in establishing plants in
Israel to benefit from the duty-free access to the European Common Market.

     In the early 1950s a major focus of government policy was to create jobs
for the huge flow of immigrants and provide goods that were in short supply. A
highly protectionist policy was adopted in support of these goals. For some
officials, the increasing numbers of local manufacturers and growing
competition between them would mitigate the harmful effects of excessive
protection from the outside. It soon became apparent, however, that one or
only a few domestic producers of a specific product could supply the small
internal market.

     Since the mid-1950s the country's balance of payments dominated
government policy. Stimulating local manufacturing toward import substitution
and development of industrial exports became more important than excessive
concentration in domestic industry. Mergers were promoted to expand the size
of economic units in order to increase exports. The size of manufacturing
plants and industrial exports increased, particularly in the 1960s and 1970s,
but accompanied by the growth of cartels and monopolies in the domestic market
even though no Israeli firm was large by international standards. There was
some concern about the lack of internal competition. An effort toward
regulating cartels and restrictive trade practices became law in 1959, for
example, but legislation in 1969 removed obstacles and encouraged mergers in
a single line of production. Some economists commended government policy for
its flexibility and accomplishments, noting that reduced tariff protection and
liberalized imports would counteract the excessive concentration in domestic
industry over the long run although acknowledging that costs and prices in the
home market were higher than would have been the case with greater internal
competition in the short run.

     Since the mid-1950s industrial development policies have concentrated
largely on science-based industries, such as metal products, chemicals,
plastics, and electronics, because they best suited the country's endowments.
A substantial inflow of foreign capital permitted development of advanced
technology and capital-intensive industries. Policy attention and investments
concentrated on manufactured components or high-quality special products, such
as scientific instruments and minicomputers, requiring a large amount of
precision per unit and high value added, rather than mass produced items
requiring large production runs to be economical.

     Growth of productivity per worker has been at a sustained high rate since
independence. The skills in the labor pool added to the country's comparative
advantage in modern industries. The proportion of well-educated scientists and
engineers, skilled workmen, and able managers in the Israeli work force was
unrivaled in young, developing countries, even though Israel's development
efforts required still more. Educational and training programs for both the
already skilled and the unskilled immigrants enlarged and added to the pool of
skills.

     The country's defense needs reinforced development of science-based
industries. Facilities that originally began as repair and maintenance shops
for imported military equipment, developed competence to make substantial
modifications and adaptations on equipment and subsequently to produce Israeli
versions of guns, planes, missiles, armored vehicles, and electronic
equipment. Development of defense and related civilian products was
particularly stimulated after the 1967 war when France, a major military
supplier at the time, embargoed armaments. By 1978 Israel's defense industries
were producing for their own needs more than what they used to buy from the
French, and exports of military and related products were becoming major
foreign exchange earners.

     The government used a variety of means to influence the peace and
direction of industrial development. Availability of low interest credit, tax
incentives, tariff protection, export premiums, export insurance, and
marketing assistance were part of the policy arsenal. Legislation protected
and encouraged investment by foreigners. Foreign investments in Israel
remained low in the 1950s but became substantial in the 1960s (until the
six-day war) and in the early 1970s (until the 1973 war). The government
sponsored and promoted research and development for some products and lines
because the size of most Israeli firms was too small to support the necessary
staff.

     The government encouraged private investment in industry through
incentives and assistance rather than by creating a large public sector.
Government ownership of industry was primarily in defense, utilities (water
and power), fuels (refining), and chemicals and petrochemicals (primarily
related to processing particular refinery products, phosphate rock, and Dead
Sea brine). The government sold its shares in various industrial plants on
occasion in order to raise funds for investment in new plants.

     By 1978 industrialization had progressed rapidly and become much more
sophisticated, but major problems remained. Continuing large investments in
industry still depended heavily on an inflow of capital from world Jewry and
other sources. Manufacturing was very dependent on imported materials,
requiring more imports for further growth. The large number of industrial
establishments, frequently with nonspecialized production and underutilized
capacity, kept production costs high and dispersed skilled labor and
managerial talent. Labor's mobility proved inadequate particularly since the
1973 war; manufacturing for the domestic market encountered a slump and
underemployment, but by 1977 too few workers had moved into export industries,
which were short of labor. Strikes and disruptions by labor interfered with
production. Industrial wages were related to the cost of living and not
productivity, undermining the competitiveness of industrial exports. The
technical efficiency of many branches of industry was below international
standards, increasing production costs. Maintaining research and development
work ahead of huge international companies and major industrialized nations
in such products as weapons, instruments, optics, and selected electronics
would remain a serious challenge to continued industrialization and export
growth.

Diamond Industry

     The Israeli diamond industry is an exotic but representative example of
the country's industrialization effort and export drive. From exports of US $5
million in 1952, the industry grew and by 1977 accounted for more than half of
the world trade in cut and polished diamonds, and exports exceeded US $1
billion. Diamonds were by far the country's largest export. The industry
employed about 25,000 people in all aspects of the trade.

     Rough diamonds were purchased from an international cartel that
controlled marketing of the bulk of all rough diamonds. Israeli dealers
handled gemstones almost exclusively and specialized in medium sizes
(approximately one-fortieth to one-half a carat). A skilled worker determined
the cuts to achieve the best possible refraction of light and the least loss
to the original rough stone. Actual cutting required several hours, usually
by a machine using a diamond for a cutting edge. Polishing and removing
impurities to obtain as near as possible a blue-white color involved about six
separate steps. Cutting and polishing in Israel had been streamlined, using
automated equipment and assembly-line techniques as much as possible to reduce
costs. The polished gems were sold to international dealers primarily at the
Israeli Diamond Exchange in a suburb of Tel Aviv that had become the largest
center for gem diamonds. The United States was the largest market, accounting
for about one-third of exports in 1977. Other major markets included Hong Kong
and the industrialized countries of the world. About one-fifth of the value of
diamond exports represented foreign exchange earnings after paying for the
import of rough stones. In 1977 the net added value was estimated at US $275
million.

     The Israeli diamond industry began in the 1930s when a European Jewish
cutter immigrated. More cutters and dealers arrived in the 1940s and formed
the nucleus for the industry. Expansion since the 1950s required extensive
training of many additional cutters and substantial investments in buildings
and equipment. By 1977 there were about 750 factories and workshops. The
Israeli industry surpassed Antwerp as the largest wholesale diamond center in
the 1970s, accounting for more than 50 percent of all cut and polished gem
diamonds by 1976. Diamonds were the only export product in which Israel was
more than a marginal supplier in any market. The growth of the industry to its
present eminence in the world diamond trade partly reflected the
specialization and concentration on technical efficiency.

Defense Industries

     Given the country's national security requirements and continuous
balance-of-payments problems, it was natural to develop defense industries.
Domestic production would reduce foreign exchange costs for imports, would
ensure control of supply, and would permit adaptations of equipment to meet
Israeli requirements. A substantial number of well-qualified scientists,
engineers, and technicians and a growing industrial base facilitated
increasing reliance on local production of military equipment. Defense
industries led the growth in the manufacturing sector.

     The military industrial complex was dominated by government-owned plants
under the Ministry of Defense (see Economic Impact, ch. 5). The largest was
a conglomerate, the Israeli Aircraft Industries (IAI), employing about 20,000
workers in 1977. The IAI and its subsidiaries serviced and refurbished
civilian and military aircraft, produced airplanes (civil and military),
sophisticated electronic equipment for civilian and military use, missiles,
missile-carrying patrol boats, and components for equipment in the Israeli
inventory. Other industrial facilities directly under the Ministry of Defense
supplied small arms and ammunition, some cannon and shells, ships, tanks and
parts, and major maintenance and modification of a variety of foreign
equipment. There were, in addition, private firms with varying proportions
of output sold to the Ministry of Defense, the country's largest buyer.

     The government released little data on defense industries, and most
information came from press interviews with officials. In 1977 there were
reportedly about 150 private and public firms producing military and related
products. Direct employment in defense industries was estimated at about
30,000 with perhaps another 30,000 workers in firms related to military
production, such as parts manufacturers and subcontractors.

     Basic defense industries (small arms, uniforms and related equipment, and
maintenance facilities) were constructed in the 1950s and early 1960s, but
rapid expansion and development of advanced, complex products came after the
1967 war. The sudden imposition of the French arms embargo at that time
spurred officials to achieve greater self-sufficiency. With the introduction
of the high-quality, Israeli-designed Galil assault rifle in 1973, local
industries completely outfitted the infantry soldiers and probably supplied
almost all of the country's needs for small arms and ammunition. By the
mid-1970s the bulk of electronic gear was domestically produced. In 1976 the
country reportedly manufactured about one-third of its overall defense
requirements; although Israeli officials did not indicate how this was
measured, budget data suggested a greater dependence on foreign supplies.
Defense authorities hoped eventually to receive half of the country's military
equipment needs from domestic manufacturing.

     Even with the rapid growth of the armaments factories, the country
remained heavily dependent on imports, primarily from the United States, for a
number of advanced weapons systems and key components for those produced
locally. Moreover the costs of these imports kept escalating, increasing the
burden of defense. In the mid-1970s nearly half of the military budget was for
purchases abroad. In 1976 Israel spent about US $2.3 billion for foreign
armaments, fifteen times what was imported a decade earlier. Although more
could be produced at home than ever before, the pressure on the balance of
payments had increased because of the rising force levels and the greater
sophistication of each new piece of equipment obtained by the Arabs and the
Israelis.

     Growth of defense industries was achieved by a mixture of imported
technology and Israeli innovation. Israeli firms purchased production rights
and entered into joint ventures with foreign companies to produce some
products and components. Nearly all manufacturers of electronics had links of
one sort or another to American firms. Purchase agreements for foreign
military equipment frequently specified data and design information and
coproduction rights whenever possible. The IAI tried to obtain rights to
produce a portion of the F-16s it had ordered, for example, but the United
States government rejected the request in late 1977.

     Experience and necessity led to Israeli innovation. Tank maintenance
shops, as an illustration, performed major modifications of basic American
armored vehicles, such as larger guns, improved armor, and higher powered
engines with more reliability. The shops also modified and improved the large
number of Soviet tanks captured from the Arabs and incorporated them into
their inventory. In the mid-1970s an Israeli tank (the Chariot) was designed
and built (see Size, Equipment, and Organization, ch. 5). Some equipment, such
as compact, lightweight special purpose radar for Israeli patrol boats and
planes, was locally designed to meet specific military requirements because it
was not available elsewhere. By 1978 research and development of new products
for military and civilian use was a major activity in most defense industries.

     The technical level of Israeli military products was high, production
costs were low, and foreign sales were a natural outlet for battle-proven
equipment to supplement the short production runs required to meet Israel's
own requirements. In 1977 labor costs were reportedly 40-percent lower than in
American aerospace industries, and reported export prices for various
sophisticated equipment were considerably less than for comparable items from
other countries. The sea-skimming Gabriel missile, which was so successful
against Arab shipping in 1973 and was being exported to eight countries in
1977, was priced at less than half that of a similar French missile, for
example. Exports grew rapidly. From about US $25 million in 1966, exports of
military and related equipment reached about US $60 million in the early 1970s
and US $320 million in 1976. Exports of US $400 million were expected in 1977.
The sharp rise in the value of export earnings, to a considerable extent,
resulted from the sale of higher priced equipment reflecting an overall
industrial policy to concentrate on science-based products in which there was
a high value added by local manufacturing.

     The emergence of Israel as a significant exporter of military equipment
produced new problems. Its modern fighter-bomber, the Kfir, for example, was
based on the design of the French Mirage 5, used an American General Electric
J79 engine, and had domestically designed and produced components for the
flight control and weapons delivery systems. Some parts of the J79 engine
were produced under license in Israel. Most experts rated the Kfir superior
to the French original and in a class with the Soviet MiG 21, but it was
priced at only US $5 million each. In 1977 the United States government halted
the initial foreign sale of Kfirs to Ecuador by refusing to permit reexport of
the General Electric engines. It was uncertain whether the United States would
permit shipment of the planes to other countries that had ordered them.
Governments and companies were disturbed by the country's growing competition
in arms exports, and by early 1978 some American companies appeared to be
diminishing production help to Israeli military industries.

     Techniques used in defense industries should have beneficial ripple
effects in other branches of manufacturing. Firms and shops producing for the
military worked to maintain good labor relations and had far fewer strikes
and disruptions, an example that could profit the rest of industry. Ministry
of Defense orders required a high degree of reliability imposing much more
attention on quality control than was common in Israeli industry. The recent
addition of many of the defense facilities permitted installation of the most
modern equipment, such as the latest computer-controlled machine tools, a
large vacuum furnace, special plating facilities, computer aided design
equipment, and computers in a number of other functions to improve efficiency,
which could serve as examples and directly aid other industrial branches. The
heavy reliance on research and development for advanced weapons made direct
and indirect contributions to civilian products.

     Israel's military-industrial complex had made significant contributions
to the country's defense and to the economy. There was a potential for further
expansion of exports and a substantial rise if sales of Kfir fighters were
allowed in the next few years. But there was a question of how much further
growth was possible in defense industries; the small production runs required
for Israeli forces, the escalating costs of each new system, and the limited
supply of investment funds placed the same barriers in front of Israel that
restrained the military industrial complexes in Western Europe. In 1978 the
Israeli aircraft industry and government leaders faced the difficult decision
of whether to gamble on investments to develop a new fighter plane for the
1980s with the possibility of few orders. The problem for Israel's defense
industries was no longer industrial capability but economic viability.

Foreign Trade

     The limitations of water and arable land, the lack of natural resources,
the need for industrial development, and the Arab threat to the country's
survival made Israel heavily dependent on imports for food, materials for
processing, machinery, and defense equipment. The need for imports was
always high; the problem was obtaining the foreign exchange to pay for
imports. Continuous pressure existed to develop exports, reinforced by
numerous government policy measures to induce the private sector to look to
foreign markets (see Role of Government, this ch.). The currency was
depreciated by 75 percent between late 1974 and early 1978 partly to encourage
exports.

     Imports increased from US $300 million in 1950 to US $4.1 billion in 1976,
an average increase of 10.6 percent a year. Imports grew at about the same
rate as the economy as a whole partly because of the preponderance of material
for processing-77 percent in 1976 (see table 16, Appendix A). Many settlers
just before and after independence were accustomed to an urban European
standard of living. In the 1950s the government channeled the demand for
European kinds of goods toward import substitution by domestic manufactures.
Because of the lack of natural resources, local industry had to import many
materials for processing to meet domestic consumer wants. As manufacturing
expanded in range and depth, the expansion was largely based on imported
materials. The link between imports and industrial and economic growth should
remain for the foreseeable future. In 1977 imports amounted to US $4.8 billion,
a 16-percent increase over the previous year.

     The bulk of Israeli imports came from industrialized countries. The
Common Market countries of Western Europe supplied most, 43 percent in 1976,
and all of Western Europe accounted for 51 percent of imports. The European
communist countries, primarily Romania, furnished only 1 percent of imports.
The Americas, primarily North America and essentially the United States,
accounted for nearly 23 percent (the United States 21 percent) of imports in
1976. Asia and Africa supplied only 6 percent of imports. Japan was by far
the biggest supplier in the Asia and Africa group, but it had a small share
in the Israeli market. The remainder of imports came from a number of
countries.

     Exports increased from US $35 million in 1950 to US $2.4 billion in 1976,
an average increase of nearly 18 percent a year, a rate of growth higher than
the rest of the economy, and reflecting the government's efforts (including
many tax advantages, adjustments of exchange rates for a wide range of export
goods, and a series of currency devaluations) to stimulate exports. The
growth of exports accelerated, and the rate reached 21 percent a year between
1970 and 1976. By the mid-1970s export oriented industries were primarily the
ones retaining dynamism in a generally stagnating economy. In 1977 exports
reached US $3.1 billion, an increase of 29 percent over the previous year.

     Citrus fruits, essentially oranges for Western Europe, were the basic
export in the early years after independence. Later many additional products
found markets abroad. Citrus fruits lost importance even within agricultural
produce as foreign markets for other fruits, nuts, vegetables, and cut flowers
were developed (see table 17, Appendix A). More importantly, the growth of
domestic manufacturing led to a preponderance of industrial products in
exports.

     Government policy strongly supported industrial development with an
export orientation to ease the country's continual balance-of-payments
problems. Emphasis was given to science-based industries with a large value
added by domestic manufacturing, particularly since the 1960s (see Industry,
this ch.). This was the kind of export (e.g., chemicals, metal products,
machinery, and electronic equipment) that, along with polished gem diamonds,
grew most rapidly in the 1970s. Diamonds were by far the only product in
which Israel had more than a peripheral share in any foreign market, but only
about one-fifth of the value of polished diamonds exports represented foreign
exchange earnings after paying for imports of rough stones. Net value added
by diamonds in 1977 was estimated at US $275 million. Even though government
policy had stimulated growth of exports at a rate substantially ahead of
the rest of the economy, the day when exports began to equal imports appeared
far distant.

     There were about 3,000 exporters, but 300 firms handled about 90 percent
of all exports. About 100 large plants, employing more than 300 workers,
accounted for more than 80 percent of industrial exports in 1977. The
remainder of industrial exports were almost completely from medium-sized
plants. Small plants and shops played a negligible part in sales abroad.

     The foreign markets for Israeli products, and even the pattern of
industrial growth, were shaped by the Arab boycott instituted after formation
of the state. The Arab boycott of Israeli goods, which was still in effect in
1978, precluded the possibility of Israel developing close links to the
economies of its Arab neighbors. Instead the country had to seek more distant
markets.

     West European countries brought most of Israel's exports, 48 percent in
1976. The European Common Market countries were the principal buyers (37
percent in 1976), pointing up the significance of the 1975 agreement whereby
Israeli industrial products began to enter the Common Market area duty free
after mid-1977. Economists expected increasing direct investments in Israel by
non-European international companies seeking this duty-free entry to the
Common Market. Israel's trade with communist countries, essentially those in
Europe, was small, amounting to 1 percent of exports in 1976. North and South
America (20 percent) and Asia and Africa (20 percent) were the other principal
areas for Israel's exports. The United States (18 percent) and Hong Kong (6
percent) were the main markets in these areas, partly because of diamond
sales. The United States and the Federal Republic of Germany (West Germany)
were the most important individual countries in Israel's export trade.

     Tourism was a more important net earner of foreign exchange than such
commodity exports as diamonds or citrus fruits. There were 620,000 tourists in
1975 and about 1 million in 1977. Painstaking efforts over two decades built
up a variety of facilities to broaden the appeal and lengthen the stay of
visitors. Ski slopes, beach resorts, and archaeological and historic sites
added to Israel's biblical and religious attractions. In 1977 foreign currency
receipts from tourism exceeded US $400 million and probably exceeded US $500
million if air fares on national carriers were included. Earnings from tourism
were strongly affected by the security situation in Israel, however.

Balance of Payments

     By the late 1970s Israeli leaders were extremely concerned about the
country's balance-of-payments difficulties. A very large inflow of foreign
funds, especially American aid, had been required since 1973 to finance the
level of imports needed by the economy and national security, and a financial
crisis was avoided in 1974 and 1975 only by heavy use of short-term financing.
Many officials expected the flow of aid to diminish in the near future.
Preparations had to be made for that eventuality to avoid a reduction of
imports, which would starve the economy and weaken the country's defenses.

     Since independence imports have substantially exceeded exports creating
most of the balance-of-payments problem. Balancing international transactions
was not necessary before independence because the local currency in the
Palestine Mandate was tied to and as good as English pound. The Israelis have
been able to finance a continuous import surplus, the magnitude of which
increased tremendously over time, by a large inflow of foreign funds. The
inflow of contributions, grants, and loans from major sources exceeded US $32
billion between 1950 and 1977, over half of which required no repayment.

     The most stable source of foreign funds has been world Jewry, whose
members supplied about US $11 billion between 1950 and 1977. The two major fund
raisers among Diaspora Jews, the United Jewish Appeal (in the United States)
and Keren Hayesod, collected more than US $5.7 billion between 1948 and 1978,
about two-thirds in the United States. Government bonds (Independence and
Development Bonds) sold overseas since 1950 (largely in the United States) had
yielded US $4.2 billion by the end of 1977, although US $1.7 billion had been
repaid. The remainder of the funds came from other fundraisers and unilateral
transfers by institutions and individuals, including immigrants transferring
their capital to their future home. Only a small part of the funds from
world Jewry, essentially that invested in bonds, had to be repaid. An unusual
aspect of the flow of funds from world Jewry was the increase in times of
trouble for Israel, such as the Arab-Israeli wars, which was the reverse of
most capital movements. This source of funds reached a peak of about US $1.5
billion in 1973 and was providing nearly US $900 million a year in the
mid-1970s.

     The United States government provided Israel with the most assistance
over the years, totaling nearly US $13 billion between 1948 and late 1978.
Before the 1970s financial assistance averaged less than US $75 million a year
and consisted essentially of economic help. In the 1970s and particularly
after 1972, American aid increased sharply, averaging over US $1.5 billion a
year between mid-1973 and late 1978. Although economic assistance, primarily
help to finance balance-of-payments deficits, increased by large absolute
amounts, the focus of American aid shifted toward military equipment. By the
late 1970s military aid amounted to US $1 billion annually out of total
American aid of US $1.8 billion. Between independence and late 1978 total
American military assistance had reached US $7.9 billion, US $6.5 billion of
which had been provided since the 1973 war. At the end of 1977 Israel's debt
to the United States government amounted to US $3.7 billion.

     Over US $4 billion had been received from West Germany by 1978. The West
Germany government provided US $836 million in reparation payments to the
Israeli government, but this program was completed in the 1960s. The
reparation payments were significant in Israel's development effort in the
late 1950s and early 1960s. Personal restitution payments to Israeli citizens
for acts during Nazi rule were continuing in the 1970s, amounting to US $314
million in 1976. The West German government also provided development loans,
amounting to about US $50 million in 1976 and slightly more in 1977 and 1978.
Reparations and restitution payments, the bulk of capital imports from West
Germany, required no repayment.

     More than US $4.5 billion was received from a variety of sources between
1950 and 1977. These other sources included credits from West European
governments, loans from financial institutions, such as the International Bank
for Reconstruction and Development (IBRD, also known as the World Bank) and
the International Monetary Fund, and some other private and government
borrowing on long and medium term. Short-term loans provided an additional
emergency source of funds, but they were not included in this survey of
Israel's capital imports.

     Although a large part of capital imports required no repayment, the
increased borrowing during the 1970s rapidly escalated the obligations owed
abroad from US $3 billion in 1970 to US $9.3 billion at the beginning of 1977.
At that time the external public debt amounted to US $7.4 billion, including
US $2.1 billion for the government's Independence and Development Bonds. At the
beginning of 1977 private indebtedness abroad was US $1.6 billion. Interest
payments on the public and private debt were US $523 million in 1976, and total
debt servicing amounted to US $1.1 billion, 25 percent of the export of goods
and services. In 1977 the external debt increased by 15 percent to US $10.7
billion, but debt service as a percent of goods and services continued the
decline begun in 1975 because of increased exports; in 1977 the debt burden
amounted to 23 percent of the exports of goods and services. At the end of
1977 over 55 percent of the country's foreign debt was owed to the United
States government and Israeli bond holders.

     Deterioration of the balance of payments after the 1973 war was the
result of several factors. The major ones were the high level of defense
costs, sharply rising prices for imported commodities between 1973 and 1975,
and an economic recession in industrialized countries in the mid-1970s that
contracted Israel's export markets. The interaction of these factors greatly
increased the excess of imports over exports that had to be financed by
foreign funds. The trade deficit amounted to US $232 million in 1960, US $326
million in 1965, US $1.1 billion in 1970, and US $3.5 billion in 1975. Capital
imports, including private and government transfers, also increased nearly
doubling between 1972 and 1973. Capital imports amounted to US $2.4 billion in
1974 and US $3.3 billion in 1975 and 1976. In 1974 and 1975 the usual sources
of capital imports were insufficient, and foreign exchange reserve and other
short-term financing were used, amounting to nearly US $2 billion.

     In 1976 the balance of goods and services improved primarily because of
increased exports, partly resulting from economic recovery in industrialized
countries and currency devaluation, and a reduction of imports, almost
exclusively for defense (see table 18, Appendix A). Direct military imports
amounted to US $1,846 million in 1975 compared with US $1,603 million in 1976.
The  reduced trade deficit accompanied by a shift of American aid from loans
to grants (from US $642 million in 1975 to US $1.2 billion in 1976) reduced the
amount of foreign borrowing and eliminated the need for additional short-term
financing. The improvement in 1976 eased the near crisis of 1974 and 1975.
Foreign exchange reserves had increased by nearly US $200 million by the end of
1976, and they rose another US $200 million by January 1978 as exports of goods
and services increased more than imports. The country's foreign exchange
reserves amounted to nearly US $1.6 billion by January 1978, the highest level
since the end of 1973.

     Israeli officials had no hopes for rapidly reversing the traditional
import surplus. They had labored for many years to reduce imports by
encouraging local manufacturing and to stimulate export industries through
numerous policy measures. The best they could hope for was a gradual
improvement, such as that in 1976 and 1977, meanwhile continuing to rely on a
flow of foreign funds. Nonetheless there was strong motivation to reduce the
need for future borrowing and particularly to reduce the dependence of the
country's economy and defense posture on direct financial assistance from
another government. Moreover the important flow of funds from Jews in America
hinged partly on the tax treatment afforded contributions to Israel. By 1978
projections of export growth and reductions of the trade imbalance in future
years were optimistic, but realization depended on adjustments in
domestic industry that would improve its competitive position in foreign
markets and, above all, on peace and a reduction of the level of military
imports.