US embassy cable - 04TELAVIV1708

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 
----------------------- 
 
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 
----------------------- 
 
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 
------------- 
 
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. 
 
--------------------------------------------- ----------- 
The Future Costs: MoF and BoI Present Different Analyses 
--------------------------------------------- ----------- 
 
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 
------- 
 
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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