Israel’s Economic Success Isn’t Because of Industrial Policy

B y all accounts, the State of Israel is an impressive economic success. Despite a number of social and security-related challenges present from the day of its founding, Israel sports a first-world economy in a hostile environment of third-world countries. Thus, for instance, Israel’s GDP per capita is about $50,000, unemployment rates have been low for a decade now, social mobility is impressive, the national debt is under control, and the Israeli market has avoided a series of economic recessions that hit other strong economies.

Yet, this was not always the case here. After all, Israel was founded by a socialist left-wing party, and many of the immigrants who arrived on its shores hailed from countries that lacked a democratic, liberal culture. These facts, together with the reality of an ever-present existential threat, could easily have served as the backdrop for a militaristic state, not a wealthy, high-tech nation. How then, can Israel’s economic flourishing be explained? What was the recipe that enabled the state to transform from an oranges-exporting economy to a developed, technological one?

One explanation, fluently articulated by American Compass executive director Oren Cass, attributes Israel’s economic success to determined industrial policy. According to Cass, it was government guidance — including generous subsidies, tight oversight by the Chief Scientist, and other public projects — that caused Israel’s economy to leap forward. According to this narrative, Israeli high-tech is a product of the state’s visible hand, not the market’s invisible one. However, this interpretation is far from convincing.

When discussing Israel’s economy, it’s important to remember the big picture. Israel’s economic success should be credited first and foremost to the continuous and consistent liberalization processes that began in the mid Eighties and continue today. Entire industries in the Israeli market were exposed to importation and free competition for the first time. The Israeli tax system was reformed, including a substantial reduction in the rate of marginal income tax, as well as a reduction of the tax rates for companies and capital. Most significant, however, is the financial revolution the economy underwent. Up until the mid Eighties, Israeli governments crudely interfered with the financial system and attempted to narrowly direct existing capital in accordance with political concerns. One can only imagine what prosperous firms might have developed in Israel if its financial system had been free. It is no wonder that in the mid Eighties, when the state relinquished its chokehold on the system, economic flourishing was not long in coming.

Alongside these changes in economic policy, it is important to highlight the cultural shift in Israel that pushed economic growth forward as well. In the Eighties, the communal ideal of the halutz (an early Israeli immigrant), working the land changed to a bourgeois ideal. The businessman, doctor, scientist, and entrepreneur replaced the swamp-draining halutz living on a kibbutz. In other words, the communal ethos began to fade, while the individualistic one began to rise. Culturally and in terms of economic policy, the history of Israel’s economy is the story of slow emancipation from a collectivist economic heritage handed down by its founders and the gradual adoption of ever greater economic liberty.

Most specific to the high-tech sector, what enables growth isn’t government investment — which was always comparatively meager and often channeled towards economically failing avenues — but an entrepreneur-friendly institutional environment and mostly, as I’ve pointed out, the removal of government control of the financial system. Unlike other industries, such as housing and transportation, which suffer from overregulation and the harmful impact of workers’ organizations, Israeli high-tech benefits from comparatively low governmental interference. It is the atmosphere of freedom in the high-tech industry that enables Israeli entrepreneurs to efficiently take advantage of Israel’s human capital.

There is good reason we tend, in Israel, to contrast the high-tech industry with public services or with industries such as education, that are extensively controlled by the government. High-tech enjoys high productivity per worker and excellent consumer services, as a direct consequence of free entrepreneurship and competitive stressors. In contrast, the public sector in Israel suffers all the ailments that characterize other public sectors around the world, such as inefficiency and unaccountability. One can only wonder how it is that those central planners, apparently capable of planning industrial policy, are unable to produce efficient public service or a proper public education system.

Israeli high-tech isn’t growing and flourishing thanks to the government; it is growing and flourishing despite it. If state control and state planning were responsible for Israeli high-tech growth, we would have seen the Israeli computer and electronic industries soar much sooner than they did. Just as Israeli economist Ori Katz pointed out in his 2022 book The Israeli Miracle, similar economic policies adopted by other countries did not produce Israel’s success. Moreover, a wide array of private firms that receive no support or financial aid from state institutions succeed and thrive in Israel.

Contrary to the impression left by Cass’s article, the Israeli case persuasively exposes the harm and limitations of industrial policy. Cass avoids mentioning the many Israeli governments’ economic failures, so it is important to set the record straight. Various Israeli governments tried many times to rescue failing industries, such as the Israeli textile industry, and to direct human and physical capital to the Israeli periphery, in support of developing all corners of the country. However, despite this presumption, these attempts failed completely, wasting a huge amount of valuable public resources in the process.

Despite its remarkable achievements, the Israeli economy faces great challenges. Israel is failing to successfully integrate both the ultra-orthodox population and the Arab population into the workforce. Israeli workers’ productivity is quite low in comparison to American and European workers; capital per worker in Israel is low, and our public infrastructure is inadequate. In addition, in similar fashion to other Western countries, the Israeli economy suffers from regulatory burden.

These challenges, among others, are testament to the fact that the trouble in Israel is not “market fundamentalism.” Israel does not suffer from too much economic liberty. Quite the contrary. Our trouble lies in the baseless presumption of politicians and bureaucrats that assume they can satisfy consumers better than the free action of entrepreneurs.