Since independence, Israel's economy has been faced with serious problems. The government makes large outlays for social welfare purposes, but is obliged to divert a considerable portion of its income to defense. In addition, traditional Middle Eastern sources of supply (e.g., of oil and wheat) and nearby markets for goods and services have been closed off. Israel must export on a large scale to maintain its relatively high standard of living; hence, it remains dependent on a continuing flow of investment capital and of private and public assistance from abroad.
The economy is a mixture of private, state, and cooperative ownership and holdings of the labor movement. In the first 35 years of Israel's existence, the number of industrial enterprises more than doubled; over 700 agricultural settlements were established; and there were notable advances in housing, transportation, and exploitation of natural resources. From 1975 to 1980, GNP grew at an annual rate of 3.1% (at constant prices). Between 1980 and 1985, real GNP growth was 10%. In the period 1990–1996, real GDP growth averaged 2.6%. It was below this average in the period after 1989 when the country had to absorb more that half a million new immigrants. Most of these immigrants were relatively well educated, however, adding to Israel's already considerable base of technologically aware workforce and population. Real growth in per capita income was 2% in 1990 and 1991, and increased to 3% in 1992, but then fell back to .9% in 1993.
The Oslo Peace Accords were signed 13 September 1993 between Israel and the PLO, ending the first intifada (uprising) that had begun in 1987. The Peace Treaty with Jordan followed quickly, signed 26 October 1994. The Oslo Accords granted the Palestinian Authority (PA) limited sovereignty over areas in the West Bank and Gaza within the context of a timetable of confidence-building expansions. From the inception of the Oslo process, the Israeli economy has wavered between hopeful spurts of growth and cooperation, as openings and investor confidence increase, and recession, as extremists on both sides have sought to shut the process down. The accords brought to a formal end the Arab Boycott of Israel (BOI), in place since 1951, with the shutdown of the Central Boycott Office (CBO) in Damascus. From 1992–95, Israeli exports to Asia grew by 86% and by 1999 accounted for 20% of Israel's total exports. In October 2000, however, following the eruption of the second intifada in September, the Arab League passed a resolution calling for the reinstatement of the BOI. This time, however, agreement was not unanimous among the 22 members, and international pressure is strong against it. In May 2002 in a meeting in Damascus 19 Arab states drew up a list of firms to be blacklisted, but did not publish it. Tourism also benefited from the Peace Accords. Tourism grew to be Israel's second- or third-largest industry, reaching $4.3 billion in 2000. In October 2000, however, the month following the eruption of the renewed intifada, the number of tourists declined 43%. An estimated 50,000 workers in the tourist industry were laid off, helping push unemployment from 8.8% in 2002 to 9.3% in 2001 and an estimated 10.5% in 2002. In 2002, the Israeli Ministry of Tourism estimated that revenues from tourism had fallen by over half, to $2.1 billion. Foreign investment, once very hard to obtain, also grew substantially in years following the signing of the Oslo Accords.
The Oslo Accords were both a political agreement and an economic program that explicitly acknowledged that peace could not be attained or sustained without the establishment mutually beneficial economic relationships. Two annexes to the Oslo Accords laid out protocols for joint economic cooperation and regional development, listing specific projects to be pursued, including a Gaza seaport, a Gaza airport, a Mediterranean-Dead Sea Canal (MDSC) project, (that would also provide water desalinization and farm irrigation), and a Red Sea-Dead Sea Canal (RSDSC) project (similarly aimed at providing desalinization and crop irrigation), as well general provisions for the establishment of border and local industrial estates to encourage economic cooperation and investment. International donors pledged more than $2.4 billion over the years 1994–99, much of which was to be used on the infrastructural projects identified in Oslo protocols. While the canal projects, which had been under consideration for many years, remained tied up in political and economic controversies, construction proceeded on the sea port and airport for Gaza, and the Kami Industrial Estate on the Gaza-Israeli border, funded primarily by aid from the US and the EU. In the years immediately following the Peace Accords, 1994 to 1996, real per capita GDP growth in Israel was propelled to a relatively high sustained average of 4.1% despite the continued heavy influx of immigrants from ex-Soviet countries. In 1995, the political process moved a step forward with an interim agreement, Oslo II, providing for elections under the PA. However, in November of that year, Israeli prime minister Yitzhak Rabin, who had received the Nobel in 1994 for his work on the Oslo Accords, was assassinated by a fundamentalist Yemeni Jew.
The process became increasingly hobbled by rising violence and distrust on both sides, and required the constant vigilance of both its external supporters, primarily the United States and the EU, as well as its domestic supporters, to keep it from being derailed. In May 1996, Likud leader Benjamin Netanyahu defeated Israel's other Nobel Prize recipient for the Oslo Accords, Shimon Peres, by less than 1% under revised election laws that provided for the direct election of the prime minister. For the next three years, real GDP growth moderated to an annual average of2.87% in part because of the conservative government's greater wariness about moves to greater economic openness and cooperation. Also important, however, was the government's determined adherence to tight monetary and fiscal policies aimed at subduing Israel's chronically high inflation rate and tax burden. In the early 1980s, after the second oil shock, Israeli inflation had soared to triple digits, reaching a peak of 373.8% in 1985, the year before world oil prices collapsed. In 1986, inflation fell abruptly to 48%, and then, from 1987 to 1996, yearly inflation ranged from 10% to 20%. In 1997, Israel experienced its first single-digit level of inflation (9%) since 1970. Inflation rates continued to fall in 1998 and 1999, to 5.4% and5.2%, respectively. Strict monetary policies were not reversed by the return of a Labor-led government in 1999, as inflation fell to a record low of 1.1% in 2000 despite a spurt of real GDP growth of 6.4%. In the recession that accompanied the emergence of the new intifada in 2000, inflation has remained low to moderate, at 1.1% for 2001 and an estimated 3.5% for 2002. The moderate real GDP growth 1997 to 1999 was not sufficient to prevent per capita income from declining during this period because of continued immigration from Russia and other Eastern European countries. Although down from earlier peaks, Israel reported 64,164 immigrants in 1998 and 77,000 in 1999. Per capita GDP, at $17,720 in 1997, declined 2.5% to $17, 068 in 1998, and a further 1.8% to $16,756 in 1999.
In 2000, increased investments, foreign and domestic, as well as decreased immigration, helped produce a 6.9% increase in per capita income, which reached a record $17,913. In the political unrest that has ensued, however, per capita income has fallen back, first moderately, to $17,158 in 2001 and then sharply, to $15,895 in 2002, according to official government estimates. Israel's privatization program, begun in 1986, was given a strong impetus after the election of the Likud-led government in 1996, highlighted by the 1997 divestment of Bank Hapoalim, the country's largest bank. Privatization continued in 1998 and 1999 and the election of a Labor-led coalition in 1999 did not result in a reversal of the privatization initiatives.
Between 1986 and 2000, according to government statistics, the total extent of privatization amounted to $7.7 billion, with 60% raised from 1998 to 2000. A total of 77 companies ceased to be state-owned during this period. In 1999, elections by a margin of over 12% replaced Netanyahu with Ehud Barak of the Labour Party, who reopened peace negotiations on virtually all fronts, seeking a final status agreement. Barak and Arafat signed the Sharm El-Sheikh Agreement on 5 September 1999 finalizing border adjustments in the peace accord with Jordan and setting the Oslo Accord's seventh anniversary, September 13, 2000, as the target for reaching a final status agreement.
For the first nine months of 2000, both Israel and the areas under PA control experienced strong growth spurts. Per capita income growth in Israel was in double digits, and there was aggressive investment in new businesses, stimulated by Israel's unilateral withdrawal from southern Lebanon in May 2000. Exports surged ahead 23% on top of increases of 11.6% in 1999 and 6.6% in 1998. In the same nine months, in the areas under PA control, GDP grew 7% and unemployment dropped to an estimated 10%, down from highs of 30% in the West Bank and almost 40% in Gaza in 1996. In July, 2000, however, Palestinian negotiators broke off US-sponsored negotiations at Camp David over the status of Jerusalem, scuttling progress toward final agreement. On 28 September 2000, opposition leader, Ariel Sharon, and some other Knesset members, paid a visit to the Temple Mount/Haram al-Sharif (i.e., the Noble Sanctuary, Arab name for the 35-acre complex that includes the remains of the Jewish temple), to symbolically assert their position that these holy places should remain under Israeli sovereignty. The day after Sharon's visit, on 29 September 2000, the second intifada erupted, bringing with it an abrupt reversal of the economic progress that had marked the first part of the year. Urgently renewed US-sponsored status negotiations failed to produce an agreement and were in any case allowed to lapse by the in-coming Bush administration.
On 6 February 2001 Ariel Sharon was elected prime minister, and on 4 March, three days before he assumed office, the violence of the intifada was ratcheted up to a new level as Hamas (the Islamic Resistance Movement) announced that they had not only sponsored the suicide bomb attack that took place that day in the resort town of Netanya, that it was only the first of 10 it had planned. The proliferation of suicide bomb attacks and Israel's retaliatory incursions into the Palestinian areas brought economic decline on both sides, particularly after the conflict was effectively globalized in the 11 September 2001 attacks on the World Trade Center in New York and on the Pentagon in Washington, D.C. Official statistics estimate that Israel's economy declined 0.6% in 2001 as foreign investment fell by 7% and exports fell 16.7% from $45 billion in 2000 to $37.65 billion in 2001.
In 2002, the economy continued to stagnate at a an estimated real GDP growth rate of .7%, and a decline in per capita income of over 11% from the peak reached in 2000. However, if the Israeli economy has stagnated under the impact of the renewed intifada and the closely related global slowdown following the 11 September terrorist attacks, the economy under PA control has all but collapsed. A World Bank report on Palestine in 2002 estimated that unemployment had risen from 10% in 2000 to 26% by December 2001, and that the average income had fallen 40%, from $1,716 to $1,030, well below the $1,400 that had been reached five years before in 1996. Tourism, which is Israel's second- or third-leading industry, is the leading industry in PA areas, and it has doubly suffered from the loss of security and the destruction of infrastructure in Israeli retaliatory incursions. Virtually all of the projects built under the protocols of the Oslo Accords, including the Gaza seaport, Gaza airport, and Kami Industrial Estate, have been significantly damaged or destroyed in the fighting. In 2003, there are reports of a million Palestinians facing hunger. Although experience under the Oslo Peace process demonstrated that significant opportunities exist for economic growth and development, at the beginning of 2003, as a war with Iraq loomed on the region's horizon, it was unclear how permanent the damage had been to the peace process and to the possibilities of economic recovery.