The Israeli economy finds itself at a crossroads, facing greater strains from increased defense spending and high interest payments for war-related debt after more than 2 1/2 years of conflict, resulting in cuts or stagnation for education and welfare budgets. This also comes during a period of social and political division, particularly as Israel prepares for a national election later this year. 

To consider how the country can emerge from this situation stronger, the Israel Democracy Institute is gathering the country’s top policymakers, economists, business leaders and civil servants to discuss these issues on Tuesday and Wednesday in its annual Eli Hurvitz Conference (formerly known as the Caesarea Conference), which is being held at the Orient Hotel in Jerusalem.

Featured speakers include Eli Hurvitz, CEO of the Trump Foundation (no connection to the U.S. president); Amir Yaron, governor of the Bank of Israel; Avigdor Liberman, head of the Yisrael Beitenu party; Mansour Abbas, chairman of the Ra’am party; Benny Gantz, chair of the Blue and White party; Yair Lapid, opposition leader; and Rebecca Caspi, director general of Jewish Federations of North America’s Israel office.

Ahead of the conference, eJewishPhilanthropy spoke with Karnit Flug, the past governor of the Bank of Israel and senior fellow for economic policy at IDI’s Center for Governance and the Economy, about the challenges facing the Israeli economy and her recommendations for how to overcome them, primarily through rebuilding public trust and halting divisive sectoral spending, as well as what philanthropy can do to help. 

This interview has been edited for length and clarity.

Justin Hayet: IDI is primarily focused on strengthening Israel’s democratic institutions. This conference and your research are focused on the fiscal and economic implications of the national budget. What is the fundamental link between how the government manages its money and the long-term health of Israel’s democracy?

Karnit Flug: Both are very important for the health of the country. We talked in a previous conference about how the erosion of the strength of the democratic institutions is a risk to the economy. And there is research beyond Israel — global research — to support this, such as the extensive research of Daron Acemoglu [the 2024 Nobel laureate], who demonstrated that the strength of democratic institutions is a fundamental driver of economic growth and prosperity. There is a clear link. Our current conference is focused not on the institutions but on the economic management of Israel and how it can ensure its growth and the success of the economy and stability and resilience after 2 1/2 years of continuous conflict, which obviously has a lot of different channels of effects on the economy.  

JH: How do you assess the current state of the Israeli social contract? Has it been strengthened or strained by the challenges of the last few years?

KF: In some ways, we’ve seen it especially at the start of the war — the mobilization of the whole society, different parts of society, in trying to help the communities that were hurt. And there was a sense of solidarity, a very strong sense of togetherness. But then there is a frustration about the insufficient response of the government to the social challenges that are resulting from the war. And there is a growing frustration because [certain] communities are not addressed sufficiently, and the rehabilitation has been very slow. The budget does not seem to reflect the internalization of the challenges that are resulting from the very long war.

JH: Your presentation at the conference will highlight the dangers of sectoral budgeting and a lack of long-term planning. For international funders and those within the Jewish philanthropic world, what is the single most critical finding in your work that should change the way they engage with Israel right now?

KF: Civilian spending will remain severely constrained by increased defense obligations and rising interest payments on war-accumulated debt. As military spending remains elevated, the pressure on civilian services will only intensify. 

I think where philanthropists can make a difference is expanding their spending on education programs for specific groups that are underprivileged and do not get sufficient support. And it’s particularly important in the geographic periphery and the socioeconomic periphery. The other area is supporting the process of getting the ultra-Orthodox community to acquire the necessary skills to successfully engage in the labor market. And then there are a lot of needs in supporting communities hurt by the continuous war. The needs will only grow because of the very tight budgetary situation.

JH: We are seeing a transition from emergency funding to long-term resilience funding. How can funders pivot from “putting out fires” to leveraging their capital to incentivize the structural reforms that the government seems unwilling to undertake?

KF: There are places where the philanthropists can work with the government and condition its funding on tying it to reforms, for example, in the education system. Israel underfunds education in general. The per-student budget is relatively low, but we also have a lot of room for reform in the education system. We have four different systems [state, state-religious, Arab and Haredi] with different standards and management. For example, in the basic state system, there are very rigid rules in terms of the relationship with the unions of the teachers, and there are very few incentives for excelling. If philanthropists get into the areas of education and tie their [financial] support to the way the system is reformed, this can also incentivize the teachers and policymakers to move in the direction we would like to move. 

JH: What is the one urgent hard truth about Israel’s fiscal trajectory that must be addressed head-on?

KF: The reality is that we face higher defense spending and rising interest payments. We cannot fund these and our civilian needs by simply increasing the deficit — we must reduce our debt, which will require higher taxation. However, that tax hike is only possible if we rebuild public trust that these revenues will benefit society at large, rather than specific interest groups.

The issue of rebuilding trust is extremely important. One important element of that is eliminating the coalition money, which is directed towards specific groups, based not in professional analysis as to how best serve the public but rather on political interests. This is particularly problematic in the current economic circumstances, where the needs have mushroomed. [The government] still allocates significant resources to interest groups in a way that goes against the long-term goals.

Another element that is forgotten — but eroded the trust — is that we have some 35 ministries. Many of them were created in order to appease coalition members, and not only are they unnecessary, but they disturb one another because the territories of their are not well defined. We are not talking about a huge sum of money, but [this government] creates fictitious ministries for coalition purposes. This adds to the erosion of trust in the government. These things should be eliminated in order to be able to introduce higher taxes. When we talk about higher taxes, we are talking about taxes that broaden the tax base because there is a part of society that pays heavy taxes and another that does not, but more broadly, the overall tax revenue that Israel collects relative to gross domestic product is lower than the median OECD country.

JH: For the philanthropic community, what does an “apolitical” support strategy look like in practice, and is it possible to engage without being drawn into the political fray?

KF: Actually, I think a good example of apolitical advice is what we’ve discussed. Economic policy needs to be directed at growth, reducing social gaps, and improving the quality of life for Israeli citizens. The economic analysis that underlies these solutions is inherently apolitical. We have very fruitful discussions with professional staff across the relevant ministries, including the Ministry of Finance, regardless of which political party holds the leadership.