Mediterranean Policy ProgramSeries on the Region and the Economic Crisis Prepared in Partnership with Paralleli Euromediterranean Institute

(Turin)

Policy Brief
May 2012

Summary: Although geographically very much in the Middle East, history has left Israels economic exposure to its neighbors political fluctuations limited. Of Israels total global in $89 billion exports in 2011 (excluding exports by Israeli startup companies or their acquisition by foreign buyers) the vast majority went to Europe and the United States. Estimates indicate that indirect Israeli exports to members of the Gulf Cooperation Council, shipped through third countries and listed on official external trade statistics as exports to those third parties, make up around $500 million of the total, while Egypt and Jordan account for a modest $200 million each.

Israels Economy and the Arab Spring: Isolation Serves as a Buffer

by Stephen Weizman*

Although geographically very much in the Middle East, history has left Israels economic exposure to its neighbors political fluctuations limited. During fighting that preceded and accompanied the 1948 founding of the state of Israel, it waged war with Lebanon, Syria, Iraq, Jordan, Egypt (with contingents from Sudan), and local Palestinians supported by Arab volunteers from abroad. The Arab League at the time declared an official member boycott of Israeli companies and products, as well as a boycott of third-country companies trading with Israel. A December 2011 report by the U.S. Congressional Research Service said that overall enforcement of the boycott by the leagues 22 members now appears to be sporadic. The Arab League does not formally or publicly state which countries enforce the boycott and which do not, it added. In 1979, Egypt became the first Arab nation to sign a peace treaty with Israel, followed by Jordan in 1994. They remain the only Arab states to maintain full, if sometimes troubled, diplomatic relations with Israel.

As a consequence of interim accords between Israel and the Palestinians between 1993 and 1995, the Gulf states showed interest in establishing relations with Israel. In May 1996, Israel opened trade representation offices in Oman and Qatar to develop economic, scientific, and commercial relations, with emphasis on water resources utilization, tourism, agriculture, chemicals, and advanced technologies as the Israeli Ministry of Foreign Affairs (MFA) puts it. Following the outbreak in 2000 of the second Palestinian intifada against Israeli occupation, those relations cooled and Oman closed the Israeli mission. Qatar followed suit in 2009 after an Israeli military offensive in the Gaza Strip in which approximately 1,400 Palestinians and 13 Israelis were killed. In 1994, Morocco and Tunisia established diplomatic ties with Israel but severed them again with the start of the 2000 intifada. Nevertheless, some commercial relations and tourism continue, as well as contacts in other fields, the MFA website says, without elaborating.

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*Stephen Weizman has been writing from Jerusalem, mainly on political and diplomatic issues, since 1986, working for the major international news agencies and for Israeli public radio and television. He is currently employed by Agence France Presse. The views expressed in this article are his own, except where attributed to other sources.

Mediterranean Policy ProgramSeries on the Region and the Economic Crisis

Policy Brief
One of the goals of the Euro-Mediterranean Partnership, launched by the European Unions 1995 Barcelona Declaration, was the establishment of free trade among the EUs southern Mediterranean partners: Algeria, Egypt, Israel, Jordan, Lebanon, Morocco, the Palestinian Authority (PA), Syria, Tunisia and Turkey. But the European Commission acknowledged in September that fulfillment of that aim was still a long way off. Regional economic integration between Southern Mediterranean countries is still limited: total intra-regional trade amounted to 15 billion in 2009, one of the lowest levels of regional economic integration in the world, it wrote. Of Israels total global in $89 billion exports in 2011 (excluding exports by Israeli startup companies or their acquisition by foreign buyers) the vast majority went to Europe and the United States. Data published by the Israel Export and International Cooperation Institute (excluding diamonds and services) gives export sales for the year of $46 billion, of which 40 percent went to continental Europe (32 percent to the EU) and 25 percent to the United States. FDI inflows for 2010 were $8 billion. A January 2012 paper by Yitzhak Gal, of Tel Aviv Universitys Moshe Dayan Center for Middle Eastern and African Studies, says that Israeli exports to the Middle East, including the Palestinian Authority (PA), are estimated at over $6 billion in 2011, more than its combined sales to Eastern Europe, South and Central America, Africa (excluding Egypt), and Oceania. The PA, accounting for about half of that total, is Israels largest single customer in the region and second only to the United States in global terms. However, Israels tight military and economic control of the Occupied Palestinian Territories mean that events there are affected to only a very limited extent by the upheaval in other parts of the Arab world. The Dayan Center estimates that indirect Israeli exports to members of the Gulf Cooperation Council, shipped through third countries and listed on official external trade statistics as exports to those third parties, make up around $500 million of the total, while Egypt and Jordan account for a modest $200 million each. Egypt Egypt is the only one of Israels immediate neighbors to have undergone a revolution as a result of the Arab Spring. Changes there have economic, security, and psychological ramifications for the Israelis. While Israels exports to Egypt climbed to just below $200 million in 2011, from $148 million in pre-revolutionary 2010 according to the Israeli Central Bureau of Statistics (CBS), imports plummeted to $178 million from $355 million the previous year. This was mainly a result of a series of attacks on the Sinai peninsula pipeline carrying Egyptian gas to Israel, which at the time of writing had been damaged 14 times since the January 2011 outbreak of civil unrest. The attacks disrupted supplies for long periods, forcing Israel to use more costly and polluting oil or coal for its power stations. In mid-April, Egypts EGAS said that it was cancelling the 20-year contract, signed in 2005, because Israel had not honored its terms. The Israeli government said that it was a business dispute rather than a diplomatic rift, but Haaretz newspaper reported on April 29 that there had been confidential discussions on the issue between Israeli and Egyptian government officials at meetings in Cairo and Jerusalem. The paper said that due to the pipeline bombings, the actual amount of gas supplied to Israel over the past year amounted to only $56 million. On April 23, Egypts international cooperation minister was quoted by the countrys official MENA news agency as saying that her country was ready to resume gas sales to Israel, subject to a new contract and at a higher price. It remains to be seen if these demands will make economic sense to Israel or whether it might accept them anyway as a matter of political goodwill. It could also choose to carry on without Egyptian oil as it has largely done since February 2011 while it awaits new production from its own newly discovered offshore gasfields, which are expected to make it self-sufficient and, in fact, a net exporter. The Tamar field, with reserves of 246 billion cubic meters, is due to come online by April 2013. The energy ministry estimates that the offshore Mediterranean finds could altogether hold around 1 trillion cubic meters. It is seeking foreign partners to help develop their potential, and in March the ministry hosted a presentation to French energy firms. Israel is also in discussions with Mediterranean neighbor Cyprus on joint development of their respective undersea fields and possible cooperation on piping their gas to continental Europe and to Asia. Prime Minister Benjamin

Mediterranean Policy ProgramSeries on the Region and the Economic Crisis

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It remains to be seen if Egypts demands will make economic sense to Israel or whether it might accept them anyway as a matter of political goodwill.
Netanyahu held talks on the subject in Nicosia in February, the first ever visit to the island by an Israeli premier. In 2010, Israel used 5.3 billion cubic meters of natural gas, 90 percent of it for electricity generation. Its offshore Yam Thetis field supplied about 60 percent, with Egypt supplying the remainder. The pipeline attacks are seen as part of a general postrevolution breakdown in law and order in the Sinai, which has a 240-kilometre border with Israel, is remote from the centre of power in Cairo, sparsely inhabited, and characterized by impassable harsh terrain in many parts. In April this year, two Grad rockets, which Israel said were fired from the peninsula, fell in and close to the Israeli Red Sea resort of Eilat, which lies adjacent to the border. Nobody was injured, and Egypt denied that the rockets were fired from its territory. Hours after the attack, the head of Israeli military intelligence, Major-General Aviv Kochavi, told a class of graduating officers that the army had identified at least 10 militant infrastructures in Sinai in the preceding months. He did not give details, but said a rise in militant activity there, represents the drastic change the region is going through. Terror organizations continue to increasingly base there, constantly strengthening their grip. In August 2011, gunmen from the peninsula entered Israel and carried out a series of raids on traffic just north of Eilat, killing eight Israelis. In the search for the attackers along the porous border that followed, Israeli soldiers shot dead six Egyptian policemen, exacerbating already cool diplomatic relations. Israel has since said that several Palestinian militants it killed in air strikes into the Gaza Strip, which also borders the Sinai, had been planning fresh attacks into Israel by way of Egypt. The attack lent new impetus to work on an upgraded Israeli security barrier along the border with Egypt, which, in stretches, had previously been unfenced. Work is expected to be complete by this autumn, at a projected cost of about 275 million. The Israeli government says that in addition to improving border defenses against militant attack, it is also meant to prevent widespread smuggling of women for the sex trade, drugs, and weapons and halt the passage of African economic migrants. The Israeli interior ministry said that 16,816 people illegally crossed into Israel across the Egyptian border in 2011. In the aftermath of the August border incident, protesters in Cairo attacked the Israeli embassy on September 9, forcing the evacuation of all embassy staff and the closing of the premises. Israeli ambassador Yitzhak Levanon returned to Cairo in November and completed his term there. He was replaced in February by Yaacov Amitai and in the meantime, the Israeli mission moved to new premises. Although Israeli officials are wary of the path that postrevolutionary Egypt may take in the wake of landslide Islamist victories in the parliamentary and senate elections that followed Mubaraks downfall, they have been extremely cautious in public statements, stressing the importance of maintaining the 1979 peace treaty. Israel extends its congratulations to the people of Egypt for its efforts to achieve freedom, democracy, and economic development, an MFA statement on the inauguration of the new parliament said. We trust Egypt will continue to uphold the importance of peace and stability in our region. Jordan King Abdullah II has sought to stave off popular unrest by offering modest concessions. In one response to protests demanding political and economic change, the government in April said it had approved draft electoral reform legislation that would introduce proportional representation and increase a parliamentary quota of women in the parliament. It still remains to be seen if his strategy will keep the monarchy in its present position. Israels $200 million in exports to its eastern neighbor in 2011 showed a modest rise from the previous years $186 million. Israeli imports from Jordan rose significantly to $173 million last year compared to $94 million in 2010.

Mediterranean Policy ProgramSeries on the Region and the Economic Crisis

Policy Brief
The major classes of items were plastics, livestock, and machinery. Israeli exports to both Jordan and Egypt have been boosted by the Qualifying Industrial Zone (QIZ) program set up by the United States in support of Middle East peace efforts, in which goods produced in designated manufacturing areas in both countries can be imported into the United States tariff- and quota-free if a percentage the products content is of Israeli origin (11.7 percent in the Jordanian scheme, 10.5 percent in Egypt). Israel is keen to encourage tourists to Egypt and Jordan to expand their itinerary for a visit to Israel as well, although that market is still a fledgling one, with 324,000 tourists (excluding day-trippers) entering Israel by land from Jordan in 2010 and 165,000 from Egypt. Growth in that area will obviously depend on stability and security in all three countries. In January this year, Netanyahu told colleagues from his Likud party that he intended to fortify Israels 238 kilometer border with Jordan at a cost of 129 million. The stated reason was a concern that the frontier would become a focus of attempts by illegal migrants once the barrier with Egypt is complete, but it can safely be assumed that security advisors also see a tightening of border security as prudent, given the unpredictable future of the kingdom, most of whose citizens are ethnic Palestinians. Syria Israel is legally still in a state of war with its northeastern neighbor and thus has no measurable trade with it, although some goods may arrive there through third countries. The economic impact of the violence raging in Syria finds expression mostly in Israeli preparations for border incursions that might result. Media reports say that frontier defenses are being strengthened but details have not been made public. During protests last year to mark the anniversary of Israels seizure of the Golan Heights, the West Bank, and the Gaza Strip and east Jerusalem in the Six Day War, protesters from Syria stormed the border fence and Syrian state media said that Israeli army fire killed 23 people. The Israeli military spokespersons office said that 10 people were killed by land mines on the Syrian side of the frontier. Lebanon Like Syria, Lebanon is technically in a state of war with Israel and there is no visible bilateral trade. Nevertheless, military officials from Lebanon and Israel hold regular meetings chaired by United Nations Interim Force in Lebanon officers in an effort to preempt or solve problems along their 79 kilometer joint border. Israel and Lebanons Shiite Hezbollah movement last went to war in 2006, with the loss of about 1,200 mainly civilians in Lebanon and 160 Israelis, mostly soldiers. Since then, the frontier has been mainly quiet, apart from skirmishes. While Lebanon has so far not been swept up in the political turmoil of the Arab Spring, the balance between Shiia, Sunni, Druze, and Christian interests has always been a delicate one and there are concerns, both in Beirut and Jerusalem, that the Syrian violence could overflow into its Lebanese neighbor, particularly given Hezbollahs historic ties with Damascus. Israel has started strengthening its side of the border with an anti-sniper wall around part of the Israeli frontier town of Metulla. It appears however that this is a specific consequence of a new residential neighborhood being built on a site exposed to potential cross-border fire rather than a response to overall regional unrest. The Israeli defense establishment has also said that, in the future, it intends to deploy batteries of its Iron Dome missile defense system used effectively this spring to combat rocket fire into southern Israel from the Gaza Strip along its borders with Lebanon and Syria. This would seem to be part of long-term strategic thinking and the history of conflict with both countries rather than a precaution triggered by the Arab Spring. In the 2006 conflict, Hezbollah fired about 4,000 rockets into Israel, some reaching 45 kilometers across the border. Turkey While not an Arab country, Israels large and powerful Muslim neighbor was traditionally seen as both a bridge and a buffer between the Israel and the Arab world. The two had deep defense and trade ties and a mutual suspicion of radical Islam. Turkey recognized the state of Israel in 1949, the first Muslim country to do so. Prime Minister Recep Yayyip Erdoan visited Israel in 2005, offering to serve as a Middle East peace mediator. In March 1996, Israel

Mediterranean Policy ProgramSeries on the Region and the Economic Crisis

Policy Brief
and Turkey signed a free-trade agreement. With Istanbul a 90-minute flight from Tel Aviv, Turkey became a major destination for Israeli tourists. The cozy relationship started to go sour when Turkey condemned Israels 2008/2009 Gaza offensive and Erdoan and Israeli President Shimon Peres had a public falling-out during a panel discussion on Gaza at the January 2009 World Economic Forum. Events spiraled out of control in May 2010, when Israeli commandos seized a Turkish ferry, the Mavi Marmara, that was leading a convoy of vessels carrying activists seeking to breach Israels naval blockade of the Gaza Strip. Turkey demanded an apology for the killing of nine of its citizens in the raid. Israel expressed regret at the loss of life but refuses to make a formal apology or acknowledge liability, saying that passengers used life-threatening violence against Israeli personnel seeking to enforce a legitimate search for arms or other contraband. Since then, Turkey has expelled Israels ambassador and suspended military agreements, including joint air force maneuvers in Turkish air space. In what has been seen as a diplomatic and strategic riposte, Israel has stepped up military cooperation with Greece, Cyprus, Bulgaria, and Romania. The official chill, however, does not seem to have cooled commerce so far, with Turkey remaining Israels largest regional customer, after the PA. The Dayan Center says that Turkey re-exports some of its Israeli purchases to GCC countries. Israeli CBS data show sales to Turkey in 2010, the last year for which it has published export figures, as totaling $1.3 billion, compared to the pre-crisis 2009 figure of $1 billion. It says that 2011 imports were valued at $2.2 billion, compared to $1.8 billion the previous year and $1.4 billion in 2009. The Domestic Situation In early May, after saying that he intended to bring forward the general election scheduled for October 2013, Netanyahu instead brought the opposition Kadima party into his coalition and made its leader, former general Shaul Mofaz, vice premier. The move gave Netanyahu control of 94 seats in the 120-member Knesset and should ensure political stability until the appointed election date. In a general comment on the changes sweeping the Middle East, Netanyahu said in February that he was under pressure to increase already heavy defense spending (six percent of GDP in 2010) to prepare for any possible scenario across its borders, although he did not give a figure for projected needs. What it means for us is that it places enormous pressures on our security, on our defenses, Netanyahu told a conference of American Jewish leaders in Jerusalem. We just increased our defense budget by 3 billion shekels (606 million). Thats a lot for us. But the defense establishment says, we want more. The defense ministry had previously projected the 2012 budget at around 10 billion, broadly unchanged from last year. Regional uncertainties have not had a significant impact on tourism to Israel, one of the countrys biggest earners. The tourism ministry logged 3.4 million arrivals in 2011, a drop of 2 percent from 2010 but said the visitors spent a record 7 billion. The decline in numbers is seen more as a reflection of the world economic crisis than of geostrategic change in the Middle East. Arrivals in the first quarter of 2012 reached an all-time record of 752,000, 2 percent up compared to the same period last year. In July last year, a protest movement spread by social networking media was hailed by the local press as an Israeli version of the Arab Spring, but in truth, it was of an altogether different nature. Hundreds of largely young, middle-class Israelis set up tents in one of Tel Avivs most high-rent districts in support of their demands for affordable housing and were joined by thousands more in marches that called, among other things, for cuts to the cost of groceries, cheaper pre-school education, and better deals

The official chill, however, does not seem to have cooled commerce so far, with Turkey remaining Israels largest regional customer, after the Palestinain Authority.
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Mediterranean Policy ProgramSeries on the Region and the Economic Crisis

Policy Brief
for overworked young doctors. There was no significant call for constitutional change. At their peak, on September 3, an estimated 450,000 people participated in nationwide rallies but the protests, and the tent cities that had sprung up around the country, largely melted away with the coming of winter wind and rain. They had yet to be reestablished at the time of writing. The government appointed a committee to examine the protesters grievances and it came up with a list of recommendations on breaking up commercial monopolies, providing more housing, lowering taxation, and improving social services and education. Netanyahu welcomed the proposals in principal but was adamant that any new spending would have to come from cuts to existing budget items and that he was not prepared to finance change through deficits. He promised more construction of affordable homes, many of them to be located in Israeli settlements on the occupied West Bank, and reduced duty on fuel, but rising world oil costs pushed prices up nevertheless. The Consumer Price Index rose by 3.6 percent in 2011, compared to 2.7 percent in 2010, with the rise in the price of fuel playing a significant role. On April 1, 2012, one liter of unleaded 95 octane cost 1.58, a rise of more than 5 percent from one year before. Ironically, fuel price inflation is being mainly attributed to the effect of international sanctions against Iran, for which Israel is a leading lobbyist, and to talk of a possible military strike against Iranian nuclear facilities, which Israel says it may be obliged to carry out itself at some stage. The Government does not control fuel prices, Netanyahu told a cabinet meeting after the April 1 increase. We have witnessed a constant upward movement in the past year as a result of the sanctions on Iran and other factors. We are trying to moderate the increases in order to make things easier for citizens. We are capable of doing so partially and cannot do so fully, but we have decided to do so several times in recent months. But, as usual, this is not a free lunch and, therefore, from a budgetary perspective, we need to cover the gap that results from lowering prices. A recent report by the International Monetary Fund said that while Israels 4.7 percent 2011 growth in GDP was strong, its poverty levels were paradoxically among the highest in the Organisation for Economic Co-operation and Development. While the secular Jewish population enjoys a high level of living standards, most Arab and Haredi (ultra-Orthodox Jewish) people are poor, with poverty incidence reaching 60 percent for both groups, the report says. These populations also have a large number of children, typically 6-7 in a Haredi family and 3-4 in an Arab family, and child poverty is dire. The Future The IMF forecasts 2012 GDP growth slowing to 2.8 percent but adds that Israels fundamentals are strong. Unemployment is at historic lows, the net international investment position is a surplus, and public debt has fallen steadily to below 75 percent of GDP, it wrote. It added that there is a potential upside to the fact that Arab and Haredi children currently make up more than 40 percent of first grade pupils who, if brought into the labor market, could be a pool of human resources and an engine for future growth. In February, the Israeli government approved construction of the first rail link between Israels Mediterranean and Red Sea coasts, offering a new Asia-Europe trade route to compete with the Suez Canal. Although the decision was primarily commercial, Netanyahu described it at a cabinet meeting as strategic and officials said that possible future disruption to shipping on the canal as a result of Egyptian instability had been a factor in their thinking. The project is scheduled for completion by the end of 2017. It could be used in future to deliver gas from Israels Mediterranean fields to tankers at its Red Sea port of Eilat for shipment to Asia, although long-term destabilization in the Arab world could pose security risks for gas-laden vessels sailing from Israel past the coastlines of Jordan, Egypt, Saudi Arabia, Sudan, and Yemen. As mentioned earlier, the Tamar gas field is due to come online next spring. The Yam Thetis field has been producing since 2004, and others are expected to be online by 2015. Interviewed for this article, the Dayan Centers Yizhak Gal said that should the flow of gas from Egypt be resumed and stabilized, the cash value of Israeli imports could rise in the short term due to the proposed Egyptian price-rise.

Mediterranean Policy ProgramSeries on the Region and the Economic Crisis

Policy Brief
He says that the future of Israeli exports to Egypt, mainly textile components for re-export through the QIZs, remains to be seen. In spite of the turmoil in Egypt, textile and garment exports to the U.S. have not been hurt, yet, he says. If a new Egyptian government will succeed in restabilizing the political arena, and restore orderly functioning of the economy, the present high level of Egypts textile export to the U.S. may continue, and with it, imports from Israel. Under other possible political scenarios, however, the QIZ agreement may be hurt, and with it imports from Israel. Gal adds that Israeli trade with other Middle East partners is not expected to be directly affected by the Arab Spring. Conclusion Sixty-four years of political, cultural, and economic isolation from the bulk of the surrounding Arab world have left Israel largely immune commercially to the winds of change blowing around it. Israels thriving hi-tech industry, in part a spinoff from defense R&D, looks to the West for markets and investment, while looking inward for its human resources. While there is much concern regarding a future in which radical Islam could take hold in its immediate neighbors, there is also a degree of confidence that future governments there would be sufficiently pragmatic and sufficiently occupied with rebuilding their polities and economies not to seek open hostilities with Israel. As the Arab countries represent a relatively small part of Israels foreign trade anyway, with future growth seen as coming largely from the Far East, the potential impact on Israels economy appears also to be limited.
About the Partners

The German Marshall Fund of the United States (GMF) is a non-partisan American public policy and grantmaking institution dedicated to promoting better understanding and cooperation between North America and Europe on transatlantic and global issues. GMF does this by supporting individuals and institutions working in the transatlantic sphere, by convening leaders and members of the policy and business communities, by contributing research and analysis on transatlantic topics, and by providing exchange opportunities to foster renewed commitment to the transatlantic relationship. In addition, GMF supports a number of initiatives to strengthen democracies. Founded in 1972 through a gift from Germany as a permanent memorial to Marshall Plan assistance, GMF maintains a strong presence on both sides of the Atlantic. In addition to its headquarters in Washington, DC, GMF has seven offices in Europe: Berlin, Paris, Brussels, Belgrade, Ankara, Bucharest, and Warsaw. GMF also has smaller representations in Bratislava, Turin, and Stockholm. www.gmfus.org

Paralleli Euromediterranean Institutes mandate is to contribute to the creation of a Euro-Mediterranean area of freedom and of economic and social development. The institute acts at the local, national, and international level with the aim of meeting the needs of the North-West region of Italy concerning its relations with the other sides of the Mediterranean Sea. The activities of the Institute fall within the process of Euro-Mediterranean partnership initiated by the European Union with the 1995 Barcelona Process and currently undergoing a major relaunch through the Union for the Mediterranean, since July 2008. Paralleli intends to contribute to the reinforcement of political relations, economic cooperation, cultural exchange, and human flows between the European and the South-East Mediterranean countries. Its main objective is to promote dialogue at cultural, social, and political level between the societies of the Mediterranean countries, with the aim of encouraging and improving economic relations between them, with a particular focus on the dimension of sustainability and co-development. For this reason, the institute has decided: to involve civil society in the development of Euro-Mediterranean relations; to create and to support networking in the Mediterranean area; and to increase the value of research in order to suggest truly effective policies to local, national, and international actors. www.paralleli.org