From Upheaval to Inflation: The Likud’s Neoliberal Revolution, 1977–1984

In July 1977, Milton Friedman went to Israel. He was invited by Hebrew University professor Don Patinkin to receive an honorary degree and give a seminar. The government welcomed Friedman and asked him to stay longer so he could participate in some informal consultations. As the deputy finance minister explained to the American ambassador, Friedman was chosen “to invest the Likud’s idea for liberalizing Israel’s economy with the prestige of Friedman’s name.” Friedman, who knew how to work with the media, used his visit to give several interviews to Israeli newspapers. He capitalized on his renown as a leading economist to sell to the Israeli public the economic agenda of the new Likud government, which included privatization and free-market reforms.

As it turned out, while Likud ministers were willing to meet with Friedman during his brief visit, they did not consult him about their plans, and Friedman had no influence on the decisions they made. Friedman well understood that the Israeli government had no intention of listening to his advice. Nevertheless, he believed “that I can be most useful simply by providing some respectability and prestige to [the Israeli government’s] economic program.” However, only a few years after that fateful visit, Friedman made efforts to distance himself from the Likud economic program. And it’s easy to understand why. Its economic policy was a hot mess during its first years in power.

The Likud inherited an economy in a state of crisis. In 1973, Israel’s economy was hit by a double whammy. It suffered from both the high costs of the Yom Kippur War and the concomitant rise of oil prices (Israel’s fuel costs rose by 277 percent during 1974). Inflation was 36 percent per year. The Yitzhak Rabin government (in power between 1974 and 1977) responded by raising taxes to deal with rising budget and balance-of-payment deficits. The Israeli pound was devalued numerous times to decrease imports and increase the competitiveness of Israeli exports. The results were troubling. GDP growth fell from 11.9 percent in 1972 to -0.3 percent in 1976 — i.e., the economy was contracting. With the economy in such dire straits, it’s no wonder that Labor lost badly to the Likud in the 1977 elections.

The Likud’s first major economic decision was to turn toward austerity. Simha Erlich, the first of four Likud finance ministers over the next seven years, announced a $143 million budget cut (approximately 1 percent of the 1976 GDP) in July 1977, a 25 percent cut in food and fuel subsidies, and a 2 percent devaluation of the Israeli pound. This announcement was made on the eve of a meeting between Prime Minister Menachem Begin and President Jimmy Carter. At the time, Israel was highly dependent on US economic aid. American capital transfers helped cover Israel’s large balance-of-payment deficit. Specifically, Begin was about to ask Carter for a whopping $2.3 billion in aid, a 30.5 percent increase from the previous year’s request. Ahead of the meeting, the Carter administration signaled to the Begin government that Israel must put its house in order or face the prospect that US aid would be cut. Erlich’s press conference, which announced austerity measures, was a response to that pressure.

Next came the economic revolution of October 1977. Planned in utmost secrecy by only five officials at the Treasury and reported to US Treasury secretary Michael Blumenthal only two days in advance, the main item in the package that the cabinet discussed on October 28 was making the Israeli pound fully convertible for the first time since 1939 (the British Mandate for Palestine had adopted currency control during World War II). The International Monetary Fund (IMF) was aware of this plan and was applying pressure on the Israeli Treasury to adopt it. The IMF had leverage because Israel was dependent on its loans as well. In addition, the ministers were requested to approve the abolition of various measures that protected Israeli industry from import competition. Prime Minister Begin urged them to approve the package to “increase economic freedom.” The cabinet was swayed by Begin’s presentation and voted for the plan. As always, Milton Friedman was not in the loop. But when he heard about the measures adopted by Begin’s cabinet, he was elated and said, “This is one of the greatest things that has happened to Israel since it was founded.”⁴

The experiment in shock therapy ended in shock with no therapy. Inflation rose to 167 percent by 1979. Foreign debt ballooned, and the trade deficit increased. The government’s privatization targets were not met. By that year, the second oil shock — a result of the revolution in Iran — had kicked in, and Israel was ill-prepared to deal with it. Erlich resigned in ignominy in November 1979.⁵ In his stead came Yigal Horowitz, who tried to deal with the predicament by reverting to austerity. As the outgoing minister of trade and industry, Horowitz was fairly knowledgeable in economic affairs. However, he hailed from a small splinter party that was allied with Likud and lacked a power base. When his demand for budget cuts was not backed by the cabinet, Horowitz resigned in January 1981.

Erlich’s replacement was the wily Yoram Aridor, an ambitious party apparatchik who rose within the ranks of the Likud. His policies were more about politics than economics. Ahead of the 1981 elections, Aridor sharply reduced tariffs on electronics, home appliances, and cars. Drunk on Sony TV sets and cheap Subaru cars, the Israeli electorate thanked the Likud by giving it a narrow victory at the ballot box. After the elections, Aridor wanted to revert to austerity and peg the Israeli shekel to the dollar. When details of Aridor’s dollarization plan were leaked to the press, they were met with general condemnation. As a result, Aridor resigned in October 1983. The next finance minister, Yigal Cohen-Orgad, presided over out-of-control inflation that reached 445 percent in 1984. He didn’t have time to devise a comprehensive plan to deal with the crisis, as he served in office only eleven months.

Despite this messy history, Begin and his ministers had numerous successes that would help advance the neoliberal turn. Their first achievement was to weaken organized labor. This was a formidable challenge. The Histadrut — Israel’s largest labor federation — was an organization like no other. It was established pre-independence, when the British ruled Palestine, and was built to serve as the bureaucratic infrastructure for a state. It not only unionized laborers; it also owned and managed social services such as labor exchanges, health clinics, hospitals, schools, and pension funds. It retained most of these functions post-independence. When the Likud came to power, the Histadrut had unionized 1.5 million workers, or 80 percent of the workforce. The Histadrut was also Israel’s second-largest employer. It owned several factories and controlled 25 percent of the country’s economy. Furthermore, the Histadrut’s elected leadership was dominated by Labor, which was now the main opposition party.

If that was not enough, the Likud was not of one mind regarding the fate of organized labor. The Likud was an amalgam of two main parties: Herut (“freedom” in Hebrew) and the Liberal Party. The Liberals represented medium- and large-business owners in the private sector and, as such, had a great interest in breaking the power of the Histadrut. Herut, however, was a nationalist party that had always used populist rhetoric and waxed lyrical about the need to ensure the welfare of the people. Moreover, the Likud had significant representation in the Histadrut, and some of its leaders were elected Histadrut officials. Thus, the Likud was torn between its two wings — the bourgeoisie and the plebeian.

Nevertheless, Yigal Horowitz, who served for only a year as finance minister, was able to achieve a significant breakthrough. Horowitz was a wealthy businessman who owned a large private dairy. As such, he competed with the much larger Histadrut-owned dairy, Tnuva. This experience taught him the secret of Histadrut companies. They were large and powerful because they had access to cheap loans, which they took from the Histadrut-owned pension funds. In October 1980, Horowitz passed legislation that put an end to that practice. Histadrut companies had to turn to private banks and take loans with steep interest. That was the beginning of the end for the worker companies. Finance ministers who served in the Likud government used other methods to weaken the Histadrut. They avoided consulting its leadership before making major decisions (a common practice before 1977), tried to avoid compensating workers for inflation-induced wage erosion, and encouraged employment through individual rather than collective labor contracts.⁶

Benefits for the Loyalists: How Likud Captivated Its Electorate

While dismantling universal social programs, the Likud created compensation mechanisms that ameliorated the harsh effects of its market reforms. These, however, were accessible only to groups that were willing to support the Likud’s nationalist and religious vision. A prime example was the Likud policy regarding public housing. Construction of public housing within Israel decreased dramatically under the Likud, from 27,730 apartments in 1975 to 7,320 apartments in 1983. However, the Housing Ministry, led by David Levy, a former construction worker, focused all its resources on developing highly concentrated urban clusters in the West Bank (to this day, 85 percent of Israeli settlers live on less than 6 percent of the West Bank’s territory). All of them were an hour’s drive or less from Tel Aviv and Jerusalem. The Housing Ministry planned those townlets, built their infrastructure, paved roads that would connect them to Israel’s metropolitan regions, and gave lavish grants and loans to those who chose to live there. While outside the West Bank construction decreased and housing prices rose, inside the West Bank subsidized housing was booming. The success of those policies was phenomenal. In 1977, about ten thousand Israelis were living in the West Bank. By 1986, that number rose to fifty thousand. The link between the Likud, the West Bank, and cheap housing was thus established.⁷ This was a pivotal accomplishment that put the working class and the lower-middle class on the Likud’s dole and created a strong incentive for a broad constituency to vote for the party.

Meanwhile, Likud policies turned the ultra-Orthodox Jewish population into another dependent sector. Until 1977, the ultra-Orthodox relied on the welfare state. They could buy cheap housing. The women worked in the ultra-Orthodox education system. The men found employment by providing religious services that the non-Orthodox needed, working as rabbis, mohels, and kashruth supervisors. Likud policies changed all that as public housing dried up. Begin inaugurated measures that reshaped the ultra-Orthodox community and made it dependent on handouts. He removed the limits on the number of yeshiva students exempt from military service. He also committed, in his agreement with the party representing the ultra-Orthodox, to give ultra-Orthodox service members an allowance, although many in the community didn’t serve in the army. Child allowances to the ultra-Orthodox were also increased, while child allowances to the non-Orthodox were cut. As a result, between 1977 and 1999, the number of yeshiva students increased from 8,240 to 31,174, and by 2015 that number reached 64,605. In 1977, only 5 percent of the families in the ultra-Orthodox city of Bnei Brak had six kids or more. A decade later, the share of families with six kids reached 15 percent. During those years, the trend in the general population was the opposite.⁸

Begin’s foreign policy was the continuation of his domestic policy by other means. Following the oil shock of 1973, the Carter administration was eager to bring about a peace agreement that would settle the question of the Suez Canal — a key conduit for the energy trade between the Persian Gulf and Europe. The canal was opened to international shipping in 1975 thanks to a Washington-mediated cease-fire agreement with Israel. However, another Egyptian-Israeli confrontation could bring about a closure of the Suez Canal and, as a result, another rise in the price of gasoline, something that could anger American voters. Begin responded to that pressure by starting secret talks with Egyptian president Anwar Sadat. Begin, usually an avid supporter of the “Greater Land of Israel,” was willing to give back the Sinai Peninsula in its entirety under the proviso that Sadat would relinquish his demand for a Palestinian state in the West Bank and the Gaza Strip. Begin thus made a significant territorial concession to protect the strategically desirable territory of the West Bank. The 1979 peace agreement between Israel and Egypt was fashioned accordingly.

When Ronald Reagan entered the White House in January 1981, Begin could breathe a sigh of relief. The elderly president held staunchly pro-Israel views and deemed the Jewish state an essential ally in the global battle against the “evil empire.” After his reelection in the 1981, Begin was emboldened and took a tougher line in his foreign policy. The Palestinian Liberation Organization (PLO) was in his sights. The PLO had military forces in Lebanon and could thus oppose Israel’s settlement drive in the West Bank by lobbing Katyusha rockets at settlements in the Galilee. In June 1982, Israel commenced Operation Peace for Galilee. Lasting several months and bringing much destruction to the Lebanese civilian population, the operation was successful in pushing the PLO out of Lebanon. For Begin, crushing the PLO was key to continuing the settlement drive in the West Bank that his government unleashed. The PLO’s exile to Tunis, far away from the zones of conflict in Gaza and the West Bank, prevented it from engaging in an effective armed struggle against the expansion of Israeli settlements.

Unity and Stability: Labor and Likud Make a Deal, 1984–1991

After pushing the PLO out of Lebanon, Israel planned to put in place a friendly government and withdraw. But things did not go according to plan. Instead, the Israeli Defense Forces (IDF) sunk into a quagmire of low-intensity warfare. The high costs of financing the war exacerbated Israel’s economic crisis. Begin grew increasingly despondent and resigned in October 1983. A caretaker government was able to survive for a few additional months. Finally, elections were called and took place in the summer of 1984.

These elections resulted in a hung parliament. The solution that Shimon Peres, who led Labor, and Yitzchak Shamir, the leader of the Likud, found was to form a grand coalition — known as the “unity government” — in which both parties participated. It enjoyed an overwhelming majority in parliament. And it was another milestone on Israel’s road to neoliberalism. Israeli Labor’s historic achievement was the creation of the welfare state and its attending institutions. Now back in the halls of government for the first time since 1977, Labor could work to resuscitate the welfare state after the Likud had attempted to destroy it. Instead, Labor did the opposite. It adopted neoliberalism and pushed it further still.

Shimon Peres, who served as prime minister between 1984 and 1986, began his tenure by appealing to US secretary of state George Shultz. Peres asked for an urgent aid package totaling $4 billion to help Israel deal with its economic crisis. Shultz, a renowned economist and a former secretary of the Treasury, replied that the United States could respond to that request only after Israel adopted much-needed economic reforms. As a result, Shultz and Peres agreed on the creation of a US-Israeli team of economists that would work on a plan to stabilize Israel’s troubled economy.

As his representatives in the joint team, Shultz appointed two strong supporters of Milton Friedman’s economic theories: Herbert Stein and Stanley Fischer. Shultz instructed Fischer and Stein to make clear to the Israelis that the fate of the additional aid package was conditioned upon accepting their recommendations. Whenever the negotiation got into trouble, recalled Fischer, he would simply tell his Israeli interlocutor, “The secretary believes that. . .” It would work much better, mused Fischer, than explanations about economic models.⁹

For his part, Peres appointed Israeli economics professors, such as Michael Bruno, who were formerly Keynesians but turned into ardent monetarists during the late 1970s and early 1980s. Increasingly, they were becoming convinced that Israel’s economic crisis was caused by a welfare state that was too generous and trade unions that were too powerful. These were luxuries, they wrote, that Israel could no longer afford.¹⁰

The economic plan that the joint team of Israeli and American economists helped shape was discussed by the unity government on June 30, 1985. That meeting was one of the most dramatic in Israel’s history. It continued into the night and ended only in the morning hours of the next day. Peres, presiding over the meeting as prime minister, presented the plan as a bitter medicine Israel had to swallow to cure its economic illness. A loud minority opposed him, but Peres finally wore them down. The cabinet’s resolution to adopt the plan on July 1 made headlines in the Israeli press. At first, everyone was taken aback by the harshness of the measures the unity government endorsed.

The resolution included a 19 percent devaluation of the shekel, a $1.5 billion budget cut, the dismissal of 3 percent of government workers (about 10,000), and a three-month price and wage freeze. Tough as they were, these were not the most important components of the plan. In fact, the layoffs and the budget cuts were quite reversible. What turned the 1985 stabilization plan, as it became known, into a milestone were the accompanying laws. These shifted decision-making in economic affairs from politicians to technocrats, who were for the most part economists. This, one should add, was a world trend. It’s hard to believe nowadays, but until the late 1970s, the influence of economists on the government’s policy was quite limited. They could advise, but the decisions were made by the politicians. This was about to change dramatically. The Israeli and American economists who were part of the Shultz-Peres team joined hands to present the new laws as an absolute necessity, although many years later they would admit they were dissembling.

Under the pressure of Stein and Fischer, who believed, like Milton Friedman, that the money supply was the only thing that mattered in an economy, a law enshrining the independence of the Bank of Israel was inserted into the plan. Until that point, the governor of the bank was wholly subservient to the whims of the politicians. The bank would loan the government as much as 3 percent of the GDP, a procedure known in Israeli parlance as “printing money.” Hence the Bank of Israel law received the nickname the “nonprinting law.” From that point onward, the governor would make the highly political decision over interest rates alone. The government of the day could ask but not order. The law thus put a strict limit on the government’s ability to increase its debt and spend money.

Two other laws were passed as emergency legislation but given permanent status in the following years. Just like the Bank of Israel law, the “Foundation of the Budget” law and the Arrangement Law entrenched the agency of technocrats. These laws have turned the economists at the Finance Ministry into economic dictators. The Foundation of the Budget Law allowed them to control the budgets of the ministries as well as each budgeted agency, such as municipal councils. Not a nickel could be spent without approval from the Treasury boys. In addition, the Arrangement Law enabled the Finance Ministry economists to accompany each budget with a lengthy omnibus bill that included economic reforms they deemed necessary. They usually wrote it in such dense gobbledygook that neither ministers nor members of parliament could follow. Often it would be submitted at the last minute, leaving politicians very little time to read or digest what they were voting for.¹¹ One journalist called the law “anti-democratic.”

These laws explain the consistency of Israel’s neoliberal project. Governments came and went with surprising speed since 1985, but the technocrats, who served longer than ministers and enjoyed immense power, were able to promote their economic agenda regardless. In 1985, government spending in Israel was 65 percent of GDP. Three decades later, government spending was one of the lowest in the OECD, at less than 40 percent. This was a testament to the ability of economic technocrats to make a series of incremental changes to budgets and laws that seemed arcane to the wider public but had real-world consequences.¹²

Another potential obstacle to the stabilization plan was organized labor. The government’s unilateral decisions about layoffs and wage freezes should have angered the Histadrut. But at that stage, it was hobbled by the high debt of its economic enterprises, especially the worker companies and the sick fund, and the steep interest rates it had to pay. The Histadrut was willing to play along with the stabilization plan in return for a promise that Labor ministers would arrange bailouts for its ailing companies.¹³

Why the Israeli Labor Party Embraced Neoliberalism

The stabilization plan marks the moment when neoliberal ideology became hegemonic. This was no longer a right-wing project. With the enthusiastic participation of Labor, neoliberalism became a bipartisan policy. The question is why. What were the interests of Labor in promoting this scheme? American pressure certainly played a role, but what stands out is how little Peres resisted US demands — surely he could have pushed back, leaning on the resistance within his own cabinet.

Perhaps Peres understood that there was simply no other way to deal with inflation. Yet the Keynesian and pro-industrial economist Esther Alexander, who advised both the Energy and the Economic Affairs ministries, believed that claim was bogus. In her reading, inflation was reduced significantly thanks to two corporatist package deals signed between the Finance Ministry, the Histadrut, and the private sector in November 1984 and January 1985. Inflation came back roaring in February 1985 only when the officials at the Finance Ministry broke their promises by unilaterally cutting food subsidies and ending price controls.¹⁴

The most plausible explanation is that Labor’s eager adoption of the program was a response to its institutional aspects. By 1985, the educated middle class understood that the upheaval of 1977 was no aberration but rather a sign of a demographic and sociological shift in Israeli society. The growing numbers of settlers and ultra-Orthodox, as well as the working class’s alignment with the Likud, gave the Likud party a permanent majority. The 1984 elections were seen as solid proof of this. The Likud entered the election in the worst circumstances possible. The fiery orator Begin was gone. Leading the party was the dull Yitzhak Shamir. The economy was in the doldrums. The war in Lebanon was dragging on. Peres, who had lost to the Likud in the two previous election cycles, was certain that this time he would emerge the victor. Surprisingly, though, the social alliances that Begin forged in the previous years withstood the electoral test. The Likud lost seven seats in parliament but was not defeated. Peres found that Labor, and the parties willing to serve in a coalition led by it, could not win a majority in parliament.

Rather than changing his party’s platform in a way that would help Labor win new voters, Peres preferred to give power to unelected bureaucrats who hailed from the ranks of the educated bourgeoisie. Peres had a natural affinity for this idea, as he himself rose to the top as a technocrat who served in the Ministry of Defense in various roles between 1953 and 1965. Moreover, according to contemporary opinion polls, that stratum supported the Labor Party. In the words of one scholar of this period, “the knowledge elite” was Peres’s “only ally at the time.” And indeed, experts, scientists, and analysts from the halls of government and academia were frequently called upon by Peres to give advice, vet policies, and write memos. This led to a detachment of Peres from the party apparatus, so much so that one party activist complained that the team surrounding him was “too professional” and that the prime minister was listening too often to “what the professors say.” Thus, Peres forged a “knowledge-power alliance.”¹⁵

Peres and Labor leadership seem to have realized that the neoliberal project played to the advantage of the classes that supported the party. As a result of the reforms that Peres supported, the authority to make political decisions shifted. It was now given to impersonal market forces and faceless bureaucrats. The Likud could continue to win at the ballot box, but real decision-making would now be in the hands of the technocrats at the Bank of Israel, the Finance Ministry, and private companies.¹⁶

Meanwhile, the settlement drive in the West Bank found a new reservoir of manpower. By the late 1980s, the ultra-Orthodox were experiencing a severe housing crisis. The privatization of housing meant that home prices were going up, far beyond the ultra-Orthodox’s means. Many of the men did not work and relied on the allowances created by the first Likud government. What they wanted most of all was to live in proximity to Jerusalem and its holy sites. David Levy, who was still serving as housing minister, wanted to expand his project of building settlements that were essentially suburbs. This is how the ultra-Orthodox settlements of Beitar Illit (established in 1988) and Modiin Illit (1991) came about. The housing ministry also took care to build vast roads that bypassed Palestinian towns and ensured denizens of ultra-Orthodox settlements easy access to Jerusalem.

Up to that point, the ultra-Orthodox supported Likud due to sheer economic necessity, not for love of the Greater Land of Israel. The new settlements changed all that. The interests of the settlers and the ultra-Orthodox began to align as the new settlements solved the latter’s housing crisis. Increasingly, the ultra-Orthodox leadership adopted the territorial ambition of the Likud, as a rising share of its voters built their homes in the West Bank. By 2013, 13 percent of the ultra-Orthodox were living there. The fact that the ultra-Orthodox joined Likud’s ranks was also important for the settlers. When the first ultra-Orthodox settlements were established, the settlement drive in the West Bank was losing demographic momentum. The ultra-Orthodox settlements reversed this. An average ultra-Orthodox family has seven children or more, and, as a result, the population of each of these settlements established in the late 1980s grew by 10 to 12 percent per year. As of 2022, 146,000 people lived in the three largest ultra-Orthodox settlements, which constituted a third of the settlers’ population in the West Bank.¹⁷

Neoliberal Peace: Rabin and the Roaring ’90s

By the late 1980s, Israel had made the changes in its economy that would allow it to become a part of the American-led project of post–Cold War globalization. Israel balanced its budget and stabilized its currency. Privatization of Histadrut industries and some public-sector companies created profitable opportunities for private investors. However, the onset of the first wave of the Palestinian uprising, the Intifada, which started in 1987, proved to be a drag on the economy and a hindrance to foreign direct investment. One of the chief benefits of the occupation to the Israeli economy — the supply of cheap Palestinian labor — was gone, as Palestinian workers were not allowed to enter Israel during the Intifada years.

The Israeli bourgeoisie realized it was time to act and flocked to support Yitzhak Rabin, who now led the Labor Party. The election cycle of 1992, which the Labor Party won, was the first in many years where the future of the occupied territories was explicitly discussed. Dov Lautman, a textile magnate and a former head of the Manufacturers’ Association, proclaimed one week ahead of the elections that only progress in the peace talks with Palestinians could make Israel attractive to foreign investors. And it was true. The Oslo peace process that the Labor government promoted served as Israel’s North American Free Trade Agreement (NAFTA). By 1993, the peace process helped to end the Intifada and enabled Israel’s integration into the world economy. The Oslo Accords bettered Israel’s relations with Jordan and Egypt and, same as NAFTA for US businesses, allowed Israeli businessmen to take advantage of the cheap labor in neighboring countries by moving labor-intensive production lines there. Furthermore, foreign direct investment in the Israeli economy, virtually negligible until 1993, reached $1.5 to $2 billion a year by the middle of the decade. McDonald’s opened its first franchise in Israel the year the Oslo process began. The Labor government also liberalized financial inflows and outflows in 1992 and 1996, respectively.

The Oslo era was a huge boon for the Israeli bourgeoisie and private capital. Privatization continued apace in such variegated sectors as housing, transportation, natural resources, telecommunication, education, and shipbuilding. Tariffs were removed, and Israel’s exposure to global markets increased. The Rabin government also set its eyes on developing Israel’s high-tech industries. The budget of the Chief Scientist’s Office, which invested in nonmilitary research and development, was doubled. The government also created a state-owned venture capital fund called Yozma (meaning “initiative”) that invested in technological start-ups. The results were impressive: while high-tech products were only 14 percent of Israel’s export of manufactured goods in the 1970s and 28 percent in the late 1980s, during the 1990s their share reached 54 percent.

The Rabin government legislated additional laws that increased the institutional autonomy of the Finance Ministry and the Bank of Israel — such as the Deficit Law, which further limited the government’s ability to spend money — each decreasing the ability of parliament and government to oversee the decisions of technocrats. Not satisfied with empowering only economists, the government strengthened the authority of judicial technocrats as well. Thus the “constitutional revolution” of 1992, which for the first time gave the Supreme Court the authority to disqualify laws that it deemed unconstitutional.

But for the Israeli working class, the Oslo years were a raw deal. Likud voters were skeptical about the promised “peace dividends.” As far as they were concerned, the decision of the Rabin government to freeze construction work in the West Bank blocked their access to cheap housing. The peace process also threatened their livelihoods in other ways. It allowed Israel to strengthen its relations with neighboring Arab countries. Israeli companies leaped on the opportunity to close labor-intensive factories, which were often located on the peripheries of the country where Likud voters lived, and reopen them in Egypt or Jordan, where labor was cheaper. The same Dov Lautman that supported Rabin in 1992 had moved, by 1998, half of his textile production lines overseas. The Rabin government also changed how it allocated export subsidies. If these were previously given to factories in the country’s periphery, they were now allotted to high-tech companies in metropolitan areas that were more profitable.

That was not all. The Rabin government worked to weaken the Histadrut as assiduously as Likud governments did. The reason was that, by the early 1990s, the Histadrut was seen as a liability rather than an asset. In both 1986 and 1988, the sorry state of its economic enterprises forced Labor to stay within the unity government to arrange loans and bailouts for the worker companies and the sick fund. Thus, the needs of the Histadrut prevented Labor from differentiating itself from the Likud. In addition, a new generation of young leaders that came out of student associations sought to destroy the dominance of the Histadrut within the internal bodies of the party that selected candidates at the local and national levels. With the blessing of the party leadership, these young politicians were able to reform internal selection procedures by replacing committees with primary elections.

These changes created political space for the Rabin government to uncouple membership in the Histadrut from access to health services. That was a severe blow to organized labor. What made the Histadrut the largest workers’ union in the country was its sick fund, which insured a majority of workers. After a tense internal struggle within the party, the Labor government legislated the National Health Law in 1994, which essentially nationalized the Histadrut’s sick fund. As a result, the number of card-carrying Histadrut members was halved between 1992 and 1996.¹⁸

While undermining organized labor, the Labor government promoted precarious forms of employment by passing legislation in 1996 that regulated the hiring of workers through “manpower companies.” Workers employed through them earned the lowest wages and could be fired arbitrarily. The courts, although empowered by the so-called constitutional revolution, often declined to protect vulnerable workers and gave the right to private property supreme status. All this suggests the unequal effects of the economic policies of the Rabin government. The integration of Israel into the global economy gave peace dividends for the educated middle classes while leaving behind the working class. Between 1990 and 2002, the income share of the top decile of earners rose from 25 to 30 percent while staying stagnant or declining for all other deciles of income. The Gini coefficient of inequality rose from 0.498 in 1993 to 0.528 in 2002.¹⁹ These were the experiences that shaped the working class’s view of the Oslo peace process, and when it had a chance, it voted the Labor government out of office.

First Time Unlucky: The Political Economy of Bibi’s Failure, 1996–1999

The Israeli arena was now cleared for a new kind of politician — a claimant to the prime minister’s office who was neither a former labor organizer nor an ex-general, as many of Israel’s leaders had been. Instead, any future contender’s main talent would be the ability to attract deep-pocketed donors. In short, it was Benjamin Netanyahu’s time to shine. One of his biggest assets would be his strong connections to rich Jewish conservative donors and a longtime acquaintance with the Republican Party.

Netanyahu, who knew Richard Perle personally, came to power imbued with the neoconservative ideas that George W. Bush would later champion. However, the time was not right for him to implement such policies. His two main coalition partners were sectoral parties. One of them, Shas, represented the religious working class. The other, Yisrael Beiteinu, represented Russian-speaking immigrants from the former USSR. Both were interested in increasing budget allocations to their sectors. Neither was supportive of a tax cut for the rich. Nor was there much room for a hawkish foreign policy. Under pressure from Bill Clinton’s administration, Netanyahu continued the Oslo process and even signed the Hebron Protocol in 1997, which placed additional West Bank territories under the control of the Palestinian Authority (PA). The extreme-right parties responded to Netanyahu’s concessions with disappointment and withdrew their support for his coalition. This was the background to the 1999 elections that Netanyahu lost. Had those three years as prime minister been his only contribution to Israeli politics, he would have been remembered as a historical footnote. The 1990s were not a propitious time for him to leave his mark.²⁰

The Neoconservative Experiment: Sharon, Netanyahu, and the 2003 Reforms

After spending three years in the political wilderness, Netanyahu staged a comeback. In 2002, he was appointed to serve as foreign minister in the cabinet of Prime Minister Ariel Sharon. A year later, in 2003, Netanyahu was appointed as finance minister in a cabinet reshuffle. Thus started one of the most consequential and least understood chapters in his career. Both Sharon and Netanyahu sought to detach themselves from the sectoral coalition of the settlers, the working class, and the ultra-Orthodox that Begin built. Instead, they wanted to strike an alliance with the bourgeoisie and the middle class.

Netanyahu’s thinking seemed to acknowledge the new reality. After two decades of neoliberal reforms, the private sector grew in power and importance. Aligning with private capital could be the best way to establish hegemony. The foreign-policy expression of that agenda was Sharon’s 2005 disengagement plan that brought about an Israeli withdrawal from the Gaza Strip and parts of the West Bank. The economic aspect of that agenda was left to Silvan Shalom, Netanyahu’s predecessor in the Finance Ministry, and to Netanyahu himself. Both Shalom and Netanyahu made savage cuts to social benefits while cutting the taxes of the very wealthy. In short, this was the mirror image of the economic policy of President Bush. According to one estimate, the Treasury lost 23 billion shekels in revenue due to Netanyahu’s tax cut for the rich. The argument was that it was necessary to ensure talented high-tech workers would not migrate overseas. But Shalom and Netanyahu found a way to recoup lost revenue. Between 2001 and 2003, the state budget was cut by 20 percent. In those same years, old-age allowances were cut by 10 percent, guaranteed-income allowances by 20 percent, benefits to single-parent families by 28 percent, and unemployment benefits by 23 percent.

The stars aligned to make the Sharon coalition amenable to such policies. Shinui, a bourgeois party, was part of the coalition and supported Netanyahu’s economic agenda enthusiastically. The ultra-Orthodox parties were not part of the Sharon coalition between 2003 and 2006, and Netanyahu used this opportunity to cut the child allowances on which this constituency was so dependent. This was a dramatic shift. Before Netanyahu entered the Finance Ministry, Israel had one of the most generous child allowances in the OECD. After the cuts, they were among the lowest. Some ultra-Orthodox families — those with six kids or more — lost as much as two-thirds of their child-allowance income.²¹

Netanyahu also used the opportunity to strike a final blow against the power of the Histadrut. He and the technocrats in the Finance Ministry engaged in a campaign to scare the public about the solvency of Histadrut-owned pension funds. Netanyahu painted a picture according to which these funds were mismanaged and incurred large debts. Based on these claims, the Finance Ministry nationalized the funds, thus delinking Histadrut membership and pension benefits. This reform, which completed the act of nationalizing the sick fund, was another blow to the Histadrut’s ability to organize workers. After taking these pension funds under its control, the Finance Ministry appointed managers that invested most of them in the stock market, thus making them very similar to American 401(k) plans. Officials in the Finance Ministry were quite open about the fact they took that step to smash the power of organized labor.²²

These reforms increased the precarity of low-wage workers and greatly empowered employers, who now enjoyed a more docile workforce. It seems astounding that such a policy would get a pass from the public, but despite a few loud protests, Israelis remained largely indifferent. The reason was that, just as in the United States under Bush, the shock of war was used as a pretext to pass painful economic reforms. In the United States it was the Iraq War, and in Israel it was the Second Intifada. At the time, the IDF unleashed Operation Defensive Shield against Palestinian armed groups in the West Bank. The reforms that Shalom and Netanyahu passed were described in the media as “the economic Defensive Shield.” Abiding by these reforms was thus tantamount to patriotic duty.²³

Unlike his time as prime minister, as finance minister Netanyahu received support from the bourgeois Haaretz newspaper, a reliable mouthpiece of the middle class and the business community, which applauded Netanyahu’s policies. The Manufacturers’ Association, which supported Labor during the 1990s, described Netanyahu’s economic agenda as “courageous and in the right direction.”²⁴

As always, the Americans were part of the story.²⁵ In 2002, the Sharon government appealed to the United States for an aid package. Israel’s economy had suffered from negative GDP growth during the previous three years as a result of the burst of the dot-com bubble and the beginning of the Second Intifada. It was also hit by the recession brought about by 9/11. In April 2003, Congress voted for $9 billion in loan guarantees to Israel to be delivered in three tranches over three years. Two months later, John Taylor, US undersecretary of the Treasury for International Affairs, spoke in Jerusalem at a public event and made it clear that Israel’s access to these tranches was conditioned upon its government’s agreement to implement an economic plan that would trim the budget and limit social transfers. In short, the Bush administration was backing Netanyahu’s economic agenda.

The result of Netanyahu’s policies was clear. Civilian expenditure as a share of GDP in Israel held steady at 35 percent until Netanyahu’s reforms in 2003. At that point, civilian expenditures began to be cut severely until they reached 30 percent in 2007. At the time they were enacted, these policies were considered a success. When Netanyahu resigned in 2005, Israel was enjoying the lowest rate of inflation in the OECD and the highest rate of growth. The credit rating agencies raised Israel’s sovereign credit score from A- to A+. However, the poverty rate grew by 10 percent. Yet that seemed like small potatoes to the pundits in the privately held media.²⁶

On paper, the neoconservative experiment was an economic success. But as a political project, it was a failure. When Netanyahu led the Likud in the 2006 elections, the party lost as much as fifteen seats in parliament. In his concession speech, he acknowledged that it was his economic policies that hurt the Likud politically. Netanyahu would spend the next three years on the opposition benches. He had learned his lesson. He would never jettison Begin’s sectoral alliance with the settlers and the ultra-Orthodox again.

From Technocratic Neoliberalism to Right-Wing Populism: Netanyahu and the Sectoral Coalition, 2009–2024

In the same way that Israel under Begin wrote the first chapters of the history of a new system of governance that became known as neoliberalism, Israel under Netanyahu wrote the first chapters of a new kind of politics that would come to define twenty-first-century populism. Moreover, this strand of populism emerged in Israel much earlier than Brexit or the rise of Donald Trump. In Israel, it began as a response to the erosion of the compensation mechanism that Likud developed. For instance, home prices in the West Bank converged with prices in the Israeli real estate market. Cheap housing in the West Bank became increasingly scarce.

Netanyahu’s response was to create a new regime that social historian Daniel Gutwein calls the “loyalty rule.”²⁷ The logic of that concept was imported from the West Bank, where different groups living in the same geographical space have different civil rights. In the same way, Netanyahu’s Likud tried to condition civil rights upon loyalty to the party. Likewise, it sought to allocate the budget according to its assessment of how loyal different sectors were. For instance, Likud ministers consistently sought to increase the budget of towns where the share of the vote that went to the Likud was particularly high. The 2018 Basic Law (“Israel as the Nation-State of the Jewish People”) was an attempt to create a legal infrastructure that would allow the Likud government to discriminate between Arabs, who consistently vote for left-wing parties, and Jews.

Another example was exhibited during the 2020 COVID9 pandemic. Netanyahu insisted on imposing national rather than regional lockdowns. However, national lockdowns were enforced unequally. In the ultra-Orthodox towns, where rabbis demanded that prayers and communal religious events continue as usual, curfews were not enforced. Likewise, when fashioning the aid program that would help those who were hurt economically by the pandemic, Netanyahu chose an option that was considerably less generous than similar programs in other OECD countries. However, he made sure that his supporters, who come from the lower deciles of income, would be hurt less by that policy. In that way, Netanyahu was rewarding them for their loyalty. Additionally, unlike in OECD countries, the pandemic benefits were not regulated and thus exposed to Netanyahu’s whims. He made it a habit to give briefings to the press in which he would announce that he personally decided to increase benefits according to the number of kids in each household “to support families ahead of the holidays.”²⁸

This discussion helps clarify how populism works as a political strategy. Populism does not deviate from the macroeconomic tenets of neoliberalism and does not seek to deal with the social tensions it creates by increasing state spending or raising taxes on the wealthy.²⁹ In that sense, populism isn’t an ideology that collides with the principles of neoliberalism. Rather, it marks a stage in its development from technocratic neoliberalism to clientelist neoliberalism.

If under the first stage of neoliberalism the technocrats were necessary to give the destruction of the welfare state a patina of legitimacy, under the clientelist stage of neoliberalism they became an object of envy and resentment for the working class as well as a target for incitement by populist politicians. If technocratic practices and rhetoric were formerly used to justify savage cuts to benefits and social spending in the name of efficiency, now the technocrats were scapegoated for the ills of the system. This political technique can work because the accusations do have a kernel of truth: technocrats were involved in the production of inequality. Yet rather than trying to bring about a redistribution of income, populist leaders seek to muddy the waters by deflecting the blame for yawning inequality to “elitist” technocrats.

The more populism adopts discriminatory practices whose aim is to privilege the “real people,” the more it collides with the economic and judicial technocrats in government whose raison d’être is enforcing universal criteria. When these professionals block attempts to condition civil rights on loyalty to the government or prevent the arbitrary allocation of state funds, clashes emerge. In the previous year, this conflict manifested in Israel through the “judicial coup” — i.e., Netanyahu’s attempt to take control over the Supreme Court and undo the 1992 constitutional revolution.

While such practices exacerbated the tensions between Netanyahu’s sectoral coalition and the educated middle class, opposition parties struggled to gain a majority in the elections that took place between 2009 and 2021. The results at the ballot box showed a rigid voting pattern: the upper-income deciles went to the opposition parties, yet the lower-middle class and the working class consistently voted for the parties participating in Netanyahu’s sectoral coalition. And it’s not hard to understand why: past experience has taught the working class that, while the Likud was offering them imperfect compensation mechanisms to help keep them afloat, the Israeli left was trying to abolish those mechanisms altogether.

The experience with the short-lived “change government” that was in power between 2021 and 2022 was instructive. As soon as it was voted into office by parliament, the Naftali Bennett–Yair Lapid cabinet ended the aid programs enacted during the pandemic, although COVID and the concomitant recession were far from over. It tabled a budget accompanied by the longest Arrangement Law ever submitted to the Knesset. The government rammed through reforms that the technocrats at the Treasury could previously only dream about. During its only year in office, the coalition raised the retirement age for women, abolished trade protections for farmers, and increased the exposure of pension funds to the stock market. Small wonder that the voters at the end of 2022 gave Netanyahu a narrow majority.

The Foreign Policy of the Occupation

Netanyahu’s foreign policy during that era was focused on the core interest of his sectoral coalition: maintaining Israeli control over the West Bank. He tried to normalize the occupation by creating an international coalition that would diversify Israel’s export markets. To prepare for European and American pressure to dismantle the settlements, Netanyahu sought to strengthen relations with India and China by offering them access to Israeli agricultural and military technologies. He also tried to leapfrog over the Palestinian issue by strengthening Israel’s relations with conservative monarchies in the Persian Gulf. To assuage their pro-Palestinian sentiment, Netanyahu offered their kings and princes an anti-Iranian alliance. Appealing to European leaders, he touted Israel’s large gas field in the Mediterranean, Leviathan, and presented it as a way to ensure Europe’s energy security. He also reminded them about Israel’s Red-to-Med pipeline that could be used to deliver oil from the Persian Gulf to European energy markets. Additionally, Netanyahu encouraged the IDF to use as much high-tech gear as possible to lower the costs of the occupation.

To make sure that Israel would never have to negotiate with a Palestinian unity government, which would unite the West Bank and the Gaza Strip, Netanyahu created the conditions that would allow Hamas to entrench its rule in Gaza. He continued the economic blockade over the strip inherited from Ehud Olmert’s government. This policy weakened pro-peace sectors of the Gazan economy that were dependent on trade with Israel. The blockade also strengthened Hamas, which controlled the tunnels through which goods were smuggled from Egypt.³⁰

At moments when the economic situation in Gaza deteriorated, Hamas would predictably attack the Israeli settlements closest to the border. Netanyahu would respond with a series of operations putatively meant to hurt Hamas and deter it. This became known in Israel as the “policy of the rounds,” which referred to the recurring cycles of violence. However, Netanyahu refused suggestions from the IDF to invade Gaza in 2014 and eradicate Hamas, which was then far weaker militarily than it is today. Likewise, he declined proposals by Israel’s intelligence agencies to assassinate Hamas leadership in Gaza. Thus, Netanyahu kept Hamas in power while simultaneously weakening the PA by avoiding meeting its president, Mahmoud Abbas, or entering negotiations with him.

The plan seemed to be working. The Palestinians remained weak and divided. The costs of the occupation seemed low, and a majority of Israelis stopped taking interest in the plight of the Palestinians. In 2018, though, these achievements were on the verge of collapse. Egypt had closed the tunnels connecting Gaza to the Egyptian economy. The PA had also stopped transferring money to Hamas, seeking to cow the recalcitrant organization. Egypt and the PA were hoping that, under extreme pressure, Hamas would agree to a unity government with the PA. The result, thought the Egyptians, would be a more pragmatic Hamas. Netanyahu, who was supposed to be a part of this initiative, dragged his feet. With its back to the wall, Hamas now tried a new strategy to break the economic blockade. It encouraged Gazans to march to the fence to protest Israel’s blockade. Israeli soldiers used live ammunition against the demonstrators. Hundreds of Gazans were killed as a result.³¹

Hamas retaliated by tying Molotov cocktails to helium balloons. The balloons, which became known in Israel as “arson kites,” crossed the fence and set fields on fire. Three-quarters of Israeli tomatoes are harvested in the Jewish settlements around Gaza, as are one-third of apples and avocados.³² The damage was severe. In the summer of 2018, hundreds of acres were burned. Netanyahu then took an unprecedented step. He appealed to Qatar, a country that was on a collision course with Saudi Arabia and Egypt for alleged ties with Islamic terrorist organizations. These countries, together with the Arab League, put Qatar under an economic blockade in 2017. Qatar was seeking to escape the tightening noose by buying influence and friends in the Arab world. A big supporter of Hamas rule in Gaza, Qatar had by 2018 already given $1.1 billion to the organization (but next to nothing to the PA). In the following years, it would transfer about $30 million a month to Hamas. The Israeli prime minister was pleased. In March 2019, he told fellow parliament members: “Those who want to thwart the establishment of a Palestinian state should support the strengthening of Hamas and the transfer of money to Hamas. This is part of our strategy — to differentiate between the Palestinians in Gaza and the Palestinians in Judea and Samaria.”³³

The Abraham Accords of 2020, which led to the establishment of a formal diplomatic relationship between Israel, Bahrain, and the United Arab Emirates, were used by Netanyahu as proof that his policies were effective. It was possible to make peace with the Arab world without making any territorial concessions to the Palestinians. Moreover, the relationship with the conservative monarchies in the Gulf came about because of a shared hostility toward Iran — a signature Netanyahu policy. Already during the negotiations over the Iran Deal between 2014 and 2015, Netanyahu was reaching out to Saudi Arabia and the UAE. The three countries worked behind the scenes to derail Barack Obama’s attempts to reconcile with Iran (something the US intelligence agencies were well aware of). Following the Abraham Accords, Israel became part of the Negev Forum, which sought to increase security cooperation between Israel and Gulf states to counter Iran’s influence in the region.³⁴

The Future of Netanyahu’s Sectoral Coalition

The conflagration of October 7 came as a dramatic shock for the Netanyahu regime. It exposed every tenet of the Netanyahu doctrine as vacuous: Hamas was not, in fact, a willing accomplice to Israeli colonialism in the West Bank; peace with rich Persian Gulf countries was not possible without solving the conflict with the Palestinians; strong ties with China and India could not replace the alliance with the United States; and technology could not replace manpower when it came to securing the border. How could Netanyahu survive the debacle?

The most immediate answer was the disastrous land operation in Gaza. Organized more to seek revenge and exact retribution than to achieve some kind of political or military goal, the operation was offered to a domestic audience in a state of shock and panic as a panacea. This bought time for an incompetent and corrupt political and military leadership. Instead of seeking the resignation of the government, Israeli TV viewers could busy themselves with gleefully watching the massive destruction, the killings of thousands of innocent civilians, and even the widespread starvation. The mainstream media dutifully used rhetoric that dehumanized the denizens of Gaza (“Hamas are Nazis, and the whole people of Gaza support Hamas”) and made Israelis feel as if the aimless land maneuver was the right thing to do. As these lines are being written, the Israeli public is only starting to debate what has been done in its name and its consequences. Yet most people are far more concerned about a looming confrontation with Iran and the long-term future of Israel. Netanyahu can thus survive once more by using the shock doctrine. Additionally, the sectors that support the Netanyahu government have no alternative. The benefits they have consistently received from Likud governments would disappear under a new bourgeois administration.

That said, since his return to power at the end of 2022, Netanyahu is no longer the bourgeoisie’s Louis Napoleon. Parts of the middle class that were willing to support him in the past are no longer willing to do so now. If anything, the last year and a half has served as a cauldron in which the educated middle class increased its cohesiveness and solidarity. For the first time in many years, it went out into the streets in droves to support the technocrats within the corridors of government and the halls of justice. Looking at the technocrats, the educated middle class saw its own. As before, this class does not exhibit any interest in striking an alliance with the working class. Rather than embracing a call for a strong welfare state to broaden the protest movement’s appeal, it continues to extol technocratic neoliberalism. Its main arguments revolve around the need to preserve the independence of the courts and the authority of Finance Ministry officials to maintain budget discipline.

Nevertheless, this is a real problem for Netanyahu. The service sector of the economy is far bigger than in other countries where populist leaders have emerged. In short, Israel’s class structure is very different than that of India, Poland, Russia, or Turkey. As a result, polls consistently show that Netanyahu’s sectoral coalition would lose badly if free and fair elections were to take place. That’s what makes the war in Gaza, in Lebanon, and most recently with Iran so crucial. Under the tension and fear that the war creates, Netanyahu’s sectoral alliance can take over more and more state institutions. Its greatest success was tightening its control over the police. Under the leadership of Itamar Ben-Gvir, a minister who is a convicted criminal and a strong believer in Jewish supremacy, the police grew intolerant of the protest movement. Arbitrary arrests of protesters and movement leaders are increasing. Additionally, in an incremental manner, more and more budgets are siphoned to enlarge the ultra-Orthodox education system and subsidize settlers. This seems to be the reason Netanyahu has derailed any attempt to end the war in Gaza through a cease-fire agreement and a hostage deal. The unending war seems to be Netanyahu’s best method of succeeding in becoming Israel’s Louis Napoleon.