EXECUTIVE SUMMARY: Changing security conditions demand a revaluation of the strategic and economic roles of the Israeli defense industry. In its earlier years, the Israeli government sought to achieve self-sufficiency and reduced reliance on defense imports. Today, however, the Israeli defense industry is largely focused on arms exports to the global market, with insufficient attention paid to the IDF’s military technology and equipment needs. It is time for a new balance between boosting private enterprise (arms sales abroad) and ensuring Israel’s military edge (supply of the IDF).

The Israeli defense industry was established to meet urgent domestic security needs, yet most of its current activities are unrelated to IDF requirements. Defense exports, initially a secondary interest and a means to counterbalance local demand fluctuations, have grown dramatically – they now account for the majority of sales, placing Israel among the largest arms suppliers in the global market.

However, changing security conditions makes it necessary for the defense industry to reevaluate its future strategic and economic roles. Particularly, it might be necessary to strike a new balance between supplying national security needs and those related to exports and overseas customers. Also, any restructuring of the defense industry sector, such as privatizing or merging government-owned defense companies, will require compliance with updated missions and priorities.

In the early 1950s, faced with ceasefire agreements that failed to bring peace to the Middle East, Israel required arms and military equipment to protect itself, but encountered severe political barriers in attempting to acquire these materials abroad. This was an intolerable situation for the newly born state, which prompted the Israeli government to adopt a dual strategy defense policy for many years: The country would make a concerted effort to exploit any opportunity for foreign purchases, but at the same time, would invest substantial resources in the expansion of indigenous production capabilities. The domestic defense industry was thus perceived as liberating Israel from absolute dependence on foreign supply sources.

Israel’s dual strategy created an inverse relation between import opportunities and efforts to achieve self-sufficiency. From mid-1950 to 1967 France was willing to provide Israel with up-to-date weapons, and as long as this supply continued, domestic defense production remained relatively limited in scope. In 1967, however, when France cut off supplies and imposed an embargo on arms transfers to Israel in connection to the Six-Day War, Israel’s industrial goals considerably broadened. Indeed, the defense industry was called upon to release Israel from absolute dependence on foreign suppliers even for major weapons systems. The self-sufficiency doctrine thus established dominated defense industry policy for the next 15 to 20 years. Only in the late 1980s, due to stable, ongoing arms supply from the United States and the dissipation of doubts over import options, did its priority gradually declined.

Opportunities for arms procurement abroad were perhaps the most important factor, though not the only one, in determining the role of Israel’s domestic defense industry. Economic constraints were relevant as well. The race for superior performance raised the cost of developing and producing novel armaments to the point where it was doubtful whether a small economy could afford a self-sufficiency-oriented policy. A turning point occurred in 1987 with the decision to cancel the development program for a new fighter aircraft ("Lavie"). Self-sufficiency was relegated to second place, and a new perception gradually emerged – that the industry had to supply the IDF with unique technological solutions for force multiplication.

The importance of force multipliers grew at that time due to the accelerated technological advancement of the battlefield, and original solutions were imperative due to the increasing globalization of the arms market and the resulting unprecedented proliferation of new military technologies. The new conditions, which became even more pronounced in the post-Cold War era and still dominate arming efforts worldwide, reinforced the idea that only indigenous, unique developments that were unobtainable in the international market and concealed until used in battle, could give Israel qualitative advantages and the ability to surprise its enemies.

Until the latter half of the 1960s, the defense industry developed mainly within the government sector and had relatively little overall economic impact. Following the Six-Day War, expanded domestic defense production became a crucial factor in bolstering economic activity through a period of depression. In the 1970s and 1980s, the defense industy became a highly significant sector of the Israeli economy, affecting macroeconomic and structural developments of the country. The rapidly growing defense industry, which focused on technological ingenuity, changed the course of industrial growth as a whole by inspiring investments in electronics, aerospace, optical instruments, and more. This created vast employment opportunities for scientists, engineers and skilled laborers.

Such accelerated development had qualitative – as well as quantitative – benefits. The level of mechanization rose, factories introduced advanced quality control systems, and these improvements permeated beyond the domain of the defense industry though many sub-contractors. Contributing to the growth and productivity of the entire economy, the defense industry was thus an important agent of modernization.

Finally, since growth was accompanied by increased exports, the industry became a major contributor to Israel’s balance of payments (BOP). Defense exports favorably affected the BOP both directly, by increasing export volumes, and also indirectly, by paving the way for civilian goods to enter overseas markets previously unfamiliar with Israeli products.

In the late 1980s and during most of the 1990s, reduced demand for military products both in the local market and abroad brought more than two decades of continuous growth to a halt, leading to the downsizing of most of the defense companies. Meanwhile, civilian economic sectors experienced a high growth rate, and the defense industry sector’s share of the economic pie decreased substantially. Currently, the defense industry’s contribution to the economy, in terms of output, employment and exports, is estimated at less than half of what it was in the 1970s and 1980s. Since it is no longer a significant macroeconomic player, any future defense industry policy should place possible macroeconomic benefits secondary to strategic implications.

In setting priorities for today’s defense industry, policymakers should rank the various threats to Israel's security according to relative severity while acknowledging the potential roles of the industry in responding to these threats. Israel is presently facing three different kinds of security threats. In order of severity, they are:
1.        Long-distance existential threats from an enemy without a common border that might involve the use of weapons of mass destruction;
2.        Threats of full-scale conventional armed conflict with neighboring enemies;
3.        Threats of terrorism against targets inside Israel or targets identified with Israel abroad.

In responding to these threats, the defense industry may fulfill three main roles: assuring the IDF’s technological superiority through original and concealed developments specifically designed to meet its operational doctrines and relevant theater conditions; providing independent and continuous supplies of armaments and enhancing the freedom of action to use them; and strengthening Israel's overall deterrence capacity by revealing cutting-edge technological and industrial capabilities.

All three roles are important, yet their respective contributions to coping with the various threats are not the same. It is plausible to assume, for example, that technological superiority could be highly effective in responding to the long-distance threats, while having limited effectiveness in thwarting terrorist attacks. In addition, the potential contribution of each of the defense industry's roles depends on the available – or achievable – technological and industrial capabilities to efficiently fulfill such roles.

An in-depth analysis, which considers the aforementioned factors, would indicate that the domestic defense industry should concentrate its efforts on meeting the operational requirements of long-distance existential threats. However, this seemingly indisputable conclusion raises serious questions regarding the current defense industry set up and its compatibility with such a mission. In particular, the high financial dependency of Israeli defense companies on export sales and overseas activities may severely undermine their ability to focus on R&D and production programs of domestic priority.

Inevitably, export orders compete with domestic orders over scarce resources – high-quality human capital, R&D capabilities, production infrastructure, financial means, and management attention. Also, when striving to increase their orders, company officials sometimes seek export permits for weapons systems even though the sale of these systems abroad involves the revelation of secret technologies. Moreover, since foreign customers tend to prefer homemade products, securing export orders often involves the transferring of development and production capacities abroad, sometimes without preserving such capacities for domestic use.

Defense companies have become dependent on export sales and overseas operations to a point that impedes the effective fulfillment of their strategic role. It is necessary then to create a new balance between the various activities of the Israeli defense industry that grants explicit and uncompromised priority to local demands. Such a change will certainly have economic and budgetary implications, but this would be no different than other justified costs of national security. Furthermore, considering Israel’s current economic situation, these costs would be well affordable.

Redefining Israeli defense priorities raises certain issues about the internal structure of the defense industry sector. Concerns center on the government’s privatization policy, the attitude toward mergers and acquisitions within the defense industry sector, the status of strategic production facilities that lack sufficient demand to assure economic viability, and the relationship between defense-oriented activities and the growing civilian hi-tech sector.

Whatever the issue is, the Israeli government should adopt an active policy for the coming years that meets the mission and updated priorities of both the military and the defense industry. Such a policy, which currently does not exist, should encourage and support structural changes in both private and public defense companies in order to meet future defense needs.

Dr. Yaacov Lifshitz, a research associate at the Begin-Sadat Center for Strategic Studies, was Chief Economic Advisor in the Israel Ministry of Defense, and was Director General of the Israel Ministry of Finance. This article is an extract from his recently published monograph, “Strategic and Economic Roles of Defense Industries in Israel” (BESA Mideast Security and Policy Studies, No. 92, Hebrew).