For decades, Israel was the ultimate Start-up Nation, a hi-tech powerhouse that grew rapidly despite the constant instability of the Middle East.
However, following the events of October 7, 2023, and the multi-front wars that followed, including the major escalation with Iran in 2025, the focus has shifted from simple growth to a desperate fight for stability.
Heavy strain
As we move through the first quarter of 2026, economic data show a nation at a critical turning point. The core of the Israeli market is now facing heavy strain from a permanent jump in military costs, a disrupted workforce, and a much more difficult global trade landscape.
This economic instability is best seen in the conflicting trends that have emerged since the war started. After a dramatic 19.4% annualized contraction in GDP in the fourth quarter of 2023, the economy has acted like a coiled spring, bouncing between sudden shrinks and quick recoveries.
Following a stagnant 2024 and a turbulent 2025, the Bank of Israel now predicts a strong 3.8% growth rate for 2026. However, experts caution that this number is misleading, as it mostly reflects delayed shopping and heavy government spending rather than real business growth.
Most importantly, the per capita GDP hasn’t returned to its old path, leaving many Israelis struggling with a lower quality of life despite the upbeat headlines.
Fundamental restructuring
Beyond the raw GDP figures, the most significant long-term impact is a fundamental restructuring of the national budget. Israel’s debt-to-GDP ratio, once a stable 60%, has climbed to 69%, signaling that the “peace dividend” has vanished. With defense spending reaching a 2024 peak of nearly 8% of GDP and remaining permanently high, the 2026 budget, recently raised to NIS 144 billion, leaves little room for civilian needs.
This fiscal strain makes it much harder for the government to tackle the high cost of living, the housing shortage, and chronic underinvestment in transport, healthcare, education, and social welfare. To cover the costs, the VAT hike to 18% and the elimination of various tax exemptions are already squeezing the middle class and slowing down domestic consumption.
The pressure on the national budget is matched by major disruptions in the workforce. While Israel’s “citizen army” is vital for security, it has become an economic challenge.
Calling up highly skilled reservists from the tech and service sectors created a massive shortage of workers. Although the number of people on active duty has dropped to about 0.4% of the workforce by early 2026, the ongoing burden of reserve duty remains high.
This has led to the permanent closure of many small businesses, especially in the Galilee and the periphery. Simultaneously, the construction and agriculture sectors remain in semi-paralysis due to the ongoing exclusion of Palestinian workers. With foreign labor failing to fill the gap, housing starts have stalled, pushing home prices back up in early 2026 despite high interest rates.
Even with workforce struggles, the hi-tech sector remains Israel’s strongest support, still making up more than 50% of the country’s exports. Interestingly, the war has acted as a catalyst for a new sub-sector: defense tech.
Start-ups focusing on AI-driven battlefield systems, drones, and cybersecurity have seen a huge wave of investment. In 2025, tech buyouts and mergers hit a record $10.5 billion, driven largely by global interest in battle-proven technologies.
Reputation risk
However, this success hides a growing “reputation risk.” To ensure business continuity, foreign VCs are increasingly conditioning investments on start-ups establishing headquarters or major operations abroad.
This quiet move of intellectual property and management abroad poses a long-term threat to Israel’s tax income, potentially weakening the very ecosystem that built the nation’s wealth.
As the country tries to balance tech growth with defense needs, several new risks are appearing for the remainder of 2026. First, the “Iran premium” still worries the markets; Israel’s risk premium remains high, forcing the government to pay more for credit, while foreign investors demand higher returns to offset geopolitical noise.
Second, global trade challenges have grown. The 15% tariffs the US placed on some Israeli exports in late 2025 have hurt the chip and pharma sectors, leading to ongoing negotiations for exemptions.
Finally, the country’s unity is being tested by the budget itself. The tension between the burden-bearing middle class and sectors less integrated into the labor force or military is reaching a boiling point.
The 2026 budget was nearly blocked by coalition funds for religious institutions at a time when reserve soldiers are seeing their businesses collapse, creating a conflict that could damage the country’s stability.
In conclusion, Israel’s economy has survived the most significant stress test in its history with remarkable resilience. It did not collapse; the shekel has actually strengthened in recent months, and inflation has moderated to 2%.
But “not collapsing” is a low bar for a country that once aspired to lead the OECD in innovation. The coming years will be defined by a “war economy” footing. This means higher taxes, higher defense costs, and a constant need to prove to the world that an Israeli start-up can deliver even when the sirens are sounding.
The resilience is there, but as the nation looks toward the second half of the decade, the margin for error has never been thinner. The transition from a consumer-led, peaceful growth model to a security-first industrial complex is complete, and the long-term prosperity of the state now depends on its ability to innovate within this new, more expensive reality.■
Gali Ingber is head of finance studies at Israel’s College of Management Academic Studies.