Marketplace’s Sabri Ben-Achour spoke with Dany Bahar, a nonresident senior fellow in the Global Economy and Development program at the Brookings Institution. The following is an edited transcript of their conversation.

Sabri Ben-Achour: Before the war started, is there any general observation to be made about the state of Israel’s economy?

Dany Bahar: Since the current government led by an Netanyahu came into power, one of the things they tried to push forward was this judicial reform. This, of course, has repercussions in the economy. And the talks were already there of the possibility of downgrading Israel’s credit rating. So Israel entered this war already after turmoil in terms of its economy that I think had played a role definitely in what came afterwards.

Ben-Achour: If we zoom out a bit, Israel has faced chronic security and insecurity problems, and I wonder if that has shaped the development of its economy generally.

Bahar: I think so. I think that the Israeli economy has really become strong and resilient to conflict. The most recent conflicts over the past 10 to 15 years, they haven’t really made any mark on the Israeli economy. That’s not the case right now. Right now, we’re seeing something that the Israeli economy is facing some challenges that are not as trivial.

Ben-Achour: Israel receives a significant amount of monetary and nonmonetary aid from the U.S. Before the war, how reliant was the Israeli economy on that aid?

Bahar: That’s a great question. So Israel receives, in normal times, about $3.8 billion a year of military aid, which, most of if not all, has to be used to buy American military equipment. The GDP of Israel is about $550 billion. So $3.8 billion a year, it really represents less than 1% of Israel’s GDP. It is a big chunk of Israel’s defense budget. So this 3.8% is about a fifth of Israel’s total defense budget, so it is important, but I typically claim that Israel can live without that. And you know, people would claim, and I think I can agree to some extent with that argument, that it’s really a win-win. I think the U.S. benefits from this strong partnership with Israel.

Ben-Achour: Initially, how much did Israel’s economy, its GDP suffer after the start of the war?

Bahar: So the numbers we have is that for the last quarter of 2023, the Israeli economy contracted by about 20% that quarter. What was different from this conflict were two things: First, there was a massive call for the reservists to go back to the army. Suddenly, you have a lot of industries, a lot of firms that couldn’t work at its fullest, as they were doing before. Second, you also have tens of thousands — even I think more than 100,000 people — were displaced, both because of the security threats, both in the south near the Gaza border and also in the north near the Lebanese border. And with that goes also the economy of these places.

Ben-Achour: Despite all of that, though, here we are eight months in the Israeli economy does appear to be rebounding in a fairly significant way. What accounts for that?

Bahar: Well, I think at this point, the Israeli economy has proven to be very resilient to conflict. We are eight months in, and I think things in Israel have gained some sort of normalcy again. You know, this is a war, of course, but overall there’s no long-term damage that can structurally challenge the Israeli economy.

Ben-Achour: Earlier this week, around 130 economists in Israel signed a fairly strongly worded letter warning that the continued exemption from military service for ultraorthodox Haredi community could significantly harm the country economically. What do you make of that?

Bahar: Yeah, you know, that’s a longstanding issue in Israel; it didn’t start now with this war, but I think this war has made it much more prominent. And it’s a fact that there is a significant portion of the Israeli public that are not either serving in the military and are also not as integrated into the labor market. And one of those groups is the ultraorthodox community. In Israel, that is a significant portion of the population. And these groups, because of political compromises in the ’50s, are exempted from actually going to the military. And this poses an important problem for the country, because it means that the burden of some of the main responsibilities for the Israeli society actually is falling and a number of people who are becoming smaller and smaller in proportion to the whole population. It is a very critical issue that, if there’s no compromise with the ultraorthodox sectors of the country, to be more active in participating, not only the army but also in the economy, it will really continue to put a lot of pressure to the economy as a whole and to the country as a whole.

Ben-Achour: Where do you see this conflict going from an economic perspective? Where do you see the Israeli economy headed?

Bahar: You know, the Israeli economy is having these short-term challenges, nothing has changed structurally in the Israeli economy because of this war that would put Israel into a different path than what it was. The thing that worried me are whether the current government of Israel, which I think it’s quite dysfunctional, is able to manage these in a way that makes sense. And are they putting the country as a first priority in terms of their own political survival? And I have my own doubts about that. On the political side, if this conflict results, hopefully, really, hopefully, on a path towards a two-state solution, I think Israel should and will and also will benefit from playing a role in the reconstruction of Gaza and the reconstruction of the Palestinian territories to really make it a win-win-win situation, because I think that’s what we all want to have.