Start-up nation at a crossroads amid widening conflict
This article is authored by Hriday Sarma, senior fellow, South Asia Democratic Forum, Brussels and analyst specialising in Israel’s economy and politics.
Israel, long recognised as a start-up nation for its vibrant tech industry, now finds itself at a significant crossroads amid deepening conflicts with Hamas in Gaza, escalating tensions in Lebanon, and the emergence of a new protracted front with Iran. While Israel's wartime innovations are fueling short-term economic gains in defence and security sectors, its previously formidable position as a global fintech hub is rapidly deteriorating.
The immediate impact of the conflict has been a surge in demand for security technologies and defense innovations. Historically, Israel's tech sector has thrived under adversity, with companies quickly adapting to meet the increased needs for military and cybersecurity solutions. This shift has led to a temporary economic boost, particularly within these specialised industries.
Israel's defence industry has seen rapid expansion during the current conflict, with companies developing sophisticated technologies such as the C-Dome (i.e., a naval version of the Iron Dome air defence system), the Arrow 3 interceptor, loitering munitions like the Spike Firefly, and advanced drones including the Heron TP MALE to support military operations. The heightened focus on security technologies exemplifies Israel's economic agility, but it also underscores a shift toward short-term gains at the expense of sustaining broader economic stability.
Despite these developments, the wider economic outlook remains grim. Israel's Gross Domestic Product (GDP) contracted by 4.1% in the weeks following the October 7 attacks, and this downturn has persisted into 2024, with further contractions in subsequent quarters. The conflict's economic toll is expected to reach $67 billion by 2025, severely straining government finances and detracting from investment in non-defence sectors, including fintech.
Israel's financial sector has also suffered. The fintech industry, once a symbol of innovation and investment, is experiencing a marked decline. Venture capital investments in tech dropped by 74% in 2023 compared to the previous year, reflecting investor apprehension and marking a shift in priorities toward immediate security needs rather than long-term technological innovation. So far, in 2024, foreign investments in the country’s high-tech sector have dropped an additional 30% amid the ongoing conflict, underscoring the increasingly challenging environment for capital inflows.
The conflict has also invited international scrutiny. Israel’s military actions, particularly the reported excessive use of force in Gaza and Lebanon, have drawn rebuke from the international community. This has exacerbated geopolitical tensions and impaired economic alliances crucial for Israel's fintech aspirations. The conflict's expansion to involve Iran further complicates Israel's international relations, particularly with neighbouring countries in the region, as well as its economic prospects.
The growing disapproval from international bodies, including the United Nations General Assembly, not only impacts Israel's diplomatic stance but also influences perceptions in global markets. Economic partnerships and alliances, vital to sustaining Israel's fintech growth, face challenges as international investors reassess the risks associated with the region's instability.
Israel’s technology sector stands at a pivotal point. For sustained economic recovery, strategic efforts are required to transition from an economy currently bolstered by defence-driven innovations to one that reclaims its fintech dominance. This will involve navigating immediate security demands while reinvesting in the foundational aspects of its tech ecosystem that initially positioned Israel as a global leader
To realise this, Israel must craft policies that balance security imperatives with economic growth. This includes fostering an innovation-friendly environment, revitalising tech investments, and leveraging its renowned entrepreneurial spirit to rebuild its fintech sector. International collaboration and restoring investor confidence will be essential. Ultimately, for these efforts to succeed, a negotiated peace on the Palestinian statehood issue must be urgently achieved.
The path Israel chooses in response to these challenges will greatly influence its economic future and its enduring legacy as a hub of innovation. The current scenario pits the resilience and ingenuity of Israel’s start-up culture against the complexities of an ever-expanding geopolitical conflict.
This article is authored by Hriday Sarma, senior fellow, South Asia Democratic Forum, Brussels and analyst specialising in Israel’s economy and politics.
