Restricting US military aid may affect more than Israeli industry and the IDF.

As has been widely reported, the United States and Israeli governments have come to a new ten-year understanding of how the former will subsidize the latter’s military spending. The new amount that the Obama Administration promises to submit annually to the US Congress will be $3.8 billion, up from $3.0 billion in the previous agreement. After inflation, this is actually not much of an increase. More notably, though, the deal phases out by 2019 an earlier clause that has allowed the Israeli government to spend some of that money in Israel; most other American military assistance worldwide mandates buying American. The first-order impact on the Israeli arms industry will be a notable drop in revenues. The second-order effects of substitution will eventually change the equipage of the Israeli Defense Forces (IDF). What’s less appreciated is how there may also be an adverse effect on American military innovation too.

Including the American aid, and depending on how you count, Israeli military budget last year was about $18.6 billion. Investment has often been about a third of that, allowing a country of eight million people an air force with over three hundred fighter jets and an army with over fourteen hundred tanks. Much of that investment has been drawn from the American aid account. The previous agreement had allowed the Israeli government to spend up to 26.3 percent of those funds—around $800 million—at home. According to Yuval Azulai of Israel’s English-language Globes newspaper, domestic Israeli military procurement has of late mostly ranged around $2.3 billion. This means that Israeli-funded, Israeli-built, Israeli-bought defense materiel has amounted to about $1.5 billion annually.

What’s often omitted from these reports is the volume of Israeli arms exports: fully $5.7 billion in 2015. At about 14 percent of all exports, it’s clearly an important part of the economy. Total revenues for the industry, domestic and international, were thus about $9 billion last year. The short-term, first-order effect of this minor diminution of American munificence is then easy to imagine. Ceteris paribus, by 2019, the revenues of the Israeli arms industry will decrease to $8.2 billion—a drop of just under 10 percent.

While this has been immediately alarming to Israeli industrialists, not everyone will suffer equally. That’s because of the second-order effect of substitution. In the long run, the Israeli Defense Forces will come to have somewhat less Israeli and somewhat more American equipment in its arsenal. This may be appealing to some American politicians, as it could theoretically increase Israel’s dependence on the United States, possibly constraining its behavior. I wouldn’t count on it; apart from its drones, the Israeli Air Force is already almost an all-American operation. Israeli Aircraft Industries (IAI) builds business jets under license, and has pioneered much of the work in unmanned aviation, but it hasn’t had a serious fighter jet effort since the debacle of the Lavi.

But because the Air Force is already so thoroughly Americanized in composition, in the long run we should further expect one of the other branches to absorb more American weaponry. The Navy is a relatively small force that has been buying its submarines in Germany and its corvettes in the United States. The next generation of the latter, the Sa’ar 6s, will be built in Germany too, with one-third German funding. Transnational substitution is already underway for the Israeli Navy, just away from the United States.

We should also expect the Israeli government to protect the core of its defense-industrial assets. As a frequent consultant to Israeli arms makers once told me, the sectors that matter most to the Defense Ministry in Tel Aviv are munitions, electronics, and software. Making bombs and bullets locally means that no boycott or blockade can cut off the most basic of wartime expendables. Designing and building electronics locally means tailoring sensors and jammers specifically for battlefield conditions found around Israel. Writing one’s own software means never having to worry about what backdoors and kill-switches your allies may have stuck in your weapon systems, just-in-case.

All this leaves ground vehicles as an obvious target. The Israeli Army’s new Namer troop carrier is a beast, as it’s based on the Merkava 4 chassis, but is even more heavily armored. (Deleting the turret freed up some weight.) It’s expensive, so the partial restriction of American funding led Tel Aviv to contract with General Dynamics for building some of the hulls in Ohio. With all funding to be restricted, Israeli Military Industries (IMI) might reasonably worry whether all Namers will soon come from Ohio. And at the same time, staff at the JSMC Lima probably relish the idea.

After all, subsidizing Israeli firms to compete against their American counterparts on the international arms markets has no domestic constituency. The change in policy is thus politically understandable, and also quite reasonable. Israel is a relatively wealthy country, and despite living in a dangerous neighborhood, it does not spend drastically more per capita on defense than the United States. All the same, the United States may still benefit by spending money with Israeli companies, and even if it doesn’t control the specifics.

Note how the new higher sum also includes some $400 million in annual transfers, previously in separate accounts, for cooperative development of missile defenses. Recall that the very successful—and indeed iconic—Iron Dome was initially developed against American advice. Since then, some of those separate funds have been buying more firing batteries and Tamir missile reloads. Yet there’s more. Raytheon is now committed to bringing the Israeli system, rebranded as the Sky Hunter, to a wide customer set, including the US Army. Had the US government mandated earlier that all US monies be spent in the US, the effect on the development of Iron Dome would not have been positive.

Last week, several essayists specifically expressed concern that the reduction in American funding could fall disproportionately on small businesses in Israel. Recovering from a 10 percent cut will require more exports, and ceteris paribus (again), small business is less well equipped to sell worldwide. As Steven Scheer wrote for Reuters, Israel has about seven hundred military contractors, most with fifty to one hundred fifty staff, and most working mostly as suppliers to Israel’s four largest contractors—Elbit, IAI, IMI, and Rafael. Recall also then that Rafael’s success with Iron Dome depended on some small and agile subcontractors, perhaps most notably mPrest Systems, which developed its battle management control software. Rafael itself took a 50 percent stake in the company back in 2012; just this January, the company raised another $20 million through GE Ventures and OurCrowd.

There’s something delightfully Startup Nation about that Israeli Kriegswirtschaft. To some extent, the American subsidy of Israeli industry has been an investment in the creativity that flows from the crucible of Middle Eastern conflict. While aid to Syrian refugees can show detached and disinterested generosity, aid to Israeli software engineers need not. But while American taxpayers can be forgiven for wanting a juste retour from their largesse, there’s reason to apply what my colleague Steve Grundman calls an investor’s mindset in military acquisition. The US Defense Department could consider some cold calculation of how best to leverage Israeli industrial skill for its own military benefit. The Defense Ministry in Tel Aviv just won’t be doing it for them anymore.

Mon, Aug 29, 2016

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James Hasik is a senior fellow at the Scowcroft Center for Strategy and Security.