An empirical analysis of determinants of foreign direct investment in Israel with emphasis on the peace process in the Middle East and the Arab boycott

In this dissertation we study the determinants of foreign direct investment in Israel over the past two decades. We focus on the effects of the geopolitical events in the Middle East since the late 1980's and early 1990's, especially the peace process and the end of the Arab boycott, and the effect on foreign investors' decision to invest in Israel.; During the first three decades after Israel was established, the Israeli economy experienced high growth rates, with an annual average of 10%, assisted by foreign aid from the Jewry of the Diaspora, repatriation from Germany, and loans from the U.S. As early as 1959, the Israeli government passed legislation to a foreign investment into the country. Under this legislation, financial and fiscal incentives were offered to foreign investors if they invested in certain specified areas of the country. These incentives, and the great performance of the economy during the first three decades, did not help in bringing FDI into Israel. The Arab-Israeli conflict and the resultant Arab boycott of Israel since the state of Israel was established were believed to be the main reasons for the lack of the anticipated increase in FDI into Israel.; Because of that Arab-Israeli conflict, several wars were fought, which made the region an unsafe place in which to invest. In addition, it caused huge military spending, exceeding 30% of the GDP in 1975, that resulted in the government playing a major role in the Israeli economy, and which in turn resulted in very high inflation rates, huge deficits in the national budget, and in the balance of payments between the early 1970's until the mid-1980's. After the Gulf war in 1990, and talks between Israel and Arab leaders brought about the signature of a peace accord between the Israelis and the Palestinians in 1993, certain countries that had been reluctant to trade with Israel mainly because of the Arab boycott started increasing their share in Israel's total trade. Since then, a great deal of foreign investment started coming to the Israeli economy.; Using a statistical model, we found breakpoints in trade shares of countries that had been reluctant previously to trade with Israel because of the Arab boycott at 1993:1. Estimating a breakpoint in FDI in Israel from within a structural model we found a breakpoint at 1993:2, and introducing a dummy variable that takes the value 1 after the breakpoint and 0 otherwise, all traditional variables were significant in explaining the FDI, but almost none of these variables were significant prior to the breakpoint. Our conclusion is that the geopolitical factors took precedence over economic factors when foreign investors considered investing in Israel.