In the run-up to the Annapolis peace summit, analysts at Morgan Stanley are forecasting a bleak outlook they say is bound to lead to a "dramatic deterioration," spurring increased extremism on all sides and constraining the country's economic potential.
"Over the past decade, failed attempts to find peace and recurring shocks of violence keep income growth below its potential and thereby result in more frustration," Serhan Cevik, an analyst at the investment bank wrote in a recent research note. "Frustration and fragmentation across the region in turn has led to an increase in extremist vocalism on all sides. Judging from the collapse of the Oslo peace process after the failure to reach a comprehensive agreement during the Camp David talks, the post-Annapolis outlook is bleak and may lead to a dramatic deterioration."
Morgan Stanley has long argued that unlike the 1970s and the first Gulf War, recent conflicts in the region, such as the Second Lebanon War have not led to a prolonged economic recession. Rather the opposite as Israel has kept growing at a robust above-trend pace.
"Although structural improvements have certainly played a key role in making growth dynamics less vulnerable to 'fat-tail' events, the key factor is the strength of the global growth, which has so far offset the burden of geopolitical shocks, helping keep economies in the Middle East on a strong growth path. But that does not mean full immunity forever," said Cevik. "Even strong growth in the past five years does not mean that Israel is realizing its full economic potential."
Furthermore, Cevik stated that Israel's per capita income growth would have been much higher if there had been an environment of peace and security attracting more foreign capital and encouraging more domestic investment.
"The constant state of war and terror in the region has forced the authorities to channel financial and human capital away from productive investments [and] into defense spending," said Cevik. "This is why we believe that the Israeli economy would benefit from a viable Palestinian state as much as Palestinians."