The years immediately following the state's creation in 1948 were difficult for the Israeli economy. The new state possessed no natural or financial resources, no monetary reserves, little economic infrastructure, and few public services. A sizable portion of the existing Arab population fled the new state, while impoverished and afflicted Jewish refugees poured in from the European displaced persons camps and, later, from the Arab countries. In contrast to the 1930s, when Jewish immigrants to the Yishuv (or prestate Israel) had arrived with ample financial and human capital, after 1948 most immigrants lacked the wealth and skills needed by the new state.

The new state had to supply food, clothing, shelter, and employment for its new citizens; set up civil and community services; and establish an independent foreign exchange, monetary, and fiscal system. Given the shortage of private capital, the burden of dealing with these problems naturally fell upon the public sector. The financial capital needed to deal with the influx of immigrants was drawn either from the high level of domestic savings, or from capital imports (such as foreign loans and grants), or foreign private sector investments (such as Israeli bonds). The government's solution to the capital shortage included an austerity program of stringent price controls and rationing. The government also decided to promote investment projects in agriculture and housing through the use of public funds rather than through private capital markets. The public sector thus gained control over a large part of Israel's investment resources and hence over the country's future economic activity.

The result of this long-term state intervention was the development of a quasi-socialist economy, which, in terms of ownership, was divided into three sectors: private, public, and Histadrut, the abbreviation of HaHistadrut HaKlalit Shel HaOdim B'Eretz Yisrael (General Federation of Laborers in the Land of Israel). The Histadrut, the umbrella organization of trade unions, quickly became one of the most powerful institutions in Israel. Although Histadrut-owned enterprises generally behaved like privately owned firms, the collective nature of the labor organization precluded the timely demise of economically inefficient enterprises. Public sector firms were owned by local authorities and quasi-governmental bodies such as the Jewish Agency. As in the case of the Histadrut-run corporations, criteria other than profit maximization dominated the economic operation of these firms.

The Israeli service sector, therefore, became totally dominated by the government and the Histadrut. Histadrut-affiliated cooperatives achieved a near monopoly in such areas as public transport and the production and marketing of many agricultural products. The Jewish Agency acquired Israel's two major banks, which together made up 70 percent of the banking system; and the two largest insurance companies were (and in 1988 continued to be) owned by the Histadrut.

The importance of the government and the Histadrut was not limited to the service sector. They became increasingly involved in the industrial sector as well. Whereas the percentage of plants owned by the public and Histadrut sectors in 1972 was less than 2.5 percent, their share of total industrial employment was 27 percent. Similarly their share of total industrial output in 1972 was 34 percent. This situation continued until 1988, when discussions were initiated to decrease government control of business activity.

The major factor accounting for the increased role in industry of the public and Histadrut sectors was the development of Israel's defense industry. After the June 1967 War and the French arms embargo that followed, the Israeli government decided to build as many domestic weapons systems as it could. In the 1980s, companies such as Israel Aircraft Industries and Israel Military Industries continued to be state owned and among the largest firms in the country. The Histadrut-owned Tadiran Electronic Industries became a major defense contractor and the state's largest electronics firm. Similarly, the government-owned Israel Chemicals Limited and its subsidiaries held the sole rights to mine potash, bromine, and other raw materials in the Dead Sea area. The oil refineries, as well as the retail gas distributors, were also mostly government owned.

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Source: U.S. Library of Congress