In June-July each year, as the coming year's state budget is being written, we prepare a macroeconomic forecast based on a rather lengthy series of assumptions that we make sure to present. As the months pass, we often find ourselves updating the forecasts to reflect events and developments that were unforeseen, in terms of their existence or pace, and assumptions that did not come to pass.

Beyond assumptions pertaining specifically to each year, two main premises underlie every year's forecast: that there will be no world economic/financial crisis that will significantly affect the Israel economy, and that no exceptional geopolitical events (for better or worse) will occur. We build these two basic assumptions into each macroeconomic forecast for the simple reason that no other assumption about them is possible. Even those who expect a financial crisis cannot predict when it will happen, how intensive it will be, what policy will be administered and in what doses, and what repercussions it will have. Even those who confidently expect a peace treaty or security unrest in the near future cannot foretell their nature, intensity, timing, and consequences. A forecast that serves as the basis for decisions that have to last for eighteen months, unlike forecasts for short-term decisions of several months' duration (as in the capital market), cannot take the risk of short-term assumptions.

In October 1998, several months after we presented the macroeconomic forecast for 1999, we were forced to adjust the growth forecast downward, from 2.5 percent to 2-2.5 percent, because the first basic assumption-no eruption of financial/economic crises that would affect the Israeli economy-had already been disproved. The crisis that broke out in the autumn in Russia and the exodus of nonresident investors from emerging markets, including Israel, was one of the main factors behind the decline in growth of world trade and Israeli exports in 1999.

In late 1999, several months after we presented the macroeconomic forecast for 2000, the second basic assumption-no dramatic geopolitical developments-was refuted. It is still premature to adjust the forecast to reflect recent developments in peace talks with Syria; for the time being, one cannot estimate when and how the talks will end and what effect they will have on progress in concluding an agreement with the Palestinians. No one doubts, however, that this development will make a positive contribution. One positive result is already visible: only a few days after the surprising political statement about the resumption of talks with Syria, Moody's investors service announced a "positive outlook" for Israel's country rating in the future. Such an announcement has direct financial value: it lowers the interest charged on loans taken by Israeli firms and the state itself. The indirect financial value is even greater.

It is easy to wax at length about the long-term impact of genuine peace with Syria (and with Lebanon and the Palestinians) after the formation of a "New Middle East." Israel's economic "opening hand," especially in respect to its population's human capital and its evolution into a "Silicon Valley" in recent years, will position its economy at an uncommon point of departure as soon as one of its biggest drawbacks-the regional conflicts and violent geopolitical events that have typified the country's history-is neutralized. However, this is probably a long-range forecast-a very long range in some opinions. Even without assuming anything about the warmth of peace with our neighbors in the long run, one may already pull out of the cupboard, as we have more than once in the past twenty years, a list of channels of economic utility-the "peace dividend"-in the short and medium terms:

Improvement in Israel's geopolitical situation-continued improvement in its country rating, less fear, and greater interest among nonresident investors in Israeli business ventures. Beyond its indirect impact, the improved country rating has an immediate direct impact in the form of lower interest rates for Israeli companies and the government.

A short-term contribution to economic activity, because of the need to build new roads, relocate military camps, and meet an upturn in demand for alternative housing in other parts of the country.

Trade with Syria-Israel's trade with Jordan and Egypt, which have a combined GDP of $200 billion, is $75 million, 0.4 percent of Israel's annual exports of goods. Most of our neighbors' imports (from all origins) are consumer goods, whereas Israeli exports (to all destinations) are typified by a very high proportion of high-tech products. By implication, the potential of Israeli exports to Syria is limited. Notably, trade among Middle East countries is very low. Examination of Syria's imports, which come to $3.5 billion per year, points to a rather high share of machinery and equipment, presumably including defense imports (which are not separately itemized).

Imports from Syria-Syria's main exports (59 percent of total exports of goods) are oil and oil products. Here we definitely see a potential for trade with Israel, similar to trade in oil and natural gas with Egypt. The other prominent industries in Syria exports, predictably, are traditional: fruit and vegetables, textiles, and cotton. In these industries, Syria has a comparative advantage over Israel. Israel still protects some of these industries, to one extent or another, from competing imports.

Joint infrastructure projects in energy, tourism, and desalination-all of these were mentioned and examined when the peace treaty with Jordan and the statement of principles with the Palestinian Authority were concluded. There is definitely a potential, but one doubts that it will be fulfilled in the foreseeable future.

Lower budget expenditure for defense-definitely not in the short term. The graph below shows defense expenditure as a percent of GDP in countries that must spend large sums on defense because they are involved in political conflicts. (The figures for the United States and Japan are presented for comparison purposes.) Even in this heat of countries, Israel's high proportion of defense spending stands out (although some of it is covered by foreign grants). Each decrease of 1 percentage point in defense spending as a share of GDP frees more than NIS 4 billion for other uses.

Budget expenditure for evacuation of settlements, compensation for evacuees, and defense redeployment will be immense. In the past few weeks, there have been recurrent reports quoting the total cost of the process in outlandish terms. It is severely premature to estimate authoritatively how much this will cost, how the cost will be spread over time, and where the funding will come from. However, the sum will undoubtedly run into many billions, spread over quite some time.

Those who believe a peace treaty with an additional country will have a substantive economic effect tend to focus on one of two types of "dividends": an improved country rating that will stimulate investments and make them less costly, and access to additional export markets (both of which transcend the long-term gain from reduced defense outlays). Here, as in respect to the recent monthly indicators, there is reason to cool the ardor. The enthusiasm is based on an examination of economic developments since 1992, when the Oslo talks gathered speed, followed by the statement of principles with the Palestinians and the peace treaty with Jordan. These developments were indeed dramatic, but it is very difficult to separate the high growth rates in the following years into its factors, i.e., to determine how much of the growth traced to mass immigration, the collapse of the Iron Curtain and the Soviet Union, the economic efflorescence in Southeast Asia (until the 1997 crisis), and the economic policies invoked during those years. Each of these factors and several additional ones contributed to the 6 percent average annual growth rate that was attained back then. Not only is it impossible to determine the contribution of each factor separately; one may also dispute the ranking of these many factors in terms of their impact. (The authors of this survey believe that mass immigration, not the peacemaking process, made the largest contribution to growth during those years.)

The effect of the peacemaking process on growth since 1992 may be seen clearly by observing the growth rate in exports of tourism services. Revenues on this account grew from $1.9 billion in 1992 to $2.9 billion three years later-a 50 percent increase. Although there were other contributory factors, the peacemaking process was undoubtedly the main one.

A third effect may be found in the steep increase in nonresidential investments-a classic indicator of optimistic economic expectations. Here, too, the positive contribution of the peacemaking process is evident, but since the steep ascent of investments began in 1990, coinciding with the onset of mass immigration, it is difficult to credit peacemaking with primacy in its favorable effect on this indicator.

A fourth effect is evident in the improvement in Israel's country rating, from BBB/A-2 in 1992 to A-/A-1 in December 1995 according to Standard & Poor's. In December 1999, after the talks with Syria resumed, Moody's announced its view of Israel's future country rating as a "Positive Outlook," meaning the possibility of a future improvement. An improved country rating will lower the cost of credit that Israeli firms and the state take, possibly to the tune of hundreds of millions of dollars over time. The peacemaking process has undoubtedly played a role in this improvement. So did other processes, such as structural reforms (applying the Reduction of the Budget Deficit Law, with emphasis on the government's commitment to reducing its share in the economy, setting inflation targets that expressed a long-term disinflationary intention, etc.).

The increase in direct foreign investment is one of the indicators in which the improvement should be credited more to the peacemaking process than to any other factor. Until 1991, typical nonresident investments were about $100 million per year. Since 1991, this sum has been climbing consistently and now comes to nearly $3 billion.

Beyond the effects mentioned here-which are familiar to those who follow the data-the peacemaking process has impacted perceptibly on many other aspects of daily life. They include private consumption, due to households' expectations of a better economic future because of peacemaking; the capital market, where rapid advances occurred (until the downfall in 1996); and in housing demand for investment and, accordingly, in housing prices; to name only a few.

Importantly, all of these effects were noticed in the short-term-some during the discussions between the sides, even before the agreements were signed. May one infer from this that, by virtue of the talks with Syria, these effects will recur at the same intensity? Probably not.

The extremely positive developments in the early 1990s, as described here, had the supreme advantage of primacy (even though Israel's first peace treaty had been concluded more than a decade earlier). For the first time, Israeli exporters made significant inroads in Asian markets; for the first time, nonresident investors discovered the Israel economy; for the first time, hundreds of thousands of tourists got to know Israel.

Sources: World Bank, IMF, UNESCO, UNICEF

* In spite of the very trustworthy sources of Syria's data, one should be weary of accepting them as is. This is especially true of the GNP figures.

It does not stand to reason that, in the short and medium terms, we will witness a stepwise increase similar to that in the early 1990s. However, it is clear that progress in peacemaking will contribute to continued positive developments in each of the fields mentioned. Continued growth-yes, a new stepwise increase in the short term-probably not. In the long-term, the story is different.