Sources of State Capacity and the Developmental State: Lessons from Israel's State-Led Industrialization 1950-1970

Why have some developing nations been more effective than others in producing economic success? A key determinant of states’ ability to effectively implement industrial policies that generate long-term economic growth rests in the realm of state-society relations, particularly in the position of the state vis-à-vis powerful industrial elites. Successful implementation, it has been shown, is highly dependent upon the state’s institutional capacity to effectively discipline domestic firms who do not adhere to the state’s developmental agenda. But what serves as the basis of this disciplinary capacity? This paper illuminates one source of state capacity by drawing lessons from the historical experience of Israel state-led industrialization in the first two decades following its independence; a case that mirrors the trajectory of paradigmatic cases such as Korea and Taiwan yet has surprisingly received very little attention in the comparative literature. With the help of archival material and a variety of other historical sources this paper will argue that the main source of Israel’s disciplinary capacity in this period rested in the somewhat unique structure of its economy, which included not only private and state owned enterprises, but also a third, equally dynamic and robust industrial sector owned and managed by the labor movement. Exploiting this tripartite structure, state mangers were able to promote domestic competition for government loans and subsidies which, in turn, provided the state’s planning agencies with the institutional capacity necessary in order to discipline private firms who did not comply with the state’s investment priorities. While private industry ended up enjoying the lion’s share of state subsides, the State's unilateral control over a significant portion of financial resources coupled with the viable threat of an alternative investment outlet in the form of the labor-owned sector, ensured private interests would accept the state’s disciplinary action. Once realized, this capacity allowed Israeli state planners to set in motion an ambitious and novel industrialization strategy I call pursuing overcapacity. By actively pursuing the installation of excess industrial capacity, state planners were able to overcome the common pitfalls and challenges of late development by curtailing monopolization and ensuring domestic firms would both reinvest their profits in productive channels and seek to expand their export capabilities. While this analysis can be no more than suggestive for the formulation of more general propositions, it does provide evidence that fits aptly into existing theoretical debates which are concerned with the issues of state autonomy and capacity, and those which revolve around the more general role of the state in producing favorable economic outcomes. In the context of these general theoretical discussions the case of Israel’s state-led industrialization becomes relevant even to those with no specific interest in Israel.