While Israel awaits a new government after its parliamentary elections, its economy is gaining steam as inflation cools and its technology sector thrives.

It is a surprising display of strength after more than three years of war. But the fighting has left Israel with a growing defense bill, forcing difficult choices over how to pay for security without sacrificing the investments needed to sustain economic growth.

This economic resilience gives the next government options, but none are easy. How much it spends on the military, whether it broadens military service, and whether it raises taxes or cuts spending on education and infrastructure will influence both Israel’s ability to confront its enemies and its economy’s capacity to pay for it.

“The economy is performing strongly but underneath, there are big challenges ahead,” said Karnit Flug, a former governor of the Bank of Israel and now a senior fellow at the Jerusalem-based Israel Democracy Institute. “The next government will face difficult choices.”Those choices have become even more pressing amid uncertainty over American support. The U.S. provides $3.8 billion annually in military aid, about 0.5% of Israel’s gross domestic product, plus billions more in emergency wartime assistance.

But President Trump said Tuesday that the U.S. would cut off military aid to Israel by the end of the year, suggesting the phaseout of U.S. financial assistance could occur much faster than expected. Prime Minister Benjamin Netanyahu had previously proposed that America eliminate direct military aid over the next decade.

Flug said Washington’s contribution goes far beyond financial support, particularly its military and intelligence cooperation. “It’s very hard to actually assign to it a dollar value, but it’s extremely valuable as a part of our defense strategy,” she said.

During the election campaign, national security, the fallout from the Oct. 7, 2023, attacks and questions over Israel’s political future have dominated the debate.

Still, kitchen-table anxieties have also weighed on voters. In an October poll conducted for Israel’s public broadcaster Kan, 34% of respondents named the economy and cost of living as the most important issues influencing their vote, compared with 32% for national security.

Those worries stand in contrast to a macroeconomic rebound that has defied years of multifront conflict, from the post-Oct. 7 fighting to this year’s war with Iran.

The International Monetary Fund expects Israel’s economy to expand by 4.5% this year, up from a July forecast of 3.5%. That is the fastest projected rate among the members of the Organization for Economic Cooperation and Development, a group of mostly wealthy countries.

Behind that economic feat is a combination of business adaptability and financial muscle.

Israeli businesses, hardened by past crises, quickly adjusted to wartime disruptions. The country also entered the conflict with a relatively low debt load, giving the government room to borrow to fund the military, compensate reservists and keep households and businesses afloat.

Meanwhile, well-capitalized banks kept credit flowing and the central bank—which had roughly $237 billion in foreign-exchange reserves as of September—stepped in to steady financial markets. Domestic offshore natural-gas fields helped keep electricity prices relatively insulated from global energy shocks.

The wars, however, have eaten into the financial cushion that helped Israel withstand them. In April, the central bank estimated government spending and other fiscal costs related to the conflicts at 405 billion shekels, or roughly $130 billion, for the period from 2023 through 2026.

The mounting costs are putting pressure on Israel’s coffers. Public debt is forecast to reach 68% of GDP this year, up from around 60% before the 2023 war. The budget deficit is expected to reach 4.4% of GDP this year, compared with a surplus of 0.6% in 2022.

Military spending now absorbs about 8% of economic output, roughly double its prewar share, Flug estimated.

If that higher level of military spending persists, the government will have to raise taxes, cut civilian services or accept more borrowing. Each carries economic costs. Flug said that further cuts to education, healthcare and infrastructure could weaken the very foundations of Israel’s future growth.

“I don’t think we can afford higher deficits,” she said. “We need the fiscal space to be able to respond to shocks.”Those trade-offs are already playing out. On Oct. 18, Netanyahu’s cabinet approved about $840 million in cuts to ministry budgets, including education, health and transportation, to fund urgent military purchases. That drew criticism from opposition politicians and public-sector professionals who warned of damage to essential services. The government said the purchases were needed for national security.

London-based research firm Capital Economics said military spending could remain higher under a Netanyahu-led government after the elections, further crowding out civilian investment. Israel has yet to form a government and it remains unclear what Netanyahu’s chief rival, Gadi Eisenkot, would spend on the military, should he come to power.

Israel has financed most of its war costs through budgetary revenues and borrowing. Capital Economics says the country’s low borrowing costs and a large domestic investor base make sustained military spending manageable. The bigger challenge is what civilian spending must be sacrificed to pay for it.

“There is a tension between higher security and defense spending, putting the public debt ratio on a declining path, and preserving growth-enhancing policies,” said Liam Peach, senior emerging markets economist at Capital Economics. “This tension is likely to grow over time.”Growing diplomatic rifts threaten the international ties that have helped power Israel’s economy. Britain, France and Canada have announced plans to ban trade in goods from Israeli settlements in the occupied West Bank.

While those measures stop short of sanctioning the broader Israeli economy, economists warn that deepening diplomatic isolation could jeopardize the trade, investment and research partnerships that underpin Israel’s export-driven model.

Another dividing line in the election that carries key economic implications is the role of Israel’s ultra-Orthodox community. Netanyahu’s government has sought to preserve military-service exemptions for ultra-Orthodox religious students despite Israel’s Supreme Court ruling that authorities must begin drafting eligible men.

Expanding the draft could reduce Israel’s costly reliance on reservists, many of whom must leave their civilian jobs to serve. The Bank of Israel estimates that recruiting an additional 7,500 ultra-Orthodox men annually could reduce the need for reservists, eventually saving the economy at least 9 billion shekels a year, or 0.4% of GDP.

Capital Economics expects an opposition-led government to be more likely to recruit ultra-Orthodox men to serve and reduce their incentives for staying out of the workforce. If successful, those changes could lift Israel’s potential annual economic growth by as much as half a percentage point by the 2030s, it estimates.