Big US military aid package to Israel has strings attached

An Israeli F-15 fighter jet
Jack Guez | AFP | Getty Images

After months of negotiating, the United States and Israel have signed a huge, $38 billion deal for military aid to the Jewish state — with some changes from previous pacts between the countries.

The 10-year agreement is the largest in U.S. history, with a significant portion of the money expected to be used to upgrade Israel's air force to Lockheed Martin's F-35 fighter aircraft.

But while the actual memorandum of understanding hasn't been officially released by either country, it has a number of conditions that are different from previous U.S.-Israel aid deals.

Most importantly, it's structured so that more Israeli defense spending goes to U.S. companies. Israel's long-standing special arrangement for funds from the United States previously allowed Israel to spend 26 percent of the money in Israel — on Israeli-made defense products. But that provision is being phased out over the first five years of the deal.

Sources on Capitol Hill with knowledge of the agreement said the deal states that Israel can't lobby Congress for more money unless a war breaks out. It says that funds for missile defense are included in the $38 billion — previously, that money was negotiated separately. And it states that Israel can't use any of the U.S.-provided funds for fuel, meaning more of the aid comes back to U.S. defense manufacturers.

The U.S. State Department referred an inquiry from CNBC to the White House, which said it would not comment on the deal beyond a fact sheet it released online. That document notes that the new agreement for $3.8 billion per year compares with the previous annual allotment of $3.1 billion, and it refers to the new pact as an increase "by every measure."

The changes are ringing alarm bells within the Israel Defense Forces and the Israeli military industry, which fear it will hurt the country's war footing, quality control, product development and, of course, the bottom line for Israeli defense contractors.

Some of Israel's bigger contractors own smaller American companies, which would allow Israel to spend the money in the United States, as agreed upon in the deal, while still counting on the expertise and experience of Israeli firms. The country's defense giant, Elbit Systems, for example, has a wholly owned subsidiary based in Fort Worth, Texas.

Other Israeli defense companies may soon look to buy smaller American defense contractors as well. "The big contractors in Israel will follow Elbit's methods and establish U.S. subsidiaries to work through," said Liran Lublin, an analyst who covers Elbit for Israel Brokerage and Investments.

Strengthening a domestic defense industry has been a top priority for the Israeli government for decades. Israel learned the hard way in the late 1960s and early 1970s what happens when a main supplier of arms cuts off defense aid.

Israeli soldiers of the Israeli Defense Forces
Nir Kafri | Bloomberg | Getty Images

Throughout the 1960s, France was Israel's biggest supplier of weapons until it abruptly declared an arms embargo just before the Six Day War in 1967.

Israel defeated Egypt, Syria, Jordan, Iraq and Lebanon in the fighting that followed. But in the six years between 1967 and the 1973 Yom Kippur War, Israel lacked a relationship with a steady and powerful arms supplier, while the Soviet Union showered arms, intelligence equipment and training on the Arab states.

Largely as a result, Israel lost ground to Egypt and Syria in the first stages of the Yom Kippur War before recovering to defeat them. Many in Israel still remember the conflict as a frightening episode that threatened the country's very existence.

Despite ongoing U.S. military support, there is always fear in Israel of being cut off. Though he said he's concerned by changes to American aid to Israel, the former head of the IDF's research and development division, Gen. Itzik ben Israel told CNBC, "I believe five years is enough time for Israel to be prepared to minimize the negative effects."

Israel is the largest recipient of American military aid. The country began receiving an allotment for defense spending in 1985, shortly after Israel and Egypt signed a landmark peace deal. Egypt is the second-largest recipient of U.S. military aid.

Israel also spends its own funds on its military. Its budget for the past year, not including U.S. aid, was approximately $16 billion, or 5.4 percent of Israel's gross domestic product. By comparison, the United States spends just more than 3 percent of its GDP on defense.

In addition, Israeli defense companies have opened markets for themselves all over the world. Israeli defense firm IMI announced this week that exports of bullets to the United States have increased tenfold over the last two years.