“In Israel,” David Ben Gurion once quipped, “if you do not believe in miracles, you are not a realist.”

Since Israel, alas, could not deliver a military miracle last summer, the economy did. After 20 years of no growth, the last five years have witnessed a spectacular spurt of growth despite war and terror and despite Israel’s dysfunctional political system and inept government.

As the governor of the Bank of Israel, Stanley Fischer, told us: “The Israeli economy is now into its fifth year of rapid growth, of around 5 percent per year, with inflation that has averaged less than 2 percent per annum, and a large balance of payments surplus — a result of disciplined budgetary and monetary policy, structural reforms carried out over the last two decades that have integrated the Israeli economy into the world’s markets, and especially of a vibrant and innovative private sector.”

“Provided we policymakers continue down our current path, and the world economy and the geopolitical situation remain supportive, we are very likely to be able to continue to grow rapidly, and in so doing transform the Israeli economy and the lives of Israelis.”

The miracle becomes even more impressive if we remember that when Benjamin Netanyahu became finance minister in March 2002, Israel was on the verge of an Argentina-like collapse. After decades of stagnation and recessions, the government, the largest employer and purchaser of goods and services, was not collecting enough taxes to pay public sector employees, or every third worker. It was one year in arrears in paying suppliers. Thousands of bankruptcies posed a threat to the financial system and one large bank was facing of bankruptcy.

A major pension fund defaulted and the rest had a 150 billion shekels actuarial deficit, excluding the public sector actuarial deficit, estimated at around NIS 400 billion. Unemployment at 10.7% was rising. The growth rate was -1.2%, the shekel was five a dollar. The Israeli government had difficulties in raising capital, even at rates of 12% and higher.

Netanyahu courageously cut government spending so that its share of GNP was reduced to 47% in 2006 from 53% in 2003. He instituted a comprehensive reform pillaged near bankrupt pension funds that was controlled until then by the Histadrut Labor Federation. He cut the highly abused social security allocations and unemployment benefits. He shrunk public services and pay, and launched reforms in transportation and infrastructure partly through privatization.

Arguably Netanyahu’s greatest achievement was his revolutionary reform of financial markets. Israel’s prolonged lack of growth was the result, like in Japan, of massive credit misallocation by the banks duopoly. Before Netanyahu’s reform, three large banks — two that were still government controlled — and the labor union’s pension funds controlled more than 80% of national savings.

The banking sector controlled the capital markets and it held large positions in the insurance industry. The Ha’poalim-Le’umi duopoly lent 70% of all loans to 1% of lenders, mostly cronies. Most of these loans went sour. Small and medium businesses were denied credit, causing a destructive credit starvation especially in the peripheral Negev and the Galilee regions.

After a fierce fight with the powerful banking, insurance, and the labor unions, Netanyahu, aided by an aroused public and NGOs, managed to overcome 20 years of effective resistance and forced the banks to sell assets that granted them a monopoly position and created serious conflicts of interest.

The surprisingly swift success of the reform — the banks asked for eight years to sell their assets but finally did so in several weeks — and the vivid interest of foreign investors reshaped Israeli financial markets. It introduced greater accountability, competition, and efficiency, dramatically improved credit allocation, and brought on a great increase in growth. More than NIS 100 billion of non-banking credit was issued by the Israeli capital markets, leading to job creation, productivity enhancement, and growth.

The shekel rose against the dollar by 15% to about 4.3 shekels with zero inflation. The balance of payments turned to a surprising surplus from a chronic deficit. Unemployment decreased to 7.5% — 300,000 new jobs were created and average pay increased. Short-term interest rates fell to historic lows while long-term rates remained at a low 4%.

Until the correction two weeks ago, Israel’s capital markets experienced the longest boom in their history. Leading indexes rose more than 300%. National saving grew to NIS 2.0 trillion in 2006 from NIS 1.4 trillion in 2003. The diversion of pension funds from government guaranteed bonds to the market resulted in the largest increase in public long term saving ever. Foreign investments reached record highs.

“There is a single reason for all these good things,” Ha’aretz economic editor, Nehemiah Strasler, explained: Netanyahu’s “responsible free-market economic policy … budgetary restraints … small deficits, tax cuts, reforms, privatization and opening the economy to free movement of goods, services and capital, in short: less government, more business.”

The World Economic Forum raised Israel’s ranking on its competitive index from 15th place to 23rd, ascribing this rise to Netanyahu’s bold financial market reforms.

But miracles, even of historic proportions, may not last forever. Though it has acted fairly responsibly so far, the great weakness of the Olmert coalition forces him to buy political support at ever mounting costs. If not for the powerful intervention of Governor Fischer, Mr. Olmert would have by now succumbed to the pressure to increase government deficit spending and he may still do so, especially if his many cronies start really hurting.

Equally worrisome is the fact that the basic structure of the Israeli economy still is extremely concentrated, uncompetitive, and dependent upon politicians. Israel’s private sector may be “vibrant and innovative,” but mostly in the export oriented high tech sector. As a recent BDIcoface analysis disclosed, 19 families in Israel control 34% of the income of leading companies. Their 248 billion shekels income equals 84% of the state’s budget. They employ 160,000 workers and are indirectly responsible for the livelihood of 700,000 people.

Even after the reform, the index of concentration in the banking sector is still three times higher than in America, twice as high in communications, and five times higher in insurance. This may explain why consumer prices in Israel are a third higher than international averages, why it is very costly to do business in Israel, why smaller and medium businesses are discriminated against by the banks, and why the cost of living is so high that most families cannot make ends meet.

Despite the rosy picture, reformers still have their work cut out for them. For Israel to survive it must have an efficient and thriving economy. Otherwise it will not be able to keep its young at home or pay its rising defense bills.

Mr. Doron is president of the Israel Center for Social and Economic Progress, an independent, pro-market think-tank.