Israel has one of the highest defense burdens in the world because of security threats and the related need for domestic defense production in the face of uncertain suppliers. Its vote-conscious leaders also react to the domestic political implications of economic performance. Leaders must maintain a healthy growth rate while guarding against inflation. This milieu of sometimes competing phenomena operates in one of the most volatile regions in the world. Prior to the wars in 1967 and 1973, economic growth was healthy and the defense burden was much lower. Economic growth has since rebounded but not to pre-1967 levels. There are competing explanations of the effect of the Israeli defense sector on growth. I consider the determinants and potential effects of Israeli defense spending and then test a three-sector production function model sensitive to the effects of increases in civilian technology and defense and non-defense externalities. The results suggest that when controlling for technological growth, short-term increases in defense spending diminished growth. Non-defense spending fostered growth. I discuss the implications for the much-anticipated 'peace dividend' in the Middle East. Based on the empirical findings of the model tested, the policy implication for long-term Israeli defense planning is that eventual savings from peace would be best used for non-defense spending on infrastructure and private investment.