The United States and Israel are close to clinching a massive 10-year arms deal, but Washington is pushing to scrap a coveted provision that has allowed Israel to pump hundreds of millions of dollars directly into its defense industry.

If successful, the administration’s push to remove the clause would inflict some real pain on Israel’s growing security sector, which already exports more arms overseas than almost any other country apart from the United States. On the flip side, the change would mean a potential windfall for American defense contractors scrambling to sell their wares abroad to make up for declining sales at home. The Middle East and Asia are now driving growth for major U.S. contractors, with about a quarter of revenue coming from international sales, compared with 15 percent in 2008.

The proposed shift “could be very good news for the U.S. defense industry,” said Loren Thompson, a longtime consultant for American military contractors, because “domestic defense spending is flat as a pancake and Israel is a consumer of high-end military technology.”

The issue has been a sticking point in the talks over the new military aid package because it could deprive Israel’s security firms of roughly $10 billion over the next decade, a vast sum for a crucial sector of the country’s economy. The deal, which doesn’t involve the direct transfer of military hardware but instead a commitment from Washington to finance Israel’s weapons buying, illustrates how the two countries’ security ties remain strong enough to transcend the tensions that have plagued relations between U.S. President Barack Obama and Israeli Prime Minister Benjamin Netanyahu.

Under the change proposed by the White House, Israel would have to spend all the funds it receives in the arms package on U.S.-made weapons instead of being allowed to spend a portion of it on Israeli-manufactured arms and fuel. That would mean American aerospace giants such as Lockheed Martin, which builds the F-35 fighter jet, and Raytheon, which sells precision-guided missiles and sensors to U.S. partners worldwide, would stand to benefit.

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The rationale for setting aside a chunk of U.S. money for Israeli-made arms dates back to the 1980s, when the country was trying to build up its own defense sector. But, since then, Israel’s security firms have flourished and in some cases now compete with U.S. defense contractors in global markets, selling $5.7 billion worth of weaponry in 2015, with sophisticated radars, electronic systems, drones, and missiles topping the list of high-end exports. That was almost double the $3 billion worth of equipment it exported in 2003.

Helped by the investments Washington has made in the Israeli defense industry over the decades, Israel has emerged by far as the world’s largest exporter of drones, biting into the U.S. export market with over half of all sales going to Europe while also pushing to grow its presence in Asia. Japan and Israel are currently in talks to co-develop new armed and unarmed drones.

“We believe these arrangements, which are unique to Israel, no longer serve U.S. or Israeli interests,” a senior administration official told Foreign Policy. Since the provision was introduced three decades ago, “Israel’s economy has grown dramatically, and Israel is one of the top 10 arms exporters in the world, so the objective has been achieved.”

The rule has meant U.S. companies have lost out on billions of dollars in potential revenue, the official added.

But Israel argues it faces a dizzying range of threats amid upheaval in the Middle East and that it needs to retain the flexibility to address these threats. The Israelis also maintain that their tech-savvy defense firms have cooperated closely with American contractors over the years and that the U.S. military has benefited from Israel’s innovations, including in its drone programs, cyberwarfare, and parts tailored for Apache helicopters.

The current arms package, which was signed in 2007 and will expire in 2018, provided Israel a total of $30 billion to spend on weapons and supplies over a 10-year period. That arrangement allowed for 26.3 percent of the funding to be spent on Israeli-made defense products and fuel, a provision that no other U.S. ally in the world enjoys.

Although the White House is pushing Israel to buy American, the bitter pill is offset slightly by its offering of a pot of guaranteed money for critical missile defense programs over the next decade. Traditionally, funding for programs like the Iron Dome — which has knocked down hundreds of Hezbollah rockets in recent years — has had to come from the U.S. Congress on a year-by-year basis. That proposal has received a mixed reception in Israel as well, however, because it comes with the caveat that Israeli officials would have to refrain from lobbying U.S. lawmakers for additional missile defense batteries in return for the 10-year guaranteed funding.

Analysts in Washington say the Israeli defense industry has grown by leaps and bounds since the last deal was signed in 2007 and has become one of the world’s most influential arms exporters.

Some Israeli defense companies have become players in the U.S. market as well. Elbit Systems has opened several offices in the United States in recent years and now supplies parts, to the tune of tens of millions of dollars, for advanced U.S. weapons like Apache helicopters, F-16s, and Osprey tiltrotor aircraft. In 2014, Elbit even scored a bit of a coup, beating out several U.S. defense giants for the $145 million contract to install sensor towers along the U.S.-Mexico border.

Despite misgivings on the Israeli side about the U.S. proposal, the negotiations on the new memorandum of understanding (MOU) on military aid have gained traction in recent months after nearly faltering more than once. The deep rift between Obama and Netanyahu, which came to a head over the Iran nuclear accord negotiated last year, raised doubts as to whether they could agree on any arms package while Obama was in office.

But once it became clear Republicans in Congress could not muster enough support to block the nuclear deal with Iran, U.S. and Israeli officials resumed negotiations last December.

The United States is offering Israel $3.5 billion to $3.7 billion a year in military assistance over a decade, a major increase from current levels but less than the $4 billion a year initially proposed by Netanyahu’s government.

Israel currently receives more than 50 percent of all U.S. foreign military assistance, and under the proposed deal, Israel’s share of that funding would expand further. The MOU that Washington has put on the table would represent the largest single pledge of military assistance to any country in American history, administration officials said.

There have been four rounds of talks on the MOU, and officials and experts say that after frustratingly slow progress this year, the negotiations have gained momentum and there is cautious optimism that a final agreement can be reached before Obama leaves office in January.

“We’ve made progress and closed many of the remaining gaps. We soon hope to be able to reach a final agreement,” the administration official told FP.

The political climate 10 years ago during the formation of the last aid package — before Obama entered the White House — was dramatically different. “Ten years ago, the White House was advertising its closeness to Israel, and now the White House has to remind people of its closeness to Israel,” said Jon Alterman of the Center for Strategic and International Studies. He said despite political differences, the amount of collaboration between the two countries on counterterrorism and intelligence programs is higher than at any time in history.

Despite the strain between Obama and Netanyahu, postponing a deal until the next U.S. president would mean renegotiating many issues with no result before the spring of next year, at the earliest. Given the need for Israel to continue to upgrade its arsenal and to make long-term strategic plans, Netanyahu “can’t afford not to have a deal,” Alterman said.

Former U.S. officials, congressional staffers, and experts said it was unlikely the deal would require an immediate end to U.S. funds set aside for Israeli-made arms. Instead, the provision likely will be phased out over a period of years to allow the Israeli defense sector to make a smooth transition.

“They’ll meet somewhere in the middle,” said Ilan Goldenberg, a former senior official at the State and Defense departments.

“I would expect that whatever reduction there is, it will be graduated, giving the Israeli defense industry time to adjust,” said Goldenberg, who is now a senior fellow at the Center for a New American Security.

But whatever the timeline, there will be a concrete effect felt in Israel, according to Jonathan Schanzer, the vice president for research at the Foundation for Defense of Democracies. “I think Israel will take a hit economically, and the defense industry will take a hit,” he said. “That’s a significant sum of money for a country the size of Israel.”

For U.S. defense firms selling high-end, sophisticated weapons, any expansion of the Israeli market represents a lucrative opportunity, as the American companies can no longer count on major increases in the Pentagon’s budget, which has leveled off in recent years.

Joel Johnson, an analyst with the Teal Group Corp., said even if the subsidies are phased out, Israel would seek to offset the effect by asking American companies to buy some Israeli-made products for the weapons systems being provided.

“Israelis will probably find a way to get a good deal of that back from the U.S. firms,” Johnson said.

Photo Credit: MENAHEM KAHANA/AFP/Getty Images