With its military enemies and the plague of quadruple-digit inflation at least temporarily at bay, the Israeli government is approaching a decision of watershed dimensions that it has avoided for all the country's 37 years:

Will it continue to build the Jewish State by using the nation's economy as a kind of massive public-works project -- with all the featherbedding that the term implies?

Or will it risk driving Jews from Israel by tolerating unemployment in order to steer Israel toward economic efficiency, encouraging enterprises that are productive and allowing those that are not to die? The goal would be building an economy that can support the Western lifestyle that Israel's citizens so clearly want.

The simple fact is that Israel's economy suffers from serious structural problems. It has a low-wage, labor-intensive Third World economy. However, it has managed -- by massive borrowing -- to satisfy First World tastes for such commodities as video cassette recorders, luxury automobiles and vacations abroad.

Stopping inflation -- the problem that has pre-occupied both Israeli economists and the Reagan administration's policy-makers -- will not change this fact. Even leaving out military expenditures, Israel will remain in serious economic trouble until it figures out how to climb out of its current stagnation, create productive jobs, export more than it imports, and pay its bills without massive handouts from abroad.

What life-support systems are to medicine, American foreign aid has become to Israeli life. Without the continuing flow of that aid -- roughly 19 percent of the government's budget in 1985 -- Israel would not be able to defend itself and to maintain a society that boasts five universities, sees one-seventh of its citizens travel abroad annually, has 50 percent of its work force employed in government, finance and service jobs (ranking behind only the United States and Canada -- countries far more developed than Israel) and has 29 percent of its civilian workforce on the government -- which is to say the public -- payroll.

Compared with seven leading industrial countries (the United States, Germany, Japan, Canada, the United Kingdom, Italy and Sweden) Israel has the lowest percentage of workers employed in industrial jobs except Canada.

In its 1978 report, the Bank of Israel analyzed structural problems in the country's economy.

It found that in "recent years there has been a marked structural change in employment, with the public-services sector absorbing most of the additional manpower. Since the government's ability to siphon off more money through taxes is limited . . . and since a diminished dependence on external sources of finance (foreign aid) has become a prime national target, there is no escaping the need to reduce the share of public services in total resource use.

"In other words, the freezing, and perhaps even absolute decrease, of public sector employment is necessary for relieving pressure in the labor market and making more resources available to the business sector."

This warning was not heeded by the government of Menachem Begin. If anything, rather than reducing Israel's dependence on American foreign aid, the Likud government increased that dependence. Civilian consumption was not brought under control, even when the Israeli invasion of Lebanon in 1982 resulted in an absolute decline in productivity. Consumption in that year increased. An analysis of the distribution of employment in the Israeli economy among the various sectors finds no significant difference today from what the Bank of Israel described in 1978.

Of course there are reasons for the fix that Israel is in, reasons that make it all the more difficult to solve the problem.

One of the unique features of Israel as the Jewish State has been the role of the economy -- even before the state was created -- as an instrument of nation-building. In political Zionism -- the ideology that saw the creation of a Jewish State as the only realistic solution to the "problem" of European Jewry -- the state was the end-point. A corollary of Zionist ideology in the pre- state days held that Jews should do the work, among other reasons in order to provide jobs for the Jews who were coming to Palestine in answer to Zionism's call. In the history of the United States, immigrants came here to fill jobs. In Israel's history, jobs were created to hold immigrants.

After the state was founded, full employment became a governmental goal -- not simply because it was better to have able- bodied persons working, and not simply because the country was desperately in need of development, but because Jews who did not have jobs would leave Israel. In the last 10 years in Israel, unemployment has run from a low of 2.9 percent in 1979 to the current rate which is somewhere between 7 and 8 percent, although the possibility of a rate as high as 11 percent has been mentioned.

Americans have grown accustomed to unemployment rates that Israelis find high precisely because the United States government has backed away from massive spending programs to stimulate employment. To a large extent, then, Israel's economy from its early days can be viewed as a kind of on- going public-works project.

This strategy has had its benefits. In its first 30 years, Israel increased its exports by 3,600 percent, to use only one index of success. An infrastructure, including roads, bridges and a complex water-supply system, was built. But there is no way to measure how much more successful the Israeli economy would have been if higher unemployment rates -- in the short term at least -- had been tolerable.

They were not. Where other nations might use standards of efficiency to measure the benefit of investments, Israel was willing for years to subsidize businesses that otherwise could not survive because they provided jobs. By the same token, government payrolls were padded with unnecessary workers doing non-essential jobs because economic efficiency was not a primary consideration.

Not all the jobs in Israel were make-work to be sure. Thousands of jobs were created by privately-owned (and some government-owned) companies where economic efficiency was extremely important. Israel's sophisticated high-tech industries have to compete in world markets against other companies that receive no government subsidies or help. Some of these workers, better educated and often of European descent, prospered in their private-enterprise jobs. A wealthy class developed alongside the middle class and the poor.

This situation made it especially difficult for a popularly-elected government to change policies and to begin using economic efficiency as a standard for measuring policy. As consumption among wealthier Israelis increased, the poorer class of Israelis -- often "Oriental" or Sephardic Jews -- began to demand their own share of the pie. A succession of Israeli governments responded by continuing the official make-work policy, supplemented by a combination of subsidies and welfare programs.

This policy would have been expensive enough without the enormous defense costs that Israel has had to bear, especially in the last 18 years.

But whatever the reasons for Israel's economic predicament, the question now is what happens next? If -- and despite the optimism of many Israelis on the subject, it's still a big if -- if inflation is really under control now, where does the Israeli economy go from here? The central fact of the Israeli economy is that it is not growing. Indeed, after years of growing, the Israeli economy has been contracting.

According to figures released by the government's finance ministry, Israel's national income for 1985 will be about $400 million less than it was in 1981. Israel has three clear economic choices: continued contraction, stagnation or growth. The first two are obviously undesirable, but how can growth be resumed? Since the founding of the Jewish State, a substantial amount of economic growth has been achieved by borrowing -- from other countries, especially the United States, from world Jewry and from banks. In the current Israeli government budget, debt service accounts for slightly more than half of the total. As a result, in the near term at least, Israel will probably have to forego large-scale borrowing as a way to resume growth.

The other classic way of achieving economic growth is by increasing productivity, and this gets to the core of the problem: Increasing productivity in Israel would require substantial structural changes, changes that run against the Israeli ideological and political grain.

Israel has never had a year in which its exports exceeded its imports. The reason for achieving higher productivity would be to reverse this situation, turning a deficit into a surplus. If we think of productive labor as being that which brings capital into Israel -- whether the job is in the industrial or service sector -- then part of what Israel needs to become self-sufficient is clear. Thousands of workers now on government payrolls, or working in factories producing items under Israeli government contract, or working as social workers, are not doing productive labor under this definition. They are not helping Israel to pay its bills abroad, a vital necessity for a country that must import virtually all of its raw materials.

If it were within a government's power to wave a wand and move workers from one sector of the economy to another painlessly -- that is, without unemployment -- the problem still would not be solved. Israel is one of the most heavily unionized countries in the world. More than 75 percent of the Israeli workforce belongs to a union. Even white-collar workers and professionals have their union.

Virtually all the unions in Israel are components of the Histadrut, the unique labor union that is also a worker-owned industrial conglomerate and the largest non-governmental employer in Israel. Because of its size and power, and because the Histadrut pre-dated the state, it has been characterized as a state within a state.

As a labor union, the Histadrut watches out for the interest of its members, who vote for the leadership in periodic, partisan elections. And, as a labor union, the Histadrut enforces the work rules and principles it has negotiated with management to safeguard the union's idea of what is best for the workers. It will come as no surprise to anyone familiar with labor unions to say that the idea of a worker producing more without necessarily being paid more, or producing more without fully sharing in the benefit of his or her increased production does not sit well with unions.

Nor does the idea of laying people off on the basis of merit rather than seniority sit well with labor unions. Keeping a junior worker, who happens to be more capable, on the job while laying off a more senior worker is anathema to the labor-union ethic.

But that, in stark terms, is what increasing productivity is all about. What is needed now in Israel is a sea change in public policy. If the Israeli economy is ever to be self-sustaining, the Israeli government may have to tolerate a period of relatively high unemployment -- perhaps 10 percent or more -- and resist the temptation to create jobs to put people back to work. The whole idea of this exercise would be to let ingenuity -- which Israelis have in abundance -- guided by market demand, determine where Israeli workers earned their pay.

The joker in the deck is that no Israeli government -- for practical as well as ideological reasons -- can tolerate substantial emigration of Jews. Israel's most capable technicians, scientists and engineers are on a par with quality professionals anywhere in the Western world. If they cannot find work in Israel, they can find it abroad. It is no different for less highly-trained workers, who also take the responsibility of providing for their families no less seriously.

The other major restraint against a basic restructuring of Israel's economy is political. Israel is a democracy, albeit one at present with a government of national unity. Under the best of circumstances, it is hard for democracies to undertake programs that require long-term sacrifice by the population. Even if the government's policy is well-conceived, the temptation by the opposition party to engage in demagoguery may prove irresistible.

Given the pre-existing splits in Israeli society -- between the religious and non-religious, between European and Oriental Jews, between those who would give up the West Bank for peace and those who would not -- it is hard to imagine -- not inconceivable, but hard to imagine -- that a government could sustain a long-term policy of austerity in order to restructure the economy without unrest creating pressure to change the government.

These are the Hobson's choices facing the Israeli government. It is understandable that Israelis, and those who wish them well in the United States, may fasten on the apparent success that Israel has enjoyed in curbing inflation. But that apparent success ought not to obscure the deeper, more complex and potentially far more momentous economic problem that Israel has yet to confront.