In the 1950s, as Israel faced waves of unemployed immigrants and a decrepit infrastructure, then-Minister of Commerce and Industry Pinhas Sapir attracted money from abroad and set out to develop new factories.

Textiles were a natural choice. Knowing that many Jewish industrialists had deep roots in the textile business, Sapir began contacting international clothiers such as Romanian-born Israel Pollack, who had emigrated to Chile following World War II.

When Pollack expressed fear about setting up shop in a Negev development town, Sapir retorted: "The state of Israel was built neither with an accountant's book nor a statistical table, but with the heart."

Pollack decided to open a textile factory in Kiryat Gat, then a dusty, obscure town of 4,000 residents. He moved to Israel and turned the company into a successful exporter of upscale fashions.

But today, as local production costs rise and Third-World competitors proliferate, Sapir-type idealism can no longer sustain big business. Now the relationship between Jews and shmattes — rags — which has echoes in biblical Judea, in talmudic Babylon and in turn-of-the-century Manhattan, must once again be redefined.

On a Thursday afternoon at the Pearl Anderson plant in an industrial Jerusalem neighborhood, workers busily fold and pack Liz Claiborne T-shirts into plastic bags, which are then boxed and shipped abroad.

Patterned with colored fabrics and little gold stars, the shirts are bound for Macy's in New York, where they will sell for about $50.

When British-born Kevin Pearl decided to open a factory a year and a half ago, he concluded from current market trends that if there was any future in Israeli textiles it was in better-quality, higher-priced goods. High labor costs and the falling of trade barriers were making the manufacture of more basic items unprofitable.

"The world market in textiles is looking for cheaper products and because of labor costs, Israel can't compete," said Pearl. "To compete, we have gone upmarket. Instead of selling a $3 garment, we sell a $9 one.

"It's the survival of the fittest right now," he said, noting that when one company shuts down or switches from mass production to small-volume lines of higher-quality goods, a domino effect begins.

Changes in official policy regarding grants and bailouts show that the government is willing to let the textile industry be knocked into self-sufficiency, even if scores of companies die in the process.

Last year more than 55 of Israel's textile companies shut down.

For their part, government officials like Yoram Levy, deputy director general of the Ministry of of Industry and Trade, do not echo the industrialists' sense of impending doom. In 1995 alone, he said, textile exports rose.

The downside is that the number of workers employed by the industry is about the same as it was 20 years ago. As import tariffs continued to drop, last year textile imports jumped 11 percent.

Tzach Faran, head economist of the Manufacturers Association's textile and fashion division, is afraid the government may be going too far.

Tariffs on imports are set to drop to 12 percent on finished garments and 8 percent on raw materials by the year 2000; Faran recommends they be set at 25 percent for finished goods and 12 percent for raw materials.

As a result of changes on both the local and international stages, Faran predicted that within the next 10 years, nearly half of the 1,500 small firms will disappear.

Meanwhile the biggest firms will survive by moving their labor-intensive operations to Jordan and Egypt. Large companies are already considering establishing branches abroad.