Over the past four decades, the Palestinian markets in the West
Bank and the Gaza Strip (WBGS) have been closely tied with
Israel's. As a result, the performance of the Palestinian economy
has been subject to Israeli economic forces, which have determined
its level of macroeconomic variables, such as prices, wages,
exports, imports, investment and employment. Also, Israeli security
concerns have been used to justify the imposition of economic
measures and sanctions against the Palestinian economy, creating an
artificial economy in the WBGS resulting from trade between two
unequal partners.
Since the early 1970s, the gap between Palestinian and Israeli
wages has pushed more than one-third of the Palestinian labor force
to seek jobs in Israel. Between 1999 and 2000, remittances paid to
Palestinian workers in Israel accounted for more than 20% of the
gross national disposable income (GNDI). Furthermore, the
competition in WBGS markets between local and foreign products,
primarily from Israel, has impeded the Palestinian economy's
development. Production of food, farm produce and final
manufactured commodities tended to decline from year to year,
gradually being supplanted by imports, mainly from Israel,
resulting in one-fourth of the Palestinian gross domestic product
(GDP) going to the Israeli economy.
Free labor mobility from the WBGS to Israel, on one side, and
flexible merchandise and service trade flows from Israel to
Palestinian markets, on the other, have been viewed as the main
pillars of Israeli-Palestinian trade. Some economists have regarded
this type of trade relationship as a quasi-customs union; however,
trade between unequal partners does not enable efficiency gains,
technology transfer or growth.
The signing of the Paris Protocol (PP) in 1994 between the
Palestine Liberation Organization (PLO) and the government of
Israel had minimal impact both on reshaping economic and trade
relations between Israel and the WBGS, and on restructuring the
Palestinian economy. Since the mid-1990s, the Palestinian Authority
(PA) has utilized trade policy to finance its current expenditures.
In fact, trade deficits have been utilized to finance budget
deficits. Importing from or via Israel has gradually increased
tariff revenues, which have been collected by Israel on behalf of
the PA. Annual tariff revenues averaged 60-70% of total Palestinian
public revenues and around 15% of GNDI. In 1999, Palestinian
imports peaked at $3 billion; they have been fluctuating ever
since, but have not retrieved their 1999 level.
After a decade of trade relations following the PP, tax imports,
remittances and donor disbursement have become the major sources of
PA income. Therefore, any decline or restriction on the flow of
these funds will debilitate the Palestinian economy through a rise
in unemployment rates.
Since the fourth quarter of 2000, the WBGS have been experiencing
the following macroeconomic imbalances: 1) persistent and
continuous trade deficit; 2) a huge deficit in the public budget;
3) high rates of unemployment; and 4) rising inflation rates. Under
the PP, the PA has little control over stabilization policies to
allow it to correct macroeconomic imbalances. In fact, the PP
granted the PA only limited authority to run the economic
activities in the WBGS; for example, it did not give it control
over fiscal, monetary or trade policies. A unilateral customs union
envelope remains the major determinant of the economic and trade
relationships between Israel and the WBGS. Consequently, the levels
of most Palestinian macroeconomic variables, e.g., interest rates,
exchange rates, price levels and unemployment rates, have been
determined in accordance with Israeli economic conditions and
interests. The adverse effects of the economic environment on trade
can be summarized as follows:
1) High rates of inflation and interest rates and continuous
devaluations of the Israeli currency in real terms, particularly
during 1995-2005, have made investments for the purpose of
expanding local production less attractive. Consequently, the
number of laborers employed in farming, manufacturing and
construction has declined by 8% - from 250,000 in 2000 to less than
230,000 by 2005. As a result, the local agro-industry and the
manufacture of finished goods have been undercut by cheaper
imports, mainly from Israel (Palestinian Monetary Authority, Tenth
Annual Report, 2005).
2) Dependency on the trade deficit to finance the budget deficit
has been implemented by providing facilities to importers to
increase the imports of final goods to generate tariff and tax
revenues. Consequently, the Palestinian economy has been gradually
eroded over the past decade due to low productivity and high wages,
concomitant with the low prices of imported goods (World Bank,
2006a; 2006b). The consequences of financing the budget deficit by
creating a huge trade deficit are outlined below:
a) The persistent deficit in current public expenditures has
limited allocations of public capital expenditures to reconstruct
or build the infrastructure, e.g., electricity, water and
telecommunication. Although the infrastructure remains below
international standards, the costs of public utilities in the WBGS
are higher than in neighboring countries. Furthermore, in recent
years, high percentages of international donations - chiefly from
the EU - have been directed to finance the current budget, mainly
to cover wages and salaries for employees in the public sector. In
fact, the wage bill accounts for more than 80% of the total current
budget.
b) Exporting laborers, mainly to Israel, has become the engine of
the Palestinian economy. Consequently, real growth rates in the
Palestinian GDP tend to decline from year to year, particularly
when remittances decreased sharply due to restrictions imposed on
Palestinian labor mobility. This had several multiplier effects on
consumption expenditures, GNDI, imports and public revenues.
c) The Palestinian economy and trade continue to suffer from three
major distortions: smuggling, dumping and monopoly. These
distortions have negatively affected the decisions of producers,
investors, importers and exporters.
d) The development gap between the Palestinian economy and those of
Israel and other regional countries has widened with time. During
the last four decades, Israel's occupation of the WBGS has hampered
the possibility of any economic development. Consequently, it has
become a given that any real partnership, cooperation and
development in the WBGS is not possible without ending the
occupation.
e) Most of the WBGS' trade partners have ignored the unique
situation of the WBGS economies. After four decades of isolation
and disengagement from regional and international markets, a
transitional period is required to upgrade and rehabilitate the
Palestinian economy.
Since 1994, the PA has signed several bilateral agreements with
regional and foreign countries, including Israel. The Palestinians
anticipated that these agreements would achieve the following
objectives:
* Expand Palestinian trade;
* Increase public revenues; and
* Promote employment.
So far, the benefits reaped from these bilateral agreements have
not been evaluated in detail. Most studies have focused on
analyzing the influence of non-tariff trade barriers (NTBs) and
Israeli obstructions pertaining to the Palestinian economy and
trade. Most bilateral agreements - as well as the PP - have ignored
certain conditions that are vital for trade agreements to function
properly:
* The full right of the Palestinian side to manage and use its
human and natural resources without any interference from other
parties; and
* The right of the Palestinian side to control border passages with
Egypt and Jordan. Consequently, Palestinian trade should not remain
subject to Israel's security interests and regulations. In fact,
Palestinian trade flows, labor mobility and even personal travel
have been highly restricted since the fourth quarter of 2000.
Since it occupied the WBGS, Israel has utilized trade as a means to
restructure the Palestinian economy towards dependency on the
Israeli economy, to serve its economic and security interests.
Israel began by severing all economic and trade links between the
WBGS and the rest of the world; the greater part of Palestinian
trade was limited to Israel or to passing through Israel during the
"open bridges" policy. Since 1995, border controls have been
considerably tightened to the extent that now 90% of WBGS imports
come from or through Israel, and 95% of its exports are destined
for or pass through Israel. Palestinian exports to Israel are still
very limited in terms of volume and variety compared with imports
from Israel. This has impacted negatively on the performance of the
Palestinian economy. The ratio of the trade deficit to the GDP was
very high in 1995-2005 compared to previous periods and compared to
Israel, Jordan and Egypt. Israel's monopoly over WBGS trade has
been exacerbated by the flooding of the Palestinian markets with
cheap and subsidized Israeli products, leading to a disintegration
of the relationship between production and consumption as well as
between supply and demand within the WBGS.
Evaluation of Trade Options
Any agreement for economic and trade relations between Palestine
and Israel in the foreseeable future must correct the structural
imbalances in the Palestinian economy. Therefore, any future
economic and trade arrangements with Israel must strengthen the
Palestinian capacity to implement the economic integration of the
WBGS. The present separation and the existing disparities between
their economies remain among the major challenges facing the
Palestinian economy.
Regarding the type of economic and trade relations between the WBGS
and Israel, i.e., a free trade area or a customs union, several
factors must be taken into consideration, primarily because each
option could have serious repercussions on Palestinian development
strategies. A free trade area and customs union would not, under
the current circumstances, contribute to the correction of the
structural imbalances in the Palestinian economy but would only
deepen them. Nevertheless, they should not be ruled out as
possibilities in the long term, after the structural reform of the
Palestinian economy has been completed.
Several studies conducted by this author indicate that the free
trade area option called for by some Palestinians faces a number of
structural problems and shortcomings. If the aim is to check the
financial leakage from taxes and duties imposed on Palestinian
imports from or via Israel, then this option would be of limited
value. In spite of some potential financial gains, it would lead to
the loss of sustainable development opportunities. It would also
lead to one-sided customs union that would deepen the status quo
through contractual agreements that would constrain the Palestinian
economy at a time when the regional trend is inexorably towards
free trade.
The other option is that of a customs union, advocated by the
Israelis in return for guaranteed financial gains for the
Palestinians. This option would deepen the phenomenon of
polarization The Palestinian economy will continue to depend on
exporting labor, on the one hand, and importing cheaper products
from Israel. As a result, the Palestinian economy would be deprived
of any future opportunity to benefit from spread effects with their
potential positive repercussions on the Palestinian economy, such
as the free movement of goods and services, or solid forward and
backward linkages between economic sectors. The customs union would
lead to restrictions on freedom of movement according to demand and
supply and the level and direction of the overall economic
variables in Israel.
During the past four decades, Israel has managed to forge economic
and trade relations with the WBGS. These relations have become
intertwined, as evidenced in the volume of the movement of goods,
services and other financial flows between the WBGS and Israel and
their influence on variables of GNP, GDP, consumption and rates of
employment. The impact of closures and blockades, on one hand, and
the effect of the open door policy in 1998 and 1999, on the other,
reflect the performance of these variables and the extent of the
Palestinian economy's reliance on that of Israel.
A third option currently under discussion is that of economic
separation and disengagement. This is unrealistic and would prove
costly for both sides, nor is it in the interest of either party.
Evidence shows that Israel uses this option as a threat to put
pressure on the Palestinian side. While it is true that separation
would be more detrimental to the Palestinians, who must depend on
Israel, it would also be very costly and, therefore, undesirable
for Israel as well.
A fourth option is the formulation of Palestinian-Israeli trade
relations, which paves the way for the establishment of a new
relationship to respond to a settlement of the Israeli-Palestinian
conflict. It is based on cooperation and takes into consideration
the mutual interests of both sides. It would be achieved gradually
and in a cumulative manner according to a five-year timeline. The
results of this option should be defined and understood in advance.
In other words, it is possible to change the volume of bilateral
trade as well as its components and effects. This can be done
through the substitution of polarization effects for spread effects
to create reciprocal relations aimed at building desirable economic
structures that depend on specialization.
It is possible to draw lessons from similar cases of countries that
have won independence from colonial powers. These countries have
later experienced fruitful cooperation instead of conflict. In the
case of Palestine, the essence of the envisaged arrangements
are:
1) Decreasing dependency on Israel of the surplus Palestinian labor
force by increasing the WBGS' employment capacity;
2) Phasing out the current labor export and replacing it with
labor-intensive products for export;
3) Increasing job opportunities by 10%; and
4) Restructuring the Palestinian economy, which would lead to the
restoration of more than 25% of Palestinian GDP from the Israeli
economy, particularly in the field of manufacturing products. With
time, its effect on the macroeconomic variables would double,
particularly in exports, labor imports and consumption. In light of
these results, trade relations between the WBGS and Israel could
move from being a skewed customs union, geared entirely towards
Israeli interests, to more symmetrical relations based on a
combination of a balanced customs union, a free trade area and
other options.