Introduction
The implementation of the agreements between Israel and the PLO raises hopes for faster growth of the Palestinian economy and an improvement in Palestinian standards of living. But although the PLO will quickly achieve a degree of economic independence, controlling several economic institutions and an array of Palestinian domestic markets, this will not in itself result in a significant improvement in living standards through economic growth. Real change depends on developing exports: manufactured goods, "industrialized" agricultural products, and tourist services.
Small economies should not rely on their domestic markets. This was true of the Israel of 1950, with an annual Gross National Product (GNP) of less than $3.5 billion and a per capita GNP of $2,675 per annum, and it is still true of Israel in the 1990s, with an annual GNP of more than $55 billion and a per capita GNP of $11,000. It will certainly be valid for the Palestinian economy, which takes off with an annual GNP of $2.5 billion and a per capita GNP of $1,750 (Table 1). The success and development of these economies depends on extensive imports and exports.
A considerable number of small Third World economies, including some in the Middle East, resorted to the opposite strategy of "import substitution", attempting to develop their industries as the sole suppliers of their domestic markets. The results have been utterly discouraging.
Unfortunately it has not been easy for Third World producers to gain access to the large western markets, probably both because of a lack of confidence in Third World producers on the part of western businessmen, and a lack of experience in dealing with the caprices of western markets by Third World entrepreneurs.
Learning and, adjusting has been a slow and tortuous process, as proved by the record of Middle East countries (Table 2). Per capita industrial and agricultural exports from the Middle East in 1986 was less than $100, of which only some $40 were to high income countries. In comparison, the Palestinian record in 1986 is quite impressive: over $200 per capita, of which some $160 was to high income countries.
It seems that where less developed economies have achieved a measure of success, this is due to their proximity to industrialized nations. Consequently the Palestinian economy could perform better than other Third World economies by taking advantage of the Israeli economy next door, which is twenty times its size, and has developed channels to the world's largest markets. For this purpose, the Palestinian economy needs free access to Israeli markets and marketing channels within a framework guaranteed by binding trade accords.
In striving for such accords, it must be realized that the need for such a framework is asymmetrical at the macro level: it is critical for the Palestinian economy, but - as an aggregate - marginal for Israel. At the same time it must be stressed that asymmetry at the macro level does not mean the same thing at the micro level. For the individual Israeli and Palestinian businessmen transactions, cooperation, and joint projects may be equally important and beneficial.

Background

In the past, Palestinian access to the Israeli markets was wide enough to accelerate development in a substantial number of enterprises; but it was by no means liberal or universal. Trade relations between Israel and the Palestinian economy in the territories has differed from one market to another. Trade in manufactured goods, finished consumer products, components, and producers goods was free of administrative and fiscal barriers. Israel's import of labor services from the territories has also been relatively liberal; but the situation is very different regarding the trade in farm produce. The agricultural produce of the territories is subject to a highly restrictive licensing policy, whereas Israeli agricultural exports to the territories are free.
With regard to industrial goods, Israel implemented administrative constraints. A new industrial plant in the territories had to prove it could sell its products in the territories or abroad before it received a license. This was intended to discourage Palestinian industrialists from competing in Israeli markets. In the 1980s this
policy was not always consistently implemented, and considerable number of Palestinian manufacturers developed industrial facilities relying heavily - sometimes almost exclusively - on Israeli markets. In the 1990s the futility of the restrictive policy became obvious both to the Israeli authorities and to the leading Israeli manufacturers. After being exposed to imports from both the European Community and the United States by free-trade agreements, the hard core of Israeli industry could hardly complain about a minor competitor such as the Palestinians.
As a result the industrial trade-related licensing policy was discarded, leading to the establishment of new facilities; but because of the Intifada Palestinian entrepreneurs were unable to take full advantage of the new market opportunities.
Prior to this, trade with Israel produced a comparatively modest contribution toward the growth of the Palestinian GNP. Employment of Palestinians in Israel was a far more significant factor (Table 1). In 1990, for example, the annual per capita Palestinian GNP was approximately $1,750 consisting of four major components:
* Approximately $450 from the Palestinian labor force employed in Israel.
* Approximately $100 export of goods from the territories to Israel partly value added augmented Israeli goods exported abroad.
* Approximately $50 value added in goods exported abroad.
* The remaining $1,250 consumption and capital formation in the territories.
In comparison, Israel's per capita GNP in 1990 was $10,575 annually. A mere one percent of that amount is attributable to the value added through the export of goods and services to the territories.

Trade Benefits: A Microeconomic Illustration

In an attempt to illustrate the potential of a free trade framework, we will make a number of observations about industrialized agriculture and manufacturing in the Palestinian economy, with special reference to Gaza.
Open-Market Transactions: The simplest and most common form of co¬operation between Palestinians and Israelis involves straightforward open-market transactions. Examples are a Palestinian manufacturer of farm and farm related implements, who sells to mechanized farms in Israel, a Palestinian modern stone-cutting plant selling to Israeli contractors specializing in quality construction, and several Palestinian work-shops selling injected-sole footwear to Israeli outlets.
Despite the restrictive licensing policy of Israel in the territories before 1992, several Palestinian manufacturers of metal, plastics and wood products managed to develop new plants directed at the Israeli consumer and producer markets. Their eventual success in production and marketing indicates the potential for exports from the territories to Israel, including finished leather goods, clothing, processed foods, trinkets and toys, paper products, and electrical appliances (Table 3). These goods can be sold as finished products on the Israeli market, other products can be sold as components of "composite" goods, incorporating value added by Palestinian and Israeli businesses, marketed in Israel and exported abroad.

Composite Goods, Traditional Shops: The Israeli Connection: The clothing shops of Gaza provide an example of low key "stationary" realization of Palestinian value added through an Israel connection. Twenty percent of Gaza's industrial establishments are small sewing shops, employing an average of five people per shop, with a small investment of some $2,000 per employee. These establishments function as subcontractors for the large Israeli clothing industry. The Gazans provide the sewing and their wages are low; the Israelis carry out the designing, cutting and finishing. This situation, however, does not have to continue, taking into consideration Gaza's new sewing plants, employing 15 - 20 people, with an investment of $30,000 per employee. This situation will definitely not prevail in modern industries such as horticulture, Gaza's mechanized agriculture.

Composite Goods, Modern Industry: The Israeli Connection: A water shortage, increasing salinity, and low prices for citrus in Europe have resulted in a notable decline in Gaza's traditional citrus branch. At the same time the region has developed 400 hectares of greenhouses and 700 hectares of plastic tunnels for modern horticulture. Equipped with modern appliances, including drip irrigation, these installations - and the expertise of their operators - facilitate the production of sophisticated agricultural products for even the most capricious Western markets. For example at the present time some 60 percent of strawberries exported under the "Carmel" label are grown in Gaza. In this the Palestinian farm component is sophisticated; the Israeli component is transportation and marketing. In time the Palestinians may be able to establish their own brand name in the European market; but even then it is unlikely that the Gazans will develop an air freight capacity that depends on a versatile two-way turnover in the immediate future, so the product will probably remain a composite one.
Nevertheless, the micro level relations between the Palestinian and Israeli partners will be symmetrical! The Israelis will be under pressure to maintain their strawberry exports, and they will depend on the Gaza growers. Consequently their need for the Gaza farmers' product is no less than the Gaza farmers' need for the Israeli marketing and air-freight services. There could even be a "reversed" connection: strawberries grown on Palestinian farms in Gaza, and on Israeli farms in the Jordan valley could be exported by Palestinian marketers under a Palestinian brand name.

Food Processing: An Example of a "Reversed" Connection: Canning factories, soft drink producers, and others engaged in processing food depend on the supply of metal cans. In a factory which specializes in catering-size (bulk) preserves, the percentage of the cost of the can may be as low as five percent of the final product. For consumer-size (retail) cans, it can be as high as 35 percent, or 50 percent in the case of soft drinks. Palestinian food processing plants buy their cans in Israel. In the case of the bulk-size cans this may be temporary; but in the case of consumer-size cans a Palestinian substitute is unlikely due to the smallness of the market, and importing cans from abroad will cost too much. As a result of this, there could be a very substantial proportion of value added in Israel on a product carrying a Palestinian brand name, marketed locally, in the neighboring countries or in the West.

The Rational Connection: In the examples we have considered, there is little room for an economically feasible replacement of either the Palestinian or the Israeli components. In the case of commercial and business services and material inputs, the end products of a score of Palestinian enterprises are likely to be composite products, consisting of Palestinian and Israeli values added in varying proportions. If commercial interests are paramount, the product's label will be determined to please the customers, regardless of the proportion of Israeli or Palestinian added value in the product.

Established and New Enterprises: Assortment, Size and Investment

Generally speaking, industrial development will bring about structural changes, such as a greater assortment of goods, larger plants and higher capital intensity. Extended marketing opportunities will lead to a greater assortment of products, probably more sophisticated producer and consumer goods or components thereof. Their production requires plant-size operations rather than traditional workshops, and advanced technology needing relatively expensive facilities.
Following the change in Israeli licensing policy in 1992, a wave of new initiatives has already materialized in Gaza, indicating the direction of structural change.
* Whereas 74 percent of the existing establishments specialized in the traditional clothing, wood, and metal products, only 22 percent of the new enterprises were of this sort. This was also the case in horticulture, where there was a perceptible move from vegetables to flowers.
* The workforce in the new food processing plants was double that of the traditional establishments: ten instead of five (Table 3).
* The new enterprises had an investment of $50,000 per employee (Table 1), instead of the average of $2,000 per employee in the traditional workshops. This will also lead to industrial diversification. In horticulture, roses may replace carnations as the main flower crop. Palestinian factories could start producing a variety of electrical appliances, leading to an even greater investment per employee than shown in Table3.

Conclusions

Arguments in favor of free trade between Israel and the Palestinian economy have generally been presented in aggregate economic terms. The few examples presented in this article are intended to shed light on some of the crucial microeconomic aspects of free trade.
At the micro level it is relatively easy to distinguish between conservative and progressive patterns of cooperation. The availability of cheap Palestinian labor for the Israeli clothing industry determines and maybe even perpetuates the conservative relationship. The situation in horticulture is different: while taking advantage of the available manpower of the extended farming families, it nevertheless relies on very modem techniques, representing the cutting edge of agro-technology. The dynamics of this situation guarantees continuous modernization, advancement of human capital, and improving wages. Cooperation in this industrialized agriculture, and in most of the new industrial enterprises, is therefore progressive.
With regard to the asymmetry mentioned previously, there is in the progressive relationships ample opportunity for microeconomic symmetry, even though the macroeconomic situation is fundamentally asymmetrical. As it is the microeconomic situation that determines the terms of each individual transaction, microeconomic symmetry can guarantee the Palestinian terms of trade. In a market economy it is not the macreconomic asymmetry that determines the rules of the game, except at the outset. Therefore the parties involved - particularly the Palestinians - should strive for a free trade framework, which is universal and complete, because in a sense this is the sine qua non of Palestinian development in the years to come. <