by The Aix Group
An Executive Summary
The Aix Group
Over the course of two years, the Aix Group developed an “economic” Road Map, to complement the political Road Map proposed by the Quartet (the U.S., the EU, the UN and Russia). The Aix Group includes Israeli and Palestinian academics and members of official institutions — in particular, the Ministry of Finance and the Ministry of Economy — acting in a personal capacity. The Aix Group also includes international experts and academics from the European Union, as well as members of international institutions, such as the World Bank and the International Monetary Fund also acting in a personal capacity. The initiator of the project is Professor Gilbert Benhayoun. The Israeli participants are Professor Arieh Arnon, Professor Raphael Bar-El, Professor Reuven Horesh and Dr.Ron Pundak. The Palestinian participants are Dr. Samir Hazboun, Dr. Salah Abdel Shafi, Dr. Fawaz Abu-Sitta, the economist Saeb Bamiya, Mr. Ismail Abu Shehada and Mr. Sa’ad al-Khatib. Observers include Mr. Gabby Bar and Mr. Dan Catarivas on the Israelis side and Dr. Samih el-Abed, deputy minister of planning on the Palestinian side.
The following executive summary was completed in January 2004. A longer detailed version is available at firstname.lastname@example.org or the group’s website: www.aixgroup.u-3mrs.fr
(a) This paper, prepared by a non-official group of Israeli, Palestinian and international economists, aims to establish an economic counterpart to the Road Map for Peace. The paper concentrates on economic arrangements associated with Phase III of the Road Map, since the group believes the economic content of Phases I and II can only be determined correctly if a clear vision of permanent-status arrangements first exists.
(b) In accordance with the Road Map, the paper assumes the emergence of a two-state solution embodying Palestinian economic sovereignty, unambiguous borders and the conduct of economic relations in a spirit of cooperation and mutuality. The group’s economic vision of permanent status is based on economic arrangements that will seek a convergence of Palestinian living standards with those of Israel, and promote independence in economic policy-making while acknowledging economic interdependency.
(c) Central to our discussion is a recognition that future Palestinian economic strategy can no longer afford to rely so heavily on the export of labor and remittance income. It is unlikely that the number of Palestinians working in Israel will again approach historical levels; moreover, domestic Palestinian production and exports are hampered by upward pressure on domestic wages and prices exerted by higher Israeli wage levels.
(d) The group assessed future policy options in the trade, labor, fiscal, monetary and investment areas:
* Trade. The group recommends a free-trade area (FTA) consistent with World Trade Organization (WTO) protocols. An FTA between a Palestinian state and Israel is likely to be feasible and efficient, as well as to offer exploitable development opportunities. It would provide Palestinians open access to the Israeli market, with Israel continuing to be a key trading partner. At the same time, an FTA will allow the Palestinian state to diversify its trade relations and implement development policies conducive to economic growth and prosperity. An FTA will be most efficient if accompanied by a friendly system of Rules of Origin. Israel would grant the Palestinian state, as a developing economy, the option to temporarily protect selected sectors.
* Labor. The group recommends the establishment of designated border passages through which labor flow would be unencumbered, while subject to regulation through taxes and/or permits. Palestinian workers should be given preferential access to the Israeli labor market, as compared to other foreign workers, reflecting the lower negative externalities for the Israeli economy. In addition, work permits should be granted to and held by individuals, not contractors. Although the Israeli labor market will play a diminishing role in Palestinian development, its importance in an orderly economic transition is significant.
* Fiscal Policy. Under an FTA, each country would run an independent international customs policy, but would not impose duties on goods originating in Israel/the Palestinian state (with certain exceptions as defined under the agreement). To minimize smuggling, an indirect tax policy needs to be closely coordinated, and value-added tax (VAT) and other indirect tax rates (excises, purchase taxes) should only diverge marginally, if at all. Double taxation should be avoided since this would discourage cross-border economic activity. Accordingly, there is a case for applying lower income tax rates to Palestinian workers in Israel as compared to those applicable to Israelis or other foreign workers. Alternatively, Israel should continue to remit to the Palestinian state a large portion of the income tax it levies on Palestinians working in Israel, as well as any social security deductions.
* Monetary Policy. The group recommends that the restrictions embedded in the Paris Protocol preventing the Palestinian Monetary Authority from issuing Palestinian currency be lifted in Phase II (whether or not the Palestinian Authority [PA] then decides to create a new currency). At present, the PA does not receive revenue from issuing and circulating a currency, and this raises the possibility of the PA sharing the revenue derived from the issuance of Israeli shekels while the present currency system continues. The two central banks should consult over the supervision of branches and subsidiaries operating within each other’s jurisdiction.
* Investment. The group recommends that both countries accord one another’s investors and investments national treatment — with some exemptions in cases that bear upon special national interests. The future economic agreement should permit full repatriation of revenues and income, should preclude the possibility of double taxation, and should address expropriation and regulatory matters pertaining to facts and disputes created after its entry into force. Donors can contribute to cross-border investment by establishing funds that can be used to build equity positions in Palestinian firms and to create joint ventures with Palestinian partners, as well as by continuing to offer risk insurance and guarantees to investors.
(e) The introduction of these new economic arrangements will require intensive bilateral cooperation. This would be facilitated in particular by the establishment of a joint Israeli-Palestinian economic committee, as well as by regular dialogue at expert level to exchange views on all areas of economic policy (emphasis added). The establishment of an Israeli-Palestinian development fund should be considered; this institution could play a major role in encouraging a variety of joint activities, such as industrial estates, business ventures for domestic and external markets, tourism projects and joint public/private infrastructure initiatives.
(f) The transitional period requires, above all, a vigorous effort to stimulate Palestinian economic recovery. This can only be done by restoring movement and predictability in transactions. Three basic ingredients are required to achieve this:
1. An unencumbered flow of goods across borders and within the West Bank and Gaza;
2. An unencumbered flow of people within the Palestinian territories, coupled with a flow of workers to Israel;
3. The continued uninterrupted flow of fiscal transfers from Israel to the PA.
The meaning and operation of a Palestinian state with provisional borders, as envisaged under Phase II, needs thorough exploration since it will serve as the precursor to full economic independence. Phase II arrangements must realistically be based on a “Paris Plus” formula — that is, the full implementation of the modified Paris Protocol. Phase II arrangements should include measures that ensure territorial viability, i.e., the creation of internal contiguity and the inception of economic control over external borders. Steps should be taken to denote emerging sovereignty, including the right to issue currency and the granting of observer status in the International Monetary Fund (IMF), the United Nations (UN), the World Bank and the WTO. Attention should also be given to the development of institutions that will reinforce cooperation and resolve disputes.