I. Introduction

Since the military occupation of the West Bank, East Jerusalem and the Gaza Strip (WBGS) in June 1967, the Palestinian economy has been tightly linked to Israel in an involuntary relationship that can best be characterized as asymmetric in all its aspects. Given the wide economic and developmental gap between the two sides, and according to the basic precepts of neoclassical trade theory, such a relationship was supposed to benefit the less fortunate Palestinian economy more than the more developed and advanced Israeli economy. Over time, the theory predicted a sustained convergence between the two economies should be realized, and the income gap subsequently narrowed. That, however, did not happen, and the economic gap that separates Israel and the occupied Palestinian territories (OPT) continued to grow steadily.¹ In 1968, for example, while GDP per capita in Israel (at $1,674) was 10 times higher than that of WBGS, the gap became wider in 2015, with Israeli per capita income (at $35,728) more than 12 times higher than the Palestinian one (at $2,866).² The absolute gap in GDP per capita between the two economies, however, is much more revealing. While the difference in GDP per capita between Israel and the WBGS was only $1,500 in 1968, the absolute difference jumped to close to $33,000 in 2015. Put differently, while GDP per capita in WBGS increased by only $2,700 over the entire five-decade period, Israel’s GDP per capita increased by more than $34,000 over the same period.

That outcome, however, given the overall context within which this relation was conducted, was inevitable. More specifically, and unlike economic relations between most countries, the Israeli-Palestinian relation is an atypical one; sui generis in its nature, its context and the multitude of complex factors that shape it. This is so because over the entire five-decade period, 1967-2017, as will be discussed in some detail in this work, this relationship has been conducted in the context of Israel’s colonizing military occupation; distorted by myriad constraints and restrictions imposed by the stronger party on the weaker party of the relationship; and disrupted by frequent episodes of violence and armed confrontation.

As a result, whether economic ties between the two sides were in the form of imposed integration (1967-1993), the product of lopsided negotiated arrangements (the Economic Protocol of 1994), or shaped by Israeli unilateral policies (from 2002 onward), the outcome has invariably been the same: This relationship, despite its immense potential under different political circumstances, has grossly failed to develop and mature in a way that could have permitted the Palestinian side to benefit from its close interaction with the stronger Israeli economy; gradually but steadily, bridge the income and development gap between the two sides; and, in so doing, build an economic foundation for peace. How and why this happened, and what lessons can be learned, are explained in the rest of this article.

II. The Grim Palestinian Economic Record

To assess the extent to which Israeli-Palestinian economic relations over the period 1967-2017 have positively contributed to the development prospects of the Palestinian economy and to enhancing the chances of peace, one need only look at the available data. And the record on both economic and political fronts is very grim and leaves much to be desired.

On the economic side, there is a strong case to be made that the Palestinian economy in 2017 is in much weaker shape (in terms of its capacity to generate high and sustained internal growth rates) than would have otherwise been the case had it not been subjected to a protracted colonizing military occupation. The United Nations Conference on Trade and Development (UNCTAD), for instance, had estimated that, without the occupation, the Palestinian economy could have doubled its current GDP, with unemployment and poverty levels significantly reduced, and its large trade and budget deficits receded.³ Worse still, the Palestinian Authority (PA), 23 years after its establishment, is chronically dependent for its fiscal survival on Israel’s goodwill to transfer clearance revenues without interruption,⁴ and on the continued generosity of the international community to finance its recurrent budget deficit to prevent fiscal collapse.

Furthermore, WBGS, whose future as a small economy crucially hinges on expanding its manufactured and agricultural output and on its active engagement in regional and international trade, is in 2017 substantially de-industrialized, with more economic activities conducted outside the formal sector, and increasingly restructured inward in the non-tradable and service sectors. The degree of de-industrialization, informalization and internalization of economic activities in the OPT is serious enough to lead the World Bank in 2006 to conclude that “the WBG[S]’s capacity to generate fast economic growth has been eroded, even if the [Israeli] closure regime becomes less oppressive.”⁵ This conclusion, given the continued pervasive and pernicious nature of the Israeli restrictions on the Palestinian economy, remains valid today.

Such a depressing picture can also be seen in the grim socioeconomic data of WBGS. And here the evidence of the destructive impact of the five decades of colonizing military occupation on WBGS, and the failure of the Israeli-Palestinian economic relations to benefit the Palestinian side, is overwhelming. Fifty years on, the available statistics show that a quarter of the OPT workforce is unemployed, with a similar percentage of the population languishing in poverty.⁶ Furthermore, a third of the WBGS population is food insecure;⁷ and over half is in need of some form of humanitarian assistance.⁸ More shockingly, approximately half of the OPT population suffers from more than one micronutrient deficiency.⁹ For all these five socioeconomic indicators, it should be noted, the figures for the Gaza Strip are, alarmingly, much higher — more than double — than those of the West Bank.

That is the picture on the economic front. On the political side, the record is equally bleak. A quick look at the past 30 years (from the outbreak of the first Palestinian intifada in late 1987 until today) shows that the entire period had been marred with heightened political instability and worsening security conditions, with the prospects of achieving lasting peace settlement growing dimmer and more elusive over time.

III. Explaining Failure: It’s the Context, Stupid!

That this was the outcome after five decades of Israel-Palestinian economic relations, however, need not be surprising and should not be difficult to explain. Six major underlying factors have contributed to this dismal, but largely inevitable, record; all of which are quite unique to the Israeli- Palestinian context. Taken together, the six factors listed below represent the principal reasons behind the failure of the Israeli-Palestinian economic relations to benefit the Palestinian economy or to enhance the chances of peace.

These factors, it should be strongly emphasized, are not a mere background noise or a distracting sideshow. Rather, they are the main event. Their detrimental impact is the chief reason behind the continued erosion of the Palestinian economy’s productive capacity, and their cumulative adverse weight is the main obstacle that stands in the way of fruitful economic relations between Israel and WBGS. This heavily distorted politicalterritorial- security setting, as will be explained below, has far-reaching implications which will be discussed in the final section.

First, throughout the 50-year period, economic relations between Israel and OPT have been conducted in the context of a colonizing military occupation in which Israel always assumes the upper hand in dictating the nature and terms of the relations. This was obvious during the imposed integration period (1967-1993), in how the Paris Protocol (PP) was negotiated and implemented, and in the policy of unilateral separation from the Palestinians in the post-2000 period (namely, the building of the West Bank separation barrier/wall and the Gaza disengagement plan). In other words, Israeli-Palestinian economic relations over the entire five-decade period were characterized by an absence of a level playing field, with Palestinian interests, as a result, were constantly compromised in favor of the Israeli ones. As long as this extremely adverse setting (further detailed below) remains unchanged, there is no reason to believe that the picture will be significantly different, whether under a revamped/improved PP or under any alternative trade and economic arrangement between Israel and OPT.

Second, throughout the entire 1967-2014 period, economic relations between the two parties were conducted in an environment of considerable Israeli-imposed constraints on the Palestinian economy with the nature, scope, and intensity of these constraints mutating over time. Regulatory impediments that hobbled businesses in the OPT during the 1967-1993 period, for example, were replaced after 1994 with a largely unfavorable territorial setting that was further complicated by the imposition of a very restrictive web of physical and administrative security measures designed to control Palestinian movement of people and trade with limits on the latter becoming more stringent, entrenched, and institutionalized after the year 2000. These severe restrictions on movement have pinched the supply capacity of the OPT economy, increased transportation time and costs and rendered Palestinian exports less competitive. The outcome was a growing OPT trade deficit with Israel that went from $1.5 billion in 1999 to $3.2 billion in 2014.¹⁰ As a result, more Palestinian financial resources were diverted to finance a rising import bill at the expense of financing domestic investment that is needed for a self-sustaining economy.

Third, over the entire 1967-2017 period, Palestinians’ ability to access and utilize their land, water and other critical natural resources import raw materials and machinery and freely reach regional and international markets were severely limited. This lack of sovereign control over resources and borders was a direct outcome of the colonizing nature of the Israeli military occupation and the constraints imposed on Palestinian economic activities. The restrictive post-Oslo political and security setting did little to change this picture, which was further complicated by the unabated construction and expansion of Jewish settlements; the construction of the separation barrier/ wall and the lack of economic access to the resource-rich Area C (which amounts to 60% of the land of the West Bank), including the Jordan Valley and northern Dead Sea. Israeli-Palestinian economic relations can hardly contribute to the development of WBGS or enhance the chances of peace when the economic space of the OPT is continuously shrinking, its natural resource base is steadily corroding, and its economic growth prospects are stunted and persistently frustrated.

Fourth, Palestinian economic interests were also compromised by the terms of the Paris Protocol (PP) that has governed economic ties with Israel since 1994.11 On many grounds, the terms of the PP have been very damaging to the Palestinian side. For instance, the PP has preserved the pre-Oslo customs union trade regime and thus continued to obligate the Palestinian economy to operate under the high Israeli cost structure, despite the huge income and development differences that existed between the two economies — a major disadvantage on its own right for the Palestinian economy. Furthermore, in the four areas that represented the core of the PP — trade, fiscal, monetary, and labor — there were serious shortcomings which resulted in substantial revenue losses for the Palestinian side. Worse still, on several occasions, Israel suspended the monthly transfers of clearance revenues (the PA’s largest source of income, which was estimated at over $2 billion in 2016, amounting to over two-thirds of the PA’s total revenues, and covering about 40% of its recurrent expenditures) and used the transfer of tax money as a tool to politically pressure the PA, thus violating its commitment of regular revenue transfer under the terms of the PP.

Fifth, the Palestinian economic policy space was also limited, if not totally absent. Both before and after Oslo, the Palestinian side lacked a whole host of policy tools crucial for short-term stabilization and long-term economic growth. The lack of policy instruments (fiscal, monetary, exchange rate, trade, etc…) was total during the forced integration period of 1967- 1993, and the PP of 1994 had virtually cemented this problem. With no policy tools present, the OPT economy during the post-Oslo era was made vulnerable; Palestinian policy-makers’ ability to adjust to frequent fiscal shocks was extremely limited; and their capacity to successfully implement economic recovery plans, let alone construct long-term growth strategies, was highly constrained. Worse still, and as an economy operating under colonizing occupation, Palestinian policy-makers even lack the freedom to act independently or undertake decisions, however minor, without the prior approval of the Israeli overbearing military authority,12 which has the overriding power to control or veto all major economic decisions in the OPT.13

Sixth, since the outbreak of the first intifada in December 1987, Israeli- Palestinian economic and trade relations were conducted in an environment dominated by continued conflict conditions, heightened political instability, and, at times, renewed armed confrontation and violence. This largely counterproductive setting had introduced elements of uncertainty and unpredictability to economic ties between the two sides caused frequent disruption to, and variation in, their conduct and — in the context of a high level of dependency on Israel for trade, wage employment and the transfer of clearance revenues — proved to be very costly for the Palestinian side. As one study put it, “a relationship between two neighboring economies, in which measures taken by one can cause the other to lose the income of one third of its labor force, and interrupt 70 per cent of its imports and 90 per cent of its exports, is simply untenable.”¹⁴

VII. Implications and Concluding Thoughts

The implications of the preceding discussion for the future prospects of economic relations between Israel and the Palestinian side should be clear by now. To a great extent, it is the context within which such relations are conducted that matters most, not the nature or the terms of their arrangement. In this respect, unilateral Israeli separation from the Palestinians, without any substantial change in the underlying adverse political and security setting, i.e., the context, will do little to benefit the Palestinian side (postdisengagement Gaza is a stark example of such failed policy). Conversely, continued economic relations under unchanged conflict conditions will not help the Palestinians either (as shown by the experience since 1967, but more so after 1994). In both cases, the Palestinian economy will continue to wither, the only difference being in the speed, size and scope of future deterioration.

For the Palestinian side to be able to strengthen its economic base and to have a real chance at achieving high and sustained economic growth in the future, four necessary preconditions have to be met: 1) control over natural resources; 2) control over national borders: i.e., land, airspace, and territorial waters; 3) a functional territorial link between Gaza Strip and the West Bank; and 4) control over the conduct of national economic policymaking. These four broadly-stated prerequisites, by their very nature, necessitate a political settlement that leads to an end to the Israeli military occupation of WBGS, and the creation of a territorially contiguous and economically viable Palestinian state. Absent that, no future economic arrangement with Israel will be of any significant or sustained benefit to the Palestinians. The half-century-long record of the pre- and post-Oslo years should provide us with enough evidence to make such an argument.

Another clear implication that emerges from the discussion in this article has to do with the nature of the challenges facing future Israeli- Palestinian economic relations. These challenges are not, and have never been, technical in nature; i.e., to search for an optimal trade regime that outperforms all other alternatives. Rather, the true challenge facing future economic relations between the two sides is to secure a propitious political and territorial setting within which differences among all possible trade arrangements will not be marginal in nature.

Given their geographic proximity, the small size of the territorial base of their two respective economies, the long-standing (albeit skewed) trade relations between the two sides, and the high degree of complementarities between their economic structures, a close economic relation between Israel and a sovereign future Palestine is all but inevitable.

Harnessing the potential of such relations, however, remains a tough challenge. Since 1967, and especially during the post-Oslo years, an ever increasing number of “facts on the ground” have inexorably been working against a negotiated political settlement, destroying its very basis, and persistently moving the conflict in a completely opposite direction. Whether they took the form of a protracted colonizing occupation, relentless disintegration of the Palestinian territorial space, or unilaterally attempting to mold the outcome of the final political settlement, these “facts on the ground” were in the past, and will continue to be in the future, a major impediment to the creation of a viable Palestinian state and, consequently, to a meaningful economic ties between Israel and Palestine. This extremely damaging context has already produced two intifadas and a failed peace process, fractured the Palestinian economic landscape, and increasingly made the realization of a viable political settlement based on two-state solution a physically unattainable goal.

Given the enormous gains that could be derived from politically unimpaired Israeli-Palestinian economic relations, and the substantial positive impact these relations could have on the prospects of peace and OPT development, the challenge is to provide the necessary favorable setting to make such future cooperation possible.¹⁵ Conversely, continued impediments to what would be under normal, conflict-free conditions a mutually advantageous engagement will only work to widen the existing economic and development gaps between the two sides, further increase income disparities among the two neighboring economies, and by so doing, prolong the present conflict for years to come.