The overall identity of the Palestinian economic system was defined years before the establishment of the Palestinian Authority (PA). Both the Palestinian National Charter and the Declaration of Independence stipulate that the future Palestinian state would adhere to a market economy system predicated on the free movement of goods, capital and labor, where prices are determined by supply and demand in a competitive environment, governed by all-binding legal and judicial frameworks.
Adherence to a market economy is one of the principal underpinnings of a democratic society in an age of globalization, as no country can hide for long behind the wall of protectionism. For Palestine, the option of a free economy finds further validation when one takes into account that it is among the least endowed countries in natural resources, and has a very small domestic market. Therefore, it is impossible to contemplate a closed economy based on self-sufficiency, unless one is ready to accept very low living standards and high unemployment. In addition, adherence to a market economy should be perceived as a basic requisite for encouraging the flow of foreign investment from the Palestinian diaspora, as well as from other Arab, Muslim and international sources.

The Palestinian Economic System after the Establishment of the PA

The discourse of the Palestinian economic system following the establishment of the Palestinian Authority in 1994 reveals mixed results. After 28 years of occupation and six years of intifada, the PA has succeeded in implementing a unique level of democratic practices, such as conducting free legislative and presidential elections, allowing freedom of opinion and political pluralism - all of which are alien to most other Arab countries. The PA also took a positive stance on the establishment of civil society organizations, which indeed played a prominent role in Palestine's social and economic life.
In spite of these achievements, however, the PA's record in managing the Palestinian economy has been marred by many mistakes and deficiencies which precipitated a negative investment climate. It is of course true that the sharp economic decline affecting the Palestinian territories is attributed primarily to the punitive measures and restrictions, imposed by the occupation authorities in their declared war against the Palestinian resistance. It would be too simplistic, however, to assume that this has been the sole cause for the economic predicament of Palestine. The following "mistakes" have certainly also left deep wounds in the Palestinian economy:

1) The process of PA institution-building caused the most serious damage to the Palestinian economy and social structure in general. This has been a multifaceted problem whose most important aspects include:
* Proliferation of governmental and semi-governmental institutions. This was coupled with a large degree of overlapping in powers and functions, which led to duplication, rivalries and even inconsistencies in work mechanisms. Bureaucracy in governmental institutions has in fact become a major impediment to the promotion of work efficiency in the country's economic institutions.
* An accompanying sharp increase in the number of public sector employees - from 25,000 in 1994 to over 160,000 at present. This, too, is a two-fold problem: a) The wage bill has become a heavy burden for the PA, accounting for 70% of the general budget; and 2) unprofessional standards are used for staff appointments, especially in leading positions.

2) The PA showed an intractable tendency towards direct intervention in commercial activities, especially those of a public utility nature. Some senior officials began establishing contacts with international companies even before they relocated to the Palestinian territories. A case in point was the contract with the Israeli fuel company Dor, which was concluded without an open tender.

3) Shortly after relocating to Palestine, the PA resorted to giving monopoly "concessions" to certain governmental organizations - e.g., the Palestinian Petroleum Commission, and cement importation and distribution. In addition, the PA sought partial or full partnership in firms operating in various sectors, some of which were accorded important privileges without much competition. The PA leadership has also turned a blind eye to the long standing murky interconnections between the security apparatuses and certain financial institutions.

4) The PA gave concession rights to certain private companies, e.g., the Palestinian Telecommunications Company - which constitutes a serious breach of the PA's adherence to a free market economy.

5) In addition, the Palestinian economy and the investment climate suffered gravely due to serious deficiencies in the regulatory and legal frameworks, which were promulgated by the PA since its inception in 1994.

Distortions in Economic Policies

It should be noted that failures in the institutional framework and in economic policies have had their own deep-rooted dynamics. Since the first days after relocating to Palestine, the PA officials were faced with those problems which are typically experienced by national liberation movements when transitioning from armed resistance to building a civil-society state. The first problem is the absorption of the leaders and field operatives, especially since the majority does not have the required academic qualifications or professional experience for civilian jobs. A second problem is the imperative to secure self-financing to minimize as much as possible the nascent authority's reliance on external sources of funding. This is especially important in view of the fact that the PA has certain financial obligations which most donor countries and organizations refuse to assume.
Such abuses, however, have paved the way for major plunders, and they have precipitated a psychologically depressed atmosphere, and generated exaggerated rumors about corruption, which all have led to a significant deterioration in the investment climate, and nearly a total halt in foreign investments. All of this has also triggered a flight of capital from Palestine to other countries, either directly or through transfer of deposits in banks from branches in Palestine to external destinations. Also of note are the negative repercussions of the current regulatory framework on work efficiency in private sector enterprises, and on the cost of services they receive from government institutions, such as company registration procedures, health certificates and external trade permits.

Reform Efforts in Economic Policies

Breaches and abuses like those mentioned earlier have elicited strong reactions from the private sector and civil society organizations in Palestine. They have also generated much criticism on the side of donors and international institutions, which began to exert increasing pressure on the PA since the 1990s, especially with respect to the monopolies and direct intervention in trade transactions. But in spite of the repeated promises, no concrete steps were taken until 2000, when the PA was compelled to reshuffle the cabinet, the most notable change being the appointment of Salam Fayyad as finance minister.
Fayyad succeeded in implementing a number of reforms which for years had been high on the list of Palestinian priorities, such as the following:
* The imposition of stringent control on government spending according to the budget law;
* The consolidation of revenues in a single account under the control of the Ministry of Finance;
* Curtailing indiscriminate appointments; and
* The imposition of total transparency on trade activities owned directly or indirectly by the government.

Notwithstanding the importance of all such measures, it is clear that the Palestinian leadership did not show a comprehensive and thorough commitment to a genuine reform process. This is tangibly evidenced by the continuation of financial and administrative abuses throughout the past five years, in spite of the continued talk about reform.

The Position of the Palestinian Legislative Council

Members of the Palestinian Legislative Council (PLC) are well aware of irregularities in the PA institutions, especially those with strong ties to economic and financial matters. The overwhelming majority of members, including those affiliated with Fateh and Hamas, feel bitter because of slow improvement in the performance of most government institutions. Yet they have done nothing real except scoring points in workshops and in front of the media. The current PLC, elected in January 2006, has clearly fallen victim to the bitter struggle between Fateh and Hamas, which has led to a complete paralysis, especially in relation to the reforms file.
Nonetheless, it is the previous PLC which witnessed the majority of corruption cases in the PA institutions, and practically did nothing to stop it. Yet the former PLC members continue to reap hefty financial benefits which constitute a burden on the PA's meager resources. More fittingly, they should be held legally and historically accountable on gross oversight failures.

The Performance of the Judiciary System

The cornerstone of an attractive investment climate is establishing an independent and efficient judiciary which is capable of enforcing compliance with its rulings on all parties, including the higher echelons of the political leadership and the security apparatuses. This has always posed a big problem in Palestine; hence it is no surprise to see widespread reluctance on the part of foreign and even local investors. This was in fact one main reason why the majority of banks operating in Palestine, especially those of foreign origin, tightened their credit policies.
Of the several factors leading to the judiciary's poor performance in settling trade disputes and current paralysis, the most important is the lack of genuine backing from the political leadership. The leadership has been unable to free itself from recourse to political and factional allegiances and interests when looking into trade disputes and problems, instead of abiding by the law and court rulings. The performance of the judicial system should be perceived as the litmus test for the seriousness of the reform policies adopted by the current government. There is no doubt that the prime minister and his cabinet are well aware of the importance of this issue, and that they are committed in principle to taking the necessary corrective measures to restore the respect of the judiciary. It would be naïve, however, to expect this to be a sufficient prerequisite to overcome the deeply ingrained factional mentality, which the Palestinian leadership has pursued for more than a decade.

Non-Governmental Organizations

Several non-governmental organizations (NGOs) have played an important role in providing valuable services, not only in the political, social, health care and human rights areas but also in the governance domain. These NGOs have also been instrumental in pressuring the PA on several vital issues pertaining to governance, democracy and civil society in general.
Nonetheless, NGOs themselves have also suffered important setbacks in past years, as most of them suffer from the very same ailments prevalent in the political and public sectors, which diminishes their efficiency and results in the squandering of available financial resources. There are also clear signs that most NGOs do not observe democratic values, e.g., holding timely and real elections. This is why most of them have not seen a change in leadership for many years. Most of them tend also to have an inflated number of employees, which has entailed significant distortions on their programs and fundraising practices.

International Donor Organizations

Donor countries and certain specialized international organizations, such as the World Bank and the International Monetary Fund (IMF), have played a major role in supporting the Palestinian people since the beginning of the peace process, most importantly in providing vital health, social and educational services. The significant level of financial aid pumped into the Palestinian economic infrastructure has helped, directly or indirectly, to promote growth, or at least to avert a sharp regression in living standards.
Undoubtedly, donors and international organizations have also played a key role in prodding the PA on the reform prerogatives. Many expatriate and local experts, however, complain that many donors have also suffered from deficiencies in their own governance structures, especially in the following areas:
* The level of coordination among the donors remains low, despite the formation of several coordination mechanisms. This is exemplified most strikingly in the duplication of activities pertaining to issues of democracy, women and human rights, which have become a steady denominator in projects supported by donor countries.
* The levels of transparency and accountability in the management of aid by certain countries and funding organizations leave much to be desired. This was one important reason why public institutions and NGOs have not taken reform recipes presented by those organizations as seriously as they should.

The Banking System

The performance of the banking system is one of the key determinants of development in Palestine. Despite considerable expansion in the banking sector, both in the number of branches and size of deposits, the level of banking services remains well below optimal, as exemplified by the following features:
* The quality of services is not satisfactory, especially with regard to the slowness of loan operations, and the complications related to required collaterals.
* The cost structure of banking services is much higher than that in international financial markets.
* The volume of credit provided by banks is small compared with actual needs, and in view of available liquid assets. The ratio of loans to the volume of deposits is very low, rarely exceeding 35% .

It is understandable that weaknesses in the judicial system constitute an important cause of the modest performance of the banks operating in the Palestinian territories. Yet the main factor behind the emasculated performance of the banking system is the absence of a truly competitive environment. This, in turn, is precipitated by the monopolistic leverage associated with the large size of certain banks, which are in effect capable of setting price rates in the domestic market.

Higher Education

The human factor plays a central role in economic development in light of the accelerated technological evolution, which lies at the core of competitiveness. During the past three decades, great strides have been made in the number of higher learning institutions and in their absorption capacity, as well as in the number of specializations and graduates flooding the job market. But despite these achievements, it is clearly noted that the quality of education offered in local universities suffers from profound weaknesses, which is largely due to the dramatic increase in the number of students. Inevitably, this has reflected negatively on the capacity of Palestinian graduates, undermining the demand for them in local and external labor markets.
It should be further noted that the Palestinian education sector consumes an enormous amount of investments, which begs the question: How cost-effective is the system? Most likely the answer is not encouraging. Consequently, reform in the higher education system has also become one of the urgent priorities.

Deformations in Economic Relations with Israel

Although politicians and the media have tended to focus attention on the political and security aspects of Palestinian-Israeli relations, one should note that economic relations between the two sides have evolved considerably during the past four decades. Obviously, these relations have entailed important economic and social repercussions on both sides, but clearly more so on the Palestinians.
Notwithstanding the great importance of those relations, however, there have been basic deficiencies in the way they were managed by the relevant Palestinian institutions. Among the most important areas of mismanagement are the following:

1) Trade Relations

Trade in commodities has evolved very rapidly during the occupation period, whereby Israel became the primary trade partner for the occupied territories. Israel was the chief source of goods imported into the territories (about 90%), and the main market for Palestinian exports (about 75%). Following the Paris Economic Protocol, important amendments were introduced on the conditions of trade, mainly by opening the way for Palestinian enterprises to establish direct relations with other countries. Not surprisingly, Palestinian imports from Israel fell to 65-70%, and Israel's share of Palestinian exports rose to over 90%.
It is of course understandable that the Palestinians should do all they can to identify new markets for their products, in order to reduce dependence on Israel. What is strange, though, is to witness the very low level of interest on the Palestinian side in correcting and improving trade relations with Israel. This undoubtedly is a major cause for the continued hardships that the Palestinian firms face in their trade with or via Israel.

2) Labor Relations
The flow of workers from the Palestinian territories into the Israeli labor market was one of the major transformations in Palestinian society since the beginning of the Israeli occupation in 1967. Their number rose rapidly so that it exceeded 150,000 workers by the end of the 1990s, and their earnings contributed approximately 30% of the Palestinian gross national product (GNP).
The entry of workers into Israel was almost completely halted following the outbreak of the second intifada, once again for alleged security reasons. This was the principal and direct cause for widespread poverty among wide segments of the society, whose main source of income depended largely on remittances from Israel.
The political and economic changes during the past two years have allowed an increasing number of workers to return to the Israeli labor market. The Israeli economic recovery is likely to allow the absorption of more Palestinian workers. But again, one major impediment is the confused and shy attitude of the Palestinian partner in dealing with this issue.

3) Joint Projects
In contrast to relations in the areas of trade and labor flows, very little progress has been made with regard to capital-sharing joint ventures with Israeli enterprises. Obviously, such forms of cooperation are still on the list of taboos on the side of the Palestinian business community, seemingly for complex political and psychological reasons.
The PA's position on joint ventures, however, has been much less reserved, as the PA itself has concluded a number of joint projects with Israel, as in the case of the border industrial zones. As expected, this has caused great confusion, both at the public level and within the private sector institutions.
The issue of joint Palestinian-Israeli ventures entails political and economic implications of the utmost importance for Palestinian society, especially in the eventuality of achieving tangible progress in the peace process. It is important, therefore, that the Palestinian leadership crystallizes a unified and rational position on this issue, which is to bind all Palestinian stakeholders. This is one more important reform priority in Palestine.
To conclude, one should note that there have been limited and isolated successes in the reform efforts in the Palestinian territories, yet the commitment for this process remains weak at the top political echelons. This means that the Palestinian leadership should assume a much more determined stand on this process, and should take serious steps to implement relevant measures and policies. The success of this endeavor requires exerting more proactive efforts on the side of all stakeholders, including donors and international organizations. <