A year ago, many observers predicted that the Palestinian economy
was on the brink of collapse but, despite the battering it has
taken, the economy still functions, mainly as a result of donor
funding of the PA. (In 2001, donor disbursements doubled from
pre-Intifada levels to US$929 million, and in 2002 rose again to
US$1 billion.) Over 120,000 people still receive a regular monthly
salary and provide essential services to the population. The PA
employs a third of those people still working, and pays half of all
wages earned in the West Bank and Gaza. This in turn supports the
other two-thirds who are still employed.
Another factor contributing to the economic survival is Palestinian
society's resilience. Despite the violence, economic hardship and
daily frustrations of living under curfew and closure, lending and
sharing are widespread. Even with a dependency ratio of over 18 in
Gaza and a dearth of formal safety nets, outright destitution is
limited - those who have income generally share it with those who
do not. The West Bank and Gaza have absorbed levels of unemployment
that would have destroyed the social fabric in many other
societies.
The rate of economic decline is slowing, but the combination of
political insecurity and closure continues to choke the economy and
makes recovery more difficult. Industrial and human capital
continue to erode, impairing longer-term competitive prospects.
Total investment has contracted from about US$1.5 billion in 1999
to US$140 million in 2002. Declining health and educational
standards are eroding the skills base of Palestinian youth.
Impacting on Ordinary Palestinians
Many families have been without an income for an extended period,
and despite various employment-generation efforts of the PA, donors
and NGOs, are now dependent on food aid for survival. The World
Bank estimated that 21 percent of the Palestinian population was
living under the US$2-a-day poverty line on the eve of the
Intifada. That figure had increased to about 60 percent, or just
less than two million people, by December 2002. In Gaza, more than
75 percent of the population now lives below the poverty line. The
poor are also getting poorer. Average daily consumption has fallen
to the equivalent of US$1.32 per day, from US$1.47 in 1998. This
situation is exacerbated by the high rate of Palestinian population
growth (4.35 percent per annum).
Challenges for the Palestinian Authority
Even if donor disbursements doubled to US$2 billion in 2003, by
2004 the poverty rate would still be around 54 percent. An agreed
framework for political progress is indispensable for the
resumption of economic and social development in both Israel and
the Palestinian territories. The main service providers - the
Ministries of Health and Education, and the municipalities - have
maintained a basic network of public services despite curfews,
closures, periodic violence and severe fiscal compression. But the
PA has not managed to communicate to the public how it is coping
with the crisis, and its efforts are being undervalued. The PA
needs to develop a National Emergency Plan to energize a collective
social effort to cope with continuing crisis.
A key difference from a year ago is the PA's adoption of a serious
program of reform to weed out corruption and build a modern,
meritocratic civil service. Considerable progress has been made,
particularly in the management of the PA's finances, and much has
been done to repair the credibility of the PA in the eyes of the
international community. Having acknowledged the need to combat
corruption, the PA must deliver a successful reform program or lose
its legitimacy.
Challenges for Donors
Under the Bank's base case economic projection for 2003, donors
should aim to disburse at least US$1.1 billion, (slightly more than
in 2002). The bulk of these funds is needed for PA budget support
(US$574 million) and for other emergency and humanitarian programs
(US$375 million). An early estimate suggests that firm commitments
amount so far to some US$700 million, with a total of US$1.5
billion in commitments expected. This level of commitments should
make a US$1.1 billion disbursement target feasible.
Most critical of all is adequate support for the PA budget. The
2003 target is ambitious - US$450 million was disbursed as budget
support in 2002, and there are signs of donor fatigue. While budget
support is politically controversial and traditionally unpopular
(it is seen as a diversion of funds from growth-oriented
investment), it remains the most essential contribution that donors
can make to sustaining the economy and the structures needed to
build a Palestinian state. Donors should not abandon medium-term
development programs, and should continue to do what they can to
help create the institutions and infrastructure of a future state.
Indications of intent for 2003 show that donors wish to commit at
least US$335 million in medium-term assistance. If these plans can
be realized, they will arrest a worrying decline in donor
developmental expenditure.
Challenges for Israel
The actions of the Israeli government are crucial to the success of
the Palestinian economy in 2003. As long as Palestinian internal
economic space remains as fragmented as it is today, and as long as
the economy remains subject to extreme unpredictability and
elevated transaction costs, domestic economic activity will suffer
and Palestinian welfare will continue to decay.
The Israeli government's recent decision to resume the transfer of
the PA's monthly clearance revenues is an important initiative. If
these flows are re-established on a regular basis, they will play a
vital part in stabilizing the Palestinian economy. If the Israeli
government also repays the stock of withheld arrears, this will
permit the PA to clear its debts to the domestic private sector.
This cash injection will exert a far greater effect on the failing
Palestinian private sector than any other measure.
Donors need the Israeli government to do more to facilitate the
work of humanitarian agencies, be they donor, UN or NGO. They have
also asked the Israeli government to permit freedom of movement for
Palestinian officials critical to the implementation of the
Palestinian reform program, consistent with Israel's own call for
the reform of the PA. In addition, it is important that the Israeli
government facilitate meetings of the Palestinian Legislative
Council to enable the passage of critical reform legislation and to
enable an oversight of the reform process.
Looking Ahead
Short-term recovery depends on lifting the closures, but this will
not suffice to put the Palestinian economy on a sustainable growth
path. Long-term growth potential for the Palestinian economy has
been stunted by pressure on domestic Palestinian wages created by
salaries paid to Palestinian workers in Israel. Domestic wage
increases have exceeded any underlying growth in productivity, and
have undermined Palestinians' ability to export
competitively-priced goods to the rest of the world. The World Bank
recommends a proactive policy of export development in which a less
discriminatory trade regime is adopted, which would result in
higher incomes by 2010, rather than a return to previous levels of
employment in Israel.
Between 1968 and 2000, Palestinians in the West Bank and Gaza
exported labor rather than goods. In June 2000, three months before
the current Intifada began, 21 percent of all employed Palestinians
worked in Israel, mainly in low-skilled construction and
agricultural jobs. Net incomes from abroad provided more than 22
percent of Palestinian GDP, making it one of the most
remittance-dependent economies in the world. The Intifada has
demonstrated the vulnerability of this strategy.
Gains from trade would take time to materialize, and restoring
access to the Israeli labor market would certainly be a quicker way
to boost incomes for a large number of ordinary Palestinians - but
a return to pre-September 2000 employment levels for Palestinians
in Israel seems unlikely. It would risk perpetuating a high level
of Palestinian economic dependence on Israel, and hinder the
emergence of a more diversified development strategy. Such a policy
shift will require the active cooperation of Israel to succeed, and
is thus part and parcel of a political rapprochement.