Political Breakthrough and Peace Dividends: A Complex Reality
Many are surprised that, over the last few years, there has been so little change in the Palestinian gross national product (GNP).
Palestinian GNP per capita since 1994:

1994 - 0%
1995 - 12%
1996 - 7%
1997 - 3%
1998 - 3%

When Israel and the PLO signed the Oslo Accords, the Paris Accords and the Cairo agreement, some skepticism about the future problems was to be expected. The political response was to "sell" the agreements to the public through the optimistic forecast that peace will produce "peace dividends." Shimon Peres talked about a "new Middle East." Teams of economists produced glossy plans. On paper it looked great.

Promise and Fulfilment

So why did it not work to the extent that was promised? Most critics point at Israel as the party responsible for the poor economic performance. UN reports are even more specific. They blame the closures, since 1994, for inflicting severe economic pain on Palestine. During 1996 there were 92 days of closed borders - more than one-third of all working days. In 1997, there were 63 such days and in 1998 only 5 days. That amounts to about 160 days in three years - a heavy burden to an economy which derives a third of its GDP from labor employed in Israel. The Israeli economy succeeded in avoiding the pains of closure by importing workers from faraway countries. It will not be long before the slogan "Israel is to blame" will change to "Israel is to pay."
This scenario of the past may be comforting for some. It might make for successful politics. However, it will contribute very little to understanding the complex realities and, especially, to changing them. Israel has done much to ruin the economy of Palestine, particularly during the period of 1967-1991. Throughout this period, and focusing solely on economics, one can trace two policies, which caused long-term damage: fiscal drain and infrastructure misdevelopment.
The Israeli occupation force carried out a policy of preventing competition between Palestine and Israel. That is, Israeli products could compete in Palestine, but not the other way round. Agricultural produce by Palestinians could not cross the Green Line (though the same products by Israeli settlers had free access). Other products could officially compete. But Palestinians could not, de facto, produce and compete with Israeli products. At one point, a Palestinian could not sell in Israel pasta produced in Beit Sahur because the wrapping was in the forbidden colors of red-black-green.
On the fiscal side, what Israel did was to create fiscal surpluses. It collected from Palestine more taxes than it spent. Palestine thus subsidized Israel. The magnitude of this could easily be seen as of 1995 when Israel started paying Palestine its share - about $500 million - of indirect taxation on imports and fuel.
This policy went hand in hand with an expenditure policy of not investing in infrastructure and basic social needs in Palestine. The combination of biased trade disinvesting and tax robbing created, within 20 years, an economic area that was totally dependent on Israel. With a declining economic base of such magnitude there was no way the changes of 1994 and after could bear fruit in the short term. Peace benefits could not be reaped before occupation was over. The Oslo Accords did little to change the basic traits of the political economy of the two entities.

Israeli Restrictions

For the first time since 1967, some would say for the first time ever, a government was established in Palestine. True, this government had to operate under unusual circumstances. But a government it is. The government of Palestine has two major sources of revenue: It collects taxes and receives financial aid from donor countries. It spends about $900 million annually, far more than the Israeli occupier did between 1967-1993. This is a major change. However, the changes in fiscal and trade regimes have a much smaller impact than many envisaged when the accords were signed.
Why is this so? The Israeli side has not kept its obligations in the accord. As the UN and the World Bank have stated, Israel imposes limitations on the free movement of labor. The two organizations focus on closures. But the problem is much deeper. Movement of labor ought to be free of all restrictions. One can tell restrictions are in place not only by the licensing regime, but also via the total figures. Before the spate of suicide bombs against Israel, figures for Palestinian laborers in Israel were somewhere around 130,000. They are about half of that now. Assuming Israel has some 200,000 other non-Israeli (foreign) workers, one can estimate the potential employment of Palestinians in Israel at 250,000-300,000. Such employment could double the national income of Palestine.
Israel has also restricted development in the trade regime, by impeding movement of products between Palestine and Israel and between the various areas under Palestinian control. All this is done under the banner of security. Products imported to Israel via its own ports succeeded in moving swiftly. An ordinary person can grasp the difficulties Israel is imposing just by comparing the Bethlehem border station to those of, say, the Jordan River and Ben-Gurion Airport.
Then there is the fact that, even after almost six years, Israel still holds on to some Palestinian taxes, most notably some purchase taxes. With relative high rates of inflation, the "currency tax" should not be neglected. After forcing Palestine to use the shekel as its currency, clearly Palestine deserves a share in the seigniorage evolving from money printing. Being the richer partner to the accords, Israel is mishandling its responsibilities.

What Governments Are Supposed to Do

However, the regime of Yasser Arafat is also quite helpful in reducing the living standards of the Palestinian population. Israel, under the government of Binyamin Netanyahu, argued that the Palestinian National Authority (PNA) had exceeded the number of policemen agreed upon. The PNA did not challenge these accusations. The focus of this point has always been on the "security" and "legal" aspects of the violation. The economic aspects of this argument are far-reaching and more important. An analysis of the PNA budget has found that some 90 percent of expenditures goes to wages. The magnitude of this figure is such that one can easily reach the conclusion that the difference between pre- and post-Oslo is the enlargement of Palestine's bureaucracy by importing it from Tunis, and funding this enlargement by transfers (i.e., taxes collected by Israel and transferred to Palestine) and contributions from donors. This is not what governments are supposed to be doing.
The fiscal boost to Palestine has, by and large, been spent on "imported" workers. Some claim that this was essential. Without a large police force, one could not establish law and order. This article is not concerned with assessing such needs, or their real cost. In my view, this explains the main part of the slow development of the economy of Palestine, which was not previously understood.
The new fiscal regime has operated in the following manner: First, it increased consumption. Since the productive capacity of the economy could not grow instantly, this increase aided Israel, which supplies part of the demand for tradable goods. Part of this additional consumption spilled into the building sector, which had never before seen such a boom. Housing prices in Ramallah are now close to those of West Jerusalem.
Second, the increased consumption did not have a positive expected impact on the fiscal position of the government. Anyone visiting Palestine is impressed by the almost non-existent tax payments. The World Bank has warned the regime over the implications, especially in the long run, of such a policy. To little avail. The government of Palestine is behaving with an extreme short-term vision. It does not want to anger potential taxpayers; it does not really collect taxes. Almost exclusively the only taxes are those collected on imports. And the only reason the government of Palestine gets the money is because Israel collects it (for a fee).
Imports to Palestine since 1993 in $ U.S. million:
1993 - 1,333
1994 - 1,242
1995 - 1,908
1996 - 2,150
1997 - 2,132
1998 - 2,220

Thus, the third implication is the severe shortage of investments. Government spending is low because of the too-narrow fiscal base. The regime could have overcome part of this by borrowing. But no serious borrowing is going on because banks look at the regime and see very little to convince them that this state is here to stay, and will behave properly.

A Leap Forward

Palestine is not the only country in the world to have a problematic government. Why has the private sector not come to operate where the government is lacking? Clearly with non-existent taxes, the private sector has the necessary funds to invest. Here are the three main obstacles that have been in operation:
• Politics: There is a fundamental weakness to the peace process based on the structure of the Oslo Accords. The structure of the agreement is inductive. One step at a time. The process is on the way to an undefined future. This is exactly the structure that investors dislike. Since the future structure is unknown, the present is awash with rivals fighting for influence.
• Government complementary investment: The emphasis on consumption necessary to maintain the government of Palestine has prevented that government from adequate investment in the complementary infrastructure necessary for private investors. Such infrastructure includes water, sewage and electricity supply, roads and public transport and a strong and respected legal system. Property rights are far more important than economic incentives. If a lender cannot see a transparent bankruptcy law, even an adequate banking system will not suffice.
• Cream-skimming by state-induced monopolies: Many a small country faces a dilemma: let the private sector develop key areas, or use the state power to invest. Palestine, so it seems, has opted for the worst possible solution, i.e., creating private or semi-private monopolies. These are a combination of private and public funds under the control of private people usually associated with cronies of the ruling regime.
Where does this analysis lead? This year [1999], if the basics remain unchanged, will probably see a positive real GNP growth. This will be the outcome of very few days in which Israel was closed to Palestinian labor and produce. This will be a great change from the past and nothing should be done to minimize it. This, however, is far from the promises of the dreamers and the hopes of the population. Taking into account the politics of the region, Oslo was the only possible breakthrough. Maybe there was no other way. But it is high time to let the past rest in history books. A great leap forward is imperative. Like Oslo, the leap must necessarily be political.

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