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The Prospects for the Palestinian Economy

Source: Resolving the Palestinian Refugee Problem: What role for the International Community?

by Nigel Roberts

Much of the discourse on Palestinian refugees and displaced persons[2] has been conducted in the sphere of human and civil rights, and has dealt with the political and moral aspects of the 'right to return' and the 'right to compensation'. There is, of course, an economic dimension to the refugee question. Today I would like to explore with you what the Palestinian economy has to offer to refugees--both those who are within the present-day borders of the West Bank and Gaza Strip (WBGS), and those who might wish to return from the diaspora.

The Current Economic Situation
Right now, the Palestinian economy cannot sustain the livelihoods of those who currently live in WBGS; indeed, its capacity to do so has declined dramatically since the signing of the Declaration of Principles (DOP) in late 1993.

About 20% of the 2.7 million Palestinians in WBGS could be considered poor at the end of 1995 [3], with perhaps 30-35% of those in the camps within this category. By the end of 1997, I would estimate that these numbers had increased to about 30% and 40% respectively.

The context for this decline is one of economic frustration following the signing of the DOP. In this period per capita incomes have fallen by over 20%, while unemployment has risen from about 13% of those seeking work to about 30% today. Merchandise exports almost halved between 1992 and 1996, falling from 11% of GDP to a mere 6% [4]. Most worrying of all, in a structural sense, is the collapse in private investment, which fell from about 19% of GDP in 1993 to 10-11 % by 1997--and with 85% of this consisting of investment in residential housing, which can be seen as a form of savings, and less than 5% in equipment and machinery. Investment in WBGS appears to be driven by growth elsewhere--it consists essentially of remittances, and contributes little to future domestic growth.[5]

These are terrible economic indicators. This is certainly not where we all expected the Palestinian economy to be four-and-a-half years after Oslo, after donors have disbursed nearly $2 billion (or roughly $200 per person each year). How, you might ask, could this have happened, with so much at stake and with so much international goodwill towards the Palestinians?

There are many contributing factors, but overshadowing all of them are the permit and border closures instituted by the Government of Israel. Closure has reduced employment of Palestinians in Israel from a daily average of 116,000 persons per day in 1992 (over a third of the workforce) to 22,000 in 1996 and 35,000 in 1997. This loss of earnings has significantly depressed local consumption and demand. Closure has also required a diversion of about 25% of donor disbursements into emergency budget support and employment generation schemes--a consequent loss to the investment program. It has reduced Palestinian export competitiveness by raising transaction costs and introducing serious unpredictability. And, in addition, the fragmentation of the West Bank and the virtual separation of the West Bank from Gaza have made efficient public administration very difficult.

The World Bank recently calculated that the direct (income) and indirect (demand) losses from closure amounted to at least $2.8 billion for the 1994-6 period--a sum equivalent to a year's GDP, or $ 1500 per inhabitant--and more than the total 'peace windfall' of $2.2 billion earned from donor disbursements and tax clearances remitted by Israel within this period [6].

In effect, the Palestinian economy is trapped in an absurd contradiction.

It is highly dependent on Israel (fully 85% of import and export trade is with Israel)--a dependency recognized in the Paris Economic Protocol, which defines the economic relationship as a quasi-customs union between Israel and WBGS; but, in practice, this dependent relationship has come complete with a set of internal barriers that vitiate it.

We all know that the Palestinian economy has considerable upward potential. Palestinians are well-educated and entrepreneurial. There is abundant capital available from the diaspora (as evidenced by the build-up in commercial bank deposits in WBGS, from less than $500 million in 1993 to about $2 billion by the end of 1997 [7]). Palestinians are well-placed to act as economic intermediaries between Israel and the region, and between the region and Europe and the USA. The economy is free from any legacy of past follies, and has abundant international support--as witnessed by donor pledges of over $3 billion, and the conclusion of free trade agreements with the EU and the US.

We are also well aware that internal Palestinian governance is not all that it might have been, and that this has constrained development--but here there are promising signs too. Looking at this question from an investor's point of view, several recent initiatives are worth noting.

Most comforting is good fiscal performance, with revenues at a healthy level of about 20% of GDP, and recurrent expenditures being brought under better control over the past year [8]. The legal and regulatory regime facing Palestinian business, long a source of confusion and an area of relative inaction by the Palestinian Authority (PA), may now be transformed--President Arafat recently formed a committee including representatives from the IFC and the World Bank, and charged it with overseeing the finalization and implementation of 13 key commercial laws by the end of this year [9]. In the financial sector, one serious constraint to lending 'long' has been an absence of callable collateral; this is now being addressed by a program of land titling and moveable capital assets registration. And in the vexed area of PA financial management, last summer's two self-critical reports are to be followed up, at the request of the PA, by a World Bank project that will introduce financial and procurement control mechanisms throughout the PA. In response to such trends, 1997 witnessed the inception of the Gaza Industrial Estate project, with a number of investor commitments already firm, and the launch of the Peace Technology Fund, a project to which Palestinian and Israeli investors have committed equity for investment in small and medium-sized ventures in WBGS.

Let me recap briefly at this point. We have witnessed severe economic decline-but a decline precipitated by specific political measures. Nonetheless, there is strong evidence that investors and donors alike are still in the game [10], and have not lost all hope, nor their confidence in the fundamental potential of the Palestinian economy.

Future Scenarios
What does all of this mean, though, for the capacity of the economy to cater to returning refugees?

Let us start with a 'status quo' scenario. That is, no dramatic political improvements and a continuation of closure policies--but no dramatic worsening of bilateral relations either. The IMF recently projected that this scenario would likely yield a real GNP growth rate of about 2% in 1998. When allowance is made for population growth, though, this translated into a negative real per capita GNP growth rate of some 3-4% [11]. In other words, the status quo is not sustainable. The 40% of Palestinian residents of WBGS who are currently considered refugees will continue to get poorer, as a group, and the capacity of the economy to support them will decay further. Clearly this is not a promising platform for the reabsorption of returning refugees.

What can be done to raise the GNP growth rate? In theory at least, there is a simple and immediate answer: give Palestinians adequate access to labour and goods markets in Israel and the rest of the world--in other words, relax the closure policy. There is a raft of measures that have been discussed, seemingly endlessly, which would bring about a significant easing in closure, and which appear to be compatible with Israel's legitimate security concerns. These include the opening of the Gaza airport, the construction of the Gaza Port, the introduction of a Safe Passage between the West Bank and Gaza, and the upgrading of border infrastructure and streamlining of clearance and transshipment procedures. If Israel is seen to be committed to implementing such a program, this will have an immediate impact on investor confidence, and a real GNP growth rate of 4-6% would appear quite feasible. This, however, will do no more than arrest a further decline in living standards.

To attain the high growth rates of 8-10% of GNP which are needed to make a real dent in unemployment and poverty and to recapitalize WBGS infrastructure and social sectors, a far higher degree of political certainty will be required than exists at present. This will only be provided by significant progress towards a stable final settlement. But even these high GNP growth rates of 8-10% only translate into real per capita income gains of 2-4% per annum, given the current demographic momentum. To permit a significant reabsorption of the poorer refugees who wish to return, a quite extraordinary private sector response will be needed--and it is beyond me to predict whether this is a reasonable expectation.

But what of the donors, you may be asking--aren't they the missing ingredient? Won't they square the circle, and provide the capital that will permit a major reabsorption to take place?

I do think donors will remain engaged and will continue to be generous--the Palestinian question is one of the keys to a better world.

But it would be a mistake to think that donor finance is a panacea for the refugee problem. In the rough projections I have given you, I have already assumed a continuation of concessional donor assistance at something like current levels (c. $500 million in annual disbursements).

It may be that donors will make a special additional effort to help finance a settlement of the refugee question; but this would likely take the form of a special one-off exercise. The real solution to the challenge of reabsorption must come from private capital and private wealth creation--and here, in my opinion, it is advisable to keep a degree of sobriety. The fact that the plight of the refugees is a compelling one does not necessarily mean that everyone's economic needs can be catered for within WBGS.


1. The views expressed in this paper are those of the author and should not be attributed to the World Bank except where explicitly indicated.

2. Hereafter known collectively as 'refugees'.

3. The Bank uses a benchmark of $650 per person per annum as the WBGS poverty line; less than $2 per day in a high-cost economy represents a marginal form of subsistence.

4. IMF data.

5. IMF data.

6. Donor disbursements amounted to $1.49 billion, and clearances to $710 million. These clearances represent monies that were leaking into the Israeli economy prior to the conclusion of the Paris Economic Protocol of May 1994.

7. The loan-to-deposit ratio, though is only about 30%--where one would hope for 60+%. In other words, these funds are not being committed to investment with any great enthusiasm.

8. The key issue here is excessive growth in the public service, which has increased from 47,500 (29,500 civilian and 18,000 security) to 81,600 in 1997 (44,350 civilian and 37,250 security), partly in response to high unemployment. This has resulted in the earmarking of 57% of the 1998 budget for public sector salaries, a level that risks serious inadequacies in other essential non-wage expenditures. Neighbouring countries tend to, allocate about 40% of their recurrent budgets to public sector wages.

9. Including a revised Law for the Encouragement of Investment, and an investor-friendly Income Tax Law.

10. Donors at the Consultative Group meeting in Paris in December 1997 committed $750 million in grants and concessional loans and $150 in guarantees for 1998, and indicated that they expected to disburse $500-600 million during the year (the annual average since the DOP being about $475 million).

11. Population growth in WBGS is thought to be about 6-6 1/2 %, consisting of a natural rate of increase of about 3.9% (1994, with Gaza at 4.6%)--the highest in the world--and a modest rate of return migration making up the balance.

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