Stacking the Deck

The Economics of the Israeli-PLO Accords

by Emma Murphy
published in MER194

For many Palestinians, the political success or failure of the Palestinian Authority (PA) hinges on its ability to bring rapid economic improvement to the West Bank and Gaza Strip, where peoples’ livelihoods have been seriously eroded by the Israeli occupation, the intifada and the repercussions of the Gulf war. Some improvements in basic living standards after 30 years of occupation might stave off political opposition to the agreements sufficiently so as to give them a chance of working.

Donor countries committed themselves to injecting the cash needed to jump-start the Palestinian economy, while the PLO and Israel negotiated new economic arrangements. Despite subsequent agreements reached in Paris and Cairo, and the $2.4 billion fund offered by international donors, by the beginning of 1995 hopes of economic development had foundered, living standards were still falling and the donors themselves were declaring their strategy a failure.

Economic Aspects of Oslo

Israel’s post-Gulf war policy, acknowledging the growing security burden of occupation, aimed at increasing job opportunities for Palestinians in the occupied territories. Tax incentives and the strengthening of local banking operations would encourage some degree of new investment and production, though the basic subcontracting role of the Palestinian economy would remain. [1] The Israeli strategy was to enlarge the productive base -- especially in Gaza -- enough to reduce Palestinian dependence on employment in Israel and restore consumption capacity without encouraging competitive development. [2]

The September 1993 Declaration Of Principles was, for Israel, an extension of this policy. It made substantial reference to new economic arrangements, transferring some government economic functions to a Palestinian Authority while others would be exercised through an Israeli-Palestinian Economic Cooperation Committee. The PA would assume direct responsibility for education, culture, health, social welfare, direct taxation and tourism. Israeli control or veto remained in the more strategic areas of water, energy, financial development, transport and communications, trade, industry, environment, labor, media and international aid. Israel would divest itself of the expensive functions of government but retain control of matters directly related to economic development. (Direct taxation can be considered an expense, since a climate of widespread politically legitimate tax evasion had made such revenues increasingly marginal to Israel’s costs of occupation.)

The Declaration further sought to link projected Palestinian economic development to a regional economic development program that would integrate Israel into a network of regional trade and cooperation and trump the Arab boycott. In return for passing responsibility for the welfare of the territories (which it continued to occupy) to the PLO, the international donor community and the private sector, Israel would gain access to markets and investments long denied.

Tangible international support for the DOP came in the form of commitments of $2.4 billion in loan and grant aid from over 40 countries at a World Bank-sponsored international donors’ consultative group meeting in Paris in December 1993. The pledges were primarily to fund an Emergency Assistance Program formulated by the Bank and Palestinian representatives under the assumption that the new Palestinian Authority would fund ordinary operations from tax revenues. The emergency program was designed to channel project aid into the occupied territories, balancing long-term development needs with the immediate need for jobs. The Palestinian Economic Council for Development and Reconstruction (PECDAR) was established to channel funds and to cooperate with the Bank in both allocation and accountability.

The Paris Protocol

The Paris Protocol formally established the new economic relations between Israel and the occupied territories. Not surprisingly, Israel was in a position virtually to dictate the terms of the agreement. As Shimon Peres put it, “In some ways we are negotiating with ourselves.” [3]

On the issue of trade, Israel demanded that the Palestinians “harmonize their tax and customs regime with the high levels in force in Israel.” [4] The Palestinians countered that such a customs union would make Palestinian products too expensive, either for domestic consumption or for competitive export. The advantages of a cheaper labor force and less regulated business environment would be undercut, and the Palestinians would be unable to act as a conduit for passing third country imports onto the Israeli market. The Palestinians asked instead for free trade between Israel and the occupied territories, with the right to decide their own levels of customs duties and tariffs at a rate lower than that imposed by Israel.

Israel was unwilling to make substantial compromises, though its heavily protectionist and subsidized production and trade regime is slowly being dismantled through a wide-ranging program of economic liberalization. The Paris Protocol established Israel’s desired customs union, with Israeli import tariffs, trade taxes, import licensing regulations and trade standards.

While Israel was prepared to allow Palestinian products unhindered access to its markets, it was concerned to prevent the occupied territories from becoming a conduit for the import into Israel of cheap goods from elsewhere. The Palestinians recognized that they would have little to export to Israel, with the exception of agricultural products, except to the extent that they imported component parts or raw materials from elsewhere and used low import duties to give them a comparative advantage in the Israeli market.

Israel, in deference to its own agricultural lobby, insisted that the customs union include a degree of protection for Israeli agriculture. Six agricultural commodities, eggs, poultry, cucumbers, tomatoes, potatoes and melons, were subject to quantitative restrictions on their import into Israel until 1998, and milk production of each was to be only for domestic demand. [5] The PA, for its part, can establish its own import policy and tariff structure for certain commodities from Egypt and Jordan, and can determine customs duties and taxes for goods imported for their own economic development program (such as capital equipment and wood), on vehicle imports and petroleum products (on condition that gasoline prices remain not more than 15 percent lower than Israeli prices).

The customs unions benefit of the Palestinians was the guarantee of access, albeit limited, to the Israeli market. The Protocol offered the opportunity to diversity trade, to import some goods at the cheapest price, and to raise revenues on imports (via the Israeli customs office). On the negative side, the PA has no independence in economic decision-making. Imports from countries other than Israel are restricted by “market needs,” as determined by the Joint Economic Committee, and can originate only from Egypt and Jordan. The agreement sustains key factors which impede Palestinian competitiveness -- subsidies and protection for some Israeli production, and a Palestinian value-added tax level just 1 percent below that of Israel. Nor does the agreement address the return of Palestinian resources such as water, access to which is critical to both industry and agriculture, or land illegally expropriated by Israel, between 60 and 70 percent of the West Bank and at least 60 percent of the Gaza Strip. [6]

Regarding financial development, the Palestinians desired an independent central bank able to issue a currency, control commercial bank licenses and reserves, and direct monetary policy. Israel opposed such an obvious display of sovereignty, but agreed to a Palestinian Monetary Authority to control and license the banking system. The Protocols do establish a central Financial Management Administration to manage fiscal policy with overall responsibility for public expenditure and revenue. They also call for a central budget office to prepare an annual budget, in cooperation with UNRWA, NGOs and aid agencies, and to supervise the budgets of local authorities. A central treasury office, together with the other offices and PECDAR, would manage taxation and budgeting -- all with reference to the Joint Economic Committee. Both the Israeli shekel and the Jordanian dinar would remain legal tender, the latter being the currency of the PA. Israel has refused Palestinian applications to issue an EU-type currency for issuing income-generating bonds.

Two immediate problems have arisen. First, the PA lacks a trained staff, but administrative capacity is likely to improve given the high levels of education and approximate skills. Second, the tax base is small and incapable of paying the sums necessary for start-up costs. The PNA is forced to make up budget deficits with external development assistance, there being no capacity for domestic borrowing. The ability to service debts is as yet unproven, and the accumulation of domestic payments arrears has already proved to be seriously destabilizing.

These arrangements have already opened the way for foreign and Palestinian banks to begin operations in the Occupied Territories on terms far more favorable for Palestinian borrowers than those previously offered by Israeli banks. Jordanian, Egyptian, Saudi and Palestinian diaspora capital is now available for investment credit, beginning the process of restoring public confidence in the financial system. Israel, of course, is now able, through joint ventures, to play an active part in that system, linking itself to the capital flows of its Arab neighbors.

Given the high levels of unemployment in the West Bank and Gaza, and the impossibility for the PA to create sufficient jobs, employment in Israel remains a vital source of Palestinian income. The Paris Protocol committed Israel to refraining from imposing any obstacles to Palestinian employment in Israel, or imposing any ceiling on their numbers. Nevertheless, closures since imposed by Israel have prevented workers from traveling to work in Israel, and Prime Minister Rabin made clear that his real intention “is to reduce dramatically the number of Palestinians working in Israel.” [7] Since March 1994, Israel has imported over 70,000 foreign workers from Eastern Europe, Turkey and the Far East, and the government has encouraged Israeli immigrants to replace Palestinian workers with salary props of $13 per day/per person. [8]

The Cairo Agreement

The Cairo Agreement of May 4, 1994 affirmed the Paris Protocol, but added two conditions in Israel’s favor. First, Article VII accepted that all laws and military orders imposed by Israel should remain in force unless amended or abrogated in accordance with the agreement. The PLO thus accepted the legitimacy of a vast number of military orders used to constrain the economic activity of the Occupied Territories. Israel, should it choose to veto abrogation of some of these, can sustain existing structural obstacles to Palestinian economic development in spite of the Paris Protocol.

Similarly, Article XXII deals with claims against Israel for actions and omissions prior to the transfer of responsibilities and powers to the PA. Unbelievably, the PA accepted that it will bear financial responsibility for claims made against Israel, and will actually defend past Israeli actions in the event of a claim reaching the courts. Nowhere is Israel committed to paying any compensation, to individuals or the population as a whole, for taxes illegally levied and used to destroy property or expropriate resources.

Israeli disengagement has fallen behind schedule, elections have failed to materialize and Israeli closures have strangled the lifeline of Palestinian income. International and bilateral aid, though, has only trickled into the Occupied Territories, and living standards have fallen further. The result, not surprisingly, has been a loss of public faith in the opportunities presented by the Declaration of Principles and a rise in political tension. Of a total of $760 million pledged for 1994, only $140 million had actually been disbursed by November 1994. [9] Emergency aid, released in small payments, has covered the running costs of the police, but donors have failed to release serious development funding. Non-security services such as hospitals and schools, according to the agreement, are to be financed by tax collection of the Palestinian Authority, but current projections are for a deficit of at least $150 million in this area, owing to the devastating state of the West Bank and Gaza economies compounded by residual popular attitudes of tax evasion. The two US disbursements of $5 million in May and $4 million in October were not enough to cover the electricity bill owed by the Gaza municipality, under threat of cutoff by the Israel Electric Corporation.

Foreign assistance-led development, should it materialize, carries risks. The funds are not inexhaustible and are likely to be reduced after a relatively short period of time. The host economy’s system must be flexible enough to adjust to reduced flows, quick to develop its own sources of revenues, and not allow aid to over-inflate standards of living. Aid should complement rather than substitute for domestic taxation, and must not slide into excessive debt. The local regime must concentrate on developing a legal and political system which can successfully attract and regulate private investment.

Most importantly, foreign assistance must not become a tool for patronage by an unaccountable political elite. In this case, donors have been reluctant to hand over the cash without full transparency in its disbursement, fearful of Arafat’s reputation for using funds to buttress his personal authority. Arafat has already alienated many capable Palestinian leaders and economists with his insistence on taking direct control of expenditure at every level, bypassing PECDAR in an arbitrary manner. Donors have, at the same time, encouraged the very system they condemn by seeking back-door contracts independently of and in competition with one another.

The donors’ problem, not to mention that of the Palestinians, lies in the basic unaccountability of an unelected Palestinian Authority. Because elections have been continually delayed by Israel, it is questionable when, or whether, an accountable national authority will materialize. The international community has made the fundamental error of separating aid from the wider context of the deal, both economically and politically. The point holds true when one considers that no amount of international aid will sustain the Palestinian economy if Palestinian workers are denied employment in Israel in the short and medium term. No amount of support for agriculture will help if the best land is being expropriated. And if economic arrangements between Israel and the PA discriminate against the Palestinians, then aid money will never be used to its full potential. This is no great revelation -- but then this international aid was never meant to stimulate economic development per se, but rather to sustain a particular political process in the short term.

Aid must be tied to simultaneous and real economic and political development of the Occupied Palestinian Territories, and not to a peace process which is proving to be inherently flawed and biased in favor of one party. The economic powers which have been passed to the PA are those which cost money -- health, education, investment and so forth. Those which have been kept by Israel, or under Israeli veto, are those with strategic value. For the meantime, international aid will prop up an increasingly unpopular Palestinian leadership and provide, at best, short-term relief of poverty instead of the long-term development for which it is intended.

Endnotes

[1] See Prospects for Sustained Development of the Palestinian Economy in the West Bank and Gaza Strip, UNCTAD, Geneva, UNCTADIDSD/SEU/2, September 27, 1993.
[2] See also International Labor Conference, Session 80, Report of the Director General, Appendix II, ILO, 1993.
[3] Ha’aretz, February 14, 1994.
[4] Financial Times, October 21, 1993.
[5] It was estimated that eventually 5,000 Israeli agricultural jobs would be lost as a result of Palestinian competition.
[6] Israel has declared 70 percent of the West Bank as state land, according to The Independent, January 5, 1995. The actual amount appropriated, according to The Economist, January 21, 1995, is 60 percent of the West Bank and 40 percent of Gaza.
[7] Arab Press Service, April 11, 1994.
[8] Arab Press Service, April 9 and 16, 1994.
[9] Financial Times, November 11, 1994.

Filed under: