Israel and the Palestinian economy

Yael Mizrahi-Arnaud, who recently completed the requirements for a Masters degree in international economics and Middle East studies at Johns Hopkins SAIS, contributed this post to the Matzav blog of the Israel Policy Forum  (reprinted here with its permission). She is a former Israel Air Force officer, and project manager at the Peres Center for Peace. She has conducted research in Israel and Iraq on innovative conflict management solutions.

Recent months have seen an increase in unilateral plans to resolve, or at least mitigate, the Israeli-Palestinian conflict. Since the Oslo Accords of the mid-1990s, the international community has embraced the consensus that a two-state solution is the only viable outcome. But barring any progress towards that result on the political front, buttressing the Palestinian economy may be the only realm in which tangible results can be achieved. A boost in the Palestinian economy will not only benefit the lives of millions of people and restore waning public confidence in the Palestinian Authority, but also set up the Palestinians as a self-supporting peace partner that can maintain the institutions of statehood.

A new push to buttress the Palestinian economy would stem not from an economic-peace rationale, which sees economic advances predicating political advances and statehood, but rather from the idea that a functioning Palestinian economy is a crucial component in and of itself, independent of negotiations. The desire is to merely keep the door open for a future resilient Palestinian polity, one that can be a viable state and a constructive neighbor to Israel. The Israeli military chief of staff has put it most aptly: “there is a clear Israeli interest, beyond the issue of values, to develop the Palestinian economy.”

Current trends in Palestinian demography and economics provide reason to worry. Unemployment stands at 27 percent, and for people 20 to 24, rises to 40 percent. With half of the population under 18, the Palestinians face a youth time bomb; without avenues for employment and advancement, these youth represent a growing security threat to Israel.

In addition, the Palestinian economy relies heavily on international aid to fuel its consumption, and suffers from a bloated public sector and static private sector. Annual GDP has improved, from -0.4 percent in 2014 to 3.5 percent in 2015. These trends arise due to restrictive and outdated economic arrangements with Israel, as well as poor governance by the Palestinian leadership.

A recent World Bank Report estimated that the PA loses $285 million a year as a result of its current economic arrangements with Israel, which date back to the 1993 Paris Protocol. That agreement saw the creation of an Israeli-Palestinian customs union, and a joint economic committee tasked with overseeing the movement of goods and labor between the two economies. A common truism of the Israel-Palestinian narrative, that the interim often becomes the reality, is nowhere truer than here.

The bulk of this loss comes from value-added tax (VAT) and import duties that Israel collects on the PA’s behalf, which are handed over on a monthly basis. These taxes are known as clearance revenues, and make up two-thirds of the PA’s public revenues. Israel takes a three-percent collection and processing fee on the VAT and import duties.

Any delay in these payments creates instability in the Palestinian economy, as the PA is the largest single employer in the West Bank, employing over 16 percent of citizens. Late payments mean the PA must take out bank loans, turn to foreign aid, or leave a large number of its employees unpaid. The last of these scenarios unfolded in the first quarter of 2015, when 40 percent of public sector wages went unpaid due to Israel’s withholding clearance revenues in protest of the Palestinian move to join the International Criminal Court.

Recent deals that Israeli Minister of Finance Moshe Kahlon struck with PA Finance Minister Shukri Bishara and Civil Affairs Minister Hussein al-Sheikh have led to the transfer of $128 million in unpaid clearance revenues. Coupled with the proposed increase in cooperation in the high-tech, medical, and construction fields, this is a good start.

Still, it is far from enough. Congress also recently voted to unblock $108 million in funds placed on hold after PA President Mahmoud Abbas’s September 2015 statement that the Palestinians were not longer bound by the Oslo Accords. An additional $51 million remains blocked today.

Renegotiating the Paris Protocol (which was reportedly attempted in 2012, yet never implemented) could resolve the issue through the creation of a calendar of revenue transfers that is separate from political discussions. Additional matters to discuss include tax leakages on bilateral trade, and the undervaluation of Palestinian imports from third countries. Two final, albeit more contentious, issues include restrictions on freedom of movement in the West Bank and access to employment in Israel.

Israeli Defense Minister Moshe Ya’alon and General Yoav Mordechai of the Coordinator of Government Activities in the Territories recently proposed a plan that would increase the number of work permits for Palestinians to 30,000. The Paris Protocol allows for the issuance of 70,000-100,000 permits, yet due to the recent upsurge in Palestinian violence, such a move is likely to meet opposition among Israelis.

Regrettably, the recommendation with the most tangible results is also the least politically viable. This would see Israel ceding control over Area C, the 60 percent of the West Bank that remains under full Israeli civil and military control. A World Bank report published last year found that restrictions in access to Area C cost the Palestinian economy over $2 billion in deficits. Granting greater access to Area C could increase Palestinian GDP by one-third, leading to an additional $3.4 billion. Area C contains the majority of the West Bank’s arable land and water resources, and access to it – for farming, residential needs, tourism, and industrial zones – would spur the Palestinian economy and support long-term growth.

The Gaza Strip presents particular problems. If current trends continue, UN estimates that in five years Gaza could be uninhabitable. With close to half of the PA’s budget currently transferred to the Strip, as well a third of the Palestinian people residing in it, bolstering the territory’s economy is critical.

Unilateral withdrawal may be a contentious solution to the current political impasse. Still, a unilateral move as suggested by Israeli opposition leader Isaac Herzog – such as by converting parts of Area C to Area B – may provide the needed stimulus to keep the Palestinian economy alive. The U.S. administration and Israeli public have reason to worry about the utility of unilateral solutions (as proven by the 2005 Gaza withdrawal), yet this does not mean that the plan should be rejected outright. As Gilad Sher, a former negotiator at Camp David has noted, the plan could be relabeled “constructive unilateralism.” Sher’s plan one-ups Herzog’s by adding the preliminary component that would see the resettlement and absorption of 100,000 settlers living in areas outside the main settlement blocs and in Area C.

Herzog’s attempts should be lauded, if only because they provide the Israeli public with an alternative to Netanyahu’s status-quo conflict-management strategy, which has failed to provide diplomatic alternatives to resolving the conflict or even enhance security.

The two-state solution remains the international community’s dominant paradigm for resolving the conflict, and according to a report published last June by RAND, remains the most promising solution for both sides economically. The report finds that such a solution would see Israel gaining more in absolute terms, yet Palestinians would see greater proportionate gains, with a 36-percent increase in average per capita income, compared with 5 percent for the average Israeli. In absolute terms, over a ten-year span, Israel would gain $123 billion, and the Palestinians $50 billion.

With the likelihood of a major political settlement increasingly unlikely, both Israelis and Palestinians have a range of options to improve their security and prosperity. The search for a political solution to one of the world’s most intractable conflicts has drawn decades of global attention, but it may be only on the economic front that genuine progress can be made.