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The Palestinian war-torn economy: Aid, development and state formation

Attachments

UNCTAD/GDS/APP/2006/1

EXECUTIVE SUMMARY

After almost four decades of occupation, restrictive measures, violent confrontations and war-like conditions continue to dominate economic prospects of the Palestinian territory of the West Bank and Gaza. Setting the Palestinian economy on a path of sustained growth requires understanding the conditions that influenced its long-term development prospects, particularly the structures established after the occupation of the West Bank and Gaza and the institutional set-up affecting its growth dynamics. Economists and economic historians have long recognized that once structures have been formed, they tend to lock-in a certain evolutionary path. It is therefore important to recognize the adverse "path dependence" of the Palestinian economy formed during the occupation era. Needless to say, conditions of conflict, political instability, an elusive sovereignty and much-promised statehood have taken a growing toll on the ability of the PA to ensure any governance, much less of the corruption-free, best-practice model against which the PA is often measured.

Despite the challenge of establishing pre-state apparatuses in the uncertain environment of 1994-2000, the PA with the support of the international community achieved significant progress in creating basic institutional and regulatory frameworks for operating the economy in the areas under its jurisdiction. This interim period has shown that the institutionalization of restrictive measures, in the context of what may be termed a policy of asymmetric containment, has inflicted a heavy toll on the economy. While the current institutional set-up does feature some aspects of integration with Israel, these are mainly shaped by the asymmetric containment policy. And though the constraints imposed on the Palestinian economy since 2000 could still subside, their persistence should nevertheless be incorporated into any analysis of development options for its recovery.

The economic crisis since 2000 created a widening consensus among Palestinian public and private sector actors on the need for a new development vision to reduce economic dependence on Israel, address the new economic realities generated by the protracted conflict and build public institutions featuring transparency, efficiency and accountability. These concerns along with renewed, though reserved, hopes in the renewal of a peace process stimulated a number of development plans by the PA, especially since 2004. These reflect an evolving debate that is yet to produce clear outlines, much less a consensus, on the optimal strategy for setting the economy on the path of recovery and sustained development.

In the context of the limited economic policy options available to the PA during the interim period and a shrinking horizon for political settlement since, it resorted to rent-creation strategies, which included participation in commercial ventures, promotion of expatriate investment and non-fiscal mechanisms to increase public revenues, and hence room for political manoeuvre. In the light of the persistence and intensification of constraints and the overwhelming challenge of building modern, transparent public institutions in such an environment, the quality of PA governance since the interim self-government period could only deteriorate. It is perhaps not surprising that it came to be viewed so harshly by observers, donors and evidently by the Palestinian people themselves as witnessed by the Palestinian legislative elections of 2006.

Until 2000, when the benefits of economic cooperation and integration, however limited, could still be discerned, both donor and public tolerance levels towards mismanagement and public sector corruption remained high as the promises of the peace process were still plausible. However, as income levels plunged, poverty became commonplace and the meagre political gains of the previous decade became evident, the quality of PA governance weakened under the constant pressure of confrontation, crisis management and the threat of bankruptcy.

A multiple challenge thus faces Palestinian development efforts, whereby recovery and reconstruction must proceed under: (i) adverse conditions of conflict; (ii) intensified, systematic mobility restrictions; (iii) lack of national sovereignty; (iv) an ambitious, if not unrealistically large scale, reform agenda; and (v) limited policy space available to the PA to manage the economy, and (vi) its now systemic dependence on foreign aid.

This means that any future phase of economic rehabilitation and "peace-building" in the region cannot simply take as its goal a return to the pre-crisis situation. At the same time, humanitarian and relief assistance should no longer be addressed in isolation from long-term development needs, especially in light of the debilitated supply capacity. The PA and the international community should work together within a framework of a Palestinian socio-economic development vision capable of relieving the poorest from the dire impact of the economic siege, while at the same time reducing dependence on imports from Israel and expanding markets for Palestinian exports.

While the PA did initiate sustained reform efforts in public finance and other areas, its current policy is based on the premise that it must reform and renew public institutions and policies and achieve good governance before the envisioned State of Palestine can enter the community of nations. The PA continues to reform public institutions intended for a transitional, self-government phase, instead of responding to the imperative of forming the appropriate national institutions of governance. This runs the risk that the State that emerges will respond more to the considerations of interim solutions, rather than the strategic imperatives of Palestinian sovereignty as envisioned by the international community, not to mention the Palestinian people themselves.

Reforming, and more pertinently forming, the institutions required for the efficient operation of the PA is without doubt an essential step towards the establishment of a future Palestinian State. However, what is no less essential is the national development vision that guides the priorities of reform and institutional building. The PA needs to set out the goals, policies and institutions for an independent, democratic and modern State, including an economic road map to statehood to ensure cohesion between immediate and strategic goals, where efforts are focused on addressing the economy's structural weaknesses and poverty reduction. Trade expansion should serve this focus and be addressed through a longer-term sequenced approach. But to facilitate a powerful role for trade in reducing poverty, Palestinian efforts should be rooted in a development-driven approach to trade rather than a trade-driven approach to development.

Under conflict conditions, if it is unlikely that external political influence can do much to change the internal or external constraints to development, "non-distorting" aid and relief can at best hope to identify a number of ways in which the general population can be assisted with coping strategies. In such a situation, the critical question is whether there are feasible aid strategies that could weaken these external constraints. Given the significant role of external constraints in driving both the conditions of this particular conflict and affecting economic development, analysis of distorting aid and development has to look at the interplay of all these factors.

Analysis of international aid to Palestine suggests the possibility of a distorting aid and development pattern prior to 2000, which has intensified after the escalation of conflict and the switch from development to relief assistance. It is now apparent, if it was not a decade ago, that the greatest developmental constraints facing the Palestinian people are predominantly related to the fact that they do not have their State within which a meaningful reform process can be managed. The economy's development potential has been dependent on fiscal, trade and monetary policies and labour mobility criteria, which Israel regulates in the light of its own sovereign interests. While a number of governance failures within the PA were certainly avoidable, other cases were directly induced by the external constraints under which the PA laboured. These aspects of internal governance have been the subject of a number of reforms to improve the transparency and accountability of the PA's executive branch following the developments since 2000 that led to the PA's near collapse. But the external factors that have been by far the most important constraints on development, and which arguably drove the PA to adopt some unconventional economic policy measures, remain in place. Indeed, despite progress in reform of the PA, economic decline has been persistent since 2000.

The specific characteristic of the Palestinian situation is that asymmetric economic control facilitates compliance with security and political goals. This means that attempts to foster economic development for the envisioned State of Palestine have to deal with an externally imposed institutional architecture that maintains the vulnerability of the Palestinian economy. As a result, successful developmental policies in the Palestinian context can be expected to be unorthodox owing to the unique set of externally imposed constraints. The capacity of the state to create rents for investors can be useful if there are specific external constraints that need to be overcome. These capacities can be adversely affected if they are subjected to sustained attrition or even neglect.

This is not an argument against traditional relief in a context of extreme human hardship. There is no question that in the immediate future, humanitarian relief and budget support must continue to account for a major part of aid delivery. But vital as they may be, such instruments have to be recognized as inadequate for making a lasting dent in Palestinian poverty and economic vulnerability in a context of asymmetric containment. Rather, a long-term relief strategy for the Palestinian economy is needed, and it is this that may be viewed as non-distorting aid.

There is little that suggests that occupation or the strategy of asymmetric containment are likely to be phased out any time very soon, even though they may take different forms and intensity. Relief has to be repositioned within a long-term development strategy and the attendant steps on this developmental path have to be taken even if they take time to implement. It is now evident that sustained economic recovery requires either dismantling the policy of asymmetric containment, or else pursuing a strategy to deal with it as an external constraint in the short term, while at the same time working towards its eventual elimination. Although the latter option may not lead to a high-growth recovery, it could perhaps halt or reverse the adverse path dependence, by placing the war-torn economy on a platform from which it can cope realistically with these constraints.

This in turn requires going beyond the conventional economic policy wisdom and tailoring the development process to the economy's present distinctive features and institutional set-up. Such an approach should be based on a participatory mechanism and needs to be concrete in detailing policies for poverty reduction, with specific programmes that clearly link all types of aid, including relief, to long-term development objectives and a state-formation agenda. Above all this approach has to be clearly identified as a means to achieve a widely-accepted national Palestinian socio-economic vision to drive both domestic and international support measures, as well as the reform agenda, towards the establishment of a democratic, contiguous and economically viable State of Palestine.

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