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The fragility of the Palestinian economic situation

David Brodet

The mood in the Palestinian Authority recently changed radically in the space of a few weeks. In September 2011, the attention of Palestinians and the world was directed toward the United Nations, where the Palestine Liberation Organization submitted its request to be accepted as a state by the UN and Palestinian spirits were at an all-time high.

Articles in this edition
Why we are closing - Yossi Alpher
The arc of the pendulum - Ghassan Khatib
The Palestinians announced to the world that they were ready to become a functioning, independent country. They highlighted the efforts invested by them in building professional security forces and economic and administrative institutions and in generating an economic strategy for development and growth. As proof of their capabilities, they presented positive assessments from the International Monetary Fund and the World Bank, to the effect that they were economically and institutionally prepared to take on full authority and responsibility for maintaining the economy of an independent state.

Just weeks later, the mood changed from euphoria to a hard landing in a cruel reality. The ebullient mood dropped not only because of the Security Council's rebuff of the PLO request, but also in view of a bitter daily reality that demonstrated just how fluid and fragile the Palestinian economic situation really is. The extent of the Palestinian Authority's dependence on external actors became clear to all.

Without getting into the issue of the political independence of a Palestinian state, in the economic sphere the Palestinians are very far from achieving the capacity for independent management. The heavy efforts invested in the past three or four years, mainly by Prime Minister Salam Fayyad with the support of President Mahmoud Abbas, have not yet laid the groundwork for a functioning independent country. There are both long- and short-term reasons for this.

This is the result of years of neglect and avoidance of basic economic needs on the part of the Palestinian leadership. Even after they received broad economic authority from the Paris agreement signed in accordance with the Oslo framework, the Palestinians under Yasser Arafat's leadership exploited their authority in ways that served the immediate needs of Arafat and his entourage. The large sums of aid from donor countries and tax transfers by Israel that flowed during those years were not used for building an economy.

Salam Fayyad, first as minister of finance and then as prime minister, has invested heavily in creating the infrastructure for a functioning economic authority and has registered many achievements. Yet the basic current budgetary structure of the PA, which stands at three billion dollars per annum, is dependent on donor nation transfers of around one billion dollars per annum (about a third) and on Israeli transfers of taxes collected for the Palestinians totaling around $1.3 billion (more than a third). This means heavy dependence--for more than two-thirds of the budget--on Israel and the donors.

The taxes collected by Israel on goods imported by the Palestinians are Palestinian monies that must be transferred to the PA under contractual obligation. Yet in reality, the Palestinians are dependent on an Israeli bureaucracy that on occasion invokes political considerations. For its part, the PA has failed to invest sufficient effort in building its own independent collection system, for example regarding water and electricity fees that to a large extent are never paid by consumers, thereby adding yet another financial burden.

There are undoubtedly many objective circumstances that help explain the PA's financial situation. It has no air and sea ports for direct international trade; since 2007 the Gaza-West Bank split weighs heavily on the budget; and the economic agreements signed in 1994 that were meant to last five years are still in effect today.

The PA's critical dependency on donor funds and Israeli tax transfers has become all the more salient since fiscal steps were taken to improve the Palestinian economic system. Transfer delays by Israel, for even a short period of weeks, reveal the PA's fragile economic situation. It has neither reserves nor much room for maneuver. It has no alternative source for raising funds.

Constructing a financial system is a long, drawn-out process. The PA needs to continue building itself economically, yet under current political conditions it can do little in the short term without fiscal and financial arrangements with Israel and the donors. The main damages caused by delays in transfer of funds are great uncertainty in the Palestinian economy, disruptions in the functioning of security and civilian authorities, and anger among the broad Palestinian public (mainly unemployed youth and intellectuals) that could turn violent over economic issues along the lines of the "Arab spring" demonstrations.

Israel and the donor nations share a fundamental interest in maintaining reasonable economic conditions among a population situated so close to Israel. Regardless of the question of a political solution for the conflict, Israel needs to enable Palestinians to build their economic system and it must encourage moderate and constructive sectors of the Palestinian population.-Published 5/12/2011 © bitterlemons.org

David Brodet is chairman of Bank Leumi and former director general of the Ministry of Finance. He headed the Israeli delegation to the economic negotiations with the Palestinians in Paris in 1993-4.
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