May 2017


As long as occupation continues to prevent the Palestinian people's pursuit of meaningful development strategies, closure of the resource gap may not be expected, said a UN study.

By Kanaga Raja

The occupation by Israel of the Occupied Palestinian Territory (OPT), including East Jerusalem, since 1967 has "significantly distorted and disoriented the Palestinian economy", according to a new study released by the UN Conference on Trade and Development (UNCTAD).

In its study, titled "The Occupied Palestinian Territory: Twin deficits or an imposed resource gap?", UNCTAD said the security, military, political and economic measures implemented by Israel in the Occupied Palestinian Territory (the Gaza Strip and the West Bank, including East Jerusalem) since the onset of the occupation in 1967 have resulted in a huge resource gap, whereby domestic absorption (domestic consumption and investment, both public and private) exceeds domestic production by a substantial amount.

This gap is manifested in three dis-equilibria, namely a trade deficit in the balance of payments, a savings deficit (national investment in excess of national savings) and a government budget/fiscal deficit.

In 2010-2014, the averages of the three deficits, as a percentage of the gross domestic product (GDP), were 40%, 33% and 8%, respectively.

According to the study, despite the importance of all three deficits, public and policy attention has been focused almost entirely on the fiscal deficit, the smallest of the three, which has often been portrayed as the main problem in the Palestinian economy.

This misplaced emphasis is mainly due to three factors, said UNCTAD.

First, the chronic fiscal crisis is often associated with the repeated partial or complete suspension of the monthly payment of salaries of public sector employees.

"It is difficult to exaggerate the economic hardship set off by such frequent interruptions, which deprives almost one fourth of the population of their main source of income."

Second, Palestinian clearance tax revenues are frequently withheld by Israel. These revenues from taxes on Palestinian imports are collected by Israel on behalf of the Palestinian National Authority (PNA) and then transferred to the Authority after an exaggerated 3 per cent collection and processing fee is levied.

In 2014, clearance tax revenue accounted for 75% of total Palestinian public revenue. This amount could cover the public wage bill or 50% of the current expenditure of PNA.

In the last two decades, Israel has withheld these revenues at least six times. This has left PNA exposed not only to the withholding of revenue by Israel, but also to a continuous threat of withholding, and has often aggravated the Palestinian fiscal situation and pushed it into a crisis course.

The political pressure associated with revenue withholding episodes heightens the urgency of the fiscal problems of PNA, said the study.

It noted that some international organizations and academic studies have focused almost entirely on the smallest of the three, the fiscal deficit, and portrayed it, without convincing evidence, as the main problem of the economy of the Occupied Palestinian Territory.

This singling out of the fiscal deficit was given prominence and pre-eminence by a number of academic studies that presented it as the main problem in several Arab countries.

Most of these studies were conducted within the framework of the twin deficits hypothesis, which proposes that a fiscal deficit drives a trade (or current account) deficit.

According to UNCTAD, its study demonstrates, however, that the Palestinian trade deficit is not driven by the budget deficit, and that at no time in 1968-2014 did the trade deficit respond to changes in the budget deficit, as presumed under the twin deficits hypothesis.

Rather than reasoning in terms of one deficit causing the other, the UNCTAD study states that the two deficits have been cultivated, to become permanent features of the Palestinian economy, by the economic structure imposed by the occupying Power.

In other words, the two deficits are two symptoms (and the savings deficit is a third symptom) of the same problem, namely the resource gap.

This gap was developed and is maintained mainly by occupation-related practices that have created conditions that induce Palestinian workers to seek employment in Israel, where wages are higher than in the domestic economy. This has generated a substantial increase in Palestinian aggregate demand.

Concomitantly, occupation has constrained the capacity of Palestinian firms to pursue profitable investment, particularly in the agricultural and manufacturing sectors.

Thus, the rise in aggregate demand has not been matched by equivalent increases in domestic output.

According to UNCTAD, the findings indicating that there is no Granger causality between the budget deficit and the trade deficit, and the lack of any other statistical support for the proposition that the budget deficit drives the trade deficit, suggest that within the existing economic environment under occupation, the major impact of a reduction in the budget deficit of PNA would not be a reduction in the trade deficit but rather an economic slowdown and an increase in unemployment.

Overall, there is no shortcut remedy to the complex economic problems and dis-equilibria in the Occupied Palestinian Territory. What is urgently needed is the alleviation of the distortions and constraints imposed by occupation and a well-defined strategy of growth, said UNCTAD.

It emphasised that reforms of the Palestinian economy require cognizance of certain unique features of and constraints on the Occupied Palestinian Territory.

In this context, policymakers should recognize the inaccuracy of two potentially misleading propositions.

First, there is the view of some organizations that the Palestinian economy is an average developing economy with distortions similar to those observed in other developing countries.

This view reduces the impact of the Israeli occupation to a lack of security and ignores the fact that the policies implemented by and under occupation have locked in a certain evolutionary path for the Palestinian economy.

"This path features a vicious circle of cumulative causation that fosters the enlargement of its resource gap and continuing dependence on external sources of income. Economic reforms launched without the recognition of this retarding evolutionary path will inevitably fail."

Second, there is the potential misleading implicit or explicit proposition that views the economy of the Occupied Palestinian Territory not as one in the midst of conflict, but as one in a post-conflict situation.

According to the study, the inadequacy of this view can be observed from the following facts:

(a) The Gaza Strip is under a complete blockade and has endured three consecutive Israeli military operations in the last few years, in 2009, 2012 and 2014, during which thousands of lives were lost and tens of thousands of people were rendered homeless. The level of destruction of houses, schools, hospitals and roads was unprecedented.

(b) Daily life in the West Bank is strained by conflicts related to occupation that result in the deaths of civilians and the demolition of houses and productive assets. Moreover, the construction of the separation barrier and installation of several hundred checkpoints by the occupying Power interrupt the movement of Palestinian people and goods and hinder production and trade.

Furthermore, recommendations for reductions in the expenditure of PNA are often made with reference to the fact that the level of such expenditure as a percentage of GDP is higher than in neighbouring countries.

UNCTAD said this is correct only with regard to current expenditure, not total government expenditure (current, capital and development expenditure).

In fact, the total expenditure of PNA is low by regional standards and lower than the average for the Middle East. The total expenditure is mostly aimed at coping with the unfavourable environment of a costly conflict.

The context of conflict and a relatively low total expenditure underscore the need to perceive fiscal reforms in the Occupied Palestinian Territory differently in comparison with other countries operating within a normal or post-conflict environment.

Reform in the Occupied Palestinian Territory, therefore, first and foremost, requires a process of dismantling of the economic structure and policy framework founded and reinforced by occupation.

Successful reform pre-requisites include removing all barriers to socioeconomic development, production and trade. For example, one such barrier, with a direct bearing on the fiscal position of PNA, is the leakage of Palestinian fiscal resources to Israel.

The study's analysis suggests that addressing the Palestinian resource gap requires the following:

(a) Rehabilitating Palestinian productive capacity and expanding the policy space to narrow the difference between the total income received by Palestinians and income generated by domestic Palestinian production, that is the difference between gross national disposable income and GDP.

(b) Narrowing the difference between the total number of the Palestinian labour force and the number of workers employed in the domestic economy, which is equal to the number of unemployed plus the number of those employed in Israel and in Israeli settlements in the Occupied Palestinian Territory.

The study said that guided by this perspective, under the conditions created and reinforced by occupation, the following two outcomes are observed:

(a) Attempts at reducing the resource gap by narrowing one of the two differences may not be effective.

Historically speaking, under occupation, the income difference has narrowed while the labour difference has widened, and vice versa.

(b) Within the existing economic constraints, the main impact of a reduction in the Palestinian budget deficit would be an increase in unemployment, not a reduction in the trade deficit.

The study proposes a two-pronged strategy of reform and growth to bridge the resource gap.

Setting the economy on a path of sustainable development in the Palestinian context should be understood to be a radically different process from that in other countries operating in a normal or post-abnormal environment, it said.

A pre-requisite for conventional reforms in the Palestinian context is a process of dismantling the economic structure imposed and maintained by occupation.

This entails removing all deep-seated institutional barriers to progress and development in all activities of production and trade, as well as fully stemming the leakage of Palestinian fiscal resources to Israel.

According to UNCTAD, growth needs to be pursued by a well-defined strategy that features the following three elements:

(a) Expanding the agricultural sector by adopting a revival programme that covers all aspects of the agricultural environment, including human resources, technical skills, land, water, infrastructure, institutional and legal frameworks and trade in agricultural inputs and outputs.

The decline of the importance of the agricultural sector is related to two factors. First, the sector was not given a high priority in the reconstruction and development programme implemented by PNA in 1995-2000.

Second, policies of expanded settlements and the confiscation of Palestinian natural resources by the occupying Power created an environment inimical to agricultural development.

Israeli restrictions on the Palestinian agricultural sector include denying farmers access to Palestinian water resources, confiscating lands, severing villages from cultivated plots through the separation barrier, destroying trees and crops, demolishing houses and productive assets and restricting the movement of Palestinian workers and goods through checkpoints, roadblocks and trenches.

(b) Expanding the manufacturing sector by adopting a strategy of structural transformation that starts with an import-substitution industrialization stage, followed by an export-promotion stage.

The UN Industrial Development Organization noted that, prior to occupation, 50% of Palestinian imports from Israel were produced domestically, including, among others, most non-durable goods such as garments, footwear, leather-wear, soft drinks, furniture, construction materials and pharmaceutical drugs.

At the early stage of manufacturing structural transformation, an "easy import-substitution industrialization" approach could be applied, with regard to which two important points should be considered, said the study.

First, this stage should be limited to mostly agro-industry products, which are labour intensive and allow for both a reduction in unemployment and the movement of labour from the agricultural sector to industrial production.

Second, at present, most Palestinian agro-industry firms use imported inputs, weakening the linkage between industry and domestic agricultural production. This is because local inputs are produced by numerous small farmers, who have no cooperative arrangements and lack the capacity to supply firms with needed inputs in a timely fashion.

The public sector should therefore play a leading role in strengthening linkages between agro-industry firms and domestic agriculture, to enhance growth in both sectors.

Areas of potential expansion include wine production and hide tanning, as well as dairy products, fresh juices and frozen vegetables.

Deeper import-substitution industrialization implies an increase in total imports without an immediate increase in exports. This may create foreign exchange shortages and inefficient domestic industrialization, shielded by tariff walls and other measures of protection.

Experiences in countries in East Asia show that a better strategy may be to transform easy import-substitution industrialization into easy export substitution. This may be done by initiating an import-substitution phase with an announced time period of protection, after which firms must face foreign competition.

The public sector has an important role in assisting such a process by adopting measures of export promotion, including international marketing assistance, sound monetary and exchange rate policies conducive to keeping prices stable and competitive, and education and research and development subsidies.

(c) Adopting a national strategy of technological development featuring the following two stages: acquiring an independent technological learning capacity by cultivating a domestic scientific establishment capable of understanding, processing, adopting and adapting imported technological knowledge; and establishing an independent technology-creating capacity to enable the domestic scientific community to conduct independent research and development and pursue advanced knowledge.

In the Palestinian context, it is imperative for the public sector to establish the foundations of the institutions required to build an independent technological learning capacity, to ensure the success of easy import- substitution industrialization and its evolution into export substitution.

This entails a considerable increase in resources allocated for education, especially in science and engineering.

However, as long as occupation continues to prevent the Palestinian people's pursuit of meaningful development strategies, closure of the resource gap may not be expected, said UNCTAD.

Therefore, the international community should assume its responsibility and obligations towards the Palestinian people by exerting political pressure on the occupying Power to allow the Palestinian people to acquire enough policy space to achieve the above strategy and by extending sufficient financial aid to fund the Palestinian resource gap.

The Palestinian National Authority (PNA) should exert all efforts to take full advantage of the minimal policy space and resources available to it under present conditions to achieve its national developmental objectives, while avoiding further deepening an aid-dependence trap, the study concluded. Third World Network Features.


About the author: Kanaga Raja is the Editor of the South-North Development Monitor (SUNS).

The above article is reproduced from SUNS #8457, 8 May 2017.


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