Report says policy space critically needed to end decline, spur sustainable growth in Palestinian economy

Geneva, 8 September 2008 - The war-torn Palestinian economy cannot be revived without providing the Palestinian Authority (PA) with increased policy options, a new UNCTAD report says. The report argues that lifting the Israeli closure policy and movement restrictions imposed on the occupied Palestinian territory, dismantling the Israeli separation barrier, and intensifying donor support and institutional reform, while necessary, are not sufficient for achieving economic recovery and sustained growth. To do that, the study says, Palestinian policy makers must have the full range of fiscal, monetary (national currency), trade, and labour policy instruments available to other countries.

The annual Report on UNCTAD Assistance to the Palestinian People (TD/B/55/2) also says there is an urgent need to strengthen the PA´s institutional capacities to formulate and implement economic development policies. The PA, it contends, must be able to assume a lead role in aid allocation and management. The report will be reviewed on 23 September by UNCTAD´s governing body, the Trade and Development Board.

A degraded economy and deep poverty

Following a 5% decline in 2006, the Palestinian economy had a zero growth rate in 2007. The economy would have retracted for the second year in a row if not for the gradual lifting of donor restrictions in the second half of 2007. Under the resulting stunted growth, gross domestic product (GDP) per capita continued its downward trend to 60% of the 1999 level. Unemployment increased to 29% in 2007 as compared to 21% in 1999. The percentage of those living below the national poverty line increased to 57% in 2006 from 52% in 2005. The percentage of those living in absolute poverty over that period increased from 40% to 44%. In 2007, 62% of households had lost more than 50% of the income they earned in 2000. The prolonged erosion of household coping strategies had a negative impact on education and health, with far-reaching adverse consequences for future Palestinian human resources and capacity development.

Stifled local economy in Gaza

The situation in the virtually isolated Gaza Strip, where 1.5 million Palestinians live (40% of the population of the occupied Palestinian territory), is much worse, the report says. Data indicates a widening gap in living conditions between Gaza and the West Bank. Gaza was excluded from resumed flows of foreign aid to the rest of the occupied Palestinian territory in 2007, and is suffering its worst humanitarian crisis, the study says. The closure imposed on the Gaza Strip is so tight that only the bare minimum of essential imports and humanitarian aid is allowed in. The report notes that in 2006, 66% of Gazans suffered from absolute poverty, a rate 30 percentage points higher than in the West Bank. Industrial sector divestment and capacity underutilization in Gaza is alarming. Businesses operated at only 46% of production capacity in 2007, down from 76% in 2006. By the end of 2007, about 95% of Gazan industrial operations had been suspended, while the number of working establishments dwindled from 3500 at the beginning of 2005 to a meagre 150 at the end of 2007.

Continued dependence on Israel and a deepening fiscal crisis

The Israeli closure policy and movement restrictions had a pronounced negative impact in the trade sector. Exports in 2007 were one-third lower than eight years ago, while imports increased by 4%. The trade deficit with Israel continued to expand, aggravated by the one-third loss of productive capacity and the resulting increased dependence on imports from Israel to meet local demand. The Palestinian trade deficit with Israel increased by one-fifth between 1999-2007 to reach an estimated US$2.1 billion, or 40% of GDP, and 90% of total net current transfers (mainly donor support).

Mobility restrictions, coupled with Israel´s recurrent withholding of Palestinian tax and customs revenue collected on behalf of the PA, have aggravated the ongoing fiscal crisis. This source of funds, when it is not withheld, represents 60-70% of public revenue and is therefore the cornerstone of Palestinian budget resources. As a result of Israel´s frequent withholding of these revenues, PA total revenue fluctuated sharply from US$1.1 billion in 1999 down to $300 million in 2002, up to $1.2 billion in 2005, down to $360 million in 2006, and up again to $1.2 billion in 2007. Uncertainty over this major source of income not only makes budget planning almost impossible but also deprives the PA of the fiscal policy tools it needs to manage and stimulate the economy or even to meet essential social sector needs, the report says. Consequently, despite austerity measures, the Palestinian fiscal deficit jumped from 17% of GDP in 2005 to 27% in 2007.

The report cautions that although the PA´s wage bill is the largest element of public expenditure, the prescription often recommended to developing countries to downsize public employment could be extremely harmful in this case. The 50% increase in public employment in Palestine between 1999 and 2007 was critical for compensating for jobs lost as a result of the Israeli closure policy. In light of the ongoing Palestinian economic crisis, the PA will face a difficult choice between achieving fiscal sustainability and reverting to what it terms "pro-social stability spending" where public employment acts as a safety valve. The report emphasizes that phasing out Israeli mobility restrictions is necessary if any fiscal reforms are to succeed.

Policy space for economic recovery and sustained growth

The PA´s ability to respond to the challenges of reviving a war-torn economy is constrained by the limited policy space available to it under the terms of the Paris Protocol, signed by the Palestine Liberation Organization and Israel in 1994. The report points out that what is left for the PA from a typical sovereign state policy toolkit is a limited, volatile and vulnerable fiscal policy space. If anything, the PA can do little more than allocate public expenditure, which is less than the policy space available to local governments in many countries.

UNCTAD´s projection of the Palestinian economy "baseline scenario" -- which assumes a return to the pre-2000 relatively less-restrictive Israeli closure policy and assumes continuation of the existing economic policy framework -- predicts modest improvements in major economic indicators by 2015. By contrast, empowering the PA with more substantial fiscal, monetary, trade, and labour policy tools could bring about substantially higher growth rates. Policy measures proposed by the UNCTAD Secretariat include increases in public investment and government transfers; investment and export-distortion correction schemes; sectoral-employment generation programmes; introduction of a national currency; and replacement of the quasi-customs union with Israel with a most favoured nation (MFN) trade regime. Among these proposed policies, the introduction of a national currency would have the most dramatic impact on growth, the report says. It could lead to a GDP 10% larger than that projected by the "baseline scenario" for 2015.

While each policy alternative produces better economic results than the "baseline scenario", the Secretariat´s analysis shows that bundling all policies into one integrated package would produce superior results. This package would increase GDP by 24% above the "baseline" level in 2015 and would lead to full employment by 2012. Though this may seem overly optimistic and difficult to envisage under current circumstances, it confirms that a considerable reduction in unemployment would be possible should the necessary policy instruments become available. Thus the report stresses that there is an urgent and critical need to expand the PA´s policy space.

Along with the need to end the isolation of the Palestinian economy, the report emphasizes that achieving economic recovery also requires greater consistency and predictability in foreign aid. And it requires large-scale public investment programmes to rebuild infrastructure and revitalize the economy´s eroded productive capacity. Moreover, special emphasis should be given to developing the PA´s institutional and human capacities to design and implement policies in line with the proposed integrated package, the report says.

UNCTAD´s response

Political instability has compelled the Secretariat to suspend planned technical assistance activities in the Gaza Strip. Nonetheless, UNCTAD was able, through a selective and flexible mode of operation, to achieve important milestones in the occupied Palestinian territory in 2007. Significant progress has been achieved in trade facilitation and logistics under a project to modernize and strengthen Palestinian Customs capacities. This project has entered its third and final phase. It was launched under the Arabic name "Tawasol" (trade accounting, web-based analysis solutions) to emphasize its growing importance as a key element of the PA´s renewed fiscal reform efforts. The Secretariat has also continued technical assistance under the "Establishment of the Palestinian Shippers´ Council (PSC)" project scheduled to end in October of this year. The project has been successful, and efforts are now focused on ensuring the PSC´s long-term sustainability and on enhancing its role as a focal point for addressing the needs of Palestinian exporters and importers.

In cooperation with the UN Economic and Social Commission for Western Asia (UN-ESCWA) and the United Nations Development Programme (UNDP), UNCTAD activities in the area of trade policy entered a new phase with the launching of a project to promote regional growth-oriented economic and trade policies to help achieve the UN Millennium Development Goals in six Arab countries, including the occupied Palestinian territory. The Secretariat is also working with UN-ESCWA to complete a survey-based policy paper to guide Palestinian capacity development efforts in the areas of public finance and development strategies, trade policy and trade facilitation, and investment promotion and enterprise development.

However -- and despite appeals to the donor community -- UNCTAD remains unable to build on previous achievements under its "Strengthening Capacities in Debt Monitoring and Financial Analysis" project. Lack of funds may also force the Secretariat to suspend or delay planned activities under the "Investment Retention Programme", and "Support for small and medium enterprise development (EMPRETEC Palestine)" project.