New York and Geneva, 2006
*This study has been prepared by the UNCTAD secretariat as part of a research and technical cooperation project partially funded by the International Development Research Centre (IDRC), Canada. The research benefited from contributions by UNCTAD consultants Yousef S. Daoud (Birzeit University) and Shaun P. Ferguson (formerly Advisor to the Palestinian Authority, Ministry of Planning). The designations employed and the presentation of the material in this document do not imply the expression of any opinion whatsoever on the part of the Secretariat of the United Nations concerning the legal status of any country, territory, city or area, or of its authorities, or concerning the delimitation of its frontiers or boundaries.
With funding from the International Development Research Center (IDRC), Canada, UNCTAD launched a technical assistance project in late 2004 to provide Palestinian policy makers with practical tools to assess alternative policy options and to formulate responsive development strategies. This involved the design of a quantitative integrated analytical framework that is based on a computerized econometric model capable of: (i) reflecting the present Palestinian economic reality; and, (ii) assessing and simulating the impact of alternative macroeconomic and sectoral policy options in the area of macroeconomic, trade and labour policy.
The Integrated Simulation Framework (ISF) builds on UNCTAD’s previous generations of econometric models for the Palestinian economy, incorporates recent data and applies new modeling techniques. It was developed in close cooperation with PA economic experts and Palestinian research institutions within the context of a participatory approach to ensure national ownership, and several training workshops were organized to ensure its effective institutionalization within the PA.
This technical study consolidates and elaborates on the results of the ISF, including the model design and estimations, as well as a projection of the development prospects of the Palestinian economy under the existing policy framework. Among the key findings derived from the estimation results is that while the Israeli closure policy, represented by the number of closure days per year, negatively affects Palestinian exports of labour services and goods to Israel and the rest of the world, it has a positive impact on Palestinian imports of Israeli goods and services. In addition, the estimation results suggest that domestic sectoral wages follow wages in Israel, with negative impacts on the competitiveness of domestically produced goods. The results also show that public investment crowds in private investment and that fiscal leakage could be reduced substantially if the right instruments became available to and are used efficiently by the Government.
Assessment of the baseline forecast, which covers the period 2006-2015, raises major concerns. While political stability, free mobility and increased donor support are necessary to jump-start the economy and ensure recovery in the short term, they are not sufficient to sustain the high growth rates needed to reduce unemployment and poverty meaningfully in the long term. The model predicts persistent trade and budget deficits and further polarization around the services sector and a single predominant trading partner (Israel). These polarization effects and chronic deficits are extensions of the trends that arose from the economic policy framework of the Paris Protocol. This means that it is highly unlikely that a return to the pre-Intifada (2000) framework of economic agreements and relations with Israel will bring the economy to a path of sustained poverty reduction and growth.
There is therefore a need for Palestinian policy makers to design a development strategy based on a carefully considered economic development vision. The elaboration of an integrated policy package to translate this vision into action should reconsider existing trade, fiscal, monetary and labour policy arrangements, and should be the base for any economic negotiations or agreements that might shape future Palestinian international economic cooperation.
The widespread economic crisis has generated a consensus among policy makers and experts on the necessity to re-evaluate existing economic relations, policies and development strategies within the newly enforced constraints. The Palestinian Authority (PA) has been reconsidering the existing trade regime with Israel and exploring new policy options for diversifying Palestinian trade in goods and services, including regional integration with the Arab countries. The sustainability of the Israeli market as an outlet for excess Palestinian labour is also being questioned.
However, the PA's renewed development efforts are being undermined by weak planning capacity. While the Ministry of Planning (MoP) has prepared a working framework for channeling donor support, namely the Medium-Term Development Plan (MTDP), there is no effective implementation mechanism. Meanwhile, the Ministry of the National Economy (MoNE) has conducted sectoral studies within the context of the Economic Policy Programme (EPP) to guide economic policy decisions. The Ministry of Finance (MoF) is considering the establishment of a macroeconomic analysis unit, and the Ministry of Labour (MoL) is seeking to play an enhanced role in economic policy processes through the Palestinian Fund for Employment and Social Protection (PFESP). Other contributors to the debate on the optimal development strategy for the OPT came from national research institutions, particularly the Palestinian Economic Policy Research Institute (MAS). The latter has an established track-record in the area of applied economic research and policy analysis, focusing on identifying developmental challenges and priorities.
Nonetheless, these efforts lack a cohesive framework for targeting structural weaknesses and ensuring complementarity among policy decisions. What is required is an integrated quantitative framework capable of outlining and assessing a future vision for the Palestinian economy, along with appropriate policies for achieving such a vision. Previous frameworks to evaluate alternative long-term policy options included the Quantitative Framework (QF), UNCTAD’s first macro econometric simulation model for the Palestinian economy. The framework was developed in 1992-1994 (UNCTAD, 1994a) and revised and updated in early 2000 to take into account the new developments following the establishment of the PA. The revised model, the Macroeconomic Simulation Framework (MSF) (UNCTAD, 2000), represents UNCTAD's second-generation model of the Palestinian economy.
The two models were designed to stimulate and project the Palestinian economy's performance under different policy assumptions. The MSF envisages a transitional period during which the economy would gradually reduce its dependence on the Israeli economy, absorb returnees and achieve higher investment rates. However, the intensification of the crisis since September 2000 created a reality more complex than could be captured by the MSF, and thus its detailed results were never disseminated. Nonetheless, and for the first time, these pioneering models set the stage for a logical understanding of the macro-economy of the Palestinian territory. The QF provides a reference framework for other international institutions, and has inspired limited models by individual Palestinian researchers since 1994. MAS has also developed a number of quantitative studies, which demonstrate relatively advanced econometric and modeling efforts.
Recent models include a Computable General Equilibrium (CGE) model developed by the World Bank in 2000-2001 (Astrup and Dessus, 2001a and 2001b). The model's primary objective is to assess the impact of specific alternative economic arrangements with Israel in the areas of trade policies and the labour market. Since it was constructed and calibrated before September 2000, it does not feature a major departure from the existing policy arrangements and does not take into account policy changes resulting from the crisis. The model also lacks Palestinian ownership in terms of its technical development and updates, as well as the policy options it examines. Any future development of this model will depend on an initiative by the World Bank.
During the interim period (1994-2000), factors such as weak economic policy coordination and ad hoc management, coupled with certain institutional weaknesses, undermined coherence and comprehensiveness in macroeconomic policy-making processes (UNCTAD 2006). However, the past years of war and economic siege, along with the imperatives and looming institutional and policy reform for the envisaged State of Palestine, have pushed the issue of adopting a more serious approach to economic policy-making to the top the PA agenda. Accordingly, the outcomes of international and national modeling efforts to date should be viewed as a process that started from zero and should be considered within the context of the dramatic political developments of the last 10 years.
Most notable is the fact that none of the previous frameworks or studies considered the economic consequences of the partial implementation of the Paris Protocol and those resulting from its increasing dysfunction since 2000. The structural impact of the prolonged crisis and the pending challenges arising from the 1994-2000 interim period are additional factors that should be considered for well-informed analysis of economic policy options in the short, medium and long terms. This requires an analytical framework with a much broader span, covering economy-wide and sectoral policy options. A new effort to strengthen the PA’s planning capacity must also succeed where previous efforts met with limited success. Such an effort should ensure:
In 1990, UNCTAD initiated an intersectoral research project on prospects for sustained development of the Palestinian economy, which entailed a series of economic and social studies that were completed in 1994. Drawing on the findings of these studies, the project investigated medium- and long-term Palestinian economic development prospects. It included the design of a computerized quantitative framework (QF), which charts and empirically evaluates the historical relationship between key macroeconomic aggregates. The framework was used to examine alternative paths for developing the Palestinian economy over the period 1990-2010, according to different assumptions of future demographic and policy variables (UNCTAD, 1994a). These paths included a baseline scenario that anticipated long-term economic and social decline, and an alternative scenario that featured a set of supply and demand side policies and factors to reveal the economy’s capacity for sustained economic growth and development.
The findings of this project were confirmed and further elaborated in publications by the Palestine Liberation Organization (PLO) and by the World Bank in 1993. Together, these efforts served two important objectives at the outset of the interim period as foreseen by the Israeli-Palestinian peace accords of 1993-1994:
The results of the QF reveal that, with a cohesive trade and investment policy framework addressing major structural gaps (trade, investment and employment), the Palestinian economy could recover and prosper. Projections demonstrated the economy’s capacity to reverse historical trade deficits, boost national savings and investment capacities, and reduce unemployment and underemployment resulting from the labour force’s dependence on external work opportunities. Moreover, the results also revealed the possibility of absorbing one million Palestinian returnees over a 10-year period, with their integration into the economy underpinned by significant inflows of international aid and investment.
In the macroeconomic block of the framework, the historical functions affecting the interplay between basic national account aggregates are calculated through multiple regression analysis of historical time series data. A simple supply system, driven by productivity and labour force, is used to project total potential output. This is compared to actual output, calculated with a set of demand equations derived from the historical regression analysis. The discrepancy between potential (i.e. projected) and actual output is reflected in the rate of unemployment (one of the main gaps depicted by the framework). Ways of reducing this gap and correcting other structural distortions are explored through alternative assumptions affecting different functions.
The World Bank's quantitative approach belongs to the CGE class of models (Astrup and Dessus, 2001a and 2001b). In general, CGE models range from relatively simple models with a few equations to comprehensive ones that are based on social accounting matrixes (SAM). They are known to be built around compromises, and their predictions are extremely sensitive to underlying assumptions.
The World Bank’s model uses a “nested, two-stage optimization” approach to reflect most markets. The demand and supply functions are derived and then estimated with some sort of reduced form, or by using elasticities from other countries. For example, in calculating private consumption, at the first stage (top level), consumers are depicted as optimizing their utility functions between imported and domestically produced goods. At the second stage (lower level), and after determining the real demand for imported goods, consumers are viewed as optimizing the utility function again to determine the optimal consumption mix of imports by source, thereby making it possible to calculate the share of each region (West Bank and Gaza Strip) in Palestinian imports of consumption goods. The same approach is applied to the production sectors to determine the supply side of the economy. But the important issue from an econometric point view is that when moving from the theoretical micro-optimization analysis to the reduced form (i.e. the equations to be estimated or assumed), it is difficult to discern whether an equation from a CGE model reflects reality better than an equation from a macro/Klien type model. Both will reflect the reality as good or as bad as long as the equation comprises all relevant variables. Furthermore, the structure of the model and its parameters are not clearly described and some markets (e.g. capital) are missing.
Recently CGE models have been employed with increasing frequency, rather than alternative forms such as time series econometric models, for modeling the economies of developing countries primarily for the following two reasons:
Furthermore, using data from the last few years will certainly generate misleading results. The Palestinian economy has been performing under adverse conditions of distortions and disequilibria in all markets, and has been dependent on relatively large amounts of aid. Bearing in mind that a CGE model is not used to analyse short-term fluctuations, but rather to predict medium-to-long-term structural changes, it could be misleading to use data from anomalous years. Such data will produce very peculiar SAM parameters, and the actual values for annual economic variables (production, trade, employment, prices and so on) produced by model calibration will not be suitable for use as benchmarks.
Nonetheless the World Bank study made a major contribution to the ongoing policy debate on the future policy options for the Palestinian economy. In this study, the CGE model is simulated to assess the impact of three alternative trade policy regimes: the existing Israeli-Palestinian Customs Union (CU); non-discriminatory trade policy; and a free trade agreement with Israel. According to the study, it appears that the cost of the Customs Union to the Palestinian economy outweighs its benefits. Hence the study alerts all concerned parties to the negative consequences of continuing dependence on Israel as the predominant trading partner and as the main destination for Palestinian excess labour within a Customs Union that mainly serves Israeli interests.
Labour and demographic block
The labour block consists of 11 behavioural equations and 34 identities. The explanatory variables were selected on the basis of a priori demand and supply analysis, with emphasis on the former. This is in line with the Kaleckian and Keynesian approaches, whereby output is demand-driven and the economy can reside at levels of underemployment of available resources. That is, demand for labour is not constrained by the labour supply, and the wage does not adjust to ensure full employment. The wage might equally be considered as being determined outside the system. Given the significant dependence on Israel for employment, and the higher wage rates prevailing in its markets, Palestinian domestic wages are modeled to capture the relationship with employment in Israel. Domestic employment is thereby dependent, in part, on wage rates and/or relative wage levels offered to Palestinians employed in Israel.
Palestinian employment in Israel is modeled as a function of the ratio of wages in the Palestinian territory to Israeli wages, the number of closure days, and Palestinian labour supply, while domestic sectoral employment is a function of value added, wages and lagged employment. Male and female participation rates are functions of wage rates and the size of each group’s population. Wages in the Palestinian territory are driven by the level of wages offered to Palestinians in Israel, the unemployment rate and lagged wages. In line with the a priori selection process, variables are not necessarily included on the basis of their t-statistics and standard errors. Rather, more emphasis is placed on theoretical consistency, which sometimes involved the inclusion of variables that are not statistically significant.
From 1967 to 1993, there was no national government in the West Bank and Gaza. Accordingly, data from the Israeli Civil Administration (ICA) for this time span are considered for the government sector. The period is characterized by Israeli collection of taxes, coupled with an almost total absence of programmes for the development of the Palestinian territory. The expenditure that did take place was primarily for health, educational, postal and local governmental staff. By 1992, the ICA budget was in surplus by $17 million (Khader 1999).
With the signing of the Palestinian-Israeli peace accord and the establishment of the PA in 1994, government took on a different meaning. The term has since been used to describe the PA government, with a centralized budget and some policy tools to manage the economy. Despite the fact that the PA hardly performed any fiscal management in the macroeconomic sense in its early years, it contributed to the absorption of thousands of unemployed, especially in times of restricted access to the Israeli labour markets. It also implemented several employment generation schemes.1 It is worth noting that existing Palestinian fiscal policy is governed by the 1994 Paris Protocol, which accords the PA limited manoeuvring space to change tax rates. However, the PA did not use any of the tax setting policies made available to it by the Protocol.
Public expenditures registered significant growth on a per capita basis with the PA’s assumption of power. This growth is partially explained by donor support, through significant contributions to capital expenditures. The public budget also registered substantial expansion on the revenue side, in part due to the transfer to the PA of large customs clearances, historically retained by Israel. However, Daoud (2002) points out that the PA’s fiscal decisions were not consistent with GDP growth, nor were they responsive to private sector development needs. Rather, they were generally determined by overriding political and security prerequisites of establishing and strengthening the PA
The government deficit reached unprecedented levels after September 2000, when Israel withheld customs revenues collected on behalf of the PA. This left the PA with no choice but to accumulate arrears to partly cover the accumulated recurrent deficit. In 2003, the Ministry of Finance (MoF) exerted concerted efforts to pay off arrears by limiting public employment expenditure and streamlining current expenditures (Daoud 2003). However, the weight of the ongoing crisis and the unreliability of the import revenue collected by Israel on behalf of the PA has made it increasingly difficult for the PA to balance the budget. The deficit is therefore endogenized in the ISF, with a feedback mechanism to the demand side of the economy and consequently employment.
Standard macroeconomic models treat the government sector as largely exogenous to investigate how fiscal policy affects employment, GDP and prices.2 As a natural consequence, it is often argued that the method of financing the budget deficit can limit the effectiveness of fiscal policy. Acocella (1998) reviews the various methods of deficit financing and how they are likely to affect GDP. In addition to its macroeconomic implications, fiscal policy has other microeconomic considerations such as equity and efficiency. Naqib (1996) examined the tax structure of the PA and came to the conclusion that the tax system is largely regressive, as it is comprised mostly of a benefit-based VAT system.
The empirical literature on macro-econometric models of the Palestinian economy varies in its treatment of the government sector. UNCTAD (1994a) models government consumption and investment as functions of GDP in the aggregate demand relation, but does not tackle the public deficit and revenues. El-Jafari (1998) models revenues as depending on GNP, imports, and a lagged dependent variable. He disaggregates expenditures to current and capital. Current expenditures are depicted as functions of revenues, lagged dependent variable and foreign aid, while capital expenditures depend on a lag and government revenues. Arnon,
Luski, Spivak, and Weinblatt (1997) also depict direct taxes and indirect taxes as dependent on GNP and GDP levels respectively, and use the estimated figures to distinguish national income accounts identities. The Fishelson (1989) model of the Gaza Strip and the Baums (1989) model of the West Bank treat the government as an exogenous factor. The latter uses government consumption as well as direct taxes, indirect taxes and transfers, while the former uses government consumption only. It must be noted that in the last few years the majority of capital expenditures have been financed by foreign aid. Moreover, it seems that lagged deficit is a better explanatory variable for capital expenditure than current revenues.
The ISF model considers government consumption, other revenues, and net indirect taxes and subsides as endogenous factors. This makes it possible to introduce changes in tax/subsidy switches on trade and wages to assess their impact within the context of alternative economic policy frameworks. The government block consists of three behavioural equations and 14 identities. Public consumption is determined by public employment, lagged deficit, and PA dummy and lagged dependent variables, while public investment is exogenous (policy variable), as are other government expenditures. On the revenue side, VAT is calculated twice: the first is the effective VAT rate multiplied by GDP at factor cost (value added), and the second is 17 per cent of value added, or potential VAT. The difference between the two is an estimate of the fiscal leakage to Israel, which could be a source of revenues if reduced. This leakage also explains other revenues, along with imports from the rest of the world. Income tax revenues are decomposed into domestic and income taxes imposed on Palestinians working in Israel.
The monetary sector is noticeably absent from the model because of the lack of monetary policy options available to the Palestine Monetary Authority (PMA), as well as the absence of a Palestinian currency, as agreed under the Paris Protocol. The financial sector is only considered to show the effects of credit extension and lending rates on investment. While the first instrument is available to the Palestinian policy makers, the latter is beyond their reach as it is determined by the Bank of Israel. However, the structure of the model allows for changes in export and import prices to simulate the impact of exchange rate policy on the trade balance.
Foreign trade and national accounts block
Since the Israeli occupation of the West Bank and Gaza in 1967, the Palestinian economy has become closely linked to that of Israel. Over the period 1967-2000, exports to Israel accounted for at least 60 per cent of total Palestinian exports, while imports from Israel were more than 65 per cent of total imports. The relationship between these two economies has also been affected by political instability and by Israeli policies to restrict the movement of goods and people, reflected in the ISF through a variable representing closure days. The establishment of the PA has also affected the expectations of Palestinian economic agents, which in turn affects investment decisions. Lastly, donors’ contributions to the development process of the Palestinian economy have had an impact, which must not be neglected, especially during the years since 2000.
Accordingly, the approach of the mainstream macroeconomic models has been modified in the ISF to reflect the impact of these factors on the Palestinian economy. The unique Palestinian situation requires modification of mainstream approaches to ensure proper accounting of the economic impact of the mentioned factors. Determinants of foreign trade and national income are represented through 10 behavioral equations and 62 identities. Palestinian imports from and exports to Israel are specified separately from the rest of the world to reflect the Palestinian economy’s dependence on Israel. Imports are also disaggregated into goods and services with the use of a relative share of goods to services equation. The latter is a function of time and relative prices adjusted to policy instruments. Exports to Israel are expressed as a function of real wages, an export deflator, the Israeli gross domestic product, a dummy variable for 1993 and the number of closure days per year. Exports to the rest of world are expressed as a function of its price deflator, labour productivity, dummies, Jordan’s GDP (the second trade partner of the OPT) and closure days. The share of goods to service exports is expressed as a function of time and relative prices.
The second set of equations in this block relate to national income. Net factor income is thought of as depending on employment in Israel, Jordan’s GDP and closure days. The standard Keynesian model is slightly modified to fit the Palestinian case, where private consumption is assumed to depend on its lagged value, in addition to gross private disposable income, and a dummy variable to carry the impact of the establishment of the PA, where D = 1 for the 1994-2002 period and 0 otherwise.
Private investment is expressed as a function of credit extension, gross national income, government investment, the lending rate and closure days. It is worth noting that interest rates may be the least important factor affecting investment, given the high risk resulting from the prevailing political instability. As in the case of the government block, a number of policy switches and add-factors are incorporated into this block to allow for alternatives to the existing customs union and different tariff structures that go beyond the existing policy framework of the Paris protocol.
Prices and deflators block
In the absence of monetary policy instruments, the PA is unable to ensure price stability. Inflation is transmitted to the Palestinian economy through trade with Israel. It has been aggravated by supply shortages resulting from the Israeli movement restrictions and closure policy since September 2000. Price deflators are introduced in some detail to account for inflation dynamics in the OPT and to investigate the effects of labour productivity, the new Israeli shekel (NIS) exchange rate (another policy variable beyond the reach of Palestinian policy makers) and prices in Jordan. The deflators covered are: prices of consumption, investment (construction and non-construction), exports (goods and services), and imports (goods and services).
Value added block
The model reflects the production side of the economy by disaggregating the economy’s total value added into four sectors: agriculture, industry, construction and services. The supply of each sector as measured by its value added is regressed on aggregate demand components: private consumption; private investment; public consumption; public investment; exports of goods and services; imports of goods and services. To carry the impact of technology, a time trend is added. This method of modelling the economy’s supply side follows the input-output (I-O) approach to capture production by a Leontief fixed coefficient function (Elkhafif, 1996). Optimally standard I-O tables should have been used for this purpose. However, at the time of developing this version of the model, final I-O tables had not been released by PCBS. The same set up of the I-O approach was therefore estimated econometrically, rather than using the I-O coefficients, to derive the economy's value added from the complete set of aggregate demand components.
with regression coefficients
Where the inverse covariance is
Table 3.1 - Estimates of labour block relations* - Continued
Employment in Israel is inelastic with respect to wage ratio. The estimated elasticity suggests that a 1 per cent increase in wages available to Palestinians would increase Palestinian employment in Israel by only 0.04 per cent. This implies that employment in Israel is marginally driven by relative wages. Although wages available to Palestinians had as much as a 50 per cent premium in some years (Daoud 2005), other factors have taken precedence, especially in recent years. Palestinian labour supply seems to be more influential, though the elasticity coefficient is less than one. The number of closure days per year is another factor, with a negative impact on employment in Israel by a magnitude of -0.004 per cent per day. This figure is to some extent underestimated, since the number of closure days during most of the period 1972-1990 was zero. Taking the simple correlation coefficient for the entire period and for post-1990, the figures are -0.21 and -0.73, respectively. The stronger relation is shown in figure 3.2. Adding more recent data to this variable will produce a higher elasticity coefficient.
Labour force participation
The model’s ability to explain participation rates is better for males than for females. The goodness of fit is lower for the latter, with a low level of significance. The effect of daily wages on participation is of minor economic and statistical significance for males. An increase in value added increases male participation only marginally, while closure days reduce male participation. For females, the effect of per capita gross national disposable income is negative and insignificant.
The wage equations relate sectoral wages to wages in Israel, unemployment rates, time and LDV. Historically, construction (sector 3) has had the highest premium on the four sectors, while agriculture (sector 1) has had the lowest. It is evident that work in Israel fluctuates sharply and has undergone a severe reduction since 1996. Domestic wages are closer in their co-movements (figure 3.3). However, regression results indicate that whenever wages in Israel increase, domestic wages follow suit. This relation is not strong, which could be another reason behind the weak relationship between relative wages and employment in Israel. A one per cent increase in wages in Israel leads to a less than 1 per cent increase in domestic wages for all sectors. Wage elasticity with respect to unemployment is inelastic for all sectors. Wages decrease by roughly 0.2 per cent for a one percentage point increase in unemployment in industry and services, and more so in agriculture.
Total imports and exports are broken into two components: trade with Israel (as the major trading partner) and trade with the rest of the world (ROW), which was derived as a residual. The same values of imports and exports are also disaggregated into goods and services. Although exports remained relatively stable over the entire span, imports have grown substantially. Figure 3.7 shows that the trade deficit increased nearly fivefold during the study period. A closer examination shows that while imports from Israel constitute the bulk of total imports and increased during the second Intifada (September 2000), the relative importance of imports from the ROW declined.
Estimation results of the price-deflator equations are listed in table 3.6. They suggest that the short-run elasticity for the Israeli price index is 0.035 and the long-run elasticity 0.055. This implies that almost half of Palestinian inflation comes from Israeli sources. The import deflator coefficient is much stronger at 0.82 per cent for a 1 per cent change in the price of imports. The deflator of imports of goods seems to be marginally influenced by prices in Jordan. Unlike prices of imported goods, prices of export goods are inversely affected by the exchange rate and labour productivity.
Table 3.5 – Estimates of value added equations*
Figure 3.10 – Simulated and actual series for some variables
Table 4.2 - Baseline forecast assumptions: External exogenous variables*
The baseline forecast depicts the economy’s response to the assumed political stability along with the easing of goods mobility restrictions, increased donor support in 2006-2007 and the return to the Paris Protocol policy framework as implemented during the period 1994-2000. GDP is projected to grow at an annual average of 7.4 per cent in 2005-20 10. However, the GDP annual growth rate is expected to drop to 4 per cent over the period 2010-2015, as the injection of donor funds declines. The implication of this growth pattern for poverty is reflected in the behaviour of unemployment rates and GDP per capita in table 4.3 and the relevant graphs in figure 4.1. After a significant decline from 27 per cent in 2004 to below 16 per cent in 2008, the unemployment rate starts creeping up to reach 19 per cent by the end of the forecast period. GDP per capita growth rates show a similar pattern, with the annual average growth rate dropping from 3.3 per cent in 2005-20 10 to less than half a percentage point in 2010-2015.
With this growth trajectory, table 4.5 and graph 8 of figure 4.1 show that the structure of the economy is expected to move farther towards the services sector, with that sector’s share increasing from 72 per cent in 2005 to 77 per cent in 2015. This gain is at the expense of construction and, to a lesser extent, agriculture. The decline in the share of construction could be a reflection of a long-standing occupation policy of restricting building permits. Industry will maintain its 14 per cent share of the economy. It is worth mentioning that the predicted polarization in economic structure is an extension of the trend established after the implementation of the Paris Protocol. This polarization has been further reinforced by Israeli mobility restrictions imposed on the West Bank and Gaza since 2000.
This suggests that, while political stability and goods mobility are necessary for economic recovery, they are not sufficient to maintain high growth rates over the long term. Donor support is also necessary in the short term, at least for the rehabilitation and reconstruction of the economy’s fiscal capital, but once this external support subsides, economic growth slows to rates that cannot reduce poverty and unemployment in a meaningful and sustainable way.
As previously mentioned, the model parameters reflect the structure of the economy within the existing policy framework and in line with the present investment profile and contracted capital stock. It seems that the sufficient condition for a sustainable economic recovery and poverty reduction is an alternative policy framework, with more policy instruments at the disposal of Palestinian decision makers. Such a framework should seek to expand the economy's productive capital stock, reduce the outflow of resources to Israel and the ROW, and enable the economy to achieve greater efficiency, in terms of higher growth rates, from the same level of injected resources.
Forecasting up to 2015 raises a major concern. While political stability, goods mobility and increased donor support are necessary for economic recovery in the short term, they are not sufficient to maintain high growth rates in order to meaningfully reduce unemployment and poverty over the long term. The model indicates persistent trade and public deficits, with further polarization towards the services sector and towards a single trading partner (Israel). These negative developments are an extension of the trends established under the economic policy framework of the Paris Protocol, but with much more depth and much more debilitating effects because of the Israeli restrictive measures and closure policy since 2000.
This means that a return to the pre-2000 framework of economic agreements and relations with Israel will not position the economy on a path of sustained growth. There is a need for the Palestinian policy maker to design a development strategy based on a carefully considered economic development vision supported by an integrated economic policy package capable of achieving this vision. The latter should reconsider the existing trade, fiscal, monetary and labour policy arrangements, and should be the basis for any economic negotiations or agreements that might shape future Palestinian international economic cooperation.
Owing to the unavailability of Palestinian specific deflators for the pre-1993 period, the process of arriving at series in constant 1997$ took a number of steps. First, implicit 95$ deflators for Israel were obtained from the World Bank-World Development Indicators. These were used to deflate the current series into constant 1995$. The deflation process has been applied to nine national account variables: final consumption expenditure; general government final consumption expenditure; gross capital formation; gross fixed capital formation; gross national expenditure; household final consumption expenditure; exports of goods and services; and imports of goods and services. However, whenever there was no deflator for a specific variable, the GDP general deflator was applied to convert from current to constant values.
In the pre-1993 dataset, sectoral GDP was divided into five values added: agriculture; industry; construction; public services; and private services. However, in the post-1993 dataset, PCBS provides a higher disaggregation of value added data, with 22 sectors, in line with the 1993 Revised Standard National Accounts (SNA) format. To reconcile the two datasets, some of the sectors in the post-1993 data were aggregated to reduce the total number to the five sectors. With regard to agriculture and fishing, and construction, the reconciliation was a straight match, as the two sectors appear in the pre-93 and post-93 datasets. As for the remaining sectors, table 3.1 shows how the post-1993 sectors are reconciled with those of the pre-1993 period.
Table A2: Variable definitions
2 A notable exception concerns the fact that part of government revenues and expenditures are automatically tied to the status of the economy, for example transfers and tax revenues.
3 For example, until 1998 part of Palestinian agricultural exports to Israel were subjected to quotas but there were no quotas on Israeli exports to the OPT.
4 Trade between Remaining West Bank and Israel not reported for the period 1988-1995.