In its report to the September 22, 2008 meeting of the Ad Hoc Liaison Committee (AHLC), the World Bank noted that the Palestinian Authority (PA), Israel, and the international donor community made some progress on the three parallel conditions for Palestinian economic revival, albeit to different degrees: the PA had continued in its path of fiscal and security reform; donors had provided substantial amounts of aid, but the uncertainty of flows made it difficult for the PA to plan its finances; and Israel had announced, and in some cases implemented, a series of steps to remove physical obstacles within the West Bank, which would only have an impact insofar as the number and the scope of the restrictions being addressed were scaled up significantly.
This report reviews actions taken in these fields since the September 2008 AHLC meeting. The report notes the dramatic impact of Israel’s recent three-week offensive in Gaza and analyzes the variety of recovery and reconstruction schemes being explored by the donor community. We find that these have not yet led to any significant impact on the ground due to the continued closure imposed on Gaza. The devastation in Gaza, coupled with a fluid political environment in both the PA and Israel, has made it necessary for this report to revisit the fundamentals of donor support to the PA in view of the long-term goal of establishing an economically viable Palestinian state independent of external aid. Examination through this lens reveals a fundamentally flawed picture.
Real GDP growth in 2008 is estimated at about 2 percent, which translates to an almost 1 percent decline in real per capita terms. Recent experience in other countries has shown that economies entering a post-conflict period can expect double-digit rates of growth – at least in the initial years. In some respects, the West Bank economy is better equipped than many post-conflict economies for rapid growth. Among other things, there has been a series of Quick-Impact Projects (QIPs) designed to attract private sector investment and thereby jump-start and catalyze economic activity. The fact that the West Bank economy is dramatically failing to fulfill its potential, even in periods of relative stability in the security situation, only underlines the extent to which economic restrictions are still preventing any real upturn in economic activity.
Indeed, the post-conflict economic booms in other countries were mostly not hampered by the extreme restrictions facing the Palestinian private sector today. Very few economies have faced such a comprehensive array of obstacles to investment -- not just of physical impediments to movement, but also comprehensive institutional and administrative barriers to economies of scale and natural resources, along with an unclear political horizon and the inability to predictably plan movement of people and goods. This report shows that progress in the relaxation of these restrictions during 2008 has been marginal at best. As a result of the Israeli security regime, the Palestinian economy has hollowed out, with the productive sectors declining and the public sector growing, as more of the population looks to the public sector for employment and assistance in coping with the impact of unemployment. The PA’s wage bill alone is equivalent to 22 percent of GDP . The result is a growing dependency on donor aid for the prevention of fiscal collapse. In 2008, external aid to the PA amounted to nearly 30 percent of GDP.
In this policy environment and pending a political resolution to the conflict, aid should be recognized for what it is -- more of a stabilizing measure, slowing down socio-economic decline, than a catalyst for sustainable economic development. Large amounts of donor aid have produced insignificant growth and an increase in economic dependency, despite the consistent improvement in PA governance and security performance described in this report. If this trend is to be reversed, donor funding needs to be accompanied by efforts to improve the environment for private sector growth by reducing the economic restrictions regime.
Even under the most extreme of circumstances, however, some fundamental truths remain clear and donors should be wary of steps that undermine them. First, fiscal and monetary stability and a functional PA are key to exploiting the economic potential of West Bank and Gaza (WB&G) when it becomes possible and to continuing provision of basic services in the immediate term. Therefore, neglect of PA budget support and bypassing of PA institutions in disbursement of aid is counterproductive, particularly given the PA’s good performance in public financial management (PFM), as shown in this report. This is also true for Gaza, where a number of PA agencies continue to function effectively as donors examine modalities for supporting reconstruction and recovery.
Second, the strategic goal of an economically viable Palestinian state is achievable only if Gaza and the West Bank are maintained as an integral economic entity. Schemes that attempt to create economic islands in individual West Bank cities or the Gaza Strip are development dead-ends that also have the potential to make the ultimate establishment of an integrated economy more difficult. Indeed, the fragmentation of WB&G’s economic space, both in terms of lack of access to external but also to local markets, makes the development of more advanced forms of division of labor and integration into external markets impossible . At best, such schemes may create the illusion that economic prosperity can be de-coupled from a political horizon.
Third, stand-alone development projects that do not contribute to long-term private sector development and a sustainable economy have limited impact, comparable to cash transfers. At the same time, development projects can only serve as a stimulus if the private sector has the economic freedom to exploit them for growth. Thus, for example, real reconstruction of Gaza – one including some revival of the moribund private sector -- entails not only the opening of the crossings for building materials and cash, but also enabling external trade so that the revitalized private sector can continue to mend and flourish.