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Source: United Nations Conference on Trade and Development (UNCTAD)
4 May 2017

The Occupied
Palestinian Territory:
Twin Deficits or an
Imposed Resource Gap?

Executive summary

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 occupation in 1967 have significantly distorted and disoriented the Palestinian economy. The results are reflected 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 disequilibria, namely a trade deficit in the balance of payments, a savings deficit (national investment in excess of national savings) and a government budget deficit. In 2010-2014, the averages of the three deficits, as a percentage of the gross domestic product (GDP), were 40 per cent, 33 per cent and 8 per cent, respectively. 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.

This 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. Furthermore, application of the Granger causality test disproves the hypothesis that changes in the trade deficit were caused by changes in the budget deficit.

Rather than reasoning in terms of one deficit causing the other, this 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.

The 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.

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.

Analytical and statistical evidence suggests that the resource gap cannot be closed through traditional policies used in other economies that are not occupied or in conflict or post-conflict situations. Given this context, this 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. A prerequisite 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.

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.

(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.

(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.

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. 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 also 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.

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