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The Palestinian Economy: Recent Experience and Prospects in 2010
Friday, January 22, 2010
Edited
Transcript
of Remarks by Dr. Oussama
Kanaan
Transcript No. 324 (1 February 2010)
Transcript No. 324 (1 February 2010)
To view the video of this briefing online, go to
http://www.thejerusalemfund.org/ht/display/ContentDetails/i/8923/pid/3584
The Palestine Center
Washington, D.C.
22 January 2010
Dr. Oussama Kanaan:
Thank you very much. Thank you, Yousef. I am going to try a new approach in presenting the developments and prospects this time. I was just talking with Yousef about how the numbers could really have an effect of a smoke screen very often and then you will have very often cases where the media picks on certain numbers and no matter how well you explain the context of it, the general effect that has on the interpretation of the economic conditions is misinterpreted. One important case and point recently is, my team had produced figures for the real [Gross Domestic Product] GDP growth for 2009. A projection at that time, a few months ago, and we projected a rate of growth for the West Bank at 7 percent and data so far are in line with this projection. That provoked a huge debate in the media. On one side, we had people who are trying to interpret it as meaning that you could have growth that is sustainable even under occupation and therefore this idea of economic peace that some are espousing, which if its interpreted to be economic peace without complimentary progress on the peace front, it’s possible. And others think well actually this is very unlikely that you could have that rate of growth. And comparisons were made, for example, with Singapore or with countries that had such high rates of growth and that was sustainable. So what I tried to do, and that’s perhaps an experimental approach, is to really focus on the qualitative aspects and the core issues. And for all the technicalities and all the numbers I invite you to go to the [International Monetary Fund] IMF website. We have the latest report that is published there so you could see all the numbers, all the technicalities. But here, I just want to try an approach in which I’ll try to be as qualitative as possible and focus on the core issues and try to give a sense about the forces that exist and are operative in the West Bank and Gaza that could lead to a normal life. I think this is really the core of it. We have started mid- 2007, right after the era of government by Hamas, by having an extraordinarily constrained situation and we have been moving very slowly towards normal conditions in the West Bank. And in Gaza we have a deterioration. But nevertheless, what we try to ask ourselves is, ‘What are the forces that exist that the Palestinians, the Palestinian Authority (PA) in particular as the agent, as the body, that as the policy makers could use as a basis for economy development even under those constraints?’
So just to give a retrospective of what has happened since mid-2007, if you remember the government of [Palestinian Authority] Prime Minister [Salam] Fayyad took office around the spring of 2007, right after a period of financial sanctions and a period in which the public finance management system was highly fragmented. The main challenge, from an economic stand point of the Palestinian Authority then, was to use fiscal policy and to try to bring back order to the public finance management system as to provide minimum conditions for institution building in the West Bank and Gaza. So what we had then is a budget that was largely aimed at, or largely consisted of, wages and salaries. Half of the expenditures consisted of wages and salaries. About 20 percent consisted of either of utility subsidies or of social transfers. So basically you had a budget that was aimed, or could be actually described as a large social safety net, to an important extent; a social safety net that tried to compensate for the fact that since the year 2000 the economy of the West Bank and Gaza passed through very difficult conditions and very tight restrictions were imposed on the movement of people and goods. It’s what we call restrictions of movement and access. As the consequence of that, the private sector growth suffered a lot and the economy itself shrunk tremendously.
I’ll try to just, maybe violating my rule-- just to give you a sense of the decline in the economic activity that took place--between 2000 and 2007 GDP per capita declined by about 30 percent. So people were on average 30 percent worse off in 2007 than they were in 2000. That pushed the government to use its budget, its public expenditures, as a social safety net to compensate for that. Now, what that means is that in the context of limited donor funds, you had a diversion of resources from areas that are conducive to growth, which is public investment, which invests in human capital and towards areas that just help people lead a normal life [and] provide the basic needs of people. So the challenge of the Palestinian Authority was first, to try to target the social assistance to the truly needy people. Public employment was not to be used anymore as a kind of social safety net or as part of the social safety net, but try to actually use a system of well targeted transfers and to limit the increase in public employment to health and education.
Second, the task was to actually, by the same token, phase out all the subsidies, except for the truly needed, for the poor people. Of course, politically that was very challenging because you are doing so you are actually having physical retrenchment in a situation where the economy is shrinking or it has the experience of very sharp shrinkage and people were expecting at least that donor aid and donor public investment compensated for that. Basically it was a situation where you had crisis management as supposed to a policy that is aimed at true development. Now, if you look at the three year program that the PA had, it really targeted first, a reduction in the recurring fiscal deficit which it said, ‘look, we are going to actually reduce (given the constraint on donor financing), we are going to reduce the recurring budget deficit towards a sustainable level’. Towards a level which really aimed at the long run, to use only domestic resources, domestic revenue. And that would allow a shift in donor aid from the recurring budget, that’s really affectively a big social safety net, and towards more productive areas that are conducive to growth.
So far, the picture is as follows, there has been a social adjustment as of 2008. In 2009 the adjustment continued but was disrupted, really, by the war in Gaza. The war in Gaza added 300 million dollars to the budget and therefore, the older fiscal adjustment that was intended had to be really qualified because of the emergency spending that had to take place in Gaza. But nonetheless, we can say that there was a prudent fiscal policy, transparency and accountability was in enhanced substantially. The auditing that is taking place is very rigorous within the ministry of finance and to actually make sure that the money goes where it is intended. The standards that have been reached so far compare very favorably with those of most developing countries; are comparable actually to many developed countries. So, this achievement on the fiscal front is important; especially important in the West Bank and Gaza because of the absence of a currency. Fiscal policy is the main tool of macro-economic policy making. What effect did this have? First, it allowed donors to gradually shift their spending to the other areas, what we see as the productive areas. It also had a positive effect on the private sector; all the arrears that had been accumulating prior to the advent of the Fayyad government were cleared. People were being paid on time and, most important, the private sector started gaining confidence in the ability of the Palestinian Authority to actually manage its finances. The confidence on the private sector was very important. It had an important effect.
Now when one looks at growth, and the determinants of growth and trying to actually grasp the importance of the private sector, GDP, you have private consumption plus private investment and then you have public consumption and public investment and net exports. Net exports is constrained in the West Bank and Gaza by the fact that you had very tight restrictions on movement and access. But also you had no outlet, direct outlet to external markets. There is no sea-port. There is no airport. So, net exports are constrained.
Private investment in an economy that has such a small market also is constrained and cannot really grow without the opening up of the economy, and the ability to export to markets other than Israel. But also, the exports to Israel itself have been severely restricted since 2000. So basically we have a small domestic market and a private sector that really depends for its growth, to an important extent, on first, the indirect effects of donor aid. Donor aid through 2nd round, 3rd round effects, has a positive impact on private sector activity and it has benefited, as I said, from the confidence of having an Authority that can fulfill its obligations, can honor its obligations and can provide the minimum institutions needed for private sector activity to be conducted normally, despite the restrictions imposed by the Israelis.
So, in terms of growth what has happened since the advent of the Fayyad government is first, an important confidence effect on the private sector. Security conditions improved because you had a redeployment of the police forces inside the cities. You had the private sector being paid on time, the providers of goods and services to the Palestinian Authority, being paid on time and arrears, the debt that had been accumulated, was settled. Second, the reforms of the Palestinian Authority and institution building were supported by donor aid and donor aid went largely to support the institution building of the PA, as supposed to the expansion of public employment or other subsidies that would actually indicate, or would have indicated to the private sector that the fiscal situation would continue to be out of control. So there was really a sense that you have a government that is gradually restoring fiscal sustainability. That has an important confidence effect on the private sector and that was translated, not so much in increased private investment, but in a better utilization of existing resources. So given the available pool of labor force and giving the capital stock, you had a much higher output than had prevailed prior to 2007, prior to the advent of the Prime Minister Fayyad’s government.
So if you look at what has happened in terms of growth; construction went up in important areas of the West Bank, especially in the areas in which restrictions were relaxed. You have the growth in Gaza, still, around zero or 1 percent in 2009. So, Gaza itself did not benefit from the restrictions. Nevertheless, the blockade was eased. But despite this easing you still have some very unusual constraints, even when the PA pays the salaries or credits the accounts of employees in Gaza. Still those workers don’t necessarily have the cash to actually draw their salaries. So you still have anomalies and you still have constraints that make it difficult for people to cover their basic needs even in a situation where public finances are in order. But nevertheless, we can say that in the West Bank you have restoration of confidence and a big, positive impulse from the relaxation of movement and access in major cities in the West Bank.
So we have a really gradual moment of normalcy in the West Bank, a situation that is still very difficult in Gaza but overall, an improvement in living standards. Still, it’s important to emphasize that in terms of levels, the level of real GDP per capita, is still well below that which prevailed in 2000. So the growth, if you just talk about the growth story without putting it in context of an economy in which output is well below potential output in which you have a severe under utilization of resources, then it’s very easy to actually confuse this growth with a good health of the economy. The economy is still well below potential in terms of output and the basic needs of a large part of the population are still not covered.
Now in terms of the prospects, there were several articles which actually make it appear as if this relaxation of restrictions on internal movement and access is sufficient for the growth that was witnessed last year; about 7 percent to continue over the long term. And if you look at our own studies, the message is very clear that two things need to happen for that growth to be sustained. First, that is based on the experience of almost all developing countries that have a small domestic market, all economies that have a small domestic market depend on the expansion of the export sector, for a sustainable growth in real GDP per capita. So no economy, according to the data that we have, no economy was able to grow in a sustainable way without its own export sector expanding. So simply by relaxing the restrictions on internal movement you could have, in the short run, an increase in growth just because the existing resources are better utilized. People are able to make better use of labor and capital to produce more output without necessarily actually reducing unemployment or reducing the investment rate. But just because people are able to trade from one city to another, for example, are able to have a normal life, whereby inputs can actually enter the cities and be used in production processes that were highly repressed to start with.
One important condition is the removal of the barriers on exports. First, the barriers on exports of goods and services to Israel have to be removed, this is the first condition. For an economy that does not have a seaport and an airport there is no other alternative, for this year I think, if you want to see a rate of growth that really is in the order of 7 percent. There is no alternative from having those barriers removed. Second, and as much as possible, the access to markets outside of Israel have to be encouraged. That is, we have to find a way in which in addition to access to Israel, exporters could trade with the rest of the world. This is an important element of the current two year plan by Prime Minister Fayyad where he is actually aiming at having a seaport, a functioning seaport [and] a functioning airport. Perhaps, this could not realistically be done this year but at least as an objective to be presented and to emphasize the importance of having an export market other than Israel. Second, this is something that I think is not well understood by most people, 60 percent of the land of the West Bank cannot be used economically without permission of the Israeli authorities. That is the area, Area C. So 60 percent of the land is out of bounds for the private sector. I think if we want to see sustainable growth then it is important for that constraint to be removed. In Gaza – the blockade itself, the persistence of the blockade, even in its current intensity where some basic goods can enter, but still for such a small economy, if you want to consider the economy of Gaza as a sort of sub economy of a bigger Palestinian economy – you cannot have growth even in the order of 3, 4 percent in the long run if it remains under such tight constraints.
If you look at the strategy of the Palestinian Authority now, what they aim to do is their utmost of the current conditions, that is continue to build institutions, continue with improvements in the public finance management system [and] continue to shift the composition of spending from the social safety net to the more productive areas. But still, there are two key constraints which will restrain growth for this year and over the medium term, which is the expansion of the export market first, and second the use of the full area of the West Bank and the relaxation of this constraint that Area C cannot be used by the Palestinian private sector.
I tried to distill the main messages without the usual technicalities or the numbers or the permutation with the full frame market, that you can read in our reports, but essentially these are the main messages. I encourage you to read carefully both, our own work, the work of the IMF team, but also there are very important strategies that have been presented by the Palestinian Authority. There has been an important qualitative shift and the strategy of the Palestinian Authority to develop the Palestinian economy. I think there is very often skepticism that the Palestinian Authority cannot do much given the occupation. Therefore anything that is presented in a positive light really is giving credit or is making it appear as if life could be conducted normally under occupation and that you could have development under occupation. I think this is a personal derivation. It has backfired in many ways. First of all, it really sends a message to people, to the Palestinians, that, look, you have the occupation, you have these constraints, there is not much you can do. The public sector is bloated. You have all these constraints on your daily activities so what is it that you can accomplish. I think the advantage of a division that was presented in the two year plan is it showed what can be done despite the occupation; that you can have development. [It] doesn’t mean that it’s a situation that is ideal or that can actually be accomplished in the longer run or could lead the longer run to sustainable growth. But nonetheless, it means that the Palestinians can improve the situation with very specific benchmarks in a very clear vision despite the constraints of the occupation. I think this is one of the important contributions that the current government in Palestine has made. That is to look at the constraints and ask what is it that could be done and how can we make the best use of the external resources that we have to promote development. And that is especially important given that human capital has been severely degraded in the West Bank and Gaza.
It is one of the surprises for me when I went to live in Jerusalem a year ago, even though I had been going on missions before. But coming and living in East Jerusalem and interacting with people on a daily basis, you see that you have a whole generation that has suffered in terms of human capital, schools were deprived of basic resources. Even if they had the resources they were very often closed due to the conflict. The resources were diverted like I said, from areas as I mentioned, of fiscal capital but human capital as well. Resources [that] would have gone to schools were diverted to just be able to provide the basic necessities of the population. The strategy itself has a component that aims at developing human capital and to allow or to say well, there is not much that can be done. It would allow to this continued degradation weakens the population and therefore makes it less able to resist the occupation in the long run. So this is really one of the advantages of having such a positive vision. Identifying the forces that really exist and are operative and seeing how these forces, despite the constraints, can lead to an improvement in the economic conditions. A vision that had never been presented before in such a way and today we have criticism that how can you have such a vision when you have an occupation and therefore is directly or indirectly an endorsement of the occupation. So this is really the spare if you want to look at the strategy when you examine the IMF reports or you examine the strategy that has been presented by the Palestinian Authority this is a useful way to look at it.
Second, I think it is not very helpful to start or to attempt to use numbers to compare, or to allow a comparison between the Palestinian economy and the other economies that have normal conditions. For example, I read in several articles a comparison between the growth of the West Bank and Gaza and the growth of Singapore. You have extraordinary conditions in the West Bank and Gaza where you started with severe restrictions on the movement of people and the movement of goods and the access of external outlets. Then you had the advent of the Palestinian Authority and you have positive contributions by the donor community and then some relaxation by the Israelis on internal movement, that was affecting certain numbers, those numbers have to be put in context and they are not comparable to the numbers that we see in other economies that have witnessed such a high rate growth.
I am now open to any questions you have.
Dr. Oussama Kanaan is the IMF Chief of Mission and Resident Representative for the West Bank and Gaza.
This transcript may be used without permission but with proper attribution to The Palestine Center. The speaker's views do not necessarily reflect the views of The Jerusalem Fund.