Palestine: The Israeli Occupation and the Limits of the Palestinian Economy

Video and Edited Transcript
Dr. Oussama Kanaan
Transcript No. 372 (10 November 2012)

10 November 2012
The Palestine Center
Washington, DC

Dr. Oussama Kanaan:

I just saw a few people grabbing the paper that I put out and leaving. I am usually very eager not to repeat what is in the paper. So what I would like to do then is adopt a different approach from the one that is in the paper really to answer questions that [I was asked] over the past few days when people knew that I would be talking about the present economy.

I think the most frequent question was, all these Arab countries are now prone to having an “awakening,” the ‘Arab spring’ phenomenon that has affected so many Arab countries—how likely is it that the awakening will also take place in the West Bank and Gaza?

So what I would like to do today is to really mold the presentation to be able to shed light on this question. And I would like to shed light on it from an economist’s perspective because many of the factors that have contributed to the awakening were economic, though the political factors were also very important. I would like here just to shed light on the economic factors, and I think the best way to do that is really to put myself in the shoes of an ordinary person in the West Bank and Gaza and ask, what are the factors that would be particularly relevant, or would actually be conducive to this contemporary uprising?

I would like to start by just showing you one slide. In the presentation, I just want to focus on the implications of what we see here which depicts the path of [Gross Domestic Product] GDP per capita in the West Bank and Gaza since the Oslo Accords. First, think from an ordinary person’s point of view. The GDP per capita, which reflects the standard of living, is an important factor to be taken into consideration. I think that if you look at the most recent growth in the West Bank and Gaza since 2007, you will see that—as depicted here—the growth rate in the West Bank has averaged about seven percent, real GDP per capita [growth] has averaged at about seven percent, a very high rate of growth.

In Gaza, there has been an important dip in real GDP per capita, but there has been a very important surge in growth after the blockade was eased, notably after the import restrictions on goods and services had been lifted. They had been lifted mainly for consumer goods as well as for imports for the public investment program. So if we look at the recent performance, it is indeed very impressive. However, I think here in this graph, we take a longer-term perspective and we ask, what has happened since 1994? And here you see that the real GDP per capita in the West Bank and Gaza, in 2011 in the West Bank has been only slightly greater than what has prevailed in 1994. So even though there is a surge in growth that is recent, really if you compare it with where we started from after the Oslo Accords, it is really a very modest increase.

Now for Gaza, the GDP per capita has been well below the level in 1994. Today, it is estimated at about 40 percent lower than what it used to be in 1994. So from the point of view of the ordinary person, what matters really is his or her standard of living. To what extent did it improve over the last, let’s say, 20 years? The question of growth is important because it indicates the improvement of the living standard. But still, what’s really crucial is that the level is not much higher than it used to be in 1994.

Now, in many of the Arab countries that have experienced this awakening, the long-term growth and the level of real GDP per capita has been really an important factor, I think, that has contributed to this content. There may have been recent growth, there has been growth over the past two, three, four years, but still, in the long run, if you take a long-run perspective, the improvement in real GDP per capita has not been that substantial, especially not when compared to countries in other regions of the world. So this is one indicator. I think it is important to look at the long-run perspective, where did we start from, where did we end up, not only look at the past three or four years.

I think another important factor is how widely this growth is distributed in the economy. It is important to know on average, if you take the real GDP and divide it by the number of people, is it high or low, and to what extent did it grow in recent years, but it is also important to ask how widely shared it is.

Now, if you look at the experience of the Arab countries that have experienced some awakening, you will see that there has been a disparity. First of all, geographic disparity. There are other disparities such as social classes and so on, but [geographic disparity] is an important one, for example in Syria. In Syria, the uprising started in rural areas. In rural areas, even though we don’t actually have any data but that we suspect have not really benefited from overall growth as much as in other regions, let’s say Damascus or the Aleppo region.

Now, I think the case of the West Bank and Gaza is enlightening because we have separate data for the West Bank and for Gaza. So these are two different regions and we see here from the graph that the real GDP per capita of Gaza since 1994 has declined to a much greater extent than in the West Bank. That is due to two factors: one is the very tight blockade imposed on Gaza for a substantial period of time, and second, the separation from the West Bank, the fact that it’s not actually linked to the West Bank in any way. Since the blockade, Gaza has not had access to an outside market. It has a very small market which makes its access to outside markets, [being able to] export its goods, really important for its growth. So here this is the first disparity. We see there is a regional disparity between the West Bank and Gaza. So growth has not been evenly distributed geographically and we can see that clearly here by looking at the data for the West Bank and Gaza.

What about within regions? Let’s say, what about within the West Bank? Unfortunately, we do not have data on the distribution of growth within the West Bank. However, what we can say on a priori grounds is that there were certain factors that have actually made it more difficult for some regions to grow as fast as other regions. Very simple fact, 60 percent of the land of the West Bank is highly restricted for public investment and for private investment. That is, 60 percent of the land of the West Bank–which is mostly the Jordan valley—cannot be accessed by the Palestinian public sector and Palestinian businesses except with special permits from the government of Israel. So even though we do not have data on the extent to which those living in those areas, especially the Jordan valley, [who have experienced] their incomes rise or fall or to what extent they are different from the West Bank at all, nevertheless, on a priori grounds we can say that since this huge area—60 percent—has not been accessible to investors, has not been accessible to public investment from the Palestinian Authority (PA). It is bound to have grown to a much lesser extent than other areas.

Another important factor is really the separation of East Jerusalem from the rest of the West Bank. There are three factors that have contributed to growth in the West Bank overall. One is solid institution building, fast institution building, by the PA. Notably in public finance management reforms, the development with the Palestine monetary authority and the establishment of security conditions in the West Bank. [Those] have really given confidence to the private sector and have bolstered private sector confidence and investment. The Palestinian Authority doesn’t have a presence in East Jerusalem, so this important factor has not affected East Jerusalem–East Jerusalem has not been able to benefit from it.

A second factor that has contributed to the recent growth in the West Bank has been very large amounts of dollar aid given to the PA, both to finance the recurrent budget as well as to finance development projects. And East Jerusalem has not benefited from that. Very little of that donor aid has been given to East Jerusalem.

The third factor is the relaxation on movement within the West Bank and Gaza, the relaxation of restrictions on movement and access affecting the West Bank. For those of you who recall, in 2006, there were very strict restrictions put by the government of Israel on movement within the West Bank and gradually these have been relaxed. There are still very important restrictions in place, but still, the relaxation, the easing during that period has contributed to growth in the West Bank. To a lesser extent than the other two factors, institution building and dollar aid, but still, this has been a significant factor.

East Jerusalem, on the contrary, because of the building of the separation wall between the West Bank and East Jerusalem, has been more isolated from the West Bank. That is, the traditional market for East Jerusalem has been in the West Bank, that has actually been much less important today than in 2007. So we can say, even though we do not have data that actually tells us to what extent East Jerusalem has grown in recent years, to what extent is it better off or worse off than the rest of the West Bank, we can say that the factors that have driven growth in the West Bank have not been present in East Jerusalem. So here we have really a high likelihood of geographic disparity, first between Gaza and the West Bank and then within the West Bank, between the Jordan Valley, East Jerusalem and the rest of the West Bank.

In terms of the composition of that growth, what sectors [of the economy] does this growth benefit? If you look at 1994, about 20 percent of GDP came from industry, and about 13 percent came from agriculture. In 2011, the share of manufacturing fell from 20 percent to 10 percent and agricultural production fell from 13 percent to about 6 percent, more or less about half of the shares that used to prevail. That’s actually important because it tells you that the sectors that usually are the engine of growth that are quite dynamic, are now much less important. Why? Because what happens in 1994 is that the restrictions on exports have actually increased tremendously. It is now much more difficult to export from the West Bank and Gaza today than it was in 1994. And so those sectors that depended on the growth of external markets are now playing a much less important role than they used to. Again, this feeds into economic disparity. To what extent are the fruits of growth widely shared? This has been an important factor as we have seen in other Arab countries, and it is bound to be an important factor in the West Bank and Gaza.

Another interesting conclusion from this graph, as you can see, is that real GDP per capita does not only have a downward trend for Gaza and is rising very sluggishly overall from 1994 for the West Bank, but there are actually cyclical fluctuations, it goes up and down. And it goes up and down depending on the restrictions of movements depending on the recurrence of the conflict. So that’s important because for the population, it is important to have some certainty, some sort of feeling of confidence that whatever gains are established today are going to last and are not going to be reversed.

So here if you look at the growth since 2007, it has a steady growth (for Gaza, this is much later than 2007), if you look at then the longer run, the shaded area here that goes into 2014, you will see that what is really special about this, the dips that you see in the past do not recur. If somebody just came from Mars and looked at this graph, he would say that it is very interesting that before, you had ups and downs and now when you are projecting, it is supposed to go up. So what has changed since 1994 in terms of the actual fundamentals that are driving this strange economy? And here what we can see is that there is a very high risk that we will see another dip. So if you look at the shaded area, this is a projection, and there is a high risk that it will dip again, in both the West Bank and in Gaza. And you can see in the pessimistic scenario, and the actual outcome could be even more pessimistic than what is here described.

What are the factors that could contribute to this dip over the next year or two? I think the one factor that is very important is donor aid. Donor aid has experienced very sharp shortfalls recently, and delays. If you look at the aid given to the PA, its magnitude has diminished both in dollars and real GDP because the PA itself has become much more efficient in using its expenditures. The aid has gone down from $1.8  billion in 2008 to about $1 billion today.

This really reflects the Palestinian Authority’s own strengthening of the public expenditure measurement framework. It has established a social safety net, so that those who are really truly needy get the money as opposed to having the social transfers go to those who do not need them. Electricity subsidies are being phased out. Overall, the non-priority spending has diminished substantially. So there has been progress that has been attributed really to the more efficient management, expenditure management in the PA. However, there’s also, and especially in recent months, there have been shortfalls and delays in the disbursement of that money, so that the PA has had to compress expenditures beyond what would be viewed as prudent. It’s important to actually be more efficient and reduce expenditures, but it has to be based on a reasonable budget. It has to be based on an orderly process. Now the aid recently has been much less than budgeted, which has actually both disrupted some of the functions of the PA, but also it’s reflected in the growth. The growth actually doesn’t have the same stimulus as in the past from donor aid.

Second, the restrictions on movement and access by Israel which have started to be relaxed; the base of this relaxation has diminished considerably. So there’s no more impetus from this easing of restriction. In the case of Gaza, we have seen in 2010 the restrictions on the import of consumer goods and of goods that go to public investment projects haven’t been lifted – there has not been any further relaxation in 2011. And so this is the second. The three actual important contributors to growth (institution building, donor aid, relaxation of restriction of movement and access) are now no longer present to the same extent.

There is also right now an important factor that actually is contributing to the uncertainty that was back in Gaza, which is the delay in the transfer of clearance revenue. Two-thirds of the revenue of the Palestinian Authority is collected by the government of Israel, on behalf of the PA, and transferred to the PA. We have seen in May a delay by about two weeks in the transfer of these revenues to the PA, which has actually delayed the payments of wages and salaries. We have had the recurrence of this in recent days, whereby the clearance revenue transfer has been delayed, and we hope that it will be transferred soon, but really it poses a big question mark to the private sector: how viable is this Palestinian Authority? Is this government really viable? If two-thirds of its revenue is collected by Israel and is subjected to this political uncertainty, how can we rely on the Palestinian Authority, for example, to pay not only to pay its wages, but its obligations in the private sector? The private sector provides goods and services to the Palestinian Authority. The Palestinian Authority has accumulated important arrears, domestic payment arrears, has not been able to pay on time its obligations to the private sector, and this tendency has actually be exacerbated by the delay in the transfer of clearance revenue.

So all these factors actually are posing serious risks to this upward trend that is projected here. And so, for the ordinary person looking at the next one or two years, and seeing where this economy came from, where this standard of living came from, what it is today, what are the risks… I think these factors are posing serious risks to this ordinary person’s outlook and his prospects for employment.

One important indicator here of the extent to which growth has been fairly distributed is the unemployment rate. The unemployment rate really declined very little. In the West Bank it declined from 18 percent in 2007 to 15 percent in 2011. So there has been a decline but it’s very modest. In Gaza it declined from 28 percent unemployment rate in 2007 to about 26 percent in 2011. So there has been really a positive movement, however, with these factors I just mentioned, the likelihood of this unemployment rising again is very high, and that we have seen in several of the Arab countries that have experienced the Arab Awakening. Unemployment is very important.

Youth unemployment is very high. Youth unemployment of those who are 30 years of age or below, in Gaza it is 40 percent unemployment, in the West Bank it is 25 percent. So this is another indicator that is important to take into account when looking at the likelihood that we will see deterioration in the economic outlook.

I’d like to say also a few words about institution-building. I think for many of the Arab countries that have experienced uprisings, an important factor has been how well are the public finances managed? And how transparent are they? In the case of the Palestinian Authority, it was clear that the management has been very efficient, it has actually implemented many of the best international practices with regard to making sure that subsidies are targeted to the two areas that I just mentioned by having a social safety net that protects the vulnerable social groups. And also by making sure that the average person has full access to the accounts of the Palestinian Authority — the public finance accounts. The data on revenues and expenditures, you can find, any person can go to the internet and see what has been spent exactly in what areas. Every month on the internet, the sources of revenues, and that’s done on the fifteenth of each month, after the end of the month. So today you can look at the data of October (expenditures, revenues, finance, how much money came from abroad). This lack of transparency in the other Arab countries has been an important factor in the discontent. For the Palestinian Authority, this factor does not exist. Transparency, how well the money is used, I think the institutional factor has been an important factor that I think would be taken into account by the average Palestinian.

Then how well is the financial sector being supervised and regulated? The Palestinian Authority has actually developed its capacity and has proven itself to be capable of regulating, supervising the commercial banks in an effective manner, and has actually made sure that there is a level playing field among different borrowers. Those who have special relations to the establishment do not have any preferential treatment. So this is an important factor – the institution building is an important factor.

So the level playing field, the strength of the institution, the extent of corruption; I think these are positive factors. However, what we see today is that because the public finance management system does not have the resources necessary, for example, if donor aid continues to fall well short of budget amounts, if the clearance settlement does not come in, then these institutions – even though they’re strong – are not able really to perform to their full potential. Same thing with the Palestinian Authority, it may have the capability and it may actually have the competence to supervise, and it has demonstrated that, however if the private sector is not growing, then there’s really not much to supervise as we move along and as we actually try to see the extent to which the borrowers are benefiting from this institution development.

With regard also to the extent to which some parts of the private sector are benefiting more than others from access to the establishment, I think one important factor which is not usually mentioned but I would like to actually highlight it here,  is that restrictions on movement and access not only have a direct adverse impact on the economy. But really by its nature it creates an uneven playing field whereby those who have special connections to the establishment are more likely to get these permits- permits to access the Jordan Valley, 60 percent of the land as I just mentioned a few minutes ago, permits to actually export to Israel, permits to obtain these special business licenses to be able to actually deal with Israel. So that’s actually an important factor that is creating discontent. The restrictions are there, ordinary people aren’t able to access markets as easily as before, but also there is a phenomenon of favoritism- some groups being favored more than others. That’s an important factor in some of the other Arab countries that actually contributed to discontent. Some parts of the private sector had access to the establishment, had favors given to them. That’s an important factor to be taken into consideration.

So, you know, we see important risks arising. You know, I tried to actually give you a view of the factors that have been relevant in other Arab countries and that have likely contributed to discontent and I think that unless we see movement on two main fronts (one, the relaxation of restriction of movement and access, second, donor aid that is adequate and timely) and measures to enable the strong institutions of the PA to actually continue to contribute to confidence and to growth. Unless we have these factors properly addressed, I think the outlook of the next year or so may not be that positive.

Oussama Kanaan is the IMF Chief of Mission and Resident Representative for the West Bank and Gaza. He has worked at the International Monetary Fund since 1993. He is the author of numerous publications which include articles in economics, particularly applied to countries in the Middle East (including the West Bank and Gaza), and the peace process. He holds a Ph.D. in economics from Yale University.

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.