1The period since the outbreak of the second Palestinian uprising in October 2000 has witnessed a debate on how best to set the Palestinian economy on the path of sustained recovery and growth. Palestinians are constantly reminded that they should think about the future, and establish the necessary building blocks for a viable state and economy. For after all, the ongoing confrontations will come to an end, and they should be prepared for statehood from day one of a political settlement.

2However, the discussion so far has been geared toward addressing future needs under a stable and conducive environment, and Palestinians are expected to draw on conventional wisdom in designing economic policy. They are advised to adopt across-the-board economic liberalization, and focus on reforming public institutions according to international best practices. The harsh realities on the ground tend to be discounted, and the evolving Palestinian State is often burdened with ambitious plans. Meanwhile, the Palestinian people’s ability to withstand the widespread economic crisis, let alone forge ahead with their preparations for statehood, is undermined by a range of persistent external constraints.

3If anything, the Palestinian economy is at its most vulnerable. The accumulated impact of prolonged occupation, denied sovereignty and nearly six years of war-like conditions have combined in a process of « de-development » that recent events have only accelerated and deepened [1]. The geographic fragmentation of the occupied Palestinian territory (oPt), intensified internal barriers and international isolation, are now coupled with sudden suspension of non-domestic vital sources of income, namely remittances from Palestinian workers in Israel, fiscal revenues and aid. The much sought after economic « viability », a sine qua non of realizing the vision of a Palestinian State co-existing peacefully alongside Israel in a post-occupation era, has been challenged as never before.

4Along with the threatened breakdown of central government functions, including vital social services in 2006, there appeared to be little momentum left to sustain the achievements of the Israel-Palestine accords since 1993. At the economic level, the functioning of the Protocol on Economic Relations between the sides and its continuing relevance is in question. In such a turbulent and uncertain context, the international community can realistically hope to achieve only so much when it comes to assisting the Palestinian people in economic and social fields, as mandated by the United Nations General Assembly and as demonstrated by the work of its agencies.

5As the only international agency to have examined regularly for the past two decades the challenges facing the development of the economy of the oPt, the United Nations Conference on Trade and Development (UNCTAD) secretariat has been able to derive lessons of past events and experiences, so as to better understand current economic developments and how to best deal with them, including through technical assistance activities. Regrettably, it is hard to discern today a major transformation of the broad outlines of the Palestinian economic predicament as it has evolved since the first series of shocks, which began with the first Palestinian uprising in 1988.

6Building on UNCTAD research and analysis work, this paper highlights major policy challenges to Palestinian economic development efforts. It also advances policy options that take into account present political and economic realities, while addressing the requirements of establishing the necessary institutions for the future Palestinian state.

Getting the fundamentals right

7Central to understanding the root causes of the current widespread economic crisis in the oPt is an in-depth analysis of the limited self-rule experience during 1994-2000. Such an analysis requires going beyond a discussion of leading economic performance indicators, since these can be misleading. Official Palestinian statistics depict the Palestinian economy as enjoying remarkable growth, especially since 1998. Real gross domestic product (GDP) growth was estimated at 6 % in 1999, while real per capita gross national income (GNI) growth was estimated at 3.5 %, bringing per capita GDP and per capita GNI to $1,651 and $1,965, respectively. The proportion of the population living below the poverty line decreased by 3.5 % during the period 1996-1998, from around 27 % to 23 % [2].

8This growth masked deep-seated structural imbalances and weaknesses inherited from the occupation period, namely an impoverished supply capacity, a high unemployment rate and a growing trade deficit. The widespread economic crisis since October 2000 has aggravated these structural imbalances, and transformed the oPt into a « war-torn economy ». The economic legacies of war identified in comparative research on conflict economies are relevant in recognising the true nature of the Palestinian economic predicament : structural deterioration and sustained negative growth ; declining export capacity and emergence of an unsustainable trade gap ; fiscal pressures as expenditures outpace revenues and the budget deficit widens ; a shift towards non-traded activities and de-formalisation of the economy ; deterioration of real incomes, per capita consumption and savings, greater external dependency and extended poverty.

9The need for a proper conceptualization of the Palestinian economy’s development predicament cannot be over-emphasized. As shown below, such a conceptualisation contrasts the claims of the automatic benefits conferred by unfettered liberalisation, and highlights the necessity of tailoring the development process to the economy’s present distinctive features and institutional set-up.

States, markets and distorting policies

24Development experiences show that contrary to the prevalent wisdom, government intervention does not necessarily distort development and that the state has a major role to play in generating growth. This is especially relevant to the case of the Palestinian state under formation that is confronted with a paralyzed economy, characterized by a paucity of market incentives. The PA needs to revitalize economic activities through adopting time sensitive strategies that promote a limited number of sectors in a given period (capital and labour intensive) ; correct incidents of market failure ; and create profit/investment nexus in priority sectors. The focus should be on establishing a « rent creation plus » discipline, using a proper mix of rents (subsidies, incentives, etc.), and temporary protection of selected priority sectors. In so doing, these policies should seek to address existing distortions (both internal, such as imposed lack of resources, and external, such as the war-torn economy conditions). Otherwise, the PA and the international community risk adopting distorting policies by acts of commission (i.e. creating distortions that reduce development potentials) or by acts of omission (i.e. by failing to remove existing distortions). In fact, successful development policies in the Palestinian context can be expected to be unorthodox.

25In view of the above, the PA reform agenda to date, including its economic components, has not responded to the realities of the war-torn, (effectively) land-locked, occupied Palestinian economy. It lacks measures to alleviate external constraints and is an ambitious, if not unrealistic package. Rather than tackling immediate institutional bottlenecks, the PA reform agenda (as elaborated until 2005) describes where the PA hopes to end up once it achieves statehood. As such, it overwhelms Palestinian policy makers with a multitude of best practices that only sovereign states can handle and which usually take the lifetime of more than one government. Reform efforts should be based on a well orchestrated development strategy that is geared to respond to the strategic imperatives of Palestinian national sovereignty, and not on reforming public institutions intended for a transitional phase, in addition to overcoming incidents of market failure.

26More than anytime in the past, international aid is becoming a critical element of Palestinian reform and development efforts. However, while the quantity of aid is important, it is the quality of aid that matters most. More aid is better if and only if it is non-distorting ; that is if it assists the recipient government in implementing non-distorting policies or removing internal and/or external distorting constraints. Aid policies should be based on the Palestinian people’s vision of a future national economy, with a view to overcome distorting constraints to development. This means that for aid to be non-distorting, it should seek to dismantle the policy of asymmetric containment or support specific strategies aimed at reducing Palestinian vulnerability to it. This includes supporting the PA budget and avoiding top-down approaches to aid disbursement, which involve replacing PA institutions with NGOs or private sector institutions. Otherwise, years of institution building efforts will have been in vain and the prospects of establishing a viable Palestinian economy undermined. This renders technical assistance for institution building in the current conditions almost as imperative as humanitarian or budget support.

Trade policy, poverty reduction and growth

27Among the main challenges facing the Palestinian war-torn economy is the loss of one third (estimated at $4 billion) of its 1999 capital stock as well as the chronic trade deficit with Israel, where the annual average of this deficit was $300 million larger than the annual average of $1,2 billion of donor support since 2002 [11].

28Policy advice by international institutions and donors on the optimal trade regime for a future State of Palestine tends to equate trade policy with development strategies. Trade openness, along with deregulation and privatization and full compliance with World Trade Organisation (WTO) rules and disciplines are depicted as constituting a development vision. However, development experiences elsewhere show that it is not always the case that trade liberalization directly reduces poverty, and that for trade to deliver development dividends the economy needs to have a diverse structure.

29Palestinian trade policies in a conflict/post-conflict phase cannot be developed in the abstract. They should be rooted in a national economic vision based on a development-driven approach to trade rather than a trade-driven approach to development. Trade is but one element of development policy, and trade expansion is the outcome of several policies and is a lengthy process that requires years, if not decades, of intensive efforts. The all important considerations of pace and sequencing compliance with WTO rules are relevant for Palestine, and the PA could use trade policy to support industrial and other policies.

Main elements of a Palestinian national vision

34Palestinian economic recovery requires first and above all dismantling the policy of asymmetric containment, or pursuing a strategy to deal with it and related distortions as external constraints in the short term, while at the same time working towards their elimination. While this may not lead to a high-growth recovery, it can help halt or reverse the adverse path dependence.

35At the same time, future economic rehabilitation and peace building efforts cannot take as their goal a return to the pre-2000 situation, and efforts should address the economy’s present needs, as have emerged since. Palestinian development efforts should focus on alleviating poverty, while closing the resource gap and reducing dependence on Israel. This requires rooting development efforts in a strategic vision that seeks to create dynamic synergies between immediate and long term needs. In the sense that emergency and rehabilitation efforts should be designed to accumulate development gains, no matter how modest, through building on coping strategies, assisting the poor in diversifying their sources of income and supporting domestic productive and service supply-side capacities.

36The necessity of setting sectoral priorities and aligning economic policy around the development objectives cannot be over-emphasized in order to ensure an efficient allocation of resources. Of equal importance is to base the strategic vision on a wide participatory approach involving civil society and government, and draw on successful development experiences as well as less successful ones. Most notable in the latter respect are the experiences of Latin American countries, where policy prescriptions emerging from the Washington Consensus did not produce expected results. This has been recognized by the Bretton Wood institutions (BWI), whose reports confirm historically low growth rates, worsened income distribution, no diversification of economic activities, high volatility, etc. The Latin American experience gave birth to a new development paradigm that is still taking shape. At the heart of this paradigm is the recognition that there is not a unique, fit for all fiscal policy, and that governments should act in four areas to ensure sustained growth :

• Industrial policy : to address incidents of market failure, enhance positive spillovers into the economy, and coordinate externalities.
• Development friendly macroeconomic management : the macroeconomic framework adopted by Latin American countries was not conducive to development, featuring misalignments of exchange rates, excess interest rates, and so on.
• Distributive policies : these should be set much beyond the safety net promoted by the BWI, because economic growth does not lead to a fair distribution of income.
• Human resource development, without which low labour productivity persists.

37The results of UNCTAD projections also show that the sustainability of the Palestinian economy’s growth requires :

• a national socio-economic vision, even under current conditions, focused on forming national governance institutions ;
• an aggressive and comprehensive approach to integrate trade, fiscal, investment and labor policies to reinforce complementarities among them within a single framework ;
• considering a national currency and reconsidering the existing fiscal and trade arrangements/policy framework in future economic negotiations with Israel ;
• aiming at tariff structure similar to those obtained by least developed countries under special and differential WTO provisions ;
• international support of the Palestinian vision without intervention or distortion.

Concluding remarks

38This paper highlighted the multiple challenges facing Palestinian development efforts. Recovery and reconstruction have to proceed against a background of attrition of the economic base, a war-torn economy distorted by prolonged occupation and dependence on Israel. Further complicating the task is the very limited policy space available to the PA, and the increasing need for donor support.

39The point has been made that setting the economy on the path of sustained recovery requires going beyond the conventional economic policy wisdom and tailoring the development process to the economy’s present distinctive features and institutional set-up. Such an approach should be based on a participatory mechanism and needs to be concrete in detailing policies for poverty reduction, with specific programmes that clearly link all types of aid, including relief, to long-term development objectives and a state-formation agenda.

40Above all this approach has to be clearly identified as a means to achieve a widely-accepted national Palestinian socio-economic vision to drive both domestic and international support measures, as well as the reform agenda, towards the establishment of a democratic, contiguous and economically viable State of Palestine. ?