Stagnation or Revival? Israeli Disengagement and Palestinian Economic Prospects – WB report

Stagnation or Revival?

Israeli Disengagement and Palestinian Economic Prospects

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The World Bank

1 December 2004

Introduction

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1. The World Bank’s June 23 report, Disengagement, the Palestinian Economy and the Settlements, warns of the potential disintegration of the Palestinian economy under the sustained pressures of conflict and Israeli closure policies.  The report describes a society which has, in the space of four years, lost all economic dynamism and experienced a recession of historic proportions. As a result, the strong social cohesion that characterizes Palestinian life has begun to crack, while the Palestinian Authority has lost credibility and effective control in several parts of Gaza and the West Bank. This is a situation which is potentially ruinous for both Palestinians and Israelis.

2. Today there is hope that the Israeli and Palestinian governments are once again ready to discuss their shared future. They would do so at a time when Israel is preparing, for the first time, to evacuate settlements established in Gaza and theWest Bank after the 1967 war, and when President Bush has just reminded the world of his wish to see the emergence of a “truly free” and democratic Palestinian state before the end of his second term. The PA’s decision to hold presidential elections in line with the provisions of the Basic Law and to follow them in May with parliamentary elections are very encouraging steps; and so too are indications from the Government of Israel of a new interest in holding direct discussions with the Palestinian Authority.

3. No state can be truly free with its economy in chaos and with the majority of its population living below the poverty line. While prosperity is no guarantee of tranquility, history teaches that the opposite is too often true – that destitution, political instability and violence are constant companions.

4. At this juncture, it is vital that policy-makers focus on stabilizing and reviving the economy as part of any new political process. For the PA to play an effective political role, it must preside over a period in which the Palestinian population experiences positive change in their daily lives – in their the ability to move freely, to trade, to find work, to earn a living for their families.

5. While money, and in particular donor money, has an important role to play in reviving the economy, it is not the determining factor. The last four years exemplify how little donor assistance can achieve in the absence of a positive policy environment – while donor disbursements doubled to almost US$1 billion per annum, real personal incomes fell by almost 40 percent in the same period.

6. To change this frustrating dynamic, the underlying causes of economic decline need to be addressed. It is important to emphasize this at a time of new hope, since it would be a mistake to respond to today’s potential opening by efforts to raise large sums of money without addressing the root causes of today’s economic crisis.

7. For a recovery to take place, the Government of Israel needs to roll backthe system of restrictions on the movement of people and goods imposed since the beginning of the intifada – it is these various closure measures that are the proximate cause of four years of Palestinian economic distress. Accordingly, much of the work of the Bank and donor team over the course of this summer focused on the various facets of closure, with the team benefiting from intensive, professional interaction with both parties. The Government of Israel’s willingness to engage with the donors on these issues spoke of a strategic reappraisal of the importance of Palestinian economic stability to Israel’s own security – while the work of the Bank and its partners shows that there are solutions that permit a significant dismantling of closure measures without endangering Israeli security.

8. The Government of Israel has given encouraging signs of a willingness to reform the management of border gateways, to enable a much faster and more reliable throughput of cargo and people. Unless a number of other key areas of the closure system are addressed, however, these improvements will have only limited impact. Of particular concern are the likely persistence of the back-to-back cargo handling system, the continuation of internal closures throughout the West Bank, the lack of adequate connections between Gaza and the West Bank, and Israel’s stated intention to terminate Palestinian labor permits by 2008 and to abrogate the Customs Union in Gaza after withdrawal from Philadelphi.

9. For its part, the Palestinian Authority faces two sets of challenges if it is to play its part in bringing about revival. First is the need to demonstrate strong commitment to security reform, politically risky though this may be. Without a visible and effective effort, the case for persisting with certain closure measures is hard to refute.

10. The PA also needs to reinvigorate its program of governance reforms in order to create an internal environment more attractive to private investors. Doing this will require that the PA complete the cycle of popular elections it has embarked on, control lawlessness, develop a solid judicial system and address concerns about transparency and corruption. The acquisition of the settlement areas offers the PA an opportunity to demonstrate a new spirit of openness in planning the disposal of these assets.

11. On the basis of what is on offer today, economic revival is a distant prospect, and it would be hard to justify a major new donor financing drive – the challenge, rather, will be to preserve existing aid levels of c. US$900 million per annum and thereby ensure that basic budget support, humanitarian and infrastructure development needs continue to be met.

12. Chapter Six lays out an agenda of actions that the Bank believes would lay the basis for economic regeneration. It is suggested that this agenda be further refined after the December AHLC meeting in December, if possible through direct discussion between GOI and the PA.

13. It is further proposed that the donor community track progress by the parties in tackling these key preconditions for economic revival. If significant progress is made against a set of agreed indicators, a major new donor effort would then be justified – and a donor pledging conference should be called. Calling such a conference in the absence of adequate progress would be counterproductive, however, and should not be considered.

1 – The Context

I – Introduction

14. The World Bank report of June 23, 2004, Disengagement, the Palestinian Economy and the Settlements, argues that the Palestinian economy is not viable under today’s political status quo, and that its continued deterioration will “impoverish and alienate a generation of young Palestinians…(undermining) the credibility of the Palestinian Authority (PA), increasing the appeal of militant factions and threatening Israel’s security”. The report demonstrates that the Government of Israel’s (GOI) Modified Disengagement Plan of June 6 alone “will not alter this dangerous, unsustainable situation. If implemented with wisdom and foresight, however, it could make a real difference.” This will only happen if GOI and the PA can break out of the current policy impasse – GOI by dismantling the system of closures stifling the Palestinian economy, and the PA by combating terrorism and re-launching the halting process of Palestinian reform. If the parties show they are prepared to carry out these difficult actions, then – and only then – an additional major donor financing effort is justifiable. With a growth-enhancing environment in place, a large additional injection of donor capital would “enable the Palestinian economy to turn the corner”. The basic thesis in the Bank’s report was accepted by both parties.

15. The Bank report proposed an analytical work program intended to help define “what can be done to address closure and kick-start the Palestinian economy”². At a meeting of the Quartet Envoys on July 6, the Bank was asked to oversee this work program in preparation for an Ad Hoc Liaison Committee (AHLC) meeting in late 2004. Both GOI (in a meeting between the Bank and the Israeli National Security Council (INSC) and the Ministry of Foreign Affairs (MOFA) on July 21), and the PA (in a letter from the Prime Minister to President Wolfensohn on July 18) indicated that they wished to work closely with the donor community on this analytical work program. Over the course of the past four months, therefore, a donor team led by the Bank and including experts from USAID, the European Commission, the IMF, the UN family³ and DFID prepared the four Technical Papers attached to this report.

II – The Process

16. In order to better understand the views of both parties and the extent to which policy changes might be forthcoming, the donor team worked in close consultation with GOI and PA “reference groups” – an Israeli group co-chaired by the INSC and MOFA, and a Palestinian group chaired by the PA’s Minister for National Economy⁴. In addition, the donors’ Local Task Force on Palestinian Reform has since late September been interacting with the PA’s National Reform Committee to support the definition of a core package of Palestinian reform initiatives for 2005.

17. The Bank/donor dialogue with GOI and with the PA took place in an environment of mistrust between the parties, with the PA and GOI holding divergent perceptions of the work of the donor team.

GOI expectations. For GOI, the disengagement initiative is “not dependent on cooperation with the Palestinians”, since “the State of Israel has reached the conclusion that there is currently no partner on the Palestinian side with whom progress can be made on a bilateral peace process”⁵. GOI was not prepared to discuss its response to the Bank’s June 23 paper directly with the PA, but instead chose to interact with the donor team and to convey its views to the PA through the donors.

PA reservations. Unhappy with GOI’s wish to deal with Palestinian economic issues by proxy, the PA was concerned lest the GOI/donor dialogue should encourage donors to forge understandings with GOI which would negate or diminish the bilateral economic agreements concluded in the pre-intifada “Oslo” era  The PA “reference group” underlined the need to link any discussion of the terms of disengagement with the Roadmap, and called on the donor team to take account of the provisions of the Oslo Accords as applicable to the movement of goods and people, the operation of passages and crossing points, the territorial link between Gaza and the West Bank and the quasi-Customs Union.

18. In view of the potential for misunderstanding, the Bank clarified to the parties and to donors that these consultations were not intended to substitute for bilateral negotiations, and that the Bank would take final responsibility for the analysis and the conclusions drawn from it.  Though technical and economic in intent, these papers would reference the broader frameworks within which the donor community continues to operate:

The Roadmap⁶. The political context underpinning this report is provided by the Roadmap, which has to been formally accepted by the PA and the international community, and with some caveats by GOI. Although the Roadmap is not under substantive implementation by either party, it embodies an assumption that neither has disowned – President Bush’s vision of an end of Israel’s 37-year occupation of the West Bank and Gaza, and of “the emergence of an independent, democratic, and viable Palestinian state living side by side in peace and security with Israel and its other neighbors”⁷. The actions proposed in the Bank’s June 23 report, it was noted, “conform to what the Aix Group calls a “rescue phase”, consistent with Phase I of the Roadmap (Ending Terror and Violence, Normalizing Palestinian Life and Building Palestinian Institutions)”⁸.

Legal agreements defining economic relations between Israel and the Palestinian Territories. The various interim agreements negotiated between mid-1993 and 1995, collectively known as the Oslo Accords⁹, continue to provide a framework for bilateral economic relations and for donor support to the PA. Many provisions are not currently under implementation – some never were¹⁰, while others (such as security cooperation of various kinds and the operation of the “safe passage” between Gaza and the West Bank) were suspended after the outbreak of the intifada. Statements from GOI suggest that Israel is not inclined to activate lapsed provisions, and that parts of Oslo will become irrelevant with the implementation of the Disengagement Plan¹¹. Nonetheless, no part of the Oslo Accords has been formally declared invalid by either party. All of the measures recommended in the June 23 report and expanded upon in this paper are compatible with the Oslo economic agreements.

III – Economic Implications of Israel’s Disengagement Plan

19. A number of proposals in GOI’s Plan have significant economic implications for the Palestinian population.

Evacuation from settlements in Gaza and the northern West Bank. Most domestic Israeli and international attention has focused on GOI’s plan to relinquish 21 settlements in Gaza and the northern West Bank. The Plan should result in a lifting of closures in the vacated areas, and would enable Palestinians to make use of the land and economic assets left behind. The Israeli domestic political risks involved in pursuing the evacuation are apparent to all observers.

Physical and economic separation. Israeli policy makers have stressed the need for separation between Israelis and Palestinians¹². A security-driven concept of separation permeates many aspects of Israeli disengagement policy – the intended completion of the Separation Barrier in the West Bank, the prohibition on Israelis entering industrial parks in areas not under Israeli security control, the planned termination of work permits for Palestinians in Israel by the end of 2008 and the proposed revocation of the quasi-Customs union between Israel and Gaza (see paragraphs 63ff.).

Continued Israeli settlement in parts of the West Bank. The Disengagement Plan states that “it is clear that some parts of Judea and Samaria (including key concentrations of Jewish settlements, civilian communities, security zones and areas in which Israel has a vested interest) will remain part of the State of Israel”¹³. The continued presence of 128 settlements and approximately 230,000 settlers in the West Bank¹⁴ has significant implications for the Palestinian economy. Not only do the settlement areas command natural resources that are thereby unavailable to the Palestinian population; the donor team was also informed that internal closures in the West Bank are intended in part to protect the access of Israelis to these settlements. In addition, GOI has indicated that it does not for the moment plan to reclassify evacuated areas in the West Bank, now Area C, to either Area A or Area B; this will limit the legal competence of the PA to govern in these areas, since under the Oslo Accords the PA has no civil or security jurisdiction in Area C¹⁵.

IV – The Palestinian Economy After 4 Years of Intifada

20. After a steep decline in 2001 and 2002, the Palestinian economy stabilized in 2003. In those two years, Palestinian real GDP per capita shrunk by almost 40 percent.  This trend was halted in 2003, and mild positive growth returned (see Annex Table 1). Real GDP per capita increased by one percentage point, but real GDI¹⁶ – which includes remittances from abroad and foreign assistance – increased by over 11 percent per capita. This rebound resulted from a lull in violence and less intense curfews/closures than in 2002 (the year of Operation Defensive Shield), an increase in labor flows to Israel and a resumption by GOI of revenue transfers (plus the return of US$178 million in withheld revenues¹⁷). Almost 100,000 jobs were created, albeit many of them of poor quality¹⁸, and investment grew by 14 percent (though at c. US$840 million amounting to less than a half of 1999 levels, and most in residential housing). Unemployment and poverty and rates declined by 5 and 4 percentage points respectively.

21. This fragile recovery has stalled in 2004, mainly as a result of events in Gaza. The Israeli Defense Forces (IDF) mounted several extended operations in Gaza in 2004¹⁹. The operations were accompanied by segmentation of the Gaza Strip and stiff restrictions on movements of goods and people across the borders with Israel and Egypt. This led to a sharp reduction in the volume of Gaza’s exports²⁰, as well as a temporary curtailment of humanitarian assistance²¹. The fighting resulted in significant damage to public infrastructure, private buildings²². Worker access to the Erez Industrial Estate and to Israel declined to a daily average of less than 1,000 in the second and third quarters (compared with 6,000 the previous year). Compared with 2003, 8,000 jobs have been lost within Gaza. In the West Bank, domestic job growth in 2004 has been positive but anemic (2.4 percent during the first three quarters). Unemployment rates stand at 27 percent overall, and 35 percent in Gaza, and poverty is comparable to 2003 – 48 percent overall, 65 percent in Gaza²³.

22. If the political and economic status quo persist, the medium-term outlook for the West Bank and Gaza is bleak, as Box 1 explains.

2 – Disengagement Plus: Israel’s Proposals for Easing Closure

23. Over the course of the last four months, GOI engaged with the Bank-led donor team in an wide-ranging series of discussions of Israeli security policies as they impact on the Palestinian economy. In responding to the Bank’s June 23 report, the INSC/MOFA team made clear that fostering Palestinian economic development is in Israel’s strategic interest²⁴, and that GOI is “ready to take far-reaching measures to assist in the recovery of the Palestinian economy” – while noting that “Israel will not ignore its security needs, of which it is the ultimate judge”²⁵.

24. The Bank’s 23 June report argues that “the precipitator of [Palestinian] economic crisis has been closure” and that in addition to the intended removal of internal movement restrictions in Gaza and the northern West Bank, “Palestinian economic recovery depends on a radical easing of internal closures throughout the West Bank, the opening of Palestinian external borders to commodity trade, and sustaining a reasonable flow of labor into Israel”²⁶.

25. Discussions with the INSC/MOFA team centered on these three domains of closure policy. In addition, the future of the customs envelope emerged as a fourth key topic.

I – Internal Movement

26. Internal movement is vital to the health of the Palestinian economy and economic governance. In May 2003 the Bank wrote “As long as Palestinian internal economic space remains as fragmented as it is today, and as long as the economy remains subject to extreme unpredictability and burdensome transaction costs, the revival of domestic activity will remain a distant prospect, and Palestinian welfare will continue to decay”²⁷. In the Bank’s most recent economic report, it is estimated that a removal of internal closure alone could lead to real GDP growth of 3.6% in 2005²⁸.

27. Israel’s Disengagement Plan would restore full internal movement in Gaza and should significantly reduce closure in the north-western part of the West Bank. Although several small settlements are slated to remain in the Jenin/Tulkarm/Nablus ‘triangle’, the IDF would not maintain a “permanent” presence in the area. This should lead to a meaningful restoration of internal movement, helping to stimulate local goods and labor markets and permit people to travel more freely within these governorates. It will not, however, address the need to re-connect the area with the rest of the West Bank.

Mobility in the West Bank has been seriously affected by the construction of the Separation Barrier, particularly in the seam zone areas²⁹. This will worsen with further Barrier construction, particularly as East Jerusalem becomes disconnected from the economic fabric of the remaining West Bank. Other economic consequences include loss of land for Barrier construction and restricted access to land and other investments located in the seam zone (agricultural GDP could decline as much as 17%, contributing to a 2% drop in overall GDP), losses of income from commercial relations with Israeli customers, and elimination of (illegal) access to Israeli labor markets. Upon completion, the estimated reduction in Palestinian gross national income (GNI) could range from 3-5%. A full treatment of the economic impact of the Barrier can be found in Impact of Israel’s Separation Barrier on West Bank Communities: Economic and Legal Developments³⁰.

28  The Disengagement Plan indicates that restrictions on internal movement in the remainder of the West Bank will continue³¹. The donor team was briefed by INSC/MOFA team counterparts on Israel’s proposals for restoring a measure of “continuous movement” in the West Bank. The proposed actions are of two kinds:

A reduction of the number of checkpoints, earth mounds, ditches etc. as the Separation Barrier is completed – The Plan indicates that Israel “will work to reduce the number of checkpoints throughout the West Bank.” In the northern West Bank, since the completion of Barrier Stage B in July 2004, the number of checkpoints in Jenin, Tulkarm, Nablus, Tubas, Salfit, and Qalqilia governorates has increased from 20 to 22, while the number of unmanned obstacles has decreased from 242 to 212³². For the West Bank as a whole, recent trends do not suggest any rapid improvement. In March 2004 a total of 743 obstacles were in place; today’s total is 723³³. As an example, Map 3c shows the network of movement restrictions in operation in the Hebron area in November, 2004.

The refurbishment/construction of a coordinated package of roads and junctions. The INSC/MOFA team proposed that the donor community consider financing 52 roads (totaling approximately 500 kilometers) and 16 under/overpasses in locations throughout the West Bank – stressing that this should be seen as a practical suggestion intended to deal with the realities on the ground. The proposal is illustrated in Map 2. To better appreciate the context for GOI’s proposal, Maps 3a/b/c identify Areas A, B and C, settlements in the West Bank not currently slated for evacuation, and various roads on which Palestinian movement has been restricted (the Israeli human rights organization B’Tselem reports that the combination of checkpoints, physical barriers and the arbitrary confiscation of vehicles has resulted in restricted movement on roughly 732 kilometers of roads in the West Bank³⁴). A number of the 52 roads and all of the under/overpasses bear an apparent relation either to the Separation Barrier (restoring access interrupted by its actual or potential construction) or to settlements and access routes to them.

29. The PA has made it clear that it does not find GOI’s roads and junction proposal an acceptable alternative to the lifting of internal closure in the West Bank. In October, the PA Cabinet discussed the proposal and rejected it. The PA has established an inter-ministerial committee to prepare screening criteria which would apply on a case-by-case basis to the selection of road projects in the West Bank. Roads and other structures perceived to be helping create a separate transport system, or which contour the Separation Barrier or any settlements, would be turned down³⁵.  The application of these criteria is likely to permit the construction of a number of the 52 roads, but this would not bring any fundamental improvement.

30. Israel’s “continuous movement” proposal is not acceptable to the donor community ³⁶. Donor concerns have been influenced by the recent International Court of Justice (ICJ) Advisory Opinion on the Separation Barrier ³⁷, which states that the Barrier, its associated regime (which includes the seam zone) and the settlements contravene international law, and warns against providing international assistance that would serve to maintain the current status quo ³⁸.

31. The incompatibility of GOI’s continuous movement proposal with donor and PA funding criteria, allied with GOI’s commitment to protecting access to Israeli settlements, translate to a continuing high level of restriction on Palestinian movement throughout much of the West Bank. Apart from the appreciable social friction this causes, internal markets will remain fragmented and prone to distortion. Case studies of internal movement in the West Bank cited in work done by The Services Group (TSG) as an input for Technical Paper I show that internal closures can add 50-100 percent to the cost of transporting goods along the main West Bank truck routes³⁹. Persistence of this situation will significantly undermine the improvements to border cargo management in the West Bank which GOI has proposed.

32. Attention therefore needs to return to ways of dismantling restrictions on existing roads.

II – Borders and Trade Facilitation

Border Crossings

33. The economic objective in reforming today’s border regime is to permit the market to once again determine import and export flows. The Bank’s June 23 report states that “there are a number of steps which can be taken to maintain or even enhance Israeli security while greatly improving cross-border security while greatly improving cross-border cargo management”⁴⁰, a position that the INSC/MOFA team accepted.

34. The safe and efficient operation of border crossings⁴¹ is, by definition, a cooperative effort. The difficulty of proposing improvements to two parties in conflict is obvious. While a neutral, technical analysis of options has its place, it is no substitute for the renewal of shared understandings, their translation into transparent operating procedures, and a mutually supportive effort to monitor and enforce them. With this caveat, the following conclusions can be drawn from the donor team’s extensive interaction with GOI and the PA on the subject.  A fuller treatment of the issues is to be found in Technical Paper I.

35. Israel is proposing to upgrade the border crossings. This could make a significant contribution to restoring cargo movements to pre-intifada levels, and laying a basis for future expansion.  The potential benefit from the proposed upgrades, though, may be significantly undermined if a number of key issues are not adequately addressed.

36. As detailed in Technical Paper I, needed improvements are of two types – i) physical improvements, specifically terminal reconfiguration and expansion, the introduction of up-to-date security technologies, and the expansion of the Israeli railway network; and ii) procedural reforms, featuring the introduction and monitoring of sound commercial management methods.

37. The PA welcomes “efforts to guarantee a steady volume and flow of cargo”⁴², but has emphasized that any enhancements should be consistent with the provisions of the Paris Protocol and other applicable bilateral agreements, and should not detract from the Roadmap’s call for a normalization of Palestinian life and return to the September 28, 2000 status quo ante. The PA has in particular stressed that security incidents need to be handled in a manner both proportional to the event, and coordinated between the two parties⁴³. The PA also advocates the use of published principles and rules for border crossings, and the introduction of binding dispute settlement mechanisms⁴⁴.

Proposed Physical Improvements

38. GOI is proposing to reconstruct/upgrade several terminals located between West Bank/Gaza and Israel, to improve traffic flow and berthing facilities as well as the facilities for travelers. The program would include the relocation of the Erez terminal to the Israeli side of the border and its expansion to accommodate cargo as well as people, with a planned completion date of August 2005. Initial estimates suggest that these enhancements would cost about US$59 million⁴⁵.

39. An unresolved issue relates to the number and location of border crossings between the West Bank and Israel⁴⁶. The Oslo Accords do not specify border crossings for persons and goods between Israel and the West Bank⁴⁷, but refer only to movement being controlled by applicable laws and regulations. Israel is proposing five border crossings (see Map 5b); of the five, however, three are situated on the alignment of the Separation Barrier where it deviates east from the Green Line. Neither the PA nor the majority of donors will support these proposed locations, particularly in view of the International Court of Justice’s Advisory Opinion⁴⁸. An alternative that would satisfy both the PA and the donor community would be to locate all five crossing terminals on the Green Line. The ongoing realignment of the Separation Barrier, pursuant to the Israeli High Court’s decision on the petitions filed by residents of Beit Sourik contesting the route of the Separation Barrier north-west of Jerusalem⁴⁹, should facilitate this.

40. GOI is proposing to introduce major technological upgrades, to include the purchase and installation of modern electronic systems that would permit much faster and more secure scanning of cargoes and people passing through the border crossings. The menu of technologies would vary in accordance with the projected usage of a particular crossing and the funds available. Initial estimates for an optimal technology upgrading of the 9 crossings and terminals under consideration by GOI⁵⁰ amount to some US$76 million.

41. GOI is also considering two railway projects.

The first would be a 4 km. spur to link Erez with the national grid and thereby connect to Ashdod and Haifa ports. The project would likely take about two years to complete⁵¹. The estimated cost of the rail line, a terminal in Erez and the train would be approximately US$ 21 million⁵².

The second project would connect Sha’ar Efraim (near Tulkarm) to the Israeli national railway grid via a spur to join the Eastern Railway. A short rail link an a tunnel would be needed once the main line is built (at present the Eastern Railway is planned for construction only after 2010). This, it is intended, would permit a cargo connection to Ashdod and a passenger connection between the northern West Bank and Gaza. The project’s anticipated cost is around US$18 million.

42. The PA has indicated that it would in principle welcome the two railway projects, while noting that this new mode of transport should complement, not replace existing modes⁵³. The Bank agrees with this position, since this would help foster competition. The PA has indicated that it would also welcome this project as an alternate transport mode.

43. Israel is seeking an external financing contribution to the capital costs of the terminal infrastructure/equipment program, currently estimated at US$135 million⁵⁴.

New Procedures

44. While reconstructing and reequipping border terminals paves the way for secure, rapid and predictable cargo handling, this will not occur without a significant adjustment in facility management policies; without them in fact, the net result could be higher levels of restriction. GOI has proposed four significant improvements:

Extending terminal operating hours.

Adoption of the ‘redundancy principle’. The INSC/MOFA team stated that “an alternative passage will be made available if a primary passage is closed”⁵⁵. This position acknowledges a need to avoid imposing blanket closures in response to specific incidents or threats, and is evidenced in plans to reconfigure Erez and Karni to handle both people and goods⁵⁶ – though its meaning and application in the West Bank have yet to be worked out. It will be important to clarify GOI’s policy position to transport operators; a clear written statement would have a significant impact on investors’ and shippers’ risk perceptions⁵⁷.

The application of service standards. The introduction of published norms has improved border cargo management in many countries⁵⁸. Under such a program, an individual shipper is made aware of the procedures applicable to his shipment, and the terminal agrees to abide by a set of performance measures (such as average time per inspection, and the percentage of shipments subjected to various levels of inspection).  Service standards should be applied to both security and customs inspections, and to both Israeli and Palestinian terminal managers. The INSC/MOFA team shared with the donor team a set of service standards which have been agreed for Israeli terminals (see Technical Paper I); this is promising evidence of a new approach to managing Palestinian cargo⁵⁹. It is proposed that these service standards be further refined in discussion with Israeli and Palestinian commercial operators, and that they be invited to help GOI monitor their implementation.

GOI is considering placing the management of all terminals in the hands of civilian contractors.

45. An important unresolved issue is GOI’s position that “at this time, the “back-to-back” regime will continue to apply with regard to the movement of goods”⁶⁰. The back-to-back system involves the transfer of goods from one truck/container to another, and results in extensive delays, damage and additional cost; it is motivated in part by a prohibition on Palestinian trucks from entering Israel, and on Israeli trucks from entering Gaza (though not, at present, the West Bank⁶¹). The application of this system is incompatible with an efficient flow of imports and exports. The Bank’s view is that a combination of the following measures will allow GOI to do away with mandatory back-to-back transfer without appreciable additional security risk.

Containerization/sealing. With the exception of bulk cargoes such as sand and building aggregates (which are not especially time-sensitive), all cargoes should be transported in containers or trailers that can be sealed. This can be facilitated by establishing consolidation areas on the Palestinian side of border crossings.

Scanners. Full truck/container scanners would be used to perform inspections with subsequent physical inspections limited to situations where anomalies are observed during the scanning.

One-Stop Inspection. Containers can be fitted with tamper-proof seals at the point of shipment or the entry port (for imports), or at the border terminal (for exports). Once sealed, subsequent inspections would be limited to ensuring the seals are intact.

Trailer Circulation. Back-to-back procedures can be avoided if container trailers are permitted free circulation between Israel and West Bank/Gaza, exchanging tractors and drivers in the process.  Scanning of the container would be combined with a simple chassis inspection.New trailer chasses could be custom-built without compartments or other features that can be used for illicit purposes. GOI has indicated that it is willing to test this concept.

Order and Selectivity in the Inspections System. The number of inspections can, as a result of the measures listed above, be reduced to a combination of risk-driven and random interventions. Systematizing this reduced inspection regime will require that GOI introduce an on-line cargo risk management system (combining basic information on manufacturers and shippers with specific security intelligence) in order to identify threats and build histories of reliability. Such risk management systems are commonly used by customs and port authorities worldwide.

46. Another issue for further discussion is the institution of a commercial dispute resolution mechanism⁶². To ensure full commercial confidence, a system for mediating claims made by shippers against unreasonable delay and/or cargo spoilage, subject to impartial and binding resolution, is the international norm. The PA believes such a mechanism is necessary (see paragraph 38), though GOI has indicated this may be impractical in today’s security context⁶³. In an improving bilateral environment, however, the subject should be reviewed once again. Models that can provide indicative guidance include the WTO Agreements and the TIR Convention⁶⁴.

Piloting Change

47. The combination of commitments, intentions and possible solutions related to border crossings should now be tested in the field. It is therefore recommended that integrated cargo management programs be developed as a matter of urgency at Karni Terminal (Gaza) and Jalame Terminal (northern West Bank).  These pilots, it is suggested, should feature i) terminal infrastructure upgrades on both sides of the border; ii) the introduction of electronic and biometric security equipment on the Israeli side; iii) the development of on-line information systems, with data links between GOI and the PA; iv) the abolition of back-to-back procedures for containers; and v) the development, in consultation with Israeli and Palestinian shippers, of terminal service standards and recourse methods. The pilot should be closely coordinated between GOI and the PA. It is further proposed that an independent service provider with recognized international credentials observe the progress of the pilot and report on it to the two parties and to interested donors. An early and successful implementation of this pilot program would be very important in demonstrating to investors and to donors that a border regime responsive to the needs of the Palestinian economy is under development, and merits consideration of donor financial support.

Gaza Sea and Air Connections

48. The Palestinian economy needs direct access to international markets. In this context, sea and air facilities in Gaza assume significant importance.

49. GOI has shown interest in supporting the early construction of a Roll-On, Roll-Off cargo port in Gaza, but has not made any commitments so far. In view of uncertainties about how quickly commercial demand for a Gaza port will grow, the RoRo approach offers a relatively rapid and cost-effective way to initiate the development of a full-service seaport. GOI has suggested that this projects may not after all need to await Israeli withdrawal from Philadelphi⁶⁵. For its part, the PA would “welcome a RoRo facility with Port Said which will lead to the opening of a fully functional Gaza port in the near future”. The RoRo concept is described in more detail in Technical Paper I.

50. Air services are also important, and preference should be given to reconstruction of the airport and a resumption of fixed-wing air services. The Bank has suggested beginning the restoration of Gaza’s air services with a helicopter connection to Amman⁶⁶, again arguing that this offers a rapid first step in enabling business connections. The PA insists that the airport should be reopened quickly, since a helicopter service alone is not considered adequate for Gaza’s current air transport needs⁶⁷. For its part, GOI has indicated that it is not in favor of fixed-wing services on security grounds, but has said it would consider a helicopter service with Amman⁶⁸.

51. For sea and air services to proceed, credible security arrangements need to be in place in Gaza. The Government of Egypt has indicated that it is willing to receive vessels and cargoes from Gaza⁶⁹, and would perform security inspections on incoming and outgoing cargoes.  This would not insulate a vessel against interference on the high seas, however. Since Israel is committed to evacuating all Israeli citizens from Gaza, and since PA security inspections alone are unlikely to satisfy Israeli requirements at this time, rapid development of the RoRo initiative and of air services would require a third party security involvement. One potentially workable approach would combine the use of a specialized border security firm and the active sponsorship of one or more concerned countries. The PA would not in principle be averse to this, as long as the third party works in partnership with the PA⁷⁰. For Israel, third party involvement in matters pertaining to Israeli security would break new ground, and requires further consideration.

Linking Gaza and the West Bank

52. Building a strong transport connection between Gaza and the West Bank is vital – but finding a mutually acceptable solution has not been possible to date. An unfettered flow of people and goods between Gaza and the West Bank is needed to link the two territorial elements of the Palestinian economy, and to lay the basis for viable statehood. A functioning link would create a larger effective internal market, help trigger price and income convergence between Gaza and the West Bank (by directing factors of production more efficiently), and provide a pathway from the economy of the West Bank to a future seaport in Gaza. Both GOI and the PA have taken strong positions on the issue. GOI is not willing to re-instate the “safe passage” arrangements provided for in the Oslo Accords⁷¹. For its part, the PA has indicated that “in the immediate term, a territorial link (TL) must be devised which will address the immediate economic (and other) needs of the Palestinians, without prejudicing any permanent arrangements regarding the TL. Also key is that any arrangements made must safeguard the spirit of the safe passage arrangements in Oslo”.⁷²

53. Today’s arrangements do not even satisfy minimal economic requirements.  The number of trucks crossing between the West Bank and Gaza is far fewer than in the pre-intifada period and cargoes are subject to long en-route inspection delays and low priority status at Karni, disadvantaging them relative to cargoes from Israel⁷³.

54. International experience in establishing and maintaining an efficient passage for people and goods has increased dramatically in recent years. Significant progress has been made in the design of protocols, procedures and protection to facilitate the movement of goods and people through such corridors. Such experience could be brought to bear in the local context.

55. The link between Gaza and the West Bank should permit flexible and low-cost transport compatible with improved Palestinian market competitiveness.  A simple road connection offers the best solution. Border security can be assured using a combination of container scanning and sealing technologies, combined with vehicle tracking devices to monitor movement across Israel⁷⁴. As a practical measure, it is proposed to pilot such an arrangement on one designated route as soon as the Karni and Tarkumiya border crossings have been equipped with the required technology.  In the meantime, and without prejudice to a return to the provisions of previous agreements, an escorted convoy system could be reinstated⁷⁵.

56. Options for a dedicated link are technically problematic. These would require the construction of permanent infrastructure; rail connections, elevated roads, fenced roads and tunnels have all been suggested.  GOI has proposed a rail connection, initially for people, between Tulkarm and Ashdod (see paragraph 42). The short distances and limited volume of bulk cargo would likely make this more costly and less convenient than road transport, however. An elevated road or tunnel would be expensive to build because of the civil works involved; furthermore, the traffic volumes under the most optimistic recovery scenario may make such an investment hard to justify. A structure of this kind could also be vulnerable from a security perspective.

III – Labor Flows to Israel

57. GOI is proposing to stop issuing work permits to Palestinians by the end of 2008. In the Bank’s view, this would have serious negative impacts on Palestinian incomes and on the prospects for Palestinian economic recovery.

58. Few economists would dispute the wisdom of moving away from a dependency on labor exports to Israel to a growth-path based on the export of goods and services to Israel and to other countries. This policy shift was advocated by the Bank in early 2003⁷⁶. An adjustment of this kind has in reality been underway for some time. On the eve of the intifada, the daily average of Palestinian workers entering Israel stood at 116,000 workers. By 2004, these numbers had fallen to 37,700⁷⁷. Due to continued conflict, political uncertainty and a weak commercial enabling environment, this loss of work has not been counterbalanced by adequate export growth. Palestinian real incomes have fallen steeply, and would have fallen much further were it not for the cushion afforded by donor assistance.

59. Managing this structural transition, though, will be key. The Palestinian economy is weak, with unemployment dangerously high and private investment severely depressed. With a reversal of the closure regime, a sustained effort to reform Palestinian institutions and generous additional donor assistance, it is possible to envisage a transition to growth.. It will, however, take time for the West Bank and Gaza to develop a genuine competitive edge (see Technical Paper III). During this period, priority must be given to preserving employment.  Phasing out permits would result in a loss of 9,000 of today’s jobs – but in addition, most of the approximately 20,000 illegal workers still crossing the Green Line each day would lose their jobs if the Separation Barrier is completed in 2005. This amounts to a net loss of nearly 30,000 jobs by the end of 2008.

60. A reinvigorated industrial estates program can create employment and can seed an export-based transition, but prospects appear modest over the coming few years. (see Technical Paper II). Analysis carried out by The Services Group (TSG) on behalf of USAID and by the Bank shows that an open border regime could create perhaps 8,500 new jobs by the end of 2008 – but only if GOI changes its current stance and allows Israeli investors to enter areas over which it does not exercise security control⁷⁸.

61. GOI is urged to be flexible on the issue of Palestinian labor⁷⁹. With Palestinian economic stability a shared objective, it is recommended that Israel at least maintain current Palestinian labor access over the next several years. Doing so would involve replacing illegal labor with additional permitted labor if the Separation Barrier is completed in 2005. If illegal work is thereby eliminated, Israel’s security clearance of Palestinian workers would be much more assured than today.

IV – The Future of the quasi-Customs Union

62. During the course of the summer, GOI opposition to the maintenance of the quasi-Customs Union (qCU) with the West Bank and Gaza emerged. The June 6 Modified Disengagement Plan indicates that “in general, the economic arrangements that are currently in effect between Israel and the Palestinians will remain valid. These arrangements include …. taxation arrangements and the customs envelope” ⁸⁰. As of November 14, though, the INSC/MOFA position was that “if and when Israel withdraws from the Philadelphi corridor, it will not be possible to maintain the customs union with Gaza (although it will continue to apply in the West Bank)”⁸¹. It is further understood that “adjustments” might be in time be implemented in the West Bank⁸².

63. Many economists believe it makes sense to move away from the qCU in due course. A more independent, non-discriminatory trade policy vis-à-vis third countries would help diversify Palestinian trade. The qCU has advantages for the West Bank and Gaza, including preferential access to the Israeli market, and reduced PA customs administration costs – at the same time, however, the provisions of the Paris Protocol do not provide for the collection/remittance of taxes on indirect imports.  The Bank has estimated that this omission results in fiscal losses to the PA of about US$175 million each year⁸³.

64. The World Bank and the IMF both believe that a rapid and uncoordinated abolition of the qCU would disrupt any recovery of the Palestinian economy. There are three reasons for this.

There is a risk of significant Palestinian revenue loss. Trade taxes are currently collected by Israel and remitted to the PA through the clearance system; these clearance revenues make up almost two thirds of total PA revenues⁸⁴. PA customs capacity is weak, and time is needed to equip it to take over from GOI⁸⁵. The PA cannot afford transitional revenue losses at this stage.

Abolition of the qCU would hurt Palestinian (and Israeli) trade in the short run. Palestinian exporters would lose their preferential access to the Israeli market at a time when jumpstarting Palestinian exports is critical.

Maintaining the common customs and tariff envelope in one part of the Palestinian territories while abrogating it in the other would further fragment the Palestinian economy.  Under such a scenario, goods and services traded between the West Bank and the Gaza Strip would need to be cleared by customs in both directions, since the tax regimes would be different in the two jurisdictions. This would add another layer of controls, increasing transaction costs that are already very high, and would exacerbate the division of the two parts of the Palestinian economy.

65. The technical case for the qCU’s abrogation is questionable. GOI is concerned that the PA would not protect the common customs envelope once Israel evacuates Philadelphi, and if and when direct sea access to Gaza is established. As an interim measure, though, the PA could contract a private organization to manage the customs function on the Egyptian border – an arrangement for which there are many useful precedents⁸⁶. In addition, the IMF would be willing to oversee technical assistance to upgrade Palestinian customs capacity, and could monitor the effectiveness of collection activities under its current monthly reviews of budget execution, fiscal revenues and PA expenditures. Together these measures should be sufficient to ensure that existing customs policies continue to be implemented in accordance with the Paris Protocol.

66. New customs arrangements should not be imposed unilaterally. Writing of the transition to statehood, the Aix Group has stressed the importance of fiscal cooperation, and warns against any precipitate transfer of functions: “The Group recommends that both parties closely coordinate indirect taxation policies and their administration, in order to avoid smuggling …the cost of neglect in this case would be immense for the [future] Palestinian state as well as Israel, as the stability of both tax systems would be threatened”⁸⁷.

67. During the coming period, a preferable approach would be to improve the implementation of the Paris Protocol. In particular, the revenue losses to the Palestinian budget from indirect imports should be addressed⁸⁸. In addition to this, the PA would like to see the creation of an effective dispute resolution mechanism, and a revision of lists A1, A2 and B⁸⁹. Under today’s changing circumstances, consideration should also be given to reviving the Joint Economic Committee⁹⁰.

3 – Palestinian Plans to Revive the Economy

68. Israel’s withdrawal from the Gaza Strip and the northern West Bank – be it unilateral, coordinated or negotiated – presents the PA with an opportunity to show how well it can exercise political, security and economic leadership, and to demonstrate how smoothly it can assume control over and disposes of the assets that Israel leaves behind. Palestinian, Israeli and international attention will focus intensively on PA performance in the coming months. Success in these areas should lead to a much more forthcoming attitude by GOI to bilateral cooperation, as well as creating donor and investor confidence.

I – The PA’s Strategy for Recovery and Growth

69 The PA is finalizing the Medium-Term Development Plan (MTDP) 2005-7. Like the SESP before it⁹¹, the MTDP seeks a balance between short-term relief requirements and the policies and investments intended to spark an economic revival.

The Plan places heavy reliance on the private sector, coupled with efforts to protect the poor and vulnerable. The MTDP’s overall strategy is sound, and its estimates of potential donor contributions are based on an assessment of what is probable, rather than what is desirable – consistent with the SESP’s pragmatic approach.

The recovery strategy focuses on actions to address unemployment in a sustainable manner, recognizing that this can only be done in a context of private sector growth. This in turn will require that GOI restore greater Palestinian freedom of movement, both within the West Bank and Gaza and across borders. The MTDP private sector support strategy stresses policy and technical support to agriculture, tourism and industry, along with the provision of loan guarantees to encourage commercial banks to participate in capital formation. The need to build human capital through technical and vocational education is also given high priority.

The Plan recognizes the entrenched nature of Palestinian poverty, and the need for a sustained and targeted effort to cater to those who have lost their ability to participate meaningfully in the economy without assistance.

Improving the effectiveness of PNA governance by building capacity and accelerating reform is an overarching Plan objective. The MTDP builds on the PA’s One-Year Reform Action Plan (September 2004-September 2005) – see paragraph 76.

70. The Plan employs two economic scenarios. The more cautious “delayed progress” scenario estimates likely donor disbursements at US$900 million each year during 2005-2007⁹², while the “rapid progress” scenario assumes that donors would disburse US$1.05 billion in 2005, US$1.25 billion in 2006 and US$1.45 billion in 2007⁹³. In 2005, disbursements for budget support and projected at US$419 million under “delayed progress” and US$359 million under “rapid progress”⁹⁴.

II – Palestinian Reform

71. It is imperative that the Palestinian leadership revitalize the Palestinian reform process. The Bank’s June 23 report, reflecting PA and donor analysis, listed eight areas of reform with particular importance to the economy⁹⁵. These include gaining control of the domestic security environment, renewing the legitimacy of the PA through national and local elections, maintaining fiscal stability, and combating longstanding resistance to legal and judicial reform. Since June some progress has been made, but the overall pace of reform over the last year has been slow. The Bank’s report pointed out that “an easing of closures alone….will not attract investors back to the Palestinian economy. A reinvigorated program of Palestinian reform, designed around measures that will create an investor-friendly business environment, is essential. There is no reason for the PA to delay implementation of such a program”.

72. Reforms in public financial management continued in 2004. Important milestones over the past year include⁹⁶

The payment of PA security staff salaries through direct deposit to personal bank accounts rather than in cash paid through force commanders;

International auditing of the Palestine Investment Fund;

Establishment of a Department of Supplies and Tenders in the Ministry of Finance, with full jurisdiction for all PA purchases, including those of the security agencies;

Preparation of legislation to create a new public audit institution, approved by the PLC and now before the President for signature;

Passage of a revised income tax law, consistent with international best practice.

73. Progress has also been made in the area of election reform. A Central Electoral Commission was established, and a successful voter registration process was set in motion – a development that will make it possible to conduct presidential elections in January 2005. Importantly, PLC elections are now planned for May 15 2005.

74. Public awareness of the reform process has also improved. The PLC has become actively engaged, and earlier this year established a committee to investigate the underlying causes of internal fragmentation within the PA. The committee’s findings included a number of specific recommendations on internal reform measures, including the passage of legislation defining the role and the authorities of the security forces.

Public awareness of the reform process has also improved with increasing internal calls for reform. In June 2004, the PLC established a 14 member Committee to investigate the underlying causes of internal fragmentation within the PA. In the third quarter of 2004, the Committee released its report, calling for a reorganized and empwered government and for the appointment of a parliamentarian mechanism to monitor the implementation of reforms. In protest to the Executive's reluctance to honor its promises, to approve laws earlier presented by the Committee for signature, and to push the reform process forward, the PLC suspended its plenary sessions for one month until October, 2004⁹⁷.

75. On September 27, 2004, the PA Cabinet adopted a One-Year Reform Action Plan (September 2004-2005). This document, like previous PA reform statements, is very broad – it consists of eight main areas, 46 sub-areas, a further 58 specific items, and at least 26 pieces of needed legislation. A comprehensive listing of this kind is unlikely to spark much progress unless the PA uses the Action Plan to articulate a focused “reform map” – which should identify a priority set of specific reform measures, a time-bound plan for their implementation, and clearly assigned responsibilities.

76. The donor reform support structure may have contributed to a dispersion of Palestinian effort. Seven donor “Reform Support Groups” were created in mid-2002 as a way to engage with the PA during the siege of the Muqata⁹⁸. They have done much solid analytical work, but today’s need for accelerated action suggests that a light, agile structure in which donors interact constantly with the PA may be more appropriate.

77. In today’s changed environment, three reform areas call out for rapid, concerted effort.

Security and the Rule of Law

78. The Bank’s June 23 paper observed that “a maximum PA effort to fulfill its security obligations under the Roadmap is needed if the donor community is to argue for a major easing of today’s closure regime.” While it is beyond the Bank’s competence to advise on how to approach security reform, it is clear that a revival of the private sector will not take place in an environment plagued by conflict with Israel and by domestic lawlessness. It is also clear that far-reaching changes in the security and police services are needed. Some progress has been achieved since the beginning of 2004, with the National Security Council now holding responsibility for all security forces – but much remains to be done to ensure that the security services operate within a structure of administrative and legal accountability⁹⁹.

79. An impartial and responsive courts system is essential to a healthy investment climate, but progress in establishing it has languished for many years. A fully functioning court system would instill a higher level of commercial trust in the PA. However, a number of fundamental problems remain unresolved, including the lack of clear delineation of the respective responsibilities of the Ministry of Justice and the Supreme Judicial Council, the continued absence of a Supreme Court, and the ambiguous role played by the Diwan al Fatwa¹⁰⁰ in the legislative process. These factors have hindered the timely appointment of judges, impaired court administration and created a large backlog of cases in the courts. The judicial system’s credibility has been undermined, and needs to be restored. Creating a fully functional, professional and sustainable judicial/court apparatus involves establishing clear mandates for the selection of court personnel, enhanced judicial training and attention to the administration of the courts. Criteria for the appointment and promotion of judges also need to be specified and enforced.

80. Equally necessary for the rule of law is a sound legislative process and a solid corpus of relevant law. In July the Council Affairs Committee produced a General Framework of the Reform and Development Program of the Palestinian Legislative Council, a positive step towards improving the efficiency of the PLC¹⁰¹. From a commercial perspective several core pieces of legislation are missing or outdated, lack regulations or remain unsigned¹⁰² or unimplemented¹⁰³ – while the quality of some legislation is questionable¹⁰⁴.  Commercial laws differ in the West Bank and Gaza, and need harmonization in order to reduce the transaction costs for firms doing business in both jurisdictions¹⁰⁵. Procedures, particularly those relating to the issuance of licenses and permits, require further simplification.

Fiscal Stabilization

81. The fiscal position of the PA remains very tenuous. Excessive growth in the PA’s wage bill in recent years has compounded the problems caused by closure and the erosion of the tax-base¹⁰⁶, and the PA has become too dependent on erratic and uncertain donor budget support.

82. It is essential that the PA adhere to the Wage Bill Containment Plan developed by MOF and approved by the Cabinet in June 2004¹⁰⁷. The PA’s annual wage bill this year is some US$125 million greater than in 2003 (an increase of 17 percent), mostly as a result of large public sector salary increases granted in 2003¹⁰⁸. In the face of declining donor support¹⁰⁹, the PA has been forced to squeeze non-wage expenditures 17% below budget in the first nine months of the year, but still faces month-to-month crises to pay salaries¹¹⁰. The PA can not afford to grant any further salary increases to public employees until the fiscal situation has manifestly stabilized. Under today’s conditions, in which opportunities for employment in the private sector are limited, large scale retrenchment of public servants is not a viable option; as soon as political and economic conditions make it feasible, though, the size of the public service should be reduced in line with what is needed and what is affordable – with a particular emphasis on the security services, where unmanaged recruitment has been most evident.

83. The current public sector pension schemes are unsustainable and would, if not comprehensively reformed, trigger a severe fiscal crisis¹¹¹. The stock of public sector pension liabilities resulting from these generous and under-funded schemes is currently estimated at over 50% of GDP¹¹². Without reform the current Gaza system will go bankrupt in 2-3 years, and the PA will either have to default on pensions or make all payments from the budget. The PA is committed to comprehensive reform, and a solid draft law creating a unified pension system for all public sector employees is now before the PLC. If passed in its current form, it will establish a scheme for sustainable and equitable pension benefits for all public sector employees, and will also establish an independent pension agency with governance mechanisms able to protect pension assets from political interference and fraud. For the reform to succeed, the PLC will need to resist pressure from various interest groups to provide them with excessive benefits¹¹³. After reform, PA pension expenditures will amount to US$78-80 million annually¹¹⁴. The PA will need to pay all contributions in full if the integrity of the new system is to be maintained¹¹⁵.

Transparency and Accountability

84. The PA needs to take steps to counter widespread perceptions of systemic corruption. Polling data shows that such perceptions are shared by ordinary Palestinians¹¹⁶ as well as businessmen. Such perceptions, compounded by PA shortcomings in performing its regulatory functions, can dampen entrepreneurs’ willingness to invest¹¹⁷. The PA would do well to

Actively publicize the considerable progress it is making in developing effective public financial management systems (see paragraph 73) – progress that enabled the Bank to state in early 2004 that “the Palestinian public financial management system is judged to be adequate insofar as the World Bank’s criteria and standards for approval of a general budget support operation are concerned”¹¹⁸.

Articulate a comprehensive anticorruption strategy which addresses prevention, prosecution, and public sensitization. This strategy should look at the existing institutions now charged with combating corruption (including the external public audit institution, see below) to assess how their independence can be strengthened. It should also develop anti-corruption regulations for PA ministries and agencies with major revenue, expenditure or regulatory functions, and should require senior PA officials to sign conflict of interest and financial disclosure provisions¹¹⁹.

85. A visible, sincere effort to prevent corruption and to punish offenders would pay enormous dividends for the incoming PA administration, both domestically and abroad.

86. A number of other key areas bearing on PA institutional accountability also need to be addressed.

The lack of an independent public audit function. The PLC is considering legislation which will create a new external audit institution to replace the General Control Institute. The new institution would report both to the PLC and the President, would cover all PA entities, and would be tasked with auditing the PA’s financial statements according to international auditing standards. To complement this encouraging draft law, a major capacity building program will be needed to create an institution capable of fulfilling this important role.

Anti-competitive bias in several practices of the Palestinian Authority. This takes two forms – direct PA involvement in productive activities, and indirect equity participation in private firms. The PA has taken welcome steps to ensure public disclosure of the financial data of the Palestine Investment Fund, the holding company for its investments¹²⁰. Nevertheless, further increases in transparency and accountability are desirable, including publishing the terms of exclusive licenses to firms, and creating regulatory bodies that are independent of policy ministries.

Strengthening public procurement. A significant recent improvement was the abolition of the Al Sahra Company’s monopoly on supplying basic essentials to the security services. However, public procurement remains weak overall. The laws that exist for the procurement of goods and works are only partially enforced, and many spending units have developed their own independent procurement practices – not least because many purchases are funded by donors who insist that their particular practices be adhered to. A PA Procurement Action Plan is currently being developed and could make a significant difference. Proposed actions include establishing an independent Oversight Procurement Authority to monitor all public procurement, drafting a Unified Procurement Law and developing standard bidding documents to simplify and harmonize procedures across ministries and donor-funded projects.

4 – The Settlement Assets

87. Data about settlement assets remain scarce. No firm decision has yet been taken by GOI on which assets it will transfer, or by the PA on how they will be used. Detailed preparatory work for the transfer, management and disposal (TMD) of settlement assets has therefore not been possible. Nevertheless, both GOI and the PA have advanced their planning. GOI has set up an office dealing with the evacuation, and a compensation law has passed its first reading in the Knesset. The PA is finalizing its Medium-Term Development Plan 2005-7, in which the proposed Palestinian use of relinquished settlement assets is discussed.

88. Some assets will not fit Palestinian developmental needs; these should be dismantled and the debris should be removed. In reviewing available information, the Bank has assessed the most appropriate uses of settlement assets. While such decisions will and should be taken by Palestinians themselves, the Bank’s advice is that public infrastructure can be transferred to the relevant Palestinian entities and integrated into Palestinian systems. Public buildings could be maintained if the surrounding population density and demand for social services justify their use. Productive assets would ideally be handed over as going concerns, but both technical and legal reasons complicate such transfer. Details are provided in Technical Paper IV.

89. Since land is likely to contribute more to the Palestinian economy than all other remaining assets combined, its proper use is key. The PA should establish clear policies to determine whether land should be restored to its owners, or whether they should be compensated and the land used for the public benefit. The establishment of a special administrative process for resolving ownership claims is recommended; claims would be received and resolved based on clear criteria for assessing ownership rights. It would also be advisable to separate land claims and dispute adjudication from the disposal of other assets.

90. In order to ensure the transparency of the TMD process, clear rules and procedures should be formalized and agreed upon in advance. An informal, ad hoc process with ambiguous responsibilities, rules and procedures could be very damaging – both to the reputation of the PA and in terms of missed economic opportunities.

91. GOI has clarified a number of issues related to the transfer of settlement assets. GOI may consider the transfer of some houses intact if the PA were to propose uses not inimical to Israeli interests. Nor would GOI object to the preparation of a manual of procedures, for use by both parties, explaining the TMD process in detail. Israeli utility companies will continue to provide electricity, water, gas, fuel, and telecommunications to Gaza and the West Bank under current agreements – and will provide services to the settlement sites if arrangements can be put into place which offer adequate repayment guarantees.

92. The PA’s position is that under international law decisions on the disposition and use of the settlement assets must be taken by them¹²¹, and it is currently assessing the possible integration of the assets into updated Gaza and West Bank regional development plans. These plans take into account the need for additional urban or agricultural land and the protection of natural resources (particularly water). The PA has indicated that GOI should dismantle any settlement assets that do not fit into the regional plans, and that any rubble should be removed and disposed of outside Palestinian territory.

93. The PA is advised to establish a dedicated institutional structure to plan and implement the TMD process. Decisions on this structure need to be taken soon – and well in advance of actual disengagement, since additional capacity will be needed irrespective of the detailed setup, and because establishing any structure will take time. Building on international experience, a three-tiered approach is recommended

The PLC should pass enabling legislation and should provide parliamentary oversight;

A multi-stakeholder Supervisory Board under PA leadership and assisted by donor-financed expertise should direct the TMD process;

An existing or new PA body should be responsible for TMD implementation.

94. The involvement of the general public in decisions on how the received assets will be disposed of, and to whom, is essential – as is the need to keep the public closely informed of TMD implementation.

95. In the Bank’s opinion, a small, light special agency structure, without special budget authority and provided with dedicated technical assistance, would be the preferred set-up. Compared to a “business as usual” approach whereby PA entities assume responsibility for assets under their respective jurisdiction, such an arrangement is more likely to bring to bear the necessary focus and sense of institutional accountability. Any special PA structure must not, however, evolve into an alternative power center in Gaza or add bureaucratic dead-weight.

96. Both GOI and the PA have indicated an interest in coordinating the TMD process at a technical level, possibly with the involvement of a third party. GOI does not currently intend to hand assets directly to the PA; at the same time, an acceptable third party to which GOI could transfer the assets as a “custodian” is unlikely to emerge.

To make any coordination more productive, GOI needs to furnish detailed information about the settlement assets to the PA. At the same time, the PA should formally indicate which assets it wishes to receive intact, based on current information, and for which purposes.

97. A first step would be for the PA to set up a formal working group to assess institutional options, review applicable laws and regulations and draft an enabling law, determine how claims will be handled and develop a strategy for consulting the public on all aspects of the TMD process.

5 – The Economic Outlook

98. GOI’s proposals for enhanced border cargo management will make a difference, as can be seen from a comparison of the Bank’s “Disengagement Plus” scenario with the “Disengagement” scenario presented in the June 23 report. However, the difference is not enough to trigger a Palestinian economic recovery. GOI is proposing to implement some important measures – terminal reconstruction and re-equipment, the introduction of the redundancy principle and of service standards. In addition, under the Disengagement Plan, Palestinians will gain access to valuable settlement assets and would benefit from a reduction in internal closures in Gaza and the northern West Bank. These positive measures would be undercut, however, by several key constraining factors – maintenance of the back-to-back cargo handling system, continued internal closure in the central and southern West Bank, completion of the Separation Barrier, continued poor access between Gaza and the West Bank, the termination of work permits by end-2008 and the abrogation of the quasi-Customs Union in Gaza. The collective weight of these factors would overwhelm other positive developments.

99. An emphatic doctrine of physical and economic separation cannot be expected to encourage private investment – particularly since the immediate potential for Palestinian economic recovery lies in rebuilding trading links with Israel. While it is likely that donors would support the emergence of new Palestinian leadership and a renewal of bilateral contact with additional funding in the short-term, it is hard to envisage donors making a major, sustained financial effort if the preconditions for economic recovery are absent. In the “Disengagement Plus” scenario, therefore, after a brief surge in real GDP and GDI per capita in 2005, real incomes would resume their decline and would be lower in 2008 than today (see Box 2 and Annex Table 2).

6 – How to Turn the Corner

I – Additional Measures Will Make the Difference

100. As the “Disengagement Plus” Scenario shows, the basis for vibrant economic recovery does not yet exist.

101. Recovery depends above all on a comprehensive Israeli approach to lifting closure. If GOI addresses only some components of the closure system, the impact of such initiatives will be muted by other remaining constraints. Economic life cannot recover if people and goods cannot move between cities and towns within the West Bank. If a truck carrying export goods from Hebron to Ashdod Port is delayed for an unpredictable periods of time en route to Tarkumiya, and is then subject to back-to-back unloading procedures, improved terminal layout and screening equipment will not make an appreciable difference. If goods produced in Ramallah cannot be transported through Israel to Gaza without long delays and multiple inspections, the feasibility of an otherwise attractive Gaza container port will be in doubt.

102. Israel is urged to re-examine the concept of “economic separation”. If labor permits are no longer issued from 2008 and if the quasi-Customs Union in Gaza is abrogated once Israel withdraws from Philadelphi, Palestinian economic recovery may stop in its tracks. In each case, there are ways to protect Israel’s interests. With illegal labor flows disappearing, virtually all Palestinian laborers will be permit holders, which greatly increases Israel’s security control. In the case of the Rafah customs border, a judicious mix of international customs management expertise, IMF oversight and PA capacity building would be adequate to meet the challenge of securing the common customs border. Israel could also inspect goods exiting from Gaza as a form of verification. Both parts of the Palestinian economic entity – Gaza and the West Bank – should have the same customs treatment.

103. To accelerate the dismantling of internal closures in the West Bank, the PA will need to demonstrate strong and sustained commitment to security reform. If a vigorous PA effort to enforce law and order further reduces the frequency of attacks on Israelis¹²², the case for maintaining today’s complex and invasive set of restrictions will no longer resonate.

104. The other PA governance priorities identified in this report – early elections, legal and judicial reform, fiscal containment, deeper transparency – are relevant to the internal health of Palestinian society and to the creation of an attractive environment for the private sector; they should not be seen as constituting preconditions for GOI action on dismantling closures.

105. The following paragraphs summarize key measures which, if implemented, will lay the basis for the economic revival of the West Bank and Gaza. The Bank hopes that these measures, which derive from an intensive process of donor analysis and interaction with both the parties, will be of assistance to them in individual and joint deliberations over the coming months.

The Government of Israel

Borders and Trade Logistics

Internal Movement in the West Bank

Labor

The quasi-Customs Union

Other Issues

Palestinian Authority

Security and the Rule of Law

Fiscal Management

Transparency and Accountability

The Settlement Assets

II – Economic Recovery

106. If the package of measures detailed above is implemented with commitment, the foundations for economic recovery will be laid. Under these circumstances, with donor funding levels at US$3.6 billion over four years (the same level as for the “Disengagement Plus” Scenario), the improvement in the business environment resulting from mutually reinforcing actions by the PA and the GOI would generate significant increases in investment, employment and consumption, leading to measurable positive income growth. By 2008, GDP per capita could be 10 percent higher than this year – and 24 percent higher than under “Disengagement Plus” (see Box 3 and Annex Table 2). An improving economy would help stabilize the PA’s fiscal situation and would allow donors to reprogram assistance away from budget support and humanitarian assistance into development activities, further solidifying the recovery.

III – The Donor Response

107. The experience of the past four years has shown that high levels of donor assistance cannot substitute for a positive economic environment¹²⁵, and the “Disengagement Plus” scenario reconfirms this message – even with donors contributing an average of US$900 million per annum¹²⁶, economic decline is not arrested.

108. Under the base case “Disengagement Plus” scenario, there is not justification for donors to increase funding dramatically, though a limited additional response can be expected in 2005 if the PA leadership transition is smooth and the PA presses ahead with PLC elections. The Bank has therefore assumed that disbursements in 2005 could rise to US$1.1 billion. IN this instance, priority should be given to

109. Under the high case “Economic Recovery” scenario, though, donors should be encouraged to make a major additional effort, since the economic benefits of additional donor funds under such circumstances would be considerable. An additional US$1.7 billion in 2005-2008 could be used to upgrade Palestinian basic and social infrastructure and workforce skills, creating short-term employment and improving the operating environment for industrialists and traders (see Box 4 and Annex Table 3).

110. If, and only if the parties take sufficient steps to move the economy back onto a path of sustainable growth, a donor funding conference would be justified, with donors expected to pledge substantial additional funds for developmental purposes.

111. If it becomes clear that substantial progress is emerging, preparations for the conference can commence. As a foundation for such a meeting, the Bank and other donors should work with the PA to prepare a Palestinian Reconstruction Program; this program should be based on the PA’s Medium Term Development Plan.

112. In order to assess the case for such a conference on an continuing basis, it is recommended that every three months the AHLC Chair and Secretariat should review progress by the parties, and should report to the donor community on their findings. This review would need to be based on a set of indicators that should be agreed between GOI, the PA and the donor community, and which could be drawn from the actions recommended in this paper.