Development under adversity: Palestinian economy in transition – Palestine Economic Policy Research Institute/World Bank study

19162

March 1999

Development Under Adversity: The Palestinian Economy in Transition

Edited by Ishac Diwan and Radwan A. Shaban

Palestine Economic Policy Research Institute (MAS) and the World Bank

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Contents

List of Figures, Tables and Boxes  – v

Foreword by Nabeel Kassis, Director, Palestine Economic Policy Research Institute (MAS) – ix

Foreword by Joseph Stiglitz, Senior Vice President and Chief Economist, The World Bank – xi

Acknowledgments – xiii

Definitions and Terms – xiv

Chapter 1 – Introduction and Background  – I

Ishac Diwan, The World Bank

Radwan A. Shaban, MAS and Georgia Institute of Technology

Part I. Recent Developments: New Constraints and Frustrated Developments – 15

Chapter 2 – Worsening Economic Outcomes Since 1994 Despite Elements of Improvement – 17

Radwan A. Shaban, MAS and Georgia Institute of Technology

Chapter 3 – Recent Political Developments – 33

Rex Brynen, McGill University

Chapter 4 – The Harsh Reality of Closure – 45

Radwan A. Shaban, MAS and Georgia Institute of Technology

Part II. Policies for Growth and Job Creation under Adverse Conditions – 67

Chapter 5 – Private Investment – 69

Osama Hamed, MAS

Chapter 6 – International Economic Relations: Access, Trade Regime, and Development Strategy – 84

Ishac Diwan, The World Bank

Chapter 7 – Financial Intermediation – 97

Osama Hamed, MAS

Chapter 8 – Fiscal Management – 110

Ali Khadr, The World Bank

Chapter 9 – Shocks and Stabilization – 128

Osama Hamed, MAS

Chapter 10 – Donor Assistance – 143

Ali Khadr, The World Bank

Part III. Building the Enabling Environment for Long-term Growth – 155

Chapter 11 – Improving the Education System – 157

Sue Berryman, The World Bank

Chapter 12 – Managing the Growth of the Health Sector – 170

Mustafa Barghouthi, Health Development Information Project

Jean Lennock, Health Development Information Project

Radwan A. Shaban, MAS and Georgia Institute of Technology

Chapter 13 – Infrastructure for Growth – 181

Ashoka Mody, The World Bank and University of Pennsylvania

Annex – 195

Bibliography – 225

Index – 235

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Foreword

Nabeel Kassis, MAS Director

The Declaration of Principles (DOP) signed by the Palestine Liberation Organization and Israel in 1993 was seen by many Palestinians as an important cornerstone in the process of nation-building and achieving a just and lasting peace. Raising the standards of living and laying the foundations for sustainable economic development in the West Bank and Gaza Strip are regarded as key for cementing a just political solution and ensuring the success of the peace process. Building Palestinian institutions of governance is another vital element in the success of this process. The Palestine Economic Policy Research Institute, or Ma'had Abhath As-Siyasat Al-Iqtisadiyeh Al-Filistini (MAS), is an autonomous national research institute that was established in May 1994 to utilize Palestinian expertise to provide policy makers with quality analysis of policies and strategies critical to the development of the Palestinian economy.

Over a short time period, MAS has actively contributed to the understanding of Palestinian economic development and to shaping economic policies. MAS's research has resulted in numerous publications in the areas of banking and monetary policy, fiscal policy, trade policy, poverty, social security, industrial development, and overall economic development strategies. MAS has organized several workshops on economic policy issues that have been summarized in MAS Policy Notes and in the local media. MAS's Monitoring Unit publishes the semi-annual MAS Economic Monitor and the annual Social Monitor.

This book is a product of joint effort by MAS and the World Bank. It builds on the extensive research output of MAS, the World Bank, and other researchers. The project was conceived from the beginning as an equal partnership between the two institutions. Its aim was to provide a comprehensive study of Palestinian economic development since the signing of the DOP and to present analysis on strategies and policies most conducive to sustainable economic development. This project was perceived from the outset to be a sequel to the influential 1993 six-volume report, Developing the Occupied Territories: An Investment in Peace, which was produced by the World Bank with the support of a Palestinian team appointed by the Palestine Liberation Organization.

The production of this book has entailed several iterations of reviewing the manuscript both by MAS and the World Bank; workshops at MAS involving policy makers and researchers on various background papers or chapters, with summaries published in the local media; and a review by various Palestinian ministries dealing with economic matters. The findings of this manuscript were presented and discussed in November 1997 at two conferences in Nablus and Gaza City. These conferences were well attended by the research and policy-making communities, and included high-ranking officials from several ministries. These thorough reviews have enriched and sharpened the discussion and presentation of the manuscript. We trust the book will have the intended impact of providing a better understanding of the difficulties facing both Palestinian economic development and policy-making.

Foreword

Joseph Stiglitz

Senior Vice President and Chief Economist

World Bank

The Palestinian economy has been operating far below its enormous potential. The situation has continued to deteriorate since the 1993 signing of the Declaration of Principles. Ultimately, a mutually advantageous resolution of political uncertainties is necessary for the economy to embark on a path of strong and sustained growth. However, an important message emerging from this book is that there are economic policies which the Palestinians and the donors can implement immediately to generate noticeable economic improvements.

The Palestinian economy began to weaken after 1988 with the Intifada and declined further after the Gulf War in 1990-91. Per capita expenditure has continued to fall during the interim peace process. At the end of 1995, approximately one-fifth of the population of the West Bank and Gaza Strip were living in poverty, and today the number is probably higher. The unemployment rate averages roughly 20 percent when the border is open and increases to 30 percent

when it is closed.

Development Under Adversity documents the degree to which the permit and closure policies implemented by Israel since 1993 have led to a decline in employment for Palestinians in Israel. In 1992, an average of 116,000 Palestinians worked in Israel; in 1996 the number dwindled to 28,100. This was the result of a reduced number of permits issued by Israel to Palestinians plus the sharp increase in border closures, which were in effect for more than one-third of 1996. Closures are only the most obvious manifestation of Israeli policies. An example of a less visible hindrance to Palestinian development is the delay from inspection procedures which make it virtually impossible for Palestinians to export perishable goods, like flowers and strawberries. Consequently, many promising export industries have been shut down and farmers have reverted to low-value crops, such as potatoes and onions, grown for local consumption.

Despite these obstacles and setbacks, the Palestinian economy has enormous potential. The most important asset any country has is its people. It takes much more time to build a high-quality work force than it does to build infrastructure and factories. The Palestinian economy is blessed with excellent people. Its general development indicators-including life expectancy, literacy, and child mortality rates are among the best in the Middle East and North Africa region. The average adult in the West Bank and Gaza Strip has spent eight years in school. Given the average relation between schooling and per capita income, one would expect a per capita GNP level of a little more than $10,000, adjusted for purchasing power parity. The Palestinian economy is operating at less than half of that level.

The book identifies other promising factors for economic growth, including a vibrant and well-organized civil society, the potential for significant tourism, an extensive international network of skilled and wealthy expatriates, a location at the trade intersection of East and West, no government debt, a good tax system, and widespread international sympathy.

Taken together, and given the right environment and an effective development strategy, the Palestinian economy could generate substantial growth rates in the near future. Some of the most important elements of the development strategy identified in the book are: opening up markets abroad through new trade channels and diversifying away from a disproportionate reliance on Israel in trade and delivery of services; creating a governance system with an efficient civil service, an investment-oriented public expenditure program, and suitable tools for stabilizing the economy; and taking advantage of the dynamic civil society and the resourceful non-governmental organizations in the delivery of health, education, welfare, and infrastructure services.

The book finds that donors can also make a big difference in stabilizing the economy, alleviating poverty, and laying the foundations for sustained growth. As the initial five-year pledge period draws to a close, donors need to review their role and, hopefully, renew their funding commitments into the future. The next round of support should focus less on mitigating short-term financial crises and more on investment-particularly long-term finance to support infrastruchure reconstruction and sustainable delivery of social services.

Development Under Adversity is the outcome of a collaborative effort by a Palestinian think tank-the Palestine Economic Policy Research Institute

(MAS)-and the World Bank. The process of writing the book was as important as any specific finding. At every stage there has been consultation and dialogue within Palestinian society, including a series of MAS-sponsored seminars and background papers contributed by experts and policy-makers. The World Bank has benefited from being able to assist in this Palestinian-led process of self-discovery and civic participation. The book not only embodies the conclusions of these wide-ranging discussions, but also attempts to reflect the uncertainties and debates. We see this as the beginning of an ongoing process that focuses on the vital economic development issues facing the Palestinian economy.

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