Economic situation in the OPT – UNSCO special report (Summary)

UNSCO Special Report on the West Bank and Gaza Strip Private Economy:
Conditions and Prospects
(February 1998)

EXECUTIVE SUMMARY

The West Bank and Gaza Strip (WBGS) economy’s pattern of growth and development has been conditioned by Israeli policy and the Israeli economy.  The effects of the WBGS’s integration into the Israeli economy were significant labour flows from the former to the latter, a narrow range of WBGS exports and a large flow of Israeli exports to the WBGS.  Palestinian average incomes and living levels grew markedly but market forces and Israeli policies created distortions in the WBGS labour, land and capital markets and thus reduced the viability of WBGS agriculture, manufacturing and many services.  The relationship also left the WBGS economy vulnerable to external shocks, such as civil unrest, curfews, Israeli recessions and, since 1993, to the closure and separation policies.  

 Closure reduced the flow of labour and commodities between the WBGS and Israeli economies and led to a significant decline in WBGS output, exports, investment, income and living levels and raised unemployment levels.  There were also some positive developments during the period after 1993, including the rapid expansion in the banking activities and the establishment of a stock exchange, both of which increased the potential for financing.  While deposits and lending grew significantly, the aggregate loan-to-deposit ratio remained relatively low due to perceptions of risk by lenders and borrowers.  There was also strong growth during 1992-1995 in construction and tourism, gains that were partly reversed in 1996, as well as some progress on the rehabilitation and expansion of public infrastructure on the part of the Palestinian Authority (PA).

A SECTORAL ANALYSIS of the WBGS ECONOMY

The Palestinian Central Bureau of Statistics (PCBS) Establishments Census and Economic Surveys series for 1994 provide the most detailed picture of the WBGS economy yet produced, based on field surveys.  The main findings of the Surveys at the sectoral level indicated that the 50,250 WBGS private non-agricultural establishments were mainly small businesses, employing less than three people on average, were mainly sole proprietorships and proprietors and unpaid family members were over half of all engaged persons.  Management structure was found to be relatively small and unspecialised.  Women were disproportionally underrepresented in the private economy and concentrated in professional occupations and manufacturing activities.  Average capitalisation level was found to be about US$ 10,350.  These basic features were especially pronounced in the tertiary sector (commerce and services) which accounted for more than 75 per cent of all private non-agricultural establishments.

Average annual compensation levels for clerical and managerial employees was about US$ 4,900 while production employees earned about US$ 3,350, a relatively small differential by comparison to advanced market economies.  The average capital to labour ratio in the private economy was about US$ 4,000 while average labour productivity was about US$ 7,000.  Labour productivity was found to be positively related to the capital-intensity of production and to the average size of establishments, but the association was not proportional, highlighting the importance of management, marketing and other determinants of productivity.

About 42 per cent of total private non-agricultural GDP was produced in the secondary sector (manufacturing, utilities and construction) with about 56 per cent produced in the tertiary sector (commerce and services).  Total private investment, estimated at US$ 274 million was disproportionately concentrated in the primary (mining and quarrying) and secondary sectors.  Exports were estimated at US$278 million, equal to 8.6 per cent of total sales and 10.5 per cent of GDP–about half the ratio for Middle East and North African countries with similar levels of per capita income.  The secondary sector accounted for 53.6 per cent, and the tertiary sector accounted for 46 per cent of the non-agricultural exports.  About 80 per cent of WBGS exports were to Israel, a significant portion through subcontracting arrangements.

The average rate of return on capital invested in the WBGS was 58 per cent, indicating an average capital recovery period of 21 months.  Rates of return were considerably below average in the primary and secondary sectors and considerably above average in the tertiary sector.  There was considerable variation in rates of return with more capital-intensive activities having generally lower rates and vice versa.  In general, smaller firms had higher rates of return, perhaps due to their ability to more easily adapt production and sales to turbulence in the economic environment.  

Economic resources (labour and capital) were generally allocated in accordance with the relative gains to be had in different sectors, despite market imperfections and significant barriers to resource mobility in the WBGS economy.  Resource owners seemed to have responded to prevailing market incentives.  However, the low level of WBGS integration into international markets, and the biased integration with the Israel economy, seem to have produced a divergence between internal comparative advantage, as indicated by relative rates of return, and the relative prominence of the three sectors in export trade, as indicated by export sales by sector.  This divergence was also related to the relatively low level of exports of WBGS services to Israel, despite relative cost advantages, mainly due to the closure and separation policies, but also to the incompatibility of many WBGS services with Israeli consumer preferences.

A PRACTITIONERS’ VIEW of PROBLEMS and PROSPECTS for PALESTINIAN BUSINESSES

Experts in four NGOs specialising in research and consultancy mainly to manufacturers in the WBGS, surveyed by UNSCO, ranked the closure policy and the unclear operating environment as the main obstacles facing their clients with almost equal frequency.  Managerial deficiencies were ranked nearly as high, followed by problems of market access and marketing, technical deficiencies, credit constraints and finding qualified workers.  The most frequently recommended solutions to client problems were management reorganization, followed by more business planning, improvements in marketing, export promotion, production modifications,  adoption of quality control standards and obtaining credit.

While responses confirm the negative effects of closure as the most significant obstacle, the deficiencies in the Palestinian legal, regulatory and tax regimes, were ranked equally as high in terms of negative consequences for businesses.  The fact that managerial problems were reported as more significant than technical/production ones, is consistent with the PCBS Surveys findings regarding small and apparently unspecialised management structures.  The problem of market access, in addition to closure-related impediments to local and foreign markets, is also partly the result of a weak marketing and distribution infrastructure.  The relatively low ranking of credit constraints as a problem may be due to a significant amount of self-financing of small establishments through household savings or the availability of credit through formal banking activities or micro-financing programmes, both of which have expanded in recent years.  Private sector consultants were generally positive about business prospects in the WBGS, given the proper enabling environment, political stability and freedom of movement of persons and goods.

THE PUBLIC SECTOR and the ENABLING ENVIRONMENT

A minimal enabling environment for private businesses consists of national and public security to protect lives and property, legal institutions capable of creating the rule of law, including the settling of commercial disputes, systems of transportation and communication for the efficient coordination and movement of people, materials and final goods and services, systems of energy, water and waste management, an educational system capable of producing a skilled workforce and a health care system which can maintain a productive workforce.  Many of these goods and services cannot efficiently be produced in the private sector, thus necessitating a public role.

The Palestinian Authority has repeatedly emphasised its view that the public sector should facilitate the development of the private economy as the main source of economic development.  This was reiterated in the Core Investment Programme presented to donors in January 1996, the Palestinian Public Investment Programme presented in November 1996, and the multi-year Palestinian Development Plan presented in December 1997.  

Developing the enabling environment in the WBGS, however, has faced two major obstacles.  First, are the infrastructure deficits from decades of neglect during the years of occupation.   Public infrastructure and service expenditures from the 1970s to the early 1990s constituted only about 15 per cent of aggregate expenditures, well below average in comparison to other developing countries at comparable income levels.  While public expenditures and employment have grown significantly during 1994-1997, there has been a severe decline in WBGS national income, which has increased the share of public expenditures in the GNP to about 25 per cent.   

Second, growth in public spending has not meant the elimination of the public infrastructure deficits, since the PA budget has been driven by economic, political and security exigencies emanating from the closure policy and political turbulence.  This has necessitated a diversion of considerable funds away from public investment to public consumption to address the social and political effects of closures.  Public consumption expenditures rose by 123 per cent while public investment expenditures rose only 56 per cent between 1993 and 1996.  Thus, creating an enabling environment in the WBGS is conditioned by the legacy of the past, the exigencies of the present and the political uncertainties of the future.

INITIATIVES for PRIVATE SECTOR DEVELOPMENT

Despite the complicated political environment, since 1993 there have been considerable efforts and resources expended on accelerating the economic and social development process on the part of the Palestinian Authority, donor countries, the United Nations, the World Bank and NGOs.  These have focused on legal and institutional development, capacity-building, infrastructural development, technical assistance and cooperation, the development of international trade and skills training for the work force.

The PA’s efforts since mid-1994 have sought to address numerous development objectives through the creation of the enabling environment needed to foster the growth and development of the private economy.  These efforts included the development of the legal system and the rule of law, including the law pertaining to foreign investment; capacity-building of the PA’s institutional and physical infrastructure and social services systems; providing support for the development of the rural economy and municipalities; the signing of trade agreements; the construction of the Gaza Airport; and initiating construction of the Gaza Muntar Industrial Estate in the Gaza Strip.

The PA has issued detailed plans for the development of the legal system, has drafted the Basic Law which provides for a system based on free market principles, the right to private ownership of property, independent dispute resolution and the rule of law.  The draft Industrial and Free Zones Law is also in an advanced stage of preparation.  The draft provides for the creation and operation of industrial and free zones, the definition of benefits and incentives to investors.  In 1995, the PA also adopted the first Law on the Encouragement of Investments to provide specific incentives for private investment in the WBGS.

The PA has finalised free trade agreements with Jordan and Egypt and has entered into a preferential access agreement with the European Union and negotiations for an Economic Cooperation Agreement are pending.  In October 1996, the PA signed a preferential treatment and duty-free access agreement with United States and a free trade agreement with Canada is pending, as is a free trade agreement with the European Free Trade Association.  These initiatives have been complemented by PA and Palestinian private business participation in the Middle East and North Africa (MENA) Economic Conferences which have undertaken discussions on ways of enhancing trade and investment flows within the region as well as issues of business environment, energy, water, infrastructure, tourism and human resources development.  Special attention in these conferences has been given to the Israeli-Palestinian track of the peace process and the imperative of economic development in the WBGS.  The PA has also sought to attract the talent, experience and capital resources of diaspora Palestinians through the hosting of a conference for expatriate businessmen in July 1997 and follow-up activities and conferences are being planned.

Building on the achievements of the past four years, the PA has put forward the Palestinian Development Plan (PDP) which envisions the continuation and expansion of many initiatives already undertaken.  The result of a systematic process of consultation and consensus-building among its various institutions, the PDP reflects the PA’s priorities for the 1998-2000 period.  The US$ 3.507 billion Plan, which includes ongoing projects, focuses on building the enabling environment for economic development, developing the human and physical resources of the country and on more direct assistance to the private economy.  The PDP proposes US$ 1,353 million for infrastructure development, US$ 580 million for human resources and social development, US$ 520 million for the development of agriculture, manufacturing, and tourism and US$ 278 million for institutional capacity building.  

As of third-quarter 1997, donors have pledged some US$ 3.62 billion, committed US$ 3.03 billion and disbursed US$ 1.82 billion in support of the PA’s development efforts.  Commitments directly or indirectly related to the creation of an enabling environment for the private economy were about US$ 1.7 billion and disbursements were nearly US$ 1 billion, or 55 per cent of all disbursements.  Donor assistance more directly focused on private sector development, including agriculture, industrial development and tourism, totaled US$ 265 million in commitments and more than US$ 87 million in disbursements or about 5 per cent of all disbursements.       

Some 30 United Nations organizations and programmes are currently active in assisting WBGS economic development, mainly through technical assistance to PA agencies with the aim of laying the basis for sustained private economic growth.  In addition, UN agencies, programmes and funds are providing project implementation capacity, institutional support, training and research, as well as capital investment across a wide spectrum of activities.  Such activities are having an impact on both the expansion and qualitative improvement of the enabling environment and in providing direct support to private enterprise development.

United Nations activities include work in legal reform through the United Nations High Commissioner/ Centre for Human Rights, infrastructure development through the United Nations Development Programme (UNDP) and the United Nations Relief and Works Agency for Palestine Refugees.  Planning for a functioning airport and port has been facilitated by the International Civil Aviation Organization and the International Maritime Organization and the United Nations Conference on Trade and Development (UNCTAD).  

Telecommunications development in the WBGS is being assisted by the International Telecommunications Union and the Universal Postal Union.  Human resource development is being augmented by training and support for education by the International Labour Organization (ILO), United Nations Educational, Scientific and Cultural Organization (UNESCO) and the International Atomic Energy Agency.  

United Nations assistance for private sector development includes projects and proposals related to the development of a second export-oriented industrial estate in the West Bank assisted by the UNDP and UNCTAD.  UNCTAD has also advised the PA in the area of trade policy and the emerging international trade system and its implications for the WBGS economy.  In addition, the United Nations Industrial Development Organization (UNIDO) has undertaken projects aimed at capacity development within the Ministry of Industry and other PA institutions.  UNIDO has also developed projects for the establishment of a Palestinian venture capital fund, modernisation of the footwear industry, a fashion design and technology development center, the establishment of a plastics services and training unit and the establishment of a construction resource center.  UNDP will directly support the garment and agro-industrial industries through a combination of technical assistance and capital investment while UNCTAD has put forward a

 project proposal for reorientating and strengthening the Palestinian insurance industry.  

UNDP is supporting tourism development with emphasis on the Bethlehem 2000 celebrations, working closely with the International Committee for the Bethlehem 2000 Celebrations and the Ministry of Tourism and Antiquities.  UNDP will also continue its major programme of upgrading and beautifying Bethlehem.  UNESCO will focus on the preservation and rehabilitation of the town of Bethlehem and the coordination of cultural and tourism activities around the year 2000.

A number of United Nations agencies are involved in support of the creation and expansion of small businesses through credit and technical assistance projects.  These include UNRWA's income-generation programme which has provided more than US$16 million in loans for nearly 8,000 enterprises, UNDP and the United Nations Capital Development Fund’s micro-financing programme for rural producers and micro-business development, the ILO’s technical assistance for the development of Palestinian institutions involved in promoting private sector growth and the United Nations Development Fund for Women’s Entrepreneurship Development of Women in the Gaza Strip project.

The World Bank is playing a pivotal role in both the effort to create an enabling environment and developing private enterprise through policy and planning studies, technical assistance, legal development, infrastructural projects and support for the private sector.  The World Bank’s Legal Development Project supports the modernisation of the legal and judicial infrastructure.  Infrastructural projects have involved the rehabilitation of roads, water and wastewater systems, schools and health facilities through the Emergency Rehabilitation Project and Education and Health Rehabilitation Project.  The World Bank is also involved in a water and wastewater improvement project in Gaza and in projects aimed at rehabilitating or upgrading community infrastructure in municipalities and villages in the WBGS.  

World Bank assistance to the private sector has come through three main projects.  The Microcredit Project, in conjunction with the International Finance Corporation (IFC), is creating sustainable sources of credit for small enterprises.  In addition, the IFC and the Peres Center for Peace have recently established the Peace Technology Fund to fund high-tech projects in agriculture, medicine and telecommunications in the WBGS.  The Investment Guarantee Fund, administered by the Multilateral Investment Guarantee Agency, will provide private investors political risk insurance.  Finally, the World Bank has been centrally involved in the off-site development of the Gaza Muntar Industrial Estate Project, as well as the legal framework for industrial zones.

In addition, the interventions of numerous donor-funded NGOs in private economic development in the WBGS have encompassed three areas of activity: 1) credit to establish or develop small businesses combined, oftentimes, with entrepreneurship training; 2) research, development and consultancy services to businesses; 3) vocational training for job seekers.  Beneficiaries of such programmes in the last five years, both businesses and individuals, number in the many thousands.

MOVING FORWARD

Many of the pieces in the economic and social development mosaic have been created, despite difficulties posed by closures and political turbulence.  The presentation of the three-year PDP represents a major milestone in the development of the PA.  The parties in the development process have also made significant contributions to private sector development in the form of credit, industrial zone development, research, technical assistance and vocational training.

While economic conditions have deteriorated during the last five years, most WBGS businesses have persevered.  This suggests the existence of a significant determination to succeed on the part of Palestinian businesspeople who, during years of occupation and uncertainty, have learned to survive under adverse conditions.  There are other underlying strengths including a relatively educated population, significant financial and entrepreneurial resources available domestically and from diaspora Palestinians, an active NGO sector and cultural resources such as significant tourist sites.  Moreover, the WBGS economy engenders many features of a competitive market economy, including a larger number of producers in each major manufacturing and service activity, responsiveness of businesses to prevailing market incentives and partly developed comparative advantages in certain products such as agricultural goods, processed foods, pharmaceuticals, textiles, wearing apparel, leather goods, wood and furniture products an

d construction materials.  In addition, the growth of private banking and sources of micro- and small enterprise financing over the past few years have reduced real and potential credit gaps.

To build on the potential of the WBGS economy, perhaps the most important contribution would be greater freedom of movement for persons and goods, including freer access between the West Bank and Gaza Strip and to world markets.  This would simultaneously stabilise the business environment and instill more confidence in lenders, borrowers and investors.  It would allow for a more rational allocation of resources between various economic activities than is currently the case.  Stability and freer mobility would also enhance the possibilities for the transformation of many establishments from small, owner-operated family businesses to larger, better developed enterprises.  In addition, greater political stability would relieve the pressure on the PA’s budget and allow more resources to be allocated to public investment rather than public consumption to mitigate the social consequences of closures.

As a small, open economy with limited natural resources, long-term development of the WBGS depends on significant export activity and reliance on its human resources.  Thus the development of a trade infrastructure, including the Gaza port and airport, and freer access to regional markets via border crossings are needed.  This would allow the WBGS to activate and benefit from the free trade agreements with the European Union, the US and neighbouring countries and to improve employment prospects.  Greater export activity would stimulate growth in economic activities not directly involved in export, such as construction and many services.  Political stability, and freer movement, would also permit the better utilisation of cultural assets through tourism.  

The successful implementation of the PDP, which envisions improvements in public administrative systems, should also move the PA in the direction of a clearer, more transparent legal and regulatory framework for businesses, domestic and foreign.  This would remove one of the main problems in the current business environment.  With respect to more direct assistance to business establishments, the evidence suggests that technical assistance in the form of management and marketing development may be as important, or more important, than credit provision or more modern technological inputs.  Future development may hinge on innovations in the organisational and marketing dimensions of WBGS businesses.