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"Economic integration or separation"

January 13, 2003 Edition 2

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IN THIS ISSUE
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>< “Economic separation--for political reasons” - by Yossi Alpher
The only branch of the economies where some sort of close cooperation has continued to flourish appears to be corruption.

>< “An economic bondage” - by Ghassan Khatib
There is no doubt that the economic benefits are among the reasons why Israel insists on maintaining the occupation.

>< “The dangers of economic separation” - by Ephraim Kleiman
There is no real alternative in sight today to the markets Israel provided for the Palestinian economy.

>< “Many things have changed” - interview with Hisham Awartani
The economic relationship is destined to be far more complicated, far more security-oriented and a lot smaller.
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AN ISRAELI VIEW
Economic separation--for political reasons

by Yossi Alpher
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When Yasir Arafat returned from his Tunisian exile to Gaza in July 1994, one of the first directives he reputedly gave was to detach the nascent Palestinian Authority (then limited to the Gaza Strip and Jericho) from Israel economically. His advisers, in a panic, sat him down and explained the economic and political consequences, noting that scarcely three months earlier the PA had signed the Paris Agreement, which integrated the Israeli and Palestinian economies under a single (Israeli) currency, VAT, customs regime, and open economic borders that reflected the absence of political and security borders. Arafat rescinded his order.

The story may be apocryphal, but the point should not be lost. Arafat's political instincts were healthy: you don't build the political and social infrastructure of a country by subordinating it to the economy of its stronger neighbor and recent occupier, especially when the emerging country is Arab, the occupier is Israel, and the borders between the two have not yet been determined. His advisers also had a point: from the economic standpoint, Israeli-Palestinian integration was the best thing that could happen to Palestinians.

Inevitably, it was neither political nor economic considerations, but rather security considerations, that determined the demise of productive economic relations between Palestine and Israel. Paradoxically, the closer Israel and the PLO came during the Oslo years to formalizing the existence of a Palestinian state, the more the Palestinian economy deteriorated, first as a consequence of closures and restrictions--instituted to counter suicide bombings--on the free flow of labor and goods, and ultimately due to Israel's impounding of Palestinian tax monies that it collected in the shadow of the al-Aqsa Intifada. The only branch of the economies where some sort of close cooperation has continued to flourish appears to be corruption.

This brings us full circle back to the nascence of the Oslo process. With the benefit of nearly 10 years of hindsight, it appears that one of the greatest flaws of Oslo was its conditioning of graduated progress toward peace on close economic cooperation. From a textbook standpoint the thinking was correct: economic cooperation would generate trust, confidence, prosperity and interdependence--all key building blocks for the next steps toward a two-state solution. In parallel, Shimon Peres expanded the concept and suggested an economic "New Middle East" to Israel's Arab neighbors.

But in terms of realpolitik, the whole approach was wrong. The Palestinians with whom Israel negotiates cannot or will not control their extremists, who began suicide bombings way back in 1994. Israeli governments have not controlled the settlers, who are bent on sabotaging peace, and who are plunging Israel deeper and deeper into a demographic disaster for the Jewish state. The resulting negative interaction between the two sides has meant no trust and no confidence.

The reasons are political and security-related, not economic. The solution, too, is political and security-related: separation and fences. The economic consequences are undoubtedly negative, but economics is not and cannot be the dominant consideration at this stage in Israeli-Palestinian interaction. This is what the economists don't understand. This is why "New Middle East style" Israeli economic interest and investment during the '90s was perceived by too many of our other Arab neighbors (with the exception of their economists) as neo-colonialist domination.

Ultimately, for political and security reasons unrelated to economic common sense, Israel will get a fence and Palestinians their own currency, VAT rate and protective customs. Palestinians will need international financial aid to produce more products on their own, and Israeli security experts will have to find a way to enable large scale civilian imports to enter Palestine via Jordan and Egypt rather than Ashdod port. Israel's lucrative annual two billion dollars worth of exports to Palestine will suffer.

Some areas of pragmatic "invisible" economic cooperation--electricity, fuel, water--will be able to continue, but basically Palestine will become part of the Arab political and economic world, and its border with Israel will be a political, security and economic border. For better or for worse this is the only practical possibility. In any case, the Palestinians have nowhere to go but up--things can hardly get worse economically for them--while experience shows that any economic losses suffered by Israel due to separation from Palestine will be compensated ten-fold by the prosperity that follows peace.

Once the fence, and removal of settlements beyond it, stabilize the situation, the two sides can cautiously examine ways to renew the entry of Palestinian commuter laborers to Israel. The 30 or so abortive economic and developmental cooperation programs outlined in annexes III and IV to the Oslo Declaration of Principles--testimony to the grand illusion that Israel and Palestine can turn themselves instantly into prosperous and trusting economic partners--will, in the best case, be replaced by a dynamic that more closely resembles Israeli-Jordanian economic interaction. That relationship has survived the past two years remarkably well and continues to grow--slowly, far from the media spotlight, and as a corollary to a positive strategic relationship between two Middle East neighbors.-Published 13/1/2003©bitterlemons.org.

Yossi Alpher is an Israeli strategic analyst. He is former Director of the Jaffee Center for Strategic Studies, Tel Aviv University.



A PALESTINIAN VIEW
An economic bondage

by Ghassan Khatib
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Economics has always been crucial to the Palestinian-Israeli conflict. Since the beginning of the Israeli occupation of the West Bank, East Jerusalem and Gaza Strip, Israel has pursued policies and practices of the kind that brought Israel tremendous revenues. There is no doubt that these economic benefits are among the factors why Israel insists on maintaining the occupation and establishing facts on the ground that are difficult to reverse, such as the confiscation of land for illegal Jewish settlements.

Indeed, one of the most lucrative Israeli practices has been the theft of water from reservoirs lying under the Palestinian territories. It was no coincidence that Israel built settlements over almost all these reservoirs and implemented policies that deprived the Palestinians from access to that water. Independent research shows that the average water consumption by a Jewish settler in the Palestinian territories is 20 times that the amount of water Palestinians are permitted to consume.

Another example of the economic advantages of occupation is the convenience of the Palestinian population as a captive market for Israeli products--to the extent that it remains Israel’s second largest market. Cheap Palestinian labor, at one time including some 200,000 laborers, did not require the same costly employment benefits that Israeli employers would have had to pay to the Israeli equivalent. In addition, Israel greatly benefited from tourism to Christian and Muslim sites in the occupied towns of Jerusalem, Bethlehem and Jericho.

All of these economic goodies brought Israel to treat the Palestinian territories as part of the Israeli market, maintaining one pricing system within the two economies and insisting, during peace talks, on creating a customs union. Any economic barriers or borders would be the beginning of an independent Palestinian economy and the gradual decline of Israeli economic benefits, or exploitation.

It is difficult, if not impossible, for the Palestinian economy to grow and develop as long as it is completely integrated into the Israeli economy. The huge disparities in the two economies perpetuate continued Israeli exploitation. At the same time, there is no way for the Palestinian economy to develop economic relations and exchange with the Arab world as long as it is still integrated within the Israeli economy.

It can be also argued that maintaining close economic integration between the Israeli and Palestinian economies offers two benefits to Palestinians. First, it allows Palestinians to benefit from the Israeli labor market and gain experience in advanced Israeli industries and technology. Second, these economic relations can play a constructive role in creating common interests towards future reconciliation. Joint economic activities and economic relations can lead to a common vested interest in peace and normal relations.

But while intensive economic integration between the two economies can be useful for both sides, the exaggeration of the joint relationship towards complete integration, a custom union and one pricing system unfairly benefits Israel and maintains the feeling of exploitation among Palestinians. This, in turn, will contribute negatively to the Palestinian economy and prevent its development and rehabilitation, which will in turn have a negative effect on any political effort towards peace and reconciliation.-Published 13/1/03©bitterlemons.org

Ghassan Khatib is minister of labor in the Palestinian Authority cabinet. He has served for many years as a political analyst and media contact.



AN ISRAELI VIEW
The dangers of economic separation

by Ephraim Kleiman
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Because of the great size disparity between the Palestinian and the Israeli economies, the character of the economic relationship between them is of much greater importance to the Palestinians than to Israel. Decisions regarding this relationship should, therefore, be left in their hands.

In view of the short distances between the population and business centers of the two parties, the length and geographically convoluted nature of the border between them, and the fact that there has been no customs boundary between them in the last three decades, the desirable trade arrangement for the Palestinians seems to be a customs union. This allows the free movement of goods between the two parties, unhindered by any economic control or barrier, but also requires imports from the rest of the world to be taxed at the same rates in both.

The high probability of Israel not admitting Palestinian workers in large numbers in the foreseeable future lends great importance to the substitution of exports of Palestinian labor by exports of goods produced by this labor in the Palestinian economy itself, which a customs union will facilitate marketing in Israel. The security barrier now being established creates a physical border that also makes feasible various degrees of economic separation, such as a free trade area agreement (FTA), or even a trade regime that does not discriminate at all in favor of imports from the neighboring country.

The sharp economic decline in the Palestinian territories since Oslo, following the deterioration in the security situation, has given rise there to the mistaken impression that the cause of the economic troubles is the customs union set up by it. This impression was furthered by a World Bank study that failed to separate the impact of the closures and the security restrictions from that of the customs union itself. But whatever the result of the Palestinian debate on this matter, the two economies seem bound to drift apart in the future.

It is difficult to envisage today a reasonable mechanism for joint decisionmaking, such as a customs union requires, that would be acceptable to both sides. Furthermore, the mutual lack of trust and the perceived power imbalance can be expected to result in attempts by individual Palestinians to evade the agreed upon rules, provoking an over-reaction of the Israeli customs authorities that will impede trade flows. The experience of the past two years might also make the Palestinian authorities prefer an arrangement that does away with Israel’s power to withhold from the Palestinian treasury the customs and VAT revenues collected for it by Israel.

Economic separation might, however, have serious adverse effects on the Palestinian economy, making it undesirable for both the Palestinians and Israel. Even if the slide toward it is unavoidable, all effort should be made to minimize the damage it causes. In principle, the security barrier can be consistent even with a customs union. But in practice, by raising the transportation and transaction costs of Palestinian exports, it renders them less profitable.

There are, on both sides, those who welcome the setting up of a physical border as providing the opportunity for establishing the permanent economic relationship on an FTA basis. Such an agreement allows each party to pursue its own customs and indirect tax policies, but exempts from customs duties goods produced in the other one. The definition of what constitutes local production for this purpose greatly restricts the import component that can be embodied in it. Palestinian exporters can be expected to encounter considerable difficulties in satisfying the Israeli authorities’ demand of proof that their merchandise fulfills these “rules of origin.” These difficulties cannot be dismissed by arguing that a physical border in any case creates a trade obstacle, as the costs of obtaining certificates of origin, of their examination and of the verification of the goods conforming to them raises this hurdle further.

But the greatest danger in turning the physical border also into an economic one, even within an FTA agreement, is that it will invite pressures for the further widening of economic separation. There are those in both economies who wish to be protected from competition from the other. In particular, for some years already there have been calls in the Palestinian economy to impose protective tariffs on “infant industries,” supposedly requiring a period of hothouse conditions to be able to compete with Israel’s. Such a step can be expected to raise a demand for retaliation in the form of a protective tariff on Palestinian goods, and pretty soon the FTA agreement might start to unravel in practice, if not in theory.

There is no real alternative in sight today to the markets Israel provided for the Palestinian economy. Restrictions on its access to them are bound to take a heavy toll in poverty, misery and widespread unemployment, making it imperative to minimize their scope.-Published 13/1/2003©bitterlemons.org.

Ephraim Kleiman is Patinkin Professor Emeritus of Economics at the Hebrew University of Jerusalem. He is a long-time student of Israeli-Palestinian economic relations.



A PALESTINIAN VIEW
Many things have changed

an interview with Hisham Awartani
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bitterlemons.org: The original economic agreements between Israel and the Palestine Liberation Organization were based on the idea of integrating the two economies. In hindsight, do you feel that was a good idea?

Awartani: I think given the constraints at the time, there wasn’t much that we could have done better.

bitterlemons.org: When you look forward towards future negotiations, then, do you see other arrangements being made?

Awartani: There are several ways to improve on what was achieved in the past, but we have to remember that the political setting has changed immensely. The physical setting has also changed dramatically. I don’t think that we have arrived yet at the starting point for our future discussions.

There are new realities on the ground and we will have to work a lot harder and imaginatively to arrive at something tangibly different. But that does not mean it will be better--it will be far more complicated, far more security-oriented and definitely the magnitude of economic relations between the two sides will be a lot smaller than it was years ago.

bitterlemons.org: Can you give some concrete examples?

Awartani: The most important components of economic cooperation between Palestine and Israel during the past years, especially after Oslo, are employment and trade. As you probably know, for several years after the outset of the peace process, wage remittances contributed significantly to the Palestinian income, at the rate of some 30 percent of the GNP. Some 35 to 40 percent of the labor force was directly employed in Israel. This is one area where we cannot go back to where we were. We will have to try to structure or initiate some sort of labor relations, but I do not expect the Israelis will accept a free flow of workers from the Palestinian territories across the green line.

The same is true in regards to trade. For the past ten years or so, Israel accounted for more than 90 percent of our exports. It was by far the most important destination for our exports. Again, the security implications of trade are important and I think that we will have to structure these relations on new grounds. Definitely, it will be more difficult to move commodities from the Palestinian territories to Israeli markets.

bitterlemons.org: In terms of the customs relationship that has been in effect, do you see that continuing despite the physical barrier that is being constructed between the West Bank and Israel?

Awartani: In theory, and even in practice in many countries, the mere presence of a physical border does not imply that a customs union is impossible. But I do not think that now we can realistically expect a customs union in the near future.

On the other hand, both sides realize that trade between them is very important. It is simply hard to do it. The question of security--or what is described as “security”, as the Israeli side has a terribly inflated sense of what security means here--Israel can always say that because of security, they cannot let this shipment through and so on. I think it would be possible to have a new arrangement whereby the question of security inspection is conducted by modern technology. Otherwise, one is likely see a flow of goods in only one direction--from Israel to Palestine.

bitterlemons.org: In the short term, the restriction of movement, the building of this wall, are all devastating the economy. Is there anything that Palestinians can do themselves to alleviate this situation?

Awartani: I think the question of the wall has not attracted adequate attention at the international level. I think that Palestinians have to struggle harder to oppose the wall. It is very clear that the wall is not only a security invention, it is a political border that does not coincide with the armistice line that was recognized as the dividing line between the territories. The new wall is in several places several kilometers east of the real border. We all know that the wall has been installed taking into consideration political and economic and water issues. I don’t see any real reaction to the wall project at the international level, in fact not even at the Palestinian Authority level. They have to take it much more seriously and take it to the Security Council.

bitterlemons.org: Can you give a general picture of the Palestinian economy and where it is going?

Awartani: We have all heard all kinds of figures about the economic impact of the Intifada and the corresponding Israel sanctions. It is quite clear that living standards have dropped dramatically. Unemployment is in excess of 55 or 60 percent. Poverty is well in excess of 60 percent and in Gaza, it must be in excess of 75 percent. Businesses are in very bad shape and an increasing number are rendered insolvent.

Banks are suffering and, despite the advantage of several years of good business and huge reserves, they are now in very bad shape because of the difficulties encountered by their customers. I am afraid that the Palestinian banking system is literally shaking now. It would be a shame if we witnessed a collapse of the banking system, like the private sector at large. The Palestinian Monetary Authority is monitoring what is going on and taking very tough measures, but banks are suffering and if things stay as they are now--anything could happen.-Published 13/1/03©bitterlemons.org

Hisham Awartani is an economist and director of the Center for Private Sector Development.



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Bitterlemons.org is an internet newsletter that presents Palestinian and Israeli viewpoints on prominent issues of concern. Each edition addresses a specific issue of controversy. Bitterlemons.org maintains complete organizational and institutional symmetry between its Palestinian and Israeli sides.
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