The Declaration of Principles of 1993 and the Interim Agreement of 1995 between the government of Israel and the Palestine Liberation Organization (PLO) presented the Palestinian people with new opportunities and significant challenges.1 There was widespread optimism that the economy would begin to grow and living standards improve in the West Bank and Gaza. A Palestinian administration—the Palestinian Authority (PA)—was expected to adopt policies favorable to local economic development, and public sector services and infrastructure would improve with the generous support of donor countries. The fundamental task of the PA was the provision of basic public services to improve living conditions and to enhance the economy’s human capital. Moreover, the PA needed to create an environment conducive to economic growth. This required embarking on an ambitious public investment program to meet the economy’s significant infrastructure needs, pursuing sound macroeconomic policies, and developing institutions in support of a market economy that would encourage private investment and foster growth. In sum, a favorable economic environment supported in part by the newly reemerging financial sector was expected to develop in a climate characterized by cooperative relations between Israel and the PA.
The turmoil that erupted in the fall of 2000, and the closures that followed, have caused a sharp decline in economic activity in the West Bank and Gaza, not only dashing the prospects of a fourth consecutive year of rising per capita income but also rolling back most of the gains made in the previous three years. The shock is the worst experienced by the Palestinian economy in 30 years. Up until the crisis, the Palestinian economy was enjoying fairly solid economic growth and some positive policy developments had taken place with the Palestinian Authority (PA) making progress in improving economic governance. The fragile fiscal situation before the crisis—mainly because of weak expenditure control—worsened considerably in the aftermath of closures and turmoil.
The West Bank and Gaza has the highest population growth in the world.1 Years of high fertility rates have created a very young population structure, with roughly half of the population below the age of 15. Over the medium term, the demographics are projected to change in a way that will have profound economic implications. The fertility rate is projected to decline, causing a deceleration in the population growth rate and a rise in the average age of the population so that by 2025, the share of the population older than 15 will have increased to 64 percent from about 53 percent today. As a consequence, the labor force is projected to expand by 4–4 percent a year over the next ten years and at a modestly lower rate thereafter. The numbers would obviously be higher if the West Bank and Gaza were to experience immigration, a possibility after a final peace agreement with Israel.
In the five-year period 1994–98, the Palestinian economy experienced challenges that would have been daunting even for more developed and robust economies.1 Population growth was among the highest in the world, creating substantial demand for basic social services. The policy and regulatory framework in which the private sector operated was significantly revamped. Some restrictions on the Palestinian economy became tighter, and closures, imposed by Israel for security concerns, led to a significant slowdown in economic activity.2 The cumulative effect of permits, closures, and changes to the policy and regulatory framework, together with uncertainty regarding final status, created an environment of extraordinary uncertainty for the private sector. Given the circumstances, however, the economy has shown a remarkable degree of resilience, helped by substantial improvements in infrastructure and donor aid on a very large scale. After a deep recession in 1995-96 associated with periods of severe closures, economic activity picked up, especially in 1998, and the rate of unemployment declined markedly from its peak two years earlier. For the period under review as a whole, however, economic growth did not keep pace with population growth, and per capita income declined substantially.
After the creation of the Palestinian Authority (PA) in 1994, the most important task in the fiscal area was to secure a solid revenue base within the constraints imposed by the Oslo Accords and to establish mechanisms that would allocate resources efficiently to meet the needs of the Palestinian people, particularly for basic public services. At the outset, significant uncertainty surrounded the availability of financial resources. However, the PA was authorized to levy taxes and other fees in the territories under its control to finance its operations. Moreover, in the Economic Protocol of 1994, Israel and the PA agreed on a revenue clearance system.1 In addition, in support of the Middle East peace process, the international community pledged generous financial assistance to the Palestinians ($3.7 billion) for the first five years after the peace accords. Over $2.5 billion was disbursed by donors during the period 1994-98, most of which was devoted to public investment and institution building.
Mr. Felix Fischer, Ms. Mona Said, and Rosa A. Valdivieso
A longstanding concern of Palestinian business people is the high level of transaction costs involved in conducting trade in the West Bank and Gaza, which for the most part are the product of a rather unique system of complex regulations and procedures mainly linked to Israeli security considerations. Reducing such costs is important to increase the overall competitiveness of the Palestinian economy and ensure its ability to develop, prosper, and integrate with the world economy.
Geoffrey J. Bannister, Ulric Erickson, and von Allmen
Openness to foreign trade is probably the single most important factor in supporting the growth and development of a small economy like the West Bank and Gaza. One implication of this proposition, which is supported by a large amount of empirical research, is that the future trade regime of the Palestinian Authority (PA) is one of the policy decisions that will have the most far-reaching implications for the Palestinian economy’s prospects to grow and prosper.1
The reemergence of the banking sector in the West Bank and Gaza in the last five years has been a positive development. The banking sector has grown rapidly and plays an important role in the economy. Furthermore, the Palestinian Monetary Authority (PMA) was set up in late 1994 with the responsibility, among others, to license, regulate, and supervise banks. It has achieved important progress in institution building, especially in the areas of accounting, statistics, bank licensing, regulation and supervision, and in the payments and clearing system. Still, much remains to be done, especially in banking supervision and effective enforcement of bank regulations. This chapter discusses developments in the banking sector and the progress achieved in institution building, as well as challenges for the future. It also discusses developments in bank lending for investment and the banking sector’s role in supporting economic development.
After the signing of the Declaration of Principles in late 1993, the international community sought to bolster the peace process and pledged over $3.7 billion in aid to the Palestinian people. Donors met again in Washington in November 1998 and in Frankfurt in February 1999 to reaffirm their support, pledging an additional $3.3 billion in assistance for a new five-year period. Donor assistance has played a key role by supporting the PA’s current expenditures until it built its own revenue base, by helping to rehabilitate existing and build new infrastructure, and by providing technical assistance that has contributed to strengthening institutions in the Palestinian territories. Hopes were high at the outset, perhaps unrealistically so, that donor assistance would also be able to jump-start the Palestinian economy.
The West Bank and Gaza faces considerable challenges over the medium term, and the fiscal policy of the Palestinian Authority (PA) can play an important role in overcoming them. For example, Chapter 2 discussed how difficult it will be to achieve and sustain economic growth rates high enough to reduce unemployment in a period of rapid labor force growth. By avoiding large debt-financed deficits and improving the composition of expenditure, fiscal policy can make a great contribution to this endeavor. Just as fiscal policy can play an active role in shaping the West Bank and Gaza’s economic prospects, however, it will in turn be affected by several medium-term developments, such as the very same demographic dynamics mentioned above. Apart from the expected effects of population growth, this chapter discusses briefly two further factors that can have particularly significant consequences for public finances: the future choices of tax and trade policy regimes; and a permanent solution to the refugee question.